<PAGE> 1
As filed pursuant to Rule 424(b)(2)
under the Securities Act of 1933
Registration No. 333-12065
PROSPECTUS SUPPLEMENT ISSUED SEPTEMBER 25, 1996 (SUBJECT TO COMPLETION)
(TO PROSPECTUS DATED SEPTEMBER 23, 1996)
$150,000,000
AAMES FINANCIAL CORPORATION
AAMES LOGO
% SENIOR NOTES DUE 2003
------------------------
The % Senior Notes Due 2003 (the "Notes") offered hereby are being
offered by Aames Financial Corporation (the "Company") and will mature on
, 2003. The Notes are not redeemable by the Company prior to
, 2000, except that, until , 1999, the Company may
redeem, at its option, up to 30% of the original principal amount of the Notes
at the redemption price set forth herein plus accrued interest to the date of
redemption with the net proceeds of one or more Public Equity Offerings (as
defined) if at least $100 million aggregate principal amount of the Notes
remains outstanding after such redemption. On or after , 2000, the
Notes are redeemable at the option of the Company, in whole or in part, at the
redemption prices set forth herein plus accrued interest to the date of
redemption. Upon a Change of Control (as defined), each holder of Notes may
require the Company to repurchase the Notes held by such holder at 101% of the
principal amount thereof plus accrued interest to the date of repurchase. In
addition, the obligations of the Company under the Notes will be jointly and
severally guaranteed (the "Guaranties") on an unsecured basis by each of the
Company's Restricted Subsidiaries, other than Special Purpose Subsidiaries (each
as defined) (collectively, the "Guarantors"). The Guaranties will rank pari
passu in right of payment with all existing and future Senior Indebtedness (as
defined) of the Guarantors and will rank senior in right of payment to all
indebtedness of the Guarantors expressly subordinated to the Guaranties. See
"Description of the Notes."
The Notes will be senior unsecured obligations of the Company and will rank
pari passu in right of payment with all existing and future Senior Indebtedness
of the Company and will rank senior in right of payment to all existing and
future subordinated indebtedness of the Company. The Notes and Guaranties will
be effectively subordinated to all existing and future secured indebtedness of
the Company and the Guarantors. As of September 20, 1996, after giving pro forma
effect to the offering of the Notes, the outstanding Senior Indebtedness of the
Company, on a consolidated basis, would have been approximately $270 million of
which $120 million would have been secured indebtedness. See "Description of the
Notes."
There is no established trading market for the Notes and the Company does
not intend to apply for a listing of the Notes on any national securities
exchange.
Concurrently with the offering of the Notes hereby, the Company is offering
by separate prospectus supplement 1,500,000 shares of Common Stock of the
Company (the "Concurrent Offering.") The consummation of this offering and the
Concurrent Offering are not conditioned upon each other.
------------------------
FOR INFORMATION CONCERNING CERTAIN FACTORS THAT SHOULD BE CAREFULLY
CONSIDERED BY PROSPECTIVE INVESTORS, SEE "RISK FACTORS" BEGINNING ON PAGE S-12.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
------------------------
THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR ENDORSED THE
MERITS OF THIS OFFERING. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
------------------------
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- ------------------------------------------------------------------------------------------------------
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC(1) DISCOUNT COMPANY(2)
- ------------------------------------------------------------------------------------------------------
Per Note........................................ % % %
- ------------------------------------------------------------------------------------------------------
Total........................................... $ $ $
- ------------------------------------------------------------------------------------------------------
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</TABLE>
(1) Plus accrued interest, if any, from , 1996.
(2) Before deducting expenses of this offering payable by the Company estimated
at $ .
------------------------
The Notes are being offered by Bear, Stearns & Co. Inc., Donaldson, Lufkin &
Jenrette Securities Corporation and NatWest Capital Markets Limited as the
underwriters (the "Underwriters"), subject to prior sale, when, as and if issued
to and accepted by them and subject to approval of certain legal matters by
counsel for the Underwriters and certain other conditions. The Underwriters
reserve the right to withdraw, cancel or modify such offer and to reject orders
in whole or in part. It is expected that delivery of the Notes will be made in
New York, New York on or about , 1996.
BEAR, STEARNS & CO. INC.
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
NATWEST CAPITAL MARKETS LIMITED
THE DATE OF THIS PROSPECTUS SUPPLEMENT IS , 1996.
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. THIS
PROSPECTUS SUPPLEMENT SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.
<PAGE> 2
Map showing locations of Aames Financial Corporation
branch offices (including locations of the offices
of Aames Financial Corporation's wholly owned
subsidiary, One Stop Mortgage, Inc.).
------------------------------
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE NOTES OFFERED
HEREBY AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET.
SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME WITHOUT NOTICE.
<PAGE> 3
PROSPECTUS SUPPLEMENT SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and consolidated financial
statements, including the notes thereto, appearing elsewhere in this Prospectus
Supplement. Unless the context otherwise requires, all references herein to the
"Company" and "Aames" refer to Aames Financial Corporation and its consolidated
subsidiaries. This Prospectus Supplement, including the Prospectus and other
information incorporated herein, contains certain forward-looking statements.
Actual results could differ materially from those projected in the
forward-looking statements as a result of, among other factors, the factors set
forth under the caption "Risk Factors" commencing on page S-12 of this
Prospectus Supplement. Prospective purchasers of the securities offered hereby
should carefully consider the specific matters set forth under "Risk Factors,"
as well as the other information and data included in or incorporated into this
Prospectus Supplement, prior to making an investment in the securities offered
hereby. The Company's fiscal year ends on June 30.
THE COMPANY
The Company, founded in 1954, is a consumer finance company engaged in the
business of originating, purchasing, selling and servicing home equity mortgage
loans secured by single family residences. The Company's principal market is
credit-impaired borrowers who have significant equity in their homes but whose
borrowing needs are not being met by traditional financial institutions due to
credit exceptions or other factors. The Company focuses its efforts on
collateral lending and believes that it originates a greater proportion of lower
credit grade loans ("C-" and "D" loans) than most other lenders to
credit-impaired borrowers. These lower credit grade loans are characterized by
lower combined loan-to-value ratios and higher average interest rates than
higher credit grade loans ("A-," "B" and "C" loans). The Company believes lower
credit-quality borrowers represent an underserved niche of the home equity loan
market and present an opportunity to earn a superior return for the risks
assumed. Although the Company has historically experienced delinquency rates
that are higher than those prevailing in its industry, management believes the
Company's historical loan losses are generally lower than those experienced by
most other lenders to credit-impaired borrowers because of the lower combined
loan-to-value ratios on the Company's lower credit grade loans. The mortgage
loans originated and purchased by the Company are generally used by borrowers to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes. Consequently, the Company believes that it is not as dependent
as traditional mortgage bankers on levels of home sales or refinancing activity
prevailing in its markets.
The Company originates and purchases loans through three production
channels. The Company has historically originated its loans through its retail
loan office network. In 1994, the Company diversified its production channels to
include a wholesale correspondent program which consisted initially of
purchasing loans from other mortgage bankers and financial institutions
underwritten in accordance with the Company's guidelines. In fiscal 1996, this
program was expanded to include the purchase of loans in bulk from other
mortgage bankers and financial institutions. On August 28, 1996, the Company
acquired One Stop Mortgage, Inc. ("One Stop"), which further diversified the
Company's production channels to include the origination and purchase of
mortgage loans from a network of independent mortgage brokers. While the Company
intends to continue focusing on its traditional niche in the "C-" and "D" credit
grade loans, the Company also intends to continue to diversify the loans it
originates and purchases through its three production channels to include more
"A-," "B" and "C" credit grade loans. The Company underwrites every loan it
originates and re-underwrites and reviews appraisals on all loans it purchases.
Retail Origination. The Company originates home equity mortgage loans
through its network of retail loan offices which, at August 31, 1996, consisted
of 50 retail loan offices located in 17 states. The Company markets directly to
borrowers and generates demand for its loans through its multimedia advertising
campaigns and, more recently, telemarketing. The Company continues to pursue a
strategy of expanding its retail loan office network beyond the 36 offices
located in California and the other Western states. Of the Company's 50 retail
loan offices, seven are located in the Midwest and seven are located along the
East coast. The expansion of the Company's retail loan office network has
resulted in significant increases in retail loan
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originations over the three years ended June 30, 1996. The Company originated
$130 million, $148 million and $221 million of loans through its retail loan
office network in fiscal 1994, 1995 and 1996, respectively. The Company's loans
originated through its retail loan office network had a weighted average
interest rate of 10.3%, 11.8% and 11.0%, and an average initial combined
loan-to-value ratio of 52%, 55% and 60% in fiscal 1994, 1995 and 1996,
respectively. The average loan amount originated through the Company's retail
loan office network was $38,600, $39,700 and $46,000 during fiscal 1994, 1995
and 1996, respectively.
Wholesale Correspondent Program. The Company purchases closed loans from
mortgage bankers and other financial institutions on a continuous or "flow"
basis, and through bulk purchases. In fiscal 1996, 74% of the Company's loan
production came from these sources. Loans purchased on a flow basis are
purchased from loan correspondents who are qualified by the Company after a
review of the correspondent's mortgage lending experience, financial condition
and industry reputation. The originating loan correspondent underwrites loans
intended to be purchased by the Company in accordance with the Company's
underwriting guidelines. Bulk purchases are the acquisition of large packages of
loans that are offered on the secondary market. The Company re-underwrites each
loan included in the offered portfolio (including a review of the appraisal of
the collateral). The Company acquired $19.7 million, $207 million and $628
million of loans through its wholesale correspondent program in fiscal 1994,
1995 and 1996, respectively. Loans purchased through the Company's wholesale
correspondent program had a weighted average interest rate of 11.4% and 11.7%,
and an average initial combined loan-to-value ratio of 65% and 66%, in fiscal
1995 and 1996, respectively. The average loan size purchased through the
Company's wholesale correspondent program was $89,400 and $87,700 during fiscal
1995 and 1996, respectively. The fiscal 1994 volume was too small to make those
amounts meaningful.
Independent Broker Network. On August 28, 1996, the Company acquired One
Stop, a residential mortgage lender which originates and purchases home equity
mortgage loans made to credit-impaired borrowers from a network of independent
mortgage brokers. The majority of One Stop's loans are originated through sales
representatives who have established relationships with over 1,600 independent
mortgage brokers. At August 31, 1996, One Stop operated in 26 states out of 24
offices. The independent mortgage broker identifies the potential applicant,
assists the applicant in completing the loan application and submits the
application with the other documents constituting the completed loan package to
One Stop for underwriting, review, appraisal and loan approval. All loans
originated by One Stop are underwritten pursuant to the Company's underwriting
guidelines. Once approved, the loan is funded or purchased by One Stop directly.
From One Stop's inception in October 1995 to June 30, 1996, One Stop originated
$320 million in loans, with a weighted average interest rate of 10.6%, and an
average initial combined loan-to-value ratio of 67%. For the two months ended
August 31, 1996, One Stop originated $97 million in loans, with a weighted
average interest rate of 10.1%, and an average initial combined loan-to-value
ratio of 67%.
Substantially all of the mortgage loans originated and purchased by the
Company are sold in the secondary market through public securitizations in order
to enhance profitability, maximize liquidity and reduce the Company's exposure
to fluctuations in interest rates. In a securitization, the Company recognizes a
gain on the sale of loans securitized upon the closing of the securitization,
but does not receive the excess servicing, which is payable over the actual life
of the loans securitized. The excess servicing represents, over the estimated
life of the loans, the excess of the weighted average interest rate on the pool
of loans sold over the sum of the investor pass-through rate, normal servicing
fee and the monoline insurance fee. The net present value of that excess
(determined based on certain prepayment and loss assumptions) less transaction
expenses is recorded as excess servicing gain or loss at the time of the closing
of the securitization. The Company securitized and sold in the secondary market
$107 million, $317 million and $791 million of loans during fiscal 1994, 1995
and 1996, respectively. Each of the Company's securitizations has been credit-
enhanced by insurance provided by a monoline insurance company to receive
ratings of "Aaa" by Moody's Investors Service and "AAA" from Standard & Poor's.
The Company retains the servicing rights (collecting loan payments and
handling borrower defaults) to substantially all of the loans it originates or
purchases. At June 30, 1996, the Company had a servicing portfolio of $1.25
billion, 27% of which was serviced by subservicers. In fiscal 1996, the Company
serviced directly all loans in its servicing portfolio which were secured by
mortgaged properties located in Arizona,
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California, Colorado, Nevada, Oregon, Utah and Washington. Loans secured by
properties located in other states were serviced through one or more
subservicers which were paid a fee per loan and a participation in certain other
fees paid by the borrowers. The Company will implement in fiscal 1997 a new
servicing system which will provide the Company the capability to service
in-house all loans originated or purchased by it regardless of the state in
which the mortgaged property is located. See "Business -- Loan Servicing."
The Company has experienced significant growth over the past three years.
In the three-year period ended June 30, 1996, annual loan production increased
from $150 million in fiscal 1994 to $849 million in fiscal 1996, representing a
compounded annual growth rate of 138%. Primarily as a result of this growth in
loan production, net income increased from $5.3 million to $31.0 million,
representing a compounded annual growth rate of 142.1% during the same period.
In addition, the loan servicing portfolio and stockholders' equity at June 30,
1994 and June 30, 1996 increased from $382 million to $1.25 billion, and from
$31.7 million to $110 million, respectively. These increases represent
compounded annual growth rates of 81% and 86%, respectively.
BUSINESS STRATEGIES
The Company's strategy is to continue to build on its position as a leading
lender to credit-impaired borrowers. The expansion of the Company's business
over the last three years has been driven by the growth in the volume of loans
originated and purchased by the Company and by the Company's ability to continue
to access the capital markets to facilitate the sale of these loans through
securitizations. The Company intends to pursue its growth strategy by (i)
continuing to expand its retail loan office network, wholesale correspondent
program and independent broker network, (ii) increasing its servicing portfolio
and servicing capabilities, (iii) continuing to enhance its corporate and
operating infrastructure and (iv) diversifying its funding sources. An important
long-term goal of the Company's business strategy is to continue to build its
excess servicing receivable, mortgage servicing rights and residual assets
("Excess Spread Receivables"). The Company believes that its investments in
these assets yield attractive cash on cash returns. In addition, the Company
believes its cash flow profile will change over time as the rate of loan
production growth moderates and as the size of its servicing portfolio and its
Excess Spread Receivables increase. See "Business -- Business Strategy."
RECENT DEVELOPMENTS
One Stop Acquisition. On August 28, 1996, the Company acquired One Stop, a
residential mortgage lender specializing in originating and purchasing home
equity mortgage loans made to credit-impaired borrowers from a network of
independent mortgage brokers. At August 31, 1996, One Stop operated in 26 states
out of 24 offices. The acquisition is part of the Company's strategy to
diversify its mortgage loan production sources and to expand the geographic
scope of its operations. The acquisition was accomplished through the merger of
a wholly-owned subsidiary of the Company into One Stop, in a tax-free exchange
accounted for as a pooling-of-interests. See "Management's Discussion and
Analysis of Financial Condition and Results of Operation -- One-Time Charges"
and the Supplementary Consolidated Financial Statements at pages F-19 through
F-33.
In the acquisition, the Company issued 2.3 million shares of its Common
Stock, representing approximately 14.7% of its issued and outstanding shares
(after giving effect to the acquisition), 102,750 shares of which have been
placed in escrow pursuant to an escrow agreement as security for the
indemnification obligations of One Stop and its principal stockholder, to be
released on August 28, 1997. The Company has agreed to use its best efforts to
file certain registration statements under the Securities Act covering
approximately 1.0 million of the shares of its Common Stock issued in connection
with the acquisition. Additionally, the Company assumed options granted to key
employees to purchase approximately 375,000 shares.
For the three month period ended July 31, 1996, One Stop's loan
originations and purchases totaled approximately $126 million. Neil Kornswiet,
the founder of One Stop, continues to serve as President, Chief Executive
Officer and Chairman of the Board of Directors of One Stop (which is operated as
a separate subsidiary under the name, "One Stop Mortgage, Inc.") under a five
year employment contract.
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Mr. Kornswiet also serves as Executive Vice President of the Company and is a
member of its Board of Directors.
Recent Financings. Since June 30, 1996, the Company has entered into or
renewed warehouse financing facilities, bringing its aggregate warehousing
capacity under all of its warehouse credit facilities at September 10, 1996 to
$675 million (including One Stop's warehouse facility in the aggregate amount of
$250 million which expires on September 27, 1996), and has entered into a $50.0
million credit facility secured by certain excess servicing receivables. See
"Underwriting." On September 17, 1996, the Company completed a $525 million
securitization of mortgage loans, including approximately $200 million in loans
originated or purchased by One Stop.
THE OFFERING
The following summary of certain terms of the Notes is not complete and is
qualified by all of the terms contained in the Notes and in the Indenture (as
defined). For a more detailed description of the terms of the Notes, see
"Description of the Notes."
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Securities Offered........................... $150 million aggregate principal amount of
% Senior Notes Due 2003 (the "Notes").
Maturity Date................................ , 2003.
Interest Payment Dates....................... and , commencing ,
1997.
Concurrent Offering.......................... Concurrently with the offering of the Notes,
the Company is offering (the "Concurrent
Offering") by separate prospectus 1,500,000
shares of Common Stock. The Company has
granted to the Underwriters in the Concurrent
Offering a 30-day overallotment option to
purchase up to an additional 225,000 shares
of Common Stock to cover overallotments, if
any.
Guaranties................................... The obligations of the Company under the
Notes will be jointly and severally
guaranteed by each of the Restricted
Subsidiaries (other than Special Purpose
Subsidiaries, as defined) of the Company
(collectively, the "Guarantors"), which as of
the date of this Prospectus Supplement
includes all subsidiaries of the Company. See
"Description of Notes -- Subsidiary
Guaranties."
</TABLE>
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Ranking...................................... The Notes will be senior unsecured
obligations of the Company and will rank pari
passu in right of payment with all existing
and future Senior Indebtedness (as defined)
of the Company and will be senior in right of
payment to all existing and future
subordinated indebtedness of the Company,
including $115 million in outstanding
Convertible Debentures. The guaranty of each
of the Guarantors (each a "Guaranty") will
rank pari passu in right of payment with all
Senior Indebtedness (as defined) of such
Guarantor and senior in right of payment to
all indebtedness expressly subordinated to
the Guaranty. The Notes and Guaranties will
be effectively subordinated to all existing
and future secured indebtedness of the
Company and the Guarantors. As of September
20, 1996, after giving pro forma effect to
the issuance of the Notes, the outstanding
Senior Indebtedness of the Company, on a
consolidated basis, would have been
approximately $270 million, of which $120
million is secured. See "Description of the
Notes-Ranking."
Optional Redemption.......................... The Notes are not redeemable by the Company
prior to , 2000, except that, until
, 1999, the Company may redeem, at
its option, up to 30% of the original
principal amount of the Notes at the
redemption price set forth herein plus
accrued interest to the date of redemption
with the net proceeds of one or more Public
Equity Offerings (as defined) if at least
$100 million aggregate principal amount of
the Notes remains outstanding after such
redemption. On or after , 2000, the
Notes will be redeemable at the option of the
Company, in whole or in part, at the
redemption prices set forth herein, plus
accrued interest to the date of redemption.
See "Description of the Notes -- Optional
Redemption."
Change of Control............................ Upon a Change of Control (as defined), each
holder of Notes may require the Company to
repurchase the Notes held by such holder at
101% of the principal amount thereof plus
accrued interest to the date of repurchase.
See "Description of the Notes -- Change of
Control."
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Certain Covenants............................ The indenture as supplemented by a
supplemental indenture pursuant to which the
Notes will be issued (the "Indenture") will
contain certain covenants, including
covenants with respect to the following
matters: (i) limitations on indebtedness of
the Company and its subsidiaries; (ii)
limitations on preferred stock of
subsidiaries; (iii) limitations on liens;
(iv) limitations on restricted payments such
as dividends, repurchases of the Company's or
its subsidiaries' stock and repurchases of
subordinated obligations; (v) limitations on
restrictions on distributions from
subsidiaries; (vi) limitations on sales of
assets and subsidiary stock; and (vii)
limitations on merger and consolidation.
However, all these limitations are subject to
a number of important exceptions and
qualifications. See "Description of the
Notes."
Amendment and Modification of the
Indenture.................................. Certain provisions of the Indenture,
including those related to a Change of
Control, may be amended or waived with the
consent of the Holders of at least a majority
in principal amount of then-outstanding
Notes.
Use of Proceeds.............................. The net proceeds will be used to provide the
Company with additional capital to fund its
growth, including increasing the amount of
loans the Company can fund and hold for
pooling and sale in the secondary market, to
support securitization transactions, for
other working capital needs and for general
corporate purposes. See "Use of Proceeds."
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CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JUNE 30,
------------------------------------------------------
1992 1993 1994 1995 1996
-------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Revenue:
Excess servicing gain................. $ 1,583 $ 3,486 $ 8,101 $ 22,954 $ 78,274
Commissions........................... 13,166 18,686 16,432 15,799 19,880
Loan service.......................... 3,346 4,377 6,099 8,246 18,185
Fees and other........................ 3,397 4,762 5,595 7,940 12,069
-------- -------- -------- -------- --------
Total revenue.................... 21,492 31,311 36,227 54,939 128,408
Total expenses........................ 17,466 22,955 27,244 37,788 74,877
-------- -------- -------- -------- --------
Income before income taxes............ 4,026 8,356 8,983 17,151 53,531
Provision for income taxes(1)......... 1,112 3,353 3,684 7,117 22,483
-------- -------- -------- -------- --------
Net income............................ $ 2,914 $ 5,003 $ 5,299 $ 10,034 $ 31,048
======== ======== ======== ======== ========
Net income per share (fully
diluted)............................ $ 0.51 $ 0.75 $ 0.61 $ 1.11 $ 2.09
======== ======== ======== ======== ========
Weighted average number of shares
outstanding (in thousands)(fully
diluted)............................ 5,717 6,623 8,751 9,021 15,465
CASH FLOW DATA:
(Used in) provided by operating
activities.......................... $ 3,115 $ (1,490) $(13,857) $(43,375) $ (122,233)
(Used in) investing activities........ (568) (489) (870) (988) (4,597)
Provided by (used in) financing
activities.......................... 7,515 (1,522) 22,855 48,209 124,687
Net increase (decrease) in cash and
cash equivalents.................... 10,062 (3,501) 8,128 3,846 (2,143)
RATIOS AND OTHER DATA:
Ratio of earnings to fixed
charges(2).......................... 25:1 41:1 29:1 6.4:1 6.7:1
Percentage of indebtedness to total
capitalization...................... 8.8% 5.6% 3.4% 22% 56%
Pre-tax interest coverage ratio(3).... 105:1 186:1 269:1 22:1 13:1
Return on average common equity....... NM 36% 18% 27% 33%
Return on average managed
receivables(4)...................... 1.5% 2.1% 1.6% 2.0% 3.3%
Loans originated or purchased:
Retail loans........................ $ 90,600 $122,200 $130,200 $148,200 $ 220,900
Wholesale correspondent loans....... 19,700 206,800 628,200
-------- -------- -------- -------- --------
Total(5)......................... $ 90,600 $122,200 $149,900 $355,000 $ 849,100
======== ======== ======== ======== ========
Loans pooled and sold in the secondary
market.............................. $ 11,000 $ 52,500 $106,800 $316,600 $ 791,300
Loans serviced (period end)........... $204,600 $262,100 $381,800 $608,700 $1,250,407
Weighted average commission rate on
retail loan originations(6)......... 13.0% 14.0% 12.0% 9.4% 7.7%
Weighted average interest rate(6)..... 12.7% 11.2% 10.3% 11.6% 11.5%
Weighted average initial combined
loan-to-value ratio(6)(7):
Retail loans........................ 53% 51% 52% 55% 60%
Wholesale correspondent loans....... NM NM NM 65% 66%
Number of retail loan offices (period
end)................................ 21 24 27 32 48
</TABLE>
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<TABLE>
<CAPTION>
FISCAL YEAR ENDED JUNE 30,
1992 1993 1994 1995 1996
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
ASSET QUALITY DATA:
Delinquent loans to loans serviced
(period end)(8)(9).................. 18% 16% 16% 12% 16%
Number of loans foreclosed............ 69 137 215 159 221
Dollar amount of loans foreclosed as a
percentage of average loans
serviced............................ 1.2% 2.4% 3.0% 1.2% 1.2%
Net losses as a percentage of average
amount outstanding.................. NM NM NM .03% .10%
</TABLE>
<TABLE>
<CAPTION>
AT JUNE 30,
------------------------------------------------------
1992 1993 1994 1995 1996
-------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............. $ 11,886 $ 8,385 $ 16,513 $ 20,359 $ 18,216
Excess Spread Receivable(10).......... 2,544 7,555 18,780 56,960 184,691
Total assets.......................... 18,927 21,307 53,344 114,623 293,997
10.5% Senior Notes due 2002........... 23,000 23,000
5.5% Convertible Subordinated
Debentures due 2006................. 115,000
Other long-term debt.................. 1,177 944 1,104 144 45
-------- -------- -------- -------- ----------
Total long-term debt............. 1,177 944 1,104 23,144 138,045
Stockholders' equity.................. 12,136 15,850 31,669 80,047 110,170
</TABLE>
- ---------------
(1) Prior to December 1991, the Company was operated as an S Corporation for
federal tax purposes and consequently was not responsible for federal
income taxes.
(2) Amounts represent the ratio of (i) the sum of income before income taxes
plus interest expense to (ii) interest expense.
(3) Amounts represent the ratio of (i) the sum of income before income taxes
plus interest expense on funded debt to (ii) interest expense on funded
debt.
(4) Represents net income divided by the average servicing portfolio for the
fiscal year.
(5) Does not include loans originated or purchased by One Stop during fiscal
1996 in the aggregate amount of $320 million.
(6) Computed on loans originated or purchased, as the case may be, during the
period.
(7) The weighted average combined loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the
appraised value of the mortgaged property at origination. The weighted
average combined loan-to-value ratio of loans secured by a junior mortgage
is determined by taking the sum of the loans secured by the junior and all
senior mortgages and dividing by the appraised value of the mortgaged
property at origination.
(8) Does not include loans for which only the servicing rights were purchased
by the Company. Delinquent loans are loans for which more than one payment
is past due and include properties acquired by the Company following
foreclosure sale and still serviced by the Company at period end.
(9) At June 30, 1996, the dollar volume of loans delinquent more than 90 days
in the Company's four real estate mortgage investment conduit ("REMIC")
trusts formed during the period from December 1994 to September 1995
exceeded the permitted limit in the related pooling and servicing
agreements. The higher delinquency rates could result in the termination of
the Company's normal servicing rights with respect to the loans in these
trusts, although to date no servicing rights have been terminated,
negatively affect the Company's cash flows and adversely influence the
Company's assumptions underlying the excess servicing gain (see "Risk
Factors -- Delinquencies; Negative Impact on Cash Flow; Right to Terminate
Normal Servicing").
(10) Represents the sum of excess servicing receivable and residual assets, and
at June 30, 1996, mortgage servicing rights. See Note 1 to Consolidated
Financial Statements.
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<PAGE> 11
SUMMARY SUPPLEMENTARY CONSOLIDATED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
The summary supplementary consolidated financial information is presented
to provide an understanding of the condensed historical results of the Company
and One Stop. On August 28, 1996, the Company acquired One Stop in a merger
transaction. The Company exchanged 2.3 million shares of its Common Stock for
all of the outstanding common stock of One Stop and assumed outstanding employee
stock options covering approximately 375,000 shares of the Company's Common
Stock. The merger has been accounted for as a pooling-of-interests.
One Stop commenced operations in October 1995. Since commencement of its
operations until the merger, One Stop generally sold its loans on a whole loan
servicing released basis or retained them in its portfolio. In September 1996
the Company completed a $525 million securitization, including approximately
$200 million of loans originated or purchased by One Stop, and intends to
continue to include One Stop's loans in the Company's future securitizations. In
light of these expected changes in its operations, the historical financial
performance of One Stop is of limited relevance in predicting future
performance.
The summary supplementary financial information for the Company for the one
year period ended June 30, 1996 has been derived from the audited Supplementary
Consolidated Financial Statements of the Company which appear at pages F-19
through F-33 of this Prospectus Supplement. The summary supplementary
consolidated financial information should be read in conjunction with the
Supplementary Consolidated Financial Statements and Notes thereto and other
financial information included herein. Results of operations of the Company for
the year ended June 30, 1996 reflect the Company's adoption of Statement of
Financial Accounting Standards ("SFAS") No. 122, "Accounting For Mortgage
Servicing Rights" ("SFAS 122"). See "Prospectus Supplement Summary -- Recent
Developments," "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- One-Time Charges" and the Supplementary Consolidated
Financial Statements.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
JUNE 30,
1996
-----------------
<S> <C>
STATEMENT OF INCOME DATA:
Revenue:
Excess servicing gain................................................... $ 85,465
Commissions............................................................. 19,880
Loan service............................................................ 18,185
Fees and other.......................................................... 15,345
-------
Total revenue...................................................... 138,875
Total expenses.......................................................... 86,576
-------
Income before income taxes.............................................. 52,299
Provision for income taxes.............................................. 22,508
-------
Net income.............................................................. $ 29,791
=======
Net income per share (fully diluted).................................... $ 1.71
=======
Weighted average number of shares outstanding (in thousands)
(fully diluted)....................................................... 18,135
</TABLE>
<TABLE>
<CAPTION>
AT JUNE 30,
1996
-----------------
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................................................. $ 23,941
Excess Spread Receivables(1)............................................... 184,691
Total assets............................................................... 421,475
10.5% Senior Notes due 2002................................................ 23,000
5.5% Convertible Subordinated Debentures due 2006.......................... 115,000
Other long-term debt....................................................... 45
-------
Total long-term debt.................................................... 138,045
Stockholders' equity....................................................... 133,429
</TABLE>
- ---------------
(1) Represents the sum of excess servicing receivable, residual assets and
mortgage servicing rights. See Note 1 to Supplementary Consolidated
Financial Statements.
S-11
<PAGE> 12
RISK FACTORS
In addition to the other information contained in this Prospectus
Supplement, the following risk factors should be carefully considered before
making an investment in the Company.
LEVERAGE
The Company currently has substantial outstanding indebtedness, and,
subsequent to the offering of the Notes the Company will be significantly
leveraged. Although the covenants under the Indenture will restrict the
incurrence of Indebtedness by the Company and its Restricted Subsidiaries (as
defined), the Indenture does not limit the amount of Indebtedness under
warehouse facilities that qualifies as "Permitted Warehouse Indebtedness" (as
defined). With respect to the Company's existing warehouse facilities, Permitted
Warehouse Indebtedness generally means indebtedness used exclusively to finance
or refinance the purchase or origination of mortgage loans by the Company or a
Restricted Subsidiary, up to the lesser of (i) the amount advanced by the
warehouse lender, or (ii) 100% of the principal amount of such loans. See
"Description of Notes -- Certain Definitions." All Permitted Warehouse
Indebtedness is secured by the mortgage loans financed thereby and, in some
cases, other assets. Although lenders under Permitted Warehouse Indebtedness in
a default or bankruptcy situation can be expected to seek payment first out of
the collateral securing such Indebtedness, all such existing Indebtedness is
recourse to the Restricted Subsidiaries incurring such Indebtedness and is
unconditionally guaranteed by the Company. Thus, if the value of the collateral
securing any such Indebtedness were to be insufficient to repay such
Indebtedness in full, the lenders would be entitled to seek payment of the
shortfall, if any, from the Company and its subsidiaries liable thereon.
At June 30, 1996, on an "as adjusted basis" to give effect to the offering
of the Notes and the acquisition of One Stop (See "Business -- Recent
Developments"), aggregate outstanding consolidated indebtedness (including the
current maturities thereof) of the Company would have been approximately $400
million, of which $135 million would have been secured indebtedness to which the
Notes and the Guaranties are effectively subordinated. See "Capitalization." The
Company's ability to make payments of principal of or interest on, or to
refinance its indebtedness (including the Notes) depends on its future operating
performance, and its ability to effect additional debt and/or equity financing,
which to a certain extent is subject to economic, financial, competitive and
other factors beyond its control. The degree to which the Company is leveraged
could have important consequences to the holders of the Notes, including: (i)
the Company may be more vulnerable to adverse general economic and industry
conditions; (ii) the Company may find it more difficult to obtain additional
financing for future working capital, capital expenditures, acquisitions,
general corporate purposes or other purposes; and (iii) the Company will have to
dedicate a substantial portion of the Company's cash flow from operations to the
payment of principal and interest on indebtedness (a substantial portion of
which becomes due prior to the maturity of the Notes) and to payments under
capital leases, thereby reducing the funds available for operations and future
business opportunities. In addition, the Indenture contains certain covenants
which could limit the Company's operating and financial flexibility. See
"Description of the Notes -- Certain Covenants."
The Company's ability to sustain its growth is dependent on its ability to
secure further debt arrangements or warehouse credit facilities with certain
financial institutions. The Company believes its warehouse facilities are
adequate to service its current requirements. See "-- Ability to Service Debt;
Negative Cash Flows and Capital Needs" and "-- Dependence on Funding Sources."
S-12
<PAGE> 13
FRAUDULENT CONVEYANCES AND PREFERENTIAL TRANSFERS
The ability of the holders of the Notes or the Trustee to enforce the
Guaranties may be limited by certain fraudulent conveyance laws. Various
fraudulent conveyance and similar laws have been enacted for the protection of
creditors and may be utilized by a court of competent jurisdiction to avoid the
Guaranties or to subordinate the obligations of the Company under the Notes or
the obligations of any Guarantor under its Guaranty. The requirements for
establishing a fraudulent conveyance vary depending on the law of the
jurisdiction which is being applied. Generally, if in a bankruptcy,
reorganization, rehabilitation or similar proceeding in respect of the Company
or a Guarantor, or in a lawsuit by or on behalf of creditors against the Company
or a Guarantor, a court were to find that (1) the Company or a Guarantor, as the
case may be, incurred indebtedness in connection with the Notes (including the
Guaranties) with the intent of hindering, delaying or defrauding current or
future creditors of the Company or the Guarantor, as the case may be, or (2) the
Company or a Guarantor, as the case may be, received less than reasonably
equivalent value or fair consideration for incurring such indebtedness
(including the Guaranties), as the case may be, and either (a) was insolvent at
the time of the incurrence of such indebtedness (including the Guaranties), (b)
was rendered insolvent by reason of incurring such indebtedness (including the
Guaranties), (c) was at such time engaged or about to engage in a business or
transaction for which its assets constituted unreasonably small capital or (d)
intended to incur, or believed that it would incur, debts beyond its ability to
pay such debts as they matured, such court could, with respect to the Company or
the Guarantor, as the case may be, declare void in whole or in part the
obligations of the Company or such Guarantor in connection with the Notes
(including the Guaranties) and/or subordinate claims with respect to the Notes
(including the Guaranties) to all other debts of the Company or the Guarantors,
as applicable. If the obligations of the Company or the Guarantors were
subordinated, there can be no assurance that after payment of the other debts of
the Company or the Guarantors, there would be sufficient assets to pay such
subordinated claims with respect to the Notes and the Guaranties.
Generally, an entity will be considered insolvent if the sum of its
respective debts was greater than the fair saleable value of all of its property
at a fair valuation or if the present fair saleable value of its assets is less
than the amount that will be required to pay its probable liability on its
existing debts, as they become absolute and mature.
Additionally, under federal bankruptcy or applicable state insolvency law,
if certain bankruptcy or insolvency proceedings were initiated by or against the
Company or any Guarantor within 90 days after any payment by the Company or such
Guarantor with respect to the Notes or a Guaranty, respectively, or if the
Company or such Guarantor anticipated becoming insolvent, all or a portion of
such payment could be avoided as a preferential transfer and the recipient of
such payment could be required to return such payment.
ABILITY TO SERVICE DEBT; NEGATIVE CASH FLOWS AND CAPITAL NEEDS
Although the Company believes that cash available from operations and
financing activities will be sufficient to enable it to make required interest
payments on the Notes and its other debt obligations and other required
payments, there can be no assurance in this regard and the Company may encounter
liquidity problems which could affect its ability to meet such obligations while
attempting to withstand competitive pressures or adverse economic conditions. In
such circumstances, the value of the Notes could be materially adversely
affected.
In a securitization, the Company recognizes a gain on sale of the loans
securitized upon the closing of the securitization, but does not receive the
cash representing such gain until it receives the excess servicing, which in
general is payable over the actual life of the loans securitized. The Company
incurs significant expense in connection with a securitization and incurs both
current and deferred tax liabilities as a result of the gain on sale. Net cash
used in operating activities for fiscal 1994, 1995 and 1996 was $13.9 million,
$43.4 million and $122 million, respectively. Therefore, the Company requires
continued access to short- and long-term external sources of cash to fund its
operations.
S-13
<PAGE> 14
The Company expects to continue to operate on a negative cash flow basis as
the volume of the Company's loan purchases and originations increases and its
securitization program grows. The Company's primary cash requirements include
the funding of: (i) mortgage loan originations and purchases pending their
securitization and sale; (ii) fees and expenses incurred in connection with the
securitization of loans; (iii) reserve account or overcollateralization
requirements in connection with the securitization and sale of the loans; (iv)
tax payments due on recognition of excess servicing gain; (v) ongoing
administrative and other operating expenses; and (vi) interest and principal
payments under the Company's warehouse credit facilities and other indebtedness.
The Company's primary sources of liquidity in the future are expected to be
existing cash, fundings under its warehouse and other credit facilities, sales
of mortgage loans through securitizations, the net proceeds of this offering and
the Concurrent Offering and further issuances of debt or equity. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation -- Liquidity" and "-- Capital Resources."
The Company's primary sources of liquidity as described in the paragraph
above are expected to be sufficient to fund the Company's liquidity requirements
for at least the next 12 months if the Company's future operations are
consistent with management's current growth expectations. However, because the
Company expects to continue to operate on a negative cash flow basis for the
foreseeable future, it anticipates that it will need to effect debt or equity
financings regularly. The type, timing and terms of financing selected by the
Company will be dependent upon the Company's cash needs, the availability of
other financing sources and the prevailing conditions in the financial markets.
There can be no assurance that any such sources will be available to the Company
at any given time or as to the favorableness of the terms on which such sources
may be available.
DELINQUENCIES; NEGATIVE IMPACT ON CASH FLOW; RIGHT TO TERMINATE NORMAL SERVICING
A substantial majority of the Company's servicing portfolio consists of
loans securitized by the Company and sold to REMIC trusts. Generally, the form
of pooling and servicing agreement entered into in connection with these
securitizations contains specified limits on the 90-day delinquency rate
(including properties acquired upon foreclosure and not sold) prevailing on the
loans included in each REMIC trust. If, at any measuring date, the 90-day
delinquency rate with respect to any REMIC trust were to exceed the specified
limit applicable to such trust, provisions of the pooling and servicing
agreements permit the monoline insurance company to terminate the Company's
servicing rights to the pool as more fully described below. In addition, high
delinquency rates have a negative impact on cash flow.
At June 30, 1996, four of the Company's REMIC trusts (representing 23% of
the dollar volume of the Company's servicing portfolio) exceeded the applicable
90-day delinquency standard for each trust. These four trusts were formed in the
last quarter of calendar 1994 and each of the first three quarters of calendar
1995. At June 30, 1996, the 90-day delinquency rate on these four trusts ranged
from 13.5% to 22.4%. The Company believes that the high delinquency rates it has
experienced are primarily due to the higher proportion of lower credit grade
loans ("C-" and "D" loans) originated and purchased by it compared to most other
lenders to credit-impaired borrowers (which generally have a greater focus on
"A-" through "C" loans). However, the Company believes its historical loan
losses have been below those experienced by most other lenders to
credit-impaired borrowers as a result of the higher combined loan-to-value
ratios which it requires on its lower credit grade loans. At June 30, 1996, the
weighted average of the initial combined loan-to-value ratio on loans in the
four REMIC trusts was 64%.
The Company has recently implemented a variety of measures designed to
reduce delinquency rates on loans included in REMIC trusts to be formed by the
Company in future periods, including the implementation of new procedures
designed to shorten the time required to transfer servicing on loans purchased
through the Company's wholesale correspondent program and the elimination of its
loan program which has experienced the highest delinquency rates. In addition,
as a result of the expansion of the Company's loan production capacity,
including the acquisition of One Stop, the proportion of higher credit grade
loans originated or purchased by the Company is increasing. The Company expects
that the combined effect of these
S-14
<PAGE> 15
developments will have a positive impact on 90-day delinquency rates experienced
in REMIC trusts formed by the Company in future periods, although average
combined loan-to-value ratios are likely to increase. However, there can be no
assurance that delinquency rates will in fact be positively impacted. Further,
delinquency rates and losses on the Company's existing REMIC trusts and future
REMIC trusts could increase. Although the four REMIC trusts formed by the
Company after September 1995 had delinquency rates at June 30, 1996 within
expectations and below the applicable 90-day delinquency standard (which were
raised to 13% with respect to the June 1996 REMIC trust and to 17% with respect
to the September 1996 REMIC trust), the loans included in these latter four
trusts were originated or purchased prior to these developments and have been
outstanding for a relatively short period of time and there can be no assurance
that delinquency rates on these trusts will not increase in future periods.
Under the form of pooling and servicing agreement entered into in
connection with the Company's securitizations, the monoline insurance company
insuring the senior interests in the related REMIC trust may terminate the
Company's normal servicing rights if the 90-day delinquency rate exceeds the
applicable specified limit. Although the monoline insurance company has the
right to terminate servicing with respect to the four REMIC trusts referred to
above, no servicing rights have been terminated. There can be no assurance that
the Company's servicing rights with respect to the mortgage loans in such
trusts, or any other trust which exceeds the specified limits in future periods,
will not be terminated. The monoline insurance company has other rights to
terminate servicing if the Company were to breach its obligations under the
agreement, losses on foreclosure were to exceed specified limits, the insurance
company were required to make payments under its policy or certain bankruptcy or
insolvency events were to occur. None of these events has occurred with respect
to any of the trusts formed by the Company.
The Company's cash flow is also adversely impacted by high delinquency
rates in REMIC trusts. Generally, provisions in the pooling and servicing
agreement have the effect of requiring the overcollateralization account, which
is funded primarily by the excess spread on the loans held in the trust, to be
increased up to about twice (two and one-half times in the case of the September
1996 REMIC trust) the level otherwise required when the delinquency rates exceed
the specified limit. As of June 30, 1996, the Company was required to maintain
an additional $16.5 million in overcollateralization accounts as a result of the
level of its delinquency rates above that which would have been required to be
maintained if the applicable delinquency rates had been below the specified
limit. Of this amount, at June 30, 1996, $12.5 million remains to be added to
the overcollateralization accounts from future spread income on the loans held
by these trusts.
Delinquency and loss rates also affect the assumptions used by the Company
in computing excess servicing gain and could affect the Company's ability to
effect securitizations in the capital markets.
RISKS OF CONTRACTED SERVICING
The Company currently contracts with subservicers for the servicing of all
loans it originates or purchases which are secured by properties located in
states other than Arizona, California, Colorado, Nevada, Oregon, Utah and
Washington. These subservicing arrangements accounted for approximately 27% of
the Company's $1.25 billion servicing portfolio at June 30, 1996. The Company is
subject to risks associated with inadequate or untimely service rendered by
subservicers. Many of the Company's borrowers require notices and reminders to
keep their loans current and to prevent delinquencies and foreclosures. Any
failure by a subservicer to provide adequate or timely service could result in
higher delinquency rates and foreclosure losses on the portfolio of loans.
Although the Company intends to service all loans it originates or purchases
commencing in calendar 1997 (regardless of the location of the mortgaged
property), the Company does not currently intend to transfer the subservicing
previously contracted and would be required to pay a termination fee if it were
to decide to do so.
S-15
<PAGE> 16
DEPENDENCE ON FUNDING SOURCES
Dependence on Warehouse and Other Credit Facilities. The Company is
dependent upon its access to warehouse and other credit facilities in order to
fund new originations and purchases of mortgage loans pending securitization. At
September 10, 1996, the Company had warehouse and other credit facilities with
certain financial institutions with aggregate commitments of $725 million. The
Company's warehouse and other credit facilities expire between September 27,
1996 and August 1999. In addition, the Company's growth strategies will require
significant increases in the amount of the Company's warehouse and other credit
facilities. There can be no assurance that the Company will be able to secure
such financing on affordable terms, or at all. The Company expects to be able to
maintain existing warehouse and other credit facilities (or to obtain
replacement or additional financing) as current arrangements expire or become
fully utilized; however, there can be no assurance that such financing will be
obtainable on favorable terms. To the extent that the Company is unable to
extend or replace existing facilities, and arrange new warehouse or other credit
facilities, the Company may have to curtail loan origination and purchasing
activities, which would have a material adverse effect on the Company's
financial position and results of operations.
Dependence on Securitization Program. The Company relies on its ability to
securitize and sell its mortgage loans in the secondary market in order to
generate cash proceeds for repayment of its warehouse facilities. Accordingly,
adverse changes in the Company's securitization program or in the secondary
mortgage market could impair the Company's ability to originate, purchase and
sell mortgage loans on a favorable or timely basis. Any such impairment could
have a material adverse effect upon the Company's financial position and results
of operations. In addition, in order to gain access to the secondary market, the
Company has relied upon monoline insurance companies to provide financial
guarantee insurance on the senior interests in loans sold in the secondary
market in order to obtain ratings for such interests. To date, the Company has
not structured a pool of loans for securitization and sale in the secondary
market based solely on the internal credit enhancements of the pool of loans or
the Company's credit. Any substantial reduction in the size or availability of
the secondary market for the Company's loans, or the unwillingness of the
monoline insurance companies to provide financial guaranty insurance for the
senior interests in loans sold in the secondary market, or other accounting, tax
or regulatory changes adversely affecting the Company's securitization program,
could have a material adverse effect on the Company's financial position and
results of operations.
CAPITALIZED EXCESS SERVICING RECEIVABLE; MORTGAGE SERVICING RIGHTS
The majority of the Company's revenue is recognized as excess servicing
gain, which represents the present value of the excess servicing, less
transaction expenses, on mortgage loans sold on a servicing retained basis by
the Company. The Company recognizes excess servicing gain in the fiscal year in
which such loans are sold, although cash (representing the excess servicing and
normal servicing fees) is received by the Company over the life of the loans.
Concurrent with recognizing excess servicing gain, the Company records an excess
servicing receivable as an asset on its consolidated balance sheet.
The amount of the excess servicing receivable is computed using prepayment,
loss and discount rate assumptions that the Company believes market participants
would use for similar instruments at the time of sale. Because of changes in the
markets in which the Company competes and the mix of loans included in any
particular pool, the prepayment, default and interest rate assumptions
applicable to the Company's pools may differ. Consequently, the performance of
prior securitizations effected by the Company may not constitute an accurate
predictor of future performance. In particular, the Company expects to realize a
lower percentage of excess servicing gain on the sale of loans than was the case
in prior securitizations completed by the Company as a result of changes in the
composition of the Company's loan product mix and other factors. The Company is
not aware of an active market for its excess servicing receivable. No assurance
can be given that excess servicing receivable could in fact be sold or monetized
at its stated value on the balance sheet, if at all.
The Company's capitalized excess servicing receivable is amortized over the
estimated remaining life of the underlying mortgage loans as an offset against
the excess servicing component of servicing income actually received in
connection with such loans. Although management of the Company believes that it
has made reasonable estimates, on a pool-by-pool basis, of the excess servicing
likely to be realized over the life of each
S-16
<PAGE> 17
pool, the rates of prepayment and loss assumptions utilized by the Company are
estimated and actual experience may vary from these estimates. The Company
reviews quarterly, on a pool-by-pool basis, its prepayment and loss assumptions
in relation to then current pool performance and market conditions and, if
necessary, would write down the remaining asset to the net present value of the
revised estimated remaining future excess servicing receivable.
An increase in losses from those initially assumed in valuing excess
servicing could result in capitalized excess servicing amortization expense
exceeding realized excess servicing, thereby adversely affecting the Company's
servicing income and resulting in a reduction in cash flow and a charge to
earnings in the period of adjustment. Likewise, if liquidations with respect to
such mortgage loans were to occur sooner and/or with greater frequency than
initially assumed, capitalized excess servicing amortization would occur more
quickly than originally anticipated, which would have an adverse effect on
servicing income in the period of such adjustment. The rates of foreclosures
experienced by credit-impaired borrowers in certain economic conditions may
exceed those experienced by other mortgage borrowers.
In complying with SFAS 122, beginning in fiscal 1996, the Company records
mortgage servicing rights as assets in the period of the Company's sale or
securitization of the related mortgage loans, which include the Company's
estimates of future servicing fees, prepayment fees and other ancillary income
with respect to the underlying mortgage loan, whereas, under the prior standard,
the Company recorded such amounts as received. This accounting method has
resulted in and may, in future periods in which the Company originates or
purchases mortgage loans the terms of which provide for significant prepayment
penalties or other ancillary income, result in earlier recognition of excess
servicing gain than did the Company's reporting under the prior standard.
Furthermore, insofar as the Company's ability to originate or purchase mortgage
loans with such terms may be adversely affected by federal or state regulations
(see "Business -- Regulation") or market conditions, the Company's revenue in
future periods may be negatively affected. There can be no assurance as to the
Company's ability in any future period to originate or purchase loans providing
for the same prepayment penalties or other ancillary income to the servicer.
In addition, SFAS 122 requires recognition of impairment of capitalized
mortgage servicing rights, including the Company's excess servicing receivable,
on a disaggregated basis in terms of differentiated groups of mortgage loans
identified by the predominant risk characteristics of such mortgage loans (e.g.,
seasoning of the mortgage loans or whether the related interest rates are fixed
or adjustable). Compliance with SFAS 122 may, depending on market conditions in
future periods, require the Company to recognize greater levels of impairment
(and corresponding write-downs of its Company's excess servicing receivable)
than the Company might have recognized in its reporting under the prior
standard.
HOLDING COMPANY STRUCTURE
The Company is a holding company which derives substantially all its
operating income from its subsidiaries. The Company intends to loan or
contribute substantially all of the net proceeds from the sale of the Notes to
certain of its Subsidiaries which will use the proceeds to originate and
purchase mortgage loans, to support securitization transactions, for other
working capital needs and for general corporate purposes. See "Use of Proceeds."
The Company must rely upon payments from its Subsidiaries to generate the funds
necessary to meet its obligations, including the payment of interest on and
principal of the Notes. The ability of the Company's Subsidiaries to make such
payments will be subject to, among other things, applicable state and foreign
laws. Claims of secured creditors of the Company's Subsidiaries will generally
have priority as to the assets of such Subsidiaries over the claims of the
Company. See "-- Fraudulent Conveyances and Preferential Transfers" and
"Description of the Notes -- Ranking."
Although the Guaranties provide the Note holders with a direct claim
against the assets of the Restricted Subsidiaries, enforcement of the Guaranties
against any existing or future Guarantors would be subject to certain defenses
available to guarantors generally, and would also be subject to certain defenses
available to the Company regarding enforcement of the Notes. See "-- Fraudulent
Conveyances and Preferential Transfers." Although the Indenture contains waivers
of most of those defenses, certain of those waivers may not be enforced by a
court in a particular case. To the extent that the Guaranties are not
enforceable, the
S-17
<PAGE> 18
Notes would be effectively subordinated to all liabilities of the Company's
Subsidiaries, including other Senior Indebtedness, subordinated indebtedness and
trade payables of such subsidiaries.
RECENT ADDITION OF WHOLESALE CORRESPONDENT PROGRAM
Until 1994, the Company originated substantially all of the loans it
serviced and sold through its retail loan office network. In 1994, the Company
commenced its wholesale correspondent program and in 1995 expanded it to include
purchases of loans in bulk resulting in substantial growth in the number of
loans purchased. The extent of credit or other problems associated with loans
purchased pursuant to this recent expansion into a new channel of loan
production will not become apparent until sometime in the future.
The Company's significant growth and expansion have placed substantial new
and increased pressures on the Company's personnel and systems. In order to
support the growth of its business, the Company has added a significant number
of new operating procedures, facilities and personnel. Although the Company
believes the addition of new operating procedures and personnel will be
sufficient to enable it to meet its growing operating needs, there can be no
assurance that this will be the case. Failure by the Company to manage its
growth effectively, or to sustain its historical levels of performance in credit
analysis, property appraisal and transaction structuring with respect to the
increased loan origination and purchase volume, could have a material adverse
effect on the Company's results of operations and financial condition.
RECENT ACQUISITION OF ONE STOP
On August 28, 1996, the Company acquired One Stop in a merger transaction.
One Stop will be operated as a wholly-owned subsidiary of the Company. The
Company acquired One Stop with the expectation that the acquisition will result
in beneficial synergies for the combined business. The Company's ability to
achieve these beneficial synergies will depend in part on whether the operations
of One Stop can be integrated into the Company's in an efficient, effective and
timely manner. Integral to this process is the integration of the two companies'
management teams and operating procedures. There is no assurance that this
integration will be accomplished smoothly or successfully, and the difficulties
of such integration may be increased by the necessity of coordinating
geographically separated organizations with different cultures. The integration
of operations of One Stop's business will require the dedication of management
resources, which may temporarily distract attention from the day-to-day business
of each of the companies' businesses. The inability of management to integrate
successfully the operations of One Stop's business in a timely manner may have
an adverse effect on the business, results of operations and financial condition
of the Company's business on a consolidated basis.
One Stop commenced operations in October 1995. One Stop had net income of
$547,000 for the period ended December 31, 1995 and a $1.8 million loss for the
six months ended June 30, 1996. There can be no assurance that One Stop will
achieve profitability or successfully implement its business strategy.
Since commencement of operations in October 1995, One Stop's rate of growth
in originating and purchasing loans has been significant. Further, One Stop has
generally sold its loans on a whole-loan basis or retained them in its
portfolio. The Company included in its September 1996 securitization and intends
to continue to include One Stop's loans in the Company's future securitizations.
In light of One Stop's growth and the expected changes in its operations, the
historical financial performance of One Stop is of limited relevance in
predicting future performance. Also, the loans originated and purchased by One
Stop and included in the Company's securitization in September 1996 have been
outstanding for a relatively short period of time. Consequently, the delinquency
and loss experience of One Stop's loans to date may not be indicative of that to
be achieved in future periods, and One Stop may not be able to maintain
delinquency and loan loss ratios at their present levels as One Stop's loan
portfolio becomes more seasoned.
Further, there can be no assurance that the present and potential brokers
doing business with One Stop will continue their current utilization patterns
without regard to the acquisition. Prior to its acquisition by the Company, a
substantial portion of the loans originated or purchased by One Stop were "A-,"
"B," or "C" loans. One Stop intends to increase the percentage of "C-" and "D"
loans originated and purchased by it. All loans originated by One Stop are
underwritten in accordance with the Company's underwriting guidelines.
S-18
<PAGE> 19
Once approved, the loan is funded or purchased by One Stop directly. This change
in One Stop's intentions could also have a negative impact on relations with One
Stop's brokers. Any significant reduction in utilization patterns by brokers
doing business with One Stop could have an adverse effect on the near-term
business and results of operations of One Stop, and on the Company on a
consolidated basis.
The One Stop acquisition was accounted for on a pooling-of-interests basis.
Under the pooling rules, the historical financial results of the Company will be
restated to reflect the combination, and the historical results of the Company
will be restated to reflect the historical losses of One Stop. Further, under
the pooling rules, the costs incurred by the Company and One Stop in
consummating the acquisition will be expensed during the first quarter of fiscal
1997. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- One-Time Charges" and the Supplementary Consolidated
Financial Statements at pages F-19 through F-33.
CONCENTRATION OF WHOLESALE CORRESPONDENT PROGRAM
The Company has implemented a program for purchasing mortgage loans in bulk
as well as on an ongoing or "flow" basis from mortgage bankers and financial
institutions. This program accounted for 74% of all mortgage loans originated or
purchased by the Company in fiscal 1996. Although the Company acquires mortgage
loans from a variety of sources, a significant portion of the volume of mortgage
loans acquired by the Company has been concentrated among a relatively small
number of correspondents and bulk purchase transactions, with one such
correspondent representing approximately 32% of total mortgage loans purchased
in fiscal 1996. Any significant reduction in the amount of mortgage loans
available for sale from this source or the failure to effect purchases or a
delay of a significant number of such purchases beyond the end of a quarter,
could have a material adverse impact on total loan purchases by the Company
during a quarter with a consequent material adverse impact on the Company's
revenue and results of operations.
COMPETITION
As a marketer of home equity mortgage loans, the Company faces intense
competition. Traditional competitors in the financial services business include
other mortgage banking companies, commercial banks, credit unions, thrift
institutions and finance companies. Many of these competitors in the financial
services business are substantially larger and have more capital and other
resources than the Company. Competition can take many forms, including
convenience in obtaining a loan, customer service, marketing and distribution
channels and interest rates. In addition, the current level of gains realized by
the Company and its competitors on the sale of their sub-prime mortgage loans is
attracting additional competitors into this market with the possible effect of
lowering gains that may be realized on the Company's future loan sales.
Competition may be affected by fluctuations in interest rates and general
economic conditions. During periods of rising rates, competitors which have
locked in lower borrowing costs may have a competitive advantage. During periods
of declining rates, competitors may solicit the Company's customers to refinance
their loans. During economic slowdowns or recessions, credit-impaired borrowers
may have new financial difficulties and may be receptive to offers by the
Company's competitors.
The Company's wholesale correspondent program depends largely on
independent mortgage bankers and other financial institutions for the purchases
of new loans. The Company's competitors also seek to establish relationships
with the same mortgage bankers and other financial institutions. In addition,
the Company expects the volume of loans purchased by the Company to increase and
the relative proportion of purchased loans when compared with retail loans to
expand. The Company's future results may become more exposed to fluctuations in
the volume and cost of the Company's wholesale correspondent program resulting
from competition from other purchasers of such loans, market conditions and
other factors. In addition, a number of the Company's competitors have recently
increased their access to the capital markets, which fosters their growth and
therefore competition.
S-19
<PAGE> 20
CONCENTRATION OF OPERATIONS IN CALIFORNIA
At June 30, 1996, a significant majority of the loans serviced by the
Company were secured by properties located in California. Because the Company's
servicing portfolio is currently concentrated in California, the Company's
financial position and results of operations have been and are expected to
continue to be influenced by general trends in the California economy and its
residential real estate market. The California economy has experienced a
slowdown or recession over the last several years which has been accompanied by
a sustained decline in the values of California real estate. Residential real
estate market declines may adversely affect the values of the properties
securing loans such that the principal balances of such loans, together with any
primary financing on the mortgaged properties, will equal or exceed the value of
the mortgaged properties. In addition, California historically has been
vulnerable to certain natural disaster risks, such as earthquakes and
erosion-caused mudslides, which are not typically covered by the standard hazard
insurance policies maintained by borrowers. Uninsured disasters may adversely
impact borrowers' ability to repay loans made by the Company and adversely
impact the Company's results of operations.
TIMING OF LOAN SALES
The Company endeavors to effect the securitization and sale of a loan pool
each quarter. However, market and other considerations, including the conformity
of loan pools to monoline insurance company and rating agency requirements,
could affect the timing of such transactions. Any delay in the sale of a loan
pool beyond a quarter-end would postpone the recognition of excess servicing
gain related to such loans until their sale and would likely result in losses
for such quarter being reported by the Company.
DEPENDENCE ON MANAGEMENT; EMPLOYMENT AGREEMENTS
The Company's success will continue to depend to a significant extent on
its executive officers and other key management, particularly its Chief
Executive Officer, Gary K. Judis; its Chief Operating Officer, Cary H. Thompson;
and its Executive Vice President and President of One Stop, Neil B. Kornswiet.
The Company's Chief Executive Officer, Chief Operating Officer and the Chief
Executive Officer of One Stop are each parties to employment agreements with the
Company which provide for bonus payments based upon the net income or return on
equity of the Company or One Stop, as applicable. In the case of the Chief
Executive Officer of the Company, he is entitled to receive a base salary of
$490,000 per annum and, for each quarter ended through December 31, 1996, a
bonus equal to 7.5% of the Company's pre-tax income (prior to his bonus and
prior to certain other charges). Commencing in January 1997, the Chief Executive
Officer of the Company will receive a base salary of $850,000 and a bonus
measured by the Company's return on equity. The Company's Chief Operating
Officer is entitled to a base salary of $500,000 per annum and a quarterly bonus
measured by the Company's return on equity. The Chief Executive Officer of One
Stop is entitled to a base salary of $750,000 per annum and a quarterly bonus
equal to 7.5% of One Stop's pre-tax income. Other members of senior management
are participants in a management bonus plan which awards bonuses measured by the
Company's return on equity.
ECONOMIC CONDITIONS
General. The risks associated with the Company's business become more
acute in any economic slowdown or recession. Periods of economic slowdown or
recession may be accompanied by decreased demand for consumer credit and
declining real estate values. Any material decline in real estate values reduces
the ability of borrowers to use home equity to support borrowings and increases
the current combined loan-to-value ratios of loans previously made by the
Company, thereby weakening collateral coverage and increasing the possibility of
a loss in the event of default. Further, delinquencies, foreclosures and losses
generally increase during economic slowdowns or recessions. Because of the
Company's focus on credit-impaired borrowers, the actual rates of delinquencies,
foreclosures and losses on such loans could be higher than those generally
experienced in the mortgage lending industry. In addition, in an economic
slowdown or recession, the Company's servicing costs may increase. Any sustained
period of increased delinquencies, foreclosure, losses or increased costs could
adversely affect the Company's ability to securitize or sell loans in the
secondary market and could increase the cost of securitizing and selling loans
in the secondary market.
S-20
<PAGE> 21
The Company's principal market is credit-impaired borrowers who have
significant equity in their homes and whose borrowing needs are not being met by
traditional financial institutions. Loans made to such borrowers may entail a
higher risk of delinquency and higher losses than loans made to more
creditworthy borrowers. While the Company believes that the underwriting
criteria and collection methods it employs enable it to reduce the higher risks
inherent in loans made to credit-impaired borrowers, no assurance can be given
that such criteria or methods will afford adequate protection against such
risks. In the event that pools of loans sold and serviced by the Company
experience higher delinquencies, foreclosures or losses than anticipated, the
Company's financial condition or results of operations could be adversely
affected.
Interest rates. The Company's earnings may be directly affected by the
level of and fluctuations in interest rates which affect the Company's ability
to earn a spread between interest received on its loans and the costs of its
liabilities. While the Company monitors the interest rate environment and
employs a hedging strategy designed to mitigate the impact of changes in
interest rates, there can be no assurance that the earnings of the Company would
not be adversely affected during any period of unexpected changes in interest
rates. During periods of increasing interest rates, the Company generally
experiences market pressure to reduce its servicing spread or commissions on
originations. A substantial and sustained increase in interest rates could
adversely affect the ability of the Company to originate loans and could reduce
the gains recognized by the Company upon their securitization and sale. A
significant decline in interest rates could decrease the size of the Company's
loan servicing portfolio by increasing the level of loan prepayments, thereby
shortening the life and impairing the value of the excess servicing receivables
and mortgage servicing rights. Fluctuating interest rates also may affect the
net interest income earned by the Company resulting from the difference between
the yield to the Company on mortgage loans held pending sale and the interest
paid by the Company for funds borrowed under the Company's warehouse credit
facilities or otherwise. In addition, inverse or flattened interest yield curves
could have an adverse impact on the earnings of the Company because the loans
pooled and sold by the Company have long-term rates while the senior interests
in the related REMIC trusts are priced on the basis of intermediate rates.
The Company introduced adjustable rate mortgages as a new product in
January 1994. Adjustable rate loans account for a substantial portion of the
mortgage loans originated or purchased by the Company. Substantially all such
adjustable rate mortgages include a "teaser" rate, i.e., an initial interest
rate significantly below the fully indexed interest rate at origination.
Although these loans are underwritten at the fully indexed rate at origination,
credit-impaired borrowers may encounter financial difficulties as a result of
increases in the interest rate over the life of the loan.
CONTINGENT RISKS
Although the Company sells substantially all the mortgage loans which it
originates or purchases, the Company retains some degree of credit risk on
substantially all loans sold. During the period of time that loans are held
pending sale, the Company is subject to the various business risks associated
with the lending business including the risk of borrower default, the risk of
foreclosure and the risk that a rapid increase in interest rates would result in
a decline in the value of loans to potential purchasers. The documents governing
the Company's securitization program require the Company to establish deposit
accounts or build overcollateralization levels through retention of excess
servicing distributions in such accounts or application of excess servicing
distributions to reduce the principal balances of the senior interests issued by
the related REMIC trust, respectively. Such amounts serve as credit enhancement
for the related REMIC trust and are therefore available to fund losses realized
on loans held by such trust. The Company continues to be subject to the risks of
default and foreclosure following securitization and the sale of loans to the
extent of excess servicing distributions required to be retained or applied to
reduce principal from time to time. Such amounts are determined by the monoline
insurance company issuing the guarantee of the related interests in each REMIC
trust and are a condition to obtaining the requisite rating thereon. In
addition, documents governing the Company's securitization program require the
Company to commit to repurchase or replace loans which do not conform to the
representations and warranties made by the Company at the time of sale.
When borrowers are delinquent in making monthly payments on loans included
in a REMIC trust, the Company is required to advance interest payments with
respect to such delinquent loans to the extent that the
S-21
<PAGE> 22
Company deems such advances ultimately recoverable. These advances require
funding from the Company's capital resources but have priority of repayment from
collections or recoveries on the loans in the related pool in the succeeding
month.
In the ordinary course of its business, the Company is subject to claims
made against it by borrowers and private investors arising from, among other
things, losses that are claimed to have been incurred as a result of alleged
breaches of fiduciary obligations, misrepresentations, errors and omissions of
employees and officers of the Company (including its appraisers), incomplete
documentation and failures by the Company to comply with various laws and
regulations applicable to its business. The Company believes that liability with
respect to any currently asserted claims or legal actions is not likely to be
material to the Company's financial position or results of operations; however,
any claims asserted in the future may result in legal expenses or liabilities
which could have a material adverse effect on the Company's financial position
and results of operations.
GOVERNMENT REGULATION
Members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of the Company's loans are made to borrowers
for the purpose of consolidating consumer debt or financing other consumer
needs, the competitive advantages of tax deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for loans of the
kind offered by the Company.
The operations of the Company are subject to regulation by federal, state
and local government authorities, as well as to various laws and judicial and
administrative decisions, that impose requirements and restrictions affecting,
among other things, the Company's loan originations, credit activities, maximum
interest rates, finance and other charges, disclosures to customers, the terms
of secured transactions, collection, repossession and claims-handling
procedures, multiple qualification and licensing requirements for doing business
in various jurisdictions, and other trade practices. Although the Company
believes that it is in compliance in all material respects with applicable
local, state and federal laws, rules and regulations, there can be no assurance
that more restrictive laws, rules or regulations will not be adopted in the
future that could make compliance more difficult or expensive, restrict the
Company's ability to originate, purchase or sell loans, further limit or
restrict the amount of interest and other charges earned on loans originated or
purchased by the Company, further limit or restrict the terms of loan
agreements, or otherwise adversely affect the business or prospects of the
Company.
In October 1995, certain amendments to the Truth in Lending Act (the "TILA
Amendments") went into effect. The TILA Amendments provide in general that
lenders may not include prepayment fee clauses in loans regulated by those
amendments ("Section 32 Loans") if the borrower has a debt-to-income ratio in
excess of 50%. In addition, a lender that refinances a Section 32 Loan
previously made by such lender will not be able to enforce any prepayment
penalty clause contained in such refinanced loan. A majority of the loans
originated or purchased by the Company prior to October 1995 would have been
Section 32 Loans if they had been originated after that date. The Company has
modified its loan programs to significantly reduce the number of Section 32
Loans it originates and purchases.
ABSENCE OF PUBLIC MARKET FOR THE NOTES
There is no public market for the Notes, and the Company does not intend to
apply for listing of the Notes on any national securities exchange. The Company
has been advised by the Underwriters that, following the completion of the
offering, they presently intend to make a market in the Notes; however, they are
under no obligation to do so and market-making activities with respect to the
Notes may be discontinued at any time without notice. There can be no assurance
as to the liquidity of the trading market for the Notes or that an active public
market for the Notes will develop. If an active public market for the Notes does
not develop, the market price and liquidity of the Notes may be adversely
affected.
S-22
<PAGE> 23
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of the Notes
being offered hereby, after deducting the estimated underwriting discount and
offering expenses, are estimated to be approximately $145,300,000.
The primary purpose of this offering is to provide the Company with
additional capital to fund its growth, including increasing the amount of loans
the Company can fund and hold for pooling and sale in the secondary market, to
support securitization transactions, for other working capital needs and for
general corporate purposes. Pending their ultimate application, the net proceeds
will be used to reduce the Company's balances under its existing warehouse and
other facilities. National Westminster Bank, N.A., an affiliate of one of the
Underwriters of this offering, has the right to require that a portion of the
proceeds of this offering be used to prepay the amounts outstanding under the
$50 million credit facility secured by certain excess servicing receivables more
fully described under "Underwriting." Although National Westminster Bank, N.A.
has informed the Company that it does not currently intend to exercise such
right, if it were to do so, the Company may use a portion of the proceeds of
this offering to repay such amounts. See "Underwriting."
S-23
<PAGE> 24
CAPITALIZATION
The following table sets forth the capitalization of the Company at June
30, 1996. See "Management's Discussion and Analysis of Results of Operations and
Financial Condition -- Liquidity" and "-- Capital Resources" and the
Consolidated Financial Statements of the Company included elsewhere herein.
<TABLE>
<CAPTION>
JUNE 30, 1996
----------------------------
PRO FORMA
AS ADJUSTED
ACTUAL (1)(2)
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Cash.............................................................. $ 18,216 $ 240,991
Loans held for sale............................................... 67,327 67,327
WAREHOUSE FACILITIES:
Amounts outstanding under warehouse facilities.................. 11,026 11,026
LONG-TERM DEBT:
10.5% Senior Notes due 2002..................................... 23,000 23,000
% Senior Notes due 2003..................................... 150,000
Capitalized lease obligations................................... 45 45
5.5% Convertible Subordinated Debentures due 2006............... 115,000 115,000
-------- --------
Total long-term debt.................................... 138,045 288,045
-------- --------
STOCKHOLDERS' EQUITY:
Preferred Stock, par value $.001 per share,
1,000,000 shares authorized; none outstanding................
Common Stock, par value $.001 per share,
50,000,000 shares authorized; 13,501,900 shares
outstanding(3)............................................... 14 16
Additional paid-in capital...................................... 63,628 141,101
Retained earnings............................................... 46,528 46,528
-------- --------
Total stockholders' equity...................................... 110,170 187,645
-------- --------
Total capitalization.................................... $248,215 $ 475,690
======== ========
</TABLE>
- ---------------
(1) As adjusted to give effect to the receipt of the estimated net proceeds from
the sale of the Senior Notes offered hereby (net of estimated aggregate
offering expenses of $4.7 million) and the receipt of the estimated net
proceeds from the sale of the Common Stock in the Concurrent Offering
(assuming an initial offering price of $54.25 per share, net of estimated
aggregate offering expenses of $3.9 million).
(2) Does not give effect to the acquisition of One Stop which occurred on August
28, 1996. Net of the write-off of prepaid financing costs, the acquisition
would add $5.7 million in cash, $119 million in loans held for sale, $101
million in amounts outstanding under warehouse facilities and $7.8 million
in total stockholders' equity. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- One-Time Charges" and the
Supplementary Consolidated Financial Statements at pages F-19 through F-33.
(3) Does not include (i) 2,516,305 shares of Common Stock issuable upon exercise
of outstanding options and warrants, (ii) 4,107,143 shares of Common Stock
issuable upon conversion of the Company's 5.5% Convertible Subordinated
Debentures due 2006, (iii) 2,322,940 shares of Common Stock issued in
connection with the acquisition of One Stop and (iv) 1,500,000 shares of
Common stock issuable in the Concurrent Offering (plus up to an additional
225,000 shares of Common Stock which may be issued to cover over-allotments,
if any).
S-24
<PAGE> 25
SELECTED CONSOLIDATED FINANCIAL DATA
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
The selected consolidated financial data for the Company for the five year
period ended June 30, 1996 have been derived from the Consolidated Financial
Statements of the Company which have been audited by Price Waterhouse LLP,
independent accountants. The selected consolidated financial data should be read
in conjunction with the Consolidated Financial Statements and Notes thereto and
other financial information included herein. Results of operations of the
Company for the year ended June 30, 1996 reflect the Company's adoption of SFAS
122. The selected consolidated financial data for the Company for the year ended
June 30, 1996 does not give pro forma effect to the acquisition of One Stop. See
"Prospectus Summary -- Recent Developments," "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- One-Time Charges"
and the Supplementary Consolidated Financial Statements at pages F-19 through
F-33.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JUNE 30,
------------------------------------------------------
1992 1993 1994 1995 1996
-------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Revenue:
Excess servicing gain............................... $ 1,583 $ 3,486 $ 8,101 $ 22,954 $ 78,274
Commissions......................................... 13,166 18,686 16,432 15,799 19,880
Loan service........................................ 3,346 4,377 6,099 8,246 18,185
Fees and other...................................... 3,397 4,762 5,595 7,940 12,069
-------- -------- -------- -------- ----------
Total revenue.................................. 21,492 31,311 36,227 54,939 128,408
Total expenses...................................... 17,466 22,955 27,244 37,788 74,877
-------- -------- -------- -------- ----------
Income before income taxes.......................... 4,026 8,356 8,983 17,151 53,531
Provision for income taxes(1)....................... 1,112 3,353 3,684 7,117 22,483
-------- -------- -------- -------- ----------
Net income.......................................... $ 2,914 $ 5,003 $ 5,299 $ 10,034 $ 31,048
======== ======== ======== ======== ==========
Net income per share (fully diluted)................ $ 0.51 $ 0.75 $ 0.61 $ 1.11 $ 2.09
======== ======== ======== ======== ==========
Weighted average number of shares outstanding (in
thousands)(fully diluted)......................... 5,717 6,623 8,751 9,021 15,465
CASH FLOW DATA:
(Used in) provided by operating activities............. $ 3,115 $ (1,490) $(13,857) $(43,375) $ (122,233)
(Used in) investing activities......................... (568) (489) (870) (988) (4,597)
Provided by (used in) financing activities............. 7,515 (1,522) 22,855 48,209 124,687
Net increase (decrease) in cash and cash equivalents... 10,062 (3,501) 8,128 3,846 (2,143)
RATIOS AND OTHER DATA:
Ratio of earnings to fixed charges(2).................. 25:1 41:1 29:1 6.4:1 6.7:1
Percentage of indebtedness to total capitalization..... 8.8% 5.6% 3.4% 22% 56%
Pre-tax interest coverage ratio(3)..................... 105:1 186:1 269:1 22:1 13:1
Return on average common equity........................ NM 36% 18% 27% 33%
Return on average managed receivables(4)............... 1.5% 2.1% 1.6% 2.0% 3.3%
Loans originated or purchased:
Retail loans........................................ $ 90,600 $122,200 $130,200 $148,200 $ 220,900
Wholesale correspondent loans....................... 19,700 206,800 628,200
-------- -------- -------- -------- ----------
Total(5)....................................... $ 90,600 $122,200 $149,900 $355,000 $ 849,100
======== ======== ======== ======== ==========
Loans pooled and sold in the secondary
market.............................................. $ 11,000 $ 52,500 $106,800 $316,600 $ 791,300
Loans serviced (period end)............................ $204,600 $262,100 $381,800 $608,700 $1,250,407
Weighted average commission rate on retail loan
originations(6)..................................... 13.0% 14.0% 12.0% 9.4% 7.7%
Weighted average interest rate(6)...................... 12.7% 11.2% 10.3% 11.6% 11.5%
Weighted average initial combined loan-to-value
ratio(6)(7):
Retail loans........................................ 53% 51% 52% 55% 60%
Wholesale correspondent loans....................... NM NM NM 65% 66%
Number of retail loan offices (period end)............. 21 24 27 32 48
</TABLE>
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<PAGE> 26
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JUNE 30,
------------------------------------------------------
1992 1993 1994 1995 1996
-------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
ASSET QUALITY DATA:
Delinquent loans to loans serviced (period
end)(8)(9).......................................... 18% 16% 16% 12% 16%
Number of loans foreclosed............................. 69 137 215 159 221
Dollar amount of loans foreclosed as a percentage of
average loans serviced.............................. 1.2% 2.4% 3.0% 1.2% 1.2%
Net losses as a percentage of average amount
outstanding......................................... NM NM NM .03% .10%
</TABLE>
<TABLE>
<CAPTION>
AT JUNE 30,
------------------------------------------------------
1992 1993 1994 1995 1996
-------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............................. $ 11,886 $ 8,385 $ 16,513 $ 20,359 $ 18,216
Excess Spread Receivables(10).......................... 2,544 7,555 18,780 56,960 184,691
Total assets........................................... 18,927 21,307 53,344 114,623 293,997
10.5% Senior Notes due 2002............................ 23,000 23,000
5.5% Convertible Subordinated Debentures due 2006...... 115,000
Other long-term debt................................... 1,177 944 1,104 144 45
-------- -------- -------- -------- ----------
Total long-term debt........................... 1,177 944 1,104 23,144 138,045
Stockholders' equity................................... 12,136 15,850 31,669 80,047 110,170
</TABLE>
- ---------------
(1) Prior to December 1991, the Company was operated as an S Corporation for
federal tax purposes and consequently was not responsible for federal
income taxes.
(2) Amounts represent the ratio of (i) the sum of income before income taxes
plus interest expense to (ii) interest expense.
(3) Amounts represent the ratio of (i) the sum of income before income taxes
plus interest expense on funded debt to (ii) interest expense on funded
debt.
(4) Represents net income divided by the average servicing portfolio for the
fiscal year.
(5) Does not include loans originated or purchased by One Stop during fiscal
1996 in the aggregate amount of $320 million.
(6) Computed on loans originated or purchased, as the case may be, during the
period.
(7) The weighted average combined loan-to-value ratio of a loan secured by a
first mortgage is determined by dividing the amount of the loan by the
appraised value of the mortgaged property at origination. The weighted
average combined loan-to-value ratio of loans secured by a junior mortgage
is determined by taking the sum of the loans secured by the junior and all
senior mortgages and dividing by the appraised value of the mortgaged
property at origination.
(8) Does not include loans for which only the servicing rights were purchased
by the Company. Delinquent loans are loans for which more than one payment
is past due and include properties acquired by the Company following
foreclosure sale and still serviced by the Company at period end.
(9) At June 30, 1996, the dollar volume of loans delinquent more than 90 days
in the Company's four real estate mortgage investment conduit ("REMIC")
trusts formed during the period from December 1994 to September 1995
exceeded the permitted limit in the related pooling and servicing
agreements. The higher delinquency rates could result in the termination of
the Company's normal servicing rights with respect to the loans in these
trusts, although to date no servicing rights have been terminated,
negatively affect the Company's cash flows and adversely influence the
Company's assumptions underlying the excess servicing gain (see "Risk
Factors -- Delinquencies; Negative Impact on Cash Flow; Right to Terminate
Normal Servicing").
(10) Represents the sum of excess servicing receivable and residual assets, and
at June 30, 1996, mortgage servicing rights. See Note 1 to Consolidated
Financial Statements.
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<PAGE> 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following analysis of the financial condition of the Company should be
read in conjunction with the preceding Selected Consolidated Financial Data and
the Company's Consolidated Financial Statements and the Notes thereto and the
other financial data included or incorporated by reference elsewhere in this
Prospectus Supplement.
OVERVIEW
The Company, founded in 1954, is a consumer finance company engaged in the
business of originating, purchasing, selling and servicing home equity mortgage
loans secured by single family residences. The Company's principal market is
credit-impaired borrowers who have significant equity in their homes but whose
borrowing needs are not being met by traditional financial institutions due to
credit exceptions or other factors. The Company focuses its efforts on
collateral lending and believes that it originates a greater proportion of lower
credit grade loans ("C-" and "D" loans) than most other lenders to
credit-impaired borrowers. These lower credit grade loans are characterized by
lower combined loan-to-value ratios and higher average interest rates than the
higher credit grade loans ("A-," "B" and "C" loans). The Company believes lower
credit-quality borrowers represent an underserved niche of the home equity loan
market and present an opportunity to earn a superior return for the risks
assumed. Although the Company has historically experienced delinquency rates
that are higher than those prevailing in its industry, management believes the
Company's historical loan losses are generally lower than those experienced by
most other lenders to credit-impaired borrowers because of the lower combined
loan-to-value ratios on the Company's lower credit grade loans. The mortgage
loans originated and purchased by the Company are generally used by borrowers to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes. Consequently, the Company believes that it is not as dependent
as traditional mortgage bankers on levels of home sales or refinancing activity
prevailing in its markets.
The Company originates and purchases loans through three production
channels. The Company has historically originated its loans through its retail
loan office network. In 1994, the Company diversified its production channels to
include a wholesale correspondent program which consisted initially of
purchasing loans from other mortgage bankers and financial institutions
underwritten in accordance with the Company's guidelines. In fiscal 1996, this
program was expanded to include the purchase of loans in bulk from mortgage
bankers and other financial institutions. On August 28, 1996, the Company
acquired One Stop which further diversified the Company's production channels to
include the origination and purchase of mortgage loans from a network of
independent mortgage brokers. While the Company intends to continue focusing on
its traditional niche in the "C-" and "D" credit grade loans, the Company also
intends to continue to diversify loan originations and purchases through its
three production channels to include more "A-," "B" and "C" credit grade loans.
The Company underwrites every loan it originates and re-underwrites and reviews
appraisals on all loans it purchases. See "Business -- Mortgage Loan
Production -- Underwriting."
The Company has experienced significant growth in the last three years.
Management believes that this growth is primarily attributable to (i) the
Company's geographic expansion of its retail loan office network from 21 offices
in California at July 1, 1993 to 50 offices located in 17 states at August 31,
1996, (ii) the commencement of the Company's wholesale correspondent program in
fiscal 1994, which was expanded in fiscal 1996 to include purchases of loans in
bulk, (iii) the Company's ability to complete increasingly large mortgage loan
securitizations on a quarterly basis, (iv) the Company's increased access to
warehouse and other credit facilities over this period, and (v) the Company's
ability to effect additional debt and equity financings over this period, which
in the aggregate raised net proceeds of approximately $134 million and $52.4
million, respectively. The Company has managed its growth by employing
experienced senior management, regularly monitoring its underwriting guidelines
and strengthening quality control procedures.
The acquisition of One Stop was accomplished through the merger of a
wholly-owned subsidiary of the Company into One Stop, in a tax-free exchange
accounted for as a pooling-of-interests, in which the Company issued
approximately 2.3 million shares of its Common Stock and assumed options granted
to key employees
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to purchase approximately 375,000 shares of its Common Stock. Under the pooling
rules, the historical financial results of the Company will be restated to
reflect the combination and to reflect the historical losses of One Stop.
Further, under the pooling rules, the costs incurred by the Company and One Stop
in consummating the acquisition will be expensed during the first quarter of
fiscal 1997. See "-- One-Time Charges."
ONE-TIME CHARGES
Because of several one-time charges, the Company expects to incur a net
loss for the quarter ended September 30, 1996. As a result of, and subsequent
to, the acquisition of One Stop, One Stop's credit facilities with an investment
bank were terminated and, as a consequence, the Company will accrue a pre-tax
write-off of approximately $23 million (approximately $15 million on an
after-tax basis) in prepaid financing costs capitalized by One Stop,
representing the fair market value of a warrant for 25% of the equity of One
Stop granted to the investment bank in connection with entering into those
credit facilities. However, the $15 million charge will be less than the
additions to the Company's consolidated stockholders' equity of $23.3 million
resulting from the acquisition of One Stop. Further, because the acquisition of
One Stop is to be accounted for as a pooling-of-interests, all merger costs,
which are expected to aggregate approximately $2 million, will be expensed in
the first quarter of fiscal 1997. In addition, in August 1996, the Company
entered into a lease for new corporate offices, prior to the expiration of the
lease for its existing headquarters. As a consequence, the Company will incur a
pre-tax charge of approximately $2 million in the first quarter of fiscal 1997.
RESULTS OF OPERATIONS -- FISCAL YEARS 1994, 1995 AND 1996
The following table sets forth information regarding the components of the
Company's revenue in fiscal 1994, 1995 and 1996:
<TABLE>
<CAPTION>
1994 1995 1996
--------------------- --------------------- ----------------------
DOLLARS PERCENTAGE DOLLARS PERCENTAGE DOLLARS PERCENTAGE
------- ---------- ------- ---------- -------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Excess servicing gain......... $ 8,101 22.3% $22,954 41.7% $ 78,274 61.0%
Commissions................... 16,432 45.3 15,799 28.8 19,880 15.4
Loan service:
Servicing spread.............. 2,778 7.7 4,399 8.0 12,666 9.9
Prepayment fees............... 1,866 5.2 1,974 3.6 3,228 2.5
Late charges and other
servicing fees............. 1,455 4.0 1,873 3.4 2,291 1.8
Fees and other:
Closing....................... 1,626 4.5 2,077 3.8 2,512 2.0
Appraisal..................... 893 2.5 988 1.8 1,167 0.9
Underwriting.................. 833 2.3 1,091 2.0 1,600 1.2
Interest income............... 771 2.1 2,339 4.3 5,850 4.6
Other......................... 1,472 4.1 1,445 2.6 940 0.7
------ ---- ------ ---- ------ ----
Total revenue......... $36,227 100.0% $54,939 100.0% $128,408 100.0%
====== ==== ====== ==== ====== ====
Expenses:
Compensation and related
expenses................... $13,616 37.6% $17,610 32.1% $ 33,241 25.9%
Sales and advertising costs... 7,891 21.8 9,906 18.0 18,362 14.3
General and administrative
expenses................... 5,415 15.0 7,067 12.9 13,926 10.8
Interest expense.............. 322 0.9 3,205 5.8 9,348 7.3
------ ---- ------ ---- ------ ----
Total expenses........ 27,244 75.3 37,788 68.8 74,877 58.3
------ ---- ------ ---- ------ ----
Income before income taxes.... 8,983 24.7 17,151 31.2 53,531 41.7
Income taxes.................. 3,684 10.2 7,117 13.0 22,483 17.5
------ ---- ------ ---- ------ ----
Net income............ $ 5,299 14.5% $10,034 18.2% $ 31,048 24.2%
====== ==== ====== ==== ====== ====
</TABLE>
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<PAGE> 29
REVENUE
Total revenue for fiscal 1996 increased $73.5 million, or 134%, over total
revenue for fiscal 1995 which, in turn, increased $18.7 million, or 52%, over
total revenue in fiscal 1994. These increases in total revenue were primarily
the result of higher excess servicing gain and loan service revenue resulting
from increased volumes of mortgage loans originated and purchased by the Company
and securitized and sold. The Company originated and purchased $150 million,
$355 million and $849 million of mortgage loans during fiscal 1994, 1995 and
1996, respectively.
In a securitization, the Company recognizes a gain on the sale of loans
securitized upon the closing of the securitization, but does not receive the
excess servicing, which is payable over the actual life of the loans
securitized. The excess servicing represents, over the estimated life of the
loans, the excess of the weighted average interest rate on the pool of loans
sold over the sum of the investor pass-through rate, normal servicing fee and
the monoline insurance fee. The net present value of that excess (determined
based on certain prepayment and loss assumptions) less transaction expenses is
recorded as excess servicing gain or loss at the time of the closing of the
securitization. Excess servicing gain increased by $55.3 million, or 241%, in
fiscal 1996 compared to fiscal 1995 and $14.9 million, or 183%, in fiscal 1995
compared to fiscal 1994. These increases resulted primarily from the greater
size of the mortgage loan pools securitized and sold by the Company in the
secondary market and, in fiscal 1996, increased servicing spreads and the
recognition of mortgage servicing rights pursuant to SFAS 122 in the amount of
$11.8 million (see "-- Certain Accounting Considerations"). The Company
securitized and sold $107 million, $317 million and $791 million of loans in the
secondary market during fiscal 1994, 1995 and 1996, respectively. The weighted
average servicing spread on loans securitized and sold during these periods was
3.91%, 3.91% and 4.93% for fiscal 1994, 1995 and 1996, respectively. The higher
weighted average servicing spread in 1996 reflected a decrease in pass-through
rates to investors and a change in product mix. In the future, the Company
expects to realize a lower percentage of excess servicing gain on the sale of
loans as a result of changes in assumptions to reflect the changing composition
of the Company's loan product mix and other factors.
Commissions earned on loan originations continue to be a significant
component of total revenue, although to a lesser degree than in prior years,
comprising 45%, 29% and 15% of total revenue in fiscal 1994, 1995 and 1996
respectively. Commissions increased $4.1 million, or 26%, in fiscal 1996
compared to fiscal 1995, and decreased $633,000, or 3.9%, in fiscal year 1995
compared to fiscal 1994. Commission revenue is primarily a function of the
volume of mortgage loans originated by the Company through its retail loan
office network and the weighted average commission rate charged on such loans.
The increase in commissions in fiscal year 1996 was a result of increased
origination volume, offsetting a decline in weighted average commission rate.
The decrease in commissions in fiscal year 1995 was due to a reduction in the
weighted average commission rate, partially offset by an increase in the dollar
amount of loans originated. The weighted average commission rate was 11.6 %,
9.4% and 7.7% during fiscal 1994, 1995 and 1996, respectively. The lower
weighted average commission rate in 1996 reflected competitive factors, and the
increase of higher credit grade loans originated through the Company's retail
loan office network. Commissions do not include $722,000 and $1.0 million of
commissions on loans which were held for sale as of June 30, 1995 and 1996,
respectively.
Loan service revenue increased $9.9 million, or 121%, in fiscal 1996
compared to fiscal 1995 and $2.1 million, or 35%, in fiscal 1995 compared to
fiscal 1994. Loan service revenue consists of net servicing spread earned on the
principal balances of the loans in the Company's loan servicing portfolio,
prepayment fees, late charges and other fees retained by the Company in
connection with the servicing of loans. The increases in fiscal 1996 and 1995
were due primarily to the greater size of the portfolio of loans serviced in
each of these periods. The Company's loan servicing portfolio increased to $1.25
billion at June 30, 1996, up 105% from the June 30, 1995 balance of $609 million
which, in turn, increased 59% over the June 30, 1994 balance.
Fees and other revenue increased by $4.1 million, or 52%, in fiscal 1996
compared to fiscal 1995 and increased $2.3 million, or 42%, in fiscal 1995
compared to fiscal 1994. Fees and other revenue consist of fees received by the
Company through its retail loan office network in the form of closing,
appraisal, underwriting
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<PAGE> 30
and other fees, plus interest income. The dollar amount of these fees increased
in each of the years presented due to the larger number of mortgage loans
originated through the Company's retail loan office network during the
respective periods. Interest income increased in fiscal 1996 and 1995 due to
interest earned on larger amounts of loans held by the Company during the period
from origination or purchase of the loans until the date sold by the Company.
EXPENSES
Compensation and related expenses increased $15.6 million, or 89%, in
fiscal 1996 compared to fiscal 1995 as a result of increased compensation paid
to senior management ($4.2 million) as well as the addition of new personnel.
For primarily the same reasons, compensation and related expenses increased by
$4.0 million, or 29%, in fiscal 1995 compared to fiscal 1994. Compensation and
related expenses as a percentage of total revenues were 38%, 32% and 26% for
fiscal 1994, 1995 and 1996, respectively. The Company anticipates that
compensation expense will increase in fiscal 1997 as a result of a full year's
compensation to be paid to members of senior management who joined the Company
in the latter half of fiscal 1996, as well as the addition in fiscal 1997 of One
Stop's senior management and other personnel.
Sales and advertising costs increased $8.5 million, or 85%, in fiscal 1996
compared to fiscal 1995 and $2.0 million, or 26%, in fiscal 1995 compared to
fiscal 1994, due primarily to the Company's nationwide expansion of its retail
loan office network. Sales and advertising costs as a percentage of total
revenue were 22%, 18% and 14% for fiscal 1994, 1995, and 1996, respectively.
General and administrative expenses increased $6.9 million, or 97%, in
fiscal 1996 compared to fiscal 1995 and decreased to 11% from 13% of revenue for
the same periods. General and administrative expenses increased by $1.7 million,
or 31%, in fiscal 1995 compared to fiscal 1994, a decrease to 13% from 15% of
revenue for the same periods. The dollar increases were primarily the result of
occupancy and communications costs related to the expansion of the Company's
retail loan office network (an increase of $3.7 million in 1996 when compared to
1995 and $592,000 in 1995 when compared to 1994), and equipment rental expense
(an increase of $956,000 in 1996 when compared to 1995 and $10,000 in 1995 when
compared with 1994). The increase in equipment rental expense in 1996 was
primarily attributable to an airplane lease entered into in February 1996.
Interest expense increased to $9.3 million in fiscal 1996 compared to $3.2
million in fiscal 1995 and $322,000 in fiscal 1994 primarily as a result of
increased borrowings under various financing arrangements used to fund the
origination and purchase of mortgage loans prior to their securitization and
sale in the secondary market. Interest expense is expected to increase in future
periods due to the Company's continued reliance on warehousing facilities to
fund increased originations and purchases of loans pending their securitization,
and as a result of the Company's sale in the third quarter of fiscal 1996 of
$115 million of its 5.5% Convertible Subordinated Debentures due 2006.
INCOME TAXES
The Company's provision for income taxes increased to $22.5 million in
fiscal 1996 from $7.1 million in fiscal 1995 and $3.7 million in fiscal 1994
primarily as a result of increased pre-tax income.
FINANCIAL CONDITION
Loans held for sale. Prior to securitization, the Company holds mortgage
loans in its portfolio. Due to the increased volume of loan originations and
purchases, the Company's portfolio of loans held for sale increased to $67.3
million at June 30, 1996 from $24.1 million at June 30, 1995.
Accounts receivable. Accounts receivable representing servicing fees and
advances, increased by $2.5 million from $6.1 million at June 30, 1995 to $8.6
million at June 30, 1996. This increase was primarily due to the increased size
of the servicing portfolio.
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<PAGE> 31
Excess servicing receivable. Excess servicing receivable, increased $87.0
million from $42.1 million at June 30, 1995 to $129 million at June 30, 1996
reflecting the increased size of the Company's securitizations during 1996.
Mortgage servicing rights. The June 30, 1996 balance includes $10.9
million of mortgage servicing rights capitalized in accordance with SFAS No.
122. This balance reflects the capitalization under SFAS No. 122 of $11.8
million of servicing rights partially offset by amortization of $857,000 during
fiscal 1996. See "-- Certain Accounting Considerations."
Residual assets. Residual assets represent the reserve accounts and
overcollateralization amounts required to be maintained in connection with the
securitization of loans. Residual assets include cash and mortgage loans in
excess of the principal amounts of the senior certificates of the REMIC trusts.
Residual assets increased $29.8 million from $14.9 million at June 30, 1995 to
$44.7 million at June 30, 1996.
Equipment and improvements. Primarily as a result of the expansion of the
Company's retail loan office network and the associated investment in
technology, equipment and improvements, net increased $3.5 million from $2.1
million at June 30, 1995 to $5.6 million at June 30, 1996.
Prepaid and other assets. Prepaid and other assets increased $4.6 million
from $5.0 million at June 30, 1995 to $9.6 million at June 30, 1996. The
increase was primarily related to prepaid financing costs incurred in connection
with the issuance of $115 million of 5.5% Convertible Subordinated Debentures
due 2006 in the third quarter of fiscal 1996 and, to a lesser extent, to prepaid
advertising costs.
Revolving warehouse facilities. Amounts outstanding under warehouse
facilities increased by $11.0 million from a zero balance at June 30, 1995 to an
$11.0 million balance at June 30, 1996 primarily as a result of the larger
amount of loans held for sale at such dates.
Borrowings. Notes payable increased by $115 million from $23.1 million at
June 30, 1995 to $138 million at June 30, 1996 primarily as a result of the
issuance in the third quarter of fiscal 1996 of $115 million of 5.5% Convertible
Subordinated Debentures due 2006.
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<PAGE> 32
LIQUIDITY
The table below summarizes cash flow generated by and used in operating
activities:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
-----------------------------------
1994 1995 1996
-------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING CASH INCOME:
Excess cash flows generated by securitization trusts.... $ 3,482 $ 7,984 $ 29,932
Less cash required to be invested in residual
assets(1)............................................ (4,228) (8,691) (29,794)
-------- -------- ---------
Net excess cash flow from securitization trusts......... (746) (707) 138
Other servicing fees.................................... 5,310 4,664 6,049
Interest received....................................... 771 2,339 6,397
Commission income....................................... 16,432 15,799 19,880
Other cash income....................................... 4,825 5,601 5,372
-------- -------- ---------
Total operating cash income............................. 26,592 27,696 37,836
OPERATING CASH EXPENSES:
Securitization and loan acquisition costs............... (1,589) (10,937) (37,317)
Cash operating expenses................................. (26,779) (36,377) (69,304)
Taxes paid.............................................. (2,991) (5,196) (4,240)
Interest paid........................................... (805) (2,415)
-------- -------- ---------
Total operating cash expenses........................... (31,359) (53,315) (113,276)
-------- -------- ---------
Net operating cash flow................................. (4,767) (25,619) (75,440)
Cash (used in) provided by other payables and
receivables.......................................... 875 (3,765) (3,598)
Cash used in loans held for sale........................ (9,965) (13,991) (43,195)
-------- -------- ---------
Net cash used in operating activities................... $(13,857) $(43,375) $(122,233)
======== ======== =========
Change in Excess Spread Receivables(2).................. $ 11,225 $ 38,180 $ 127,731
Net cash provided by financing activities............... $ 22,855 $ 48,209 $ 124,687
</TABLE>
- ---------------
(1) Cash required to fund initial and required overcollateralization account
balances.
(2) Represents the change in the sum of excess servicing receivables and
residual assets, and at June 30, 1996, mortgage servicing rights. See Note 1
to Consolidated Financial Statements.
The Company's operations require continued access to short-term and
long-term sources of cash. The Company's operating cash requirements include the
funding of: (i) mortgage loan originations and purchases prior to their
securitization and sale, (ii) fees and expenses incurred in connection with the
securitization and sale of loans, (iii) cash reserve account or
overcollateralization requirements in connection with the securitization and
sale of mortgage loans, (iv) tax payments due on recognition of excess servicing
gain, and (v) ongoing administrative and other operating expenses.
The Company has operated on a negative operating cash flow basis and
expects to continue to do so for as long as the Company's cash requirements
necessitated by the growth in volume of its securitization program continue to
grow at rates in excess of the cash generated by the Company from its
operations, including its servicing activities. Historically, the Company has
funded, and expects to continue to fund, these negative operating cash flows,
subject to limitations under the Company's existing credit facilities,
principally through borrowings from financial institutions, sales of equity
securities and sales of senior and subordinated notes, among other sources.
There can be no assurance that the Company will have access to the capital
markets in the future or that financing will be available to satisfy the
Company's operating and debt service requirements or to fund its future growth.
See "-- Capital Resources" and "Business -- Business Strategy."
New loan originations and purchases represent the Company's most
significant cash flow requirement. The Company pays a premium on loans purchased
through its wholesale correspondent program and on loans
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<PAGE> 33
purchased from independent mortgage brokers. The amount of cash used to pay
premiums approximated $33.7 million in 1996.
The Company securitized and sold in the secondary market $107 million, $317
million and $791 million of loans in fiscal 1994, 1995 and 1996, respectively.
In connection with securitization transactions completed during these periods,
the Company was required to provide credit enhancements in the form of reserve
accounts or overcollateralization amounts. In addition, during the life of the
related REMIC trusts, the Company subordinates a portion of the excess servicing
otherwise due it to the rights of holders of senior interests as a credit
enhancement to support the sale of the senior interests. In connection with
securitizations effected in fiscal 1994, 1995 and 1996, initial reserve accounts
or overcollateralization requirements were set at $2.2 million, $3.5 million and
$7.5 million, respectively. The terms of the REMIC trusts generally require that
all excess servicing otherwise payable to the Company during the early months of
the trusts be used to increase the cash reserve accounts, or to repay the senior
interests in order to increase overcollateralization to specified maximums. The
accumulated amounts of such cash reserve accounts and overcollateralization
amounts are reflected on the Company's balance sheet as "residual assets." At
June 30, 1996, the residual assets balance was $44.7 million.
In addition, the increasing use of securitization transactions as a funding
source by the Company has resulted in a significant increase in the amount of
excess servicing gain recognized by the Company. During fiscal 1994, 1995 and
1996, the Company recognized excess servicing gain in the amounts of $8.1
million, $23.0 million and $78.3 million, respectively. The recognition of
excess servicing gain has a negative impact on the cash flow of the Company
since the Company is required to pay federal and state taxes on a portion of
these amounts in the period recognized although it does not receive the cash
representing the gain until later periods as the related service fees are
collected and applicable reserve or overcollateralization requirements are met.
The Company also incurs certain expenses in connection with
securitizations, including underwriting fees, credit enhancement fees, trustee
fees, hedging and other costs, which in fiscal 1996 approximated 1.0% of the
principal amount of the securitized mortgage loans.
CAPITAL RESOURCES
The Company finances it operating cash requirements primarily through (i)
warehouse and other credit facilities, (ii) the securitization and sale of
mortgage loans, and (iii) the issuance of debt and equity securities.
Warehouse and Other Credit Facilities. At August 31, 1996, the Company had
four warehouse and one other credit facility in place. There is a $150 million
warehouse and working capital line of credit from a syndicate of six commercial
banks that is secured by loans originated and purchased by the Company as well
as certain servicing receivables, which bears interest at the rate of 0.875%
over one-month LIBOR. This line currently expires on December 24, 1996 and is
subject to renewal. There are two additional warehouse lines of credit from two
investment banks that are secured by loans originated and purchased by the
Company. These lines of $150 million and $125 million bear interest at the rate
of 0.875% over one-month LIBOR and are subject to renewal periodically. The $150
million line expires on January 1, 1997 and the $125 million line expires on
September 30, 1996. The Company also has a $250 million warehouse line of credit
with another investment bank that is secured by loans originated and purchased
by One Stop. This line bears interest at the rate of 1.1% over one-month LIBOR
and expires on September 27, 1996. Finally, the Company has a $50.0 million
credit facility from an investment bank that is secured by certain excess
servicing receivables in certificated form. Until February 1997 this is a
revolving facility that bears interest at the rate of 2.5% over one-month LIBOR;
during the amortizing term thereafter until August 1999, it bears interest at
the rate of 4.5% over one-month LIBOR. See "Underwriting." Management expects,
although there can be no assurance, that the Company will be able to maintain
these or similar facilities in the future. See "Risk Factors -- Dependence on
Funding Sources -- Dependence on Warehouse and Other Credit Facilities" and
"Underwriting."
Securitization Program. The Company's most important capital resource has
been its ability to sell loans originated and purchased by it in the secondary
market in order to generate cash proceeds to pay down its warehouse facilities
and fund new originations and purchases. The value of and market for the
Company's loans are dependent upon a number of factors, including general
economic conditions, interest rates and governmental
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<PAGE> 34
regulations. Adverse changes in such factors may affect the Company's ability to
securitize and sell loans for acceptable prices within a reasonable period of
time. The ability of the Company to sell loans in the secondary market on
acceptable terms is essential for the continuation of the Company's loan
origination and purchase operations. A reduction in the size of the secondary
market for loans of the types originated or purchased by the Company may
adversely affect the Company's ability to sell loans in the secondary market
with a consequent adverse impact on the Company's profitability and ability to
fund future originations and purchases. See "Risk Factors -- Dependence on
Funding Sources -- Dependence on Securitization Program."
In addition, in order to gain access to the secondary market, the Company
has relied on monoline insurance companies to provide financial guarantee
insurance on senior interests in the REMIC trusts established by the Company.
The Company has not structured a pool for securitization and sale in the
secondary market based solely on the internal credit enhancements of the pool or
the Company's guaranties. Any substantial reduction in the size or availability
of the secondary market for the Company's loans or the unwillingness of monoline
insurance companies to provide financial guarantee insurance for the senior
interests in the REMIC trusts could have a material adverse effect on the
Company's financial position and results of operations. At June 30, 1996, the
dollar volume of loans delinquent more than 90 days on the Company's four REMIC
trusts formed during the period from December 1994 to September 1995 exceeded
the permitted limit in the related pooling and servicing agreements. The higher
delinquency rates could result in the termination of the Company's normal
servicing rights with respect to the loans in these trusts, although to date no
servicing rights have been terminated, negatively affect the Company's cash
flows and adversely influence the Company's assumptions underlying the excess
servicing gain. See "Risk Factors -- Delinquencies; Negative Impact on Cash
Flow; Right to Terminate Normal Servicing."
Other Capital Resources. The Company has funded negative cash flows
primarily from the sale of its equity and debt securities. In December 1991,
July 1993, and June 1995, the Company effected offerings of its Common Stock
with net proceeds to the Company aggregating $61.1 million. In March 1995, the
Company completed an offering of its 10.5% Senior Notes due 2002 with net
proceeds to the Company of $22.2 million. In February 1996, the Company
completed an offering of its 5.5% Convertible Subordinated Debentures due 2006
with net proceeds to the Company of $112 million.
The Company had cash and cash equivalents of approximately $18.2 million
(of which $2.2 million was restricted) at June 30, 1996. However, the Company
expects to continue its growth strategies. Consequently, assuming that this
offering and the Concurrent Offering are not consummated, the Company
anticipates that it will need to arrange for additional cash resources prior to
the third quarter of fiscal 1997 through additional debt or equity financing,
additional bank borrowings or restructuring its securitization program. If this
offering and the Concurrent Offering are consummated, the Company anticipates
that its sources of liquidity are expected to be sufficient to fund the
Company's liquidity requirements for at least the next 12 months, if the
Company's future operations are consistent with management's current growth
expectations. The Company has no commitments for additional bank borrowings or
additional debt or equity financing and there can be no assurance that the
Company will be successful in consummating any such financing transaction in the
future on terms the Company would consider to be favorable. See "Risk
Factors -- Ability to Service Debt; Negative Cash Flows and Capital Needs."
RISK MANAGEMENT
The Company employs a variety of strategies in order to manage the risk
that mortgage loans held for sale pending securitization will fluctuate in value
as a result of changing interest rates prevailing in the market. The Company
hedges against interest rate fluctuations by selling United States Treasury
securities not yet purchased. The amount and timing of hedging transactions are
determined by members of the Company's senior management. Management assesses
factors including the interest rate environment, loan production levels and open
positions of current hedging positions. The Company has also mitigated its
interest rate exposure by effecting securitizations once each quarter resulting
in a holding period for most of the mortgage loans originated and purchased by
it of less than one quarter.
The Company also mitigates its exposure to interest rate risk through a
pre-funding strategy in which it agrees to sell loans to the REMIC trust in the
future at an agreed-upon price. The pre-funding locks in the price agreed upon
with investors on the pricing date (typically five business days prior to the
closing date of the securitization)
S-34
<PAGE> 35
for a period of generally 30 days. In a pre-funding arrangement, the Company
typically delivers approximately 75% of the loans sold at the closing and the
remainder generally within 30 days after the closing.
CERTAIN ACCOUNTING CONSIDERATIONS
As a fundamental part of its business and financing strategy, the Company
sells substantially all of its mortgage loans through securitizations. In a
securitization, the Company recognizes a gain on the sale of loans securitized
upon the closing of the securitization, but does not receive the cash
representing such gain until it receives the excess servicing, which is payable
over the actual life of the loans securitized. The cash purchase price is raised
through an offering of pass-through certificates by the trust. Following the
securitization, the purchasers of the pass-through certificates receive the
principal collected. The excess servicing represents, over the estimated life of
the loans, the excess of the weighted average interest rate on each pool of
loans sold over the sum of the pass-through interest rate, a normal servicing
fee and the fees of the monoline insurance carrier. The net present value of
that excess (based on certain prepayment and loss assumptions) less transaction
expenses is recorded as excess servicing gain or loss when the loan is
securitized and sold. The excess servicing receivable included in the
Consolidated Financial Statements represents these amounts reduced by direct
transaction costs. The excess servicing receivable is amortized in proportion to
and over the expected lives of the related loans.
The Company's excess servicing receivable is amortized over the estimated
remaining life of the underlying loans as an offset against the excess servicing
component of servicing income actually received in connection with such loans.
If actual prepayments with respect to sold loans occur faster or credit
experience is worse than projected at the time such loans were sold, the
carrying value of the excess servicing receivable may have to be written down
through a charge to earnings in the period of adjustment. For the three years
ended June 30, 1996, there were no material adjustments to the Company's
carrying value of the excess servicing receivable as a result of actual
prepayment experience. However, there can be no assurance of the accuracy of
management's prepayment estimates. If actual prepayments with respect to sold
loans in the secondary market or funded by private investors were to exceed
management's estimates materially, the carrying value of the excess servicing
receivable would be written down through a charge to earnings in the period of
adjustment.
Effective fiscal 1996, the Company adopted SFAS 122 which requires that
upon sale or securitization of servicing retained mortgages, companies
capitalize the cost associated with the right to service mortgage loans based on
their relative fair value. The Company determines fair value based on the
present value of estimated net future cash flows related to servicing income.
The cost allocated to the servicing rights is amortized in proportion to and
over the period of estimated net future servicing fee income. The Company
periodically reviews capitalized servicing fees receivable for valuation
impairment. This review is performed on a disaggregated basis for the
predominant risk characteristics of the underlying loans which are loan type,
term and credit quality. The Company generally makes loans to credit-impaired
borrowers whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions and other factors. Impairment is
recognized in valuation allowance for each disaggregated stratum in the period
of impairment. The effect of adopting SFAS 122 was to increase the net income of
the Company as reported in the Company's Consolidated Financial Statements for
fiscal 1996 by $5.7 million or $0.37 per weighted average share.
In May 1993, the FASB released SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan" ("SFAS 114"). SFAS 114 was amended by SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures" ("SFAS 118") released in October 1994. The Company adopted SFAS 114
in fiscal 1996. As the Company generally sells its loans within a relatively
short period, the adoption of SFAS 114, as amended by SFAS 118, did not have a
material impact on the Company's financial position or results of operations.
In October 1995, the FASB released SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). This statement establishes methods of
accounting for stock-based compensation plans. SFAS 123 is effective for fiscal
years beginning after December 15, 1995. The Company expects to continue to
apply Accounting Principles Board Opinion 25 for measurement of stock
compensation and will provide the disclosure required by SFAS 123 beginning in
fiscal year 1997. The adoption of SFAS 123 is not expected to have a material
effect on the financial position of the Company.
S-35
<PAGE> 36
BUSINESS
GENERAL
The Company, founded in 1954, is a consumer finance company engaged in the
business of originating, purchasing, selling and servicing home equity mortgage
loans secured by single family residences. The Company's principal market is
credit-impaired borrowers who have significant equity in their homes but whose
borrowing needs are not being met by traditional financial institutions due to
credit exceptions or other factors. The Company focuses its efforts on
collateral lending and believes that it originates and purchases a greater
proportion of lower credit grade loans ("C-" and "D" loans) than most other
lenders to credit-impaired borrowers. These lower credit grade loans are
characterized by lower combined loan-to-value ratios and higher average interest
rates than higher credit grade loans ("A-," "B" and "C" loans). The Company
believes lower credit-quality borrowers represent an underserved niche of the
home equity loan market and present an opportunity to earn a superior return for
the risks assumed. Although the Company has historically experienced delinquency
rates that are higher than those prevailing in its industry, management believes
the Company's historical loan losses are generally lower than those experienced
by most other lenders to credit-impaired borrowers because of the lower combined
loan-to-value ratios on the Company's lower credit grade loans. The mortgage
loans originated and purchased by the Company are generally used by borrowers to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes. Consequently, the Company believes that it is not as dependent
as traditional mortgage bankers on levels of home sales or refinancing activity
prevailing in its markets.
The Company originates and purchases loans through three production
channels. The Company has historically originated its loans through its retail
loan office network. In 1994, the Company diversified its production channels to
include a wholesale correspondent program which consisted initially of
purchasing loans from other mortgage bankers and financial institutions
underwritten in accordance with the Company's guidelines. In fiscal 1996, this
program was expanded to include the purchase of loans in bulk from other
mortgage bankers and financial institutions. On August 28, 1996, the Company
acquired One Stop, which further diversified the Company's production channels
to include the origination and purchase of mortgage loans from a network of
independent mortgage brokers. While the Company intends to continue focusing on
its traditional niche in the "C-" and "D" credit grade loans, the Company also
intends to continue to diversify the loans it originates and purchases through
its three production channels to include more "A-," "B" and "C" credit grade
loans. The Company underwrites every loan it originates and re-underwrites and
reviews appraisals on all loans it purchases. See "-- Mortgage Loan
Production -- Underwriting."
Substantially all of the mortgage loans originated and purchased by the
Company are sold in the secondary market through public securitizations in order
to enhance profitability, maximize liquidity and reduce the Company's exposure
to fluctuations in interest rates. In a securitization, the Company recognizes a
gain on the sale of loans securitized upon the closing of the securitization,
but does not receive the excess servicing, which is payable over the actual life
of the loans securitized. The excess servicing represents, over the estimated
life of the loans, the excess of the weighted average interest rate on the pool
of loans sold over the sum of the investor pass-through rate, normal servicing
fee and the monoline insurance fee. The net present value of that excess
(determined based on certain prepayment and loss assumptions) less transaction
expenses is recorded as excess servicing gain or loss at the time of the closing
of the securitization. The Company securitized and sold in the secondary market
$107 million, $317 million and $791 million of loans in the years ended June 30,
1994, 1995 and 1996, respectively. Each of the Company's securitizations has
been credit-enhanced by insurance provided by a monoline insurance company to
receive ratings of "Aaa" by Moody's Investors Service and "AAA" from Standard &
Poor's.
The Company retains the servicing rights (collecting loan payments and
handling borrower defaults) to substantially all of the loans it originates or
purchases. At June 30, 1996, the Company had a servicing portfolio of $1.25
billion, 27% of which was serviced by subservicers. In fiscal 1996, the Company
serviced directly all loans in its servicing portfolio which were secured by
mortgaged properties located in Arizona, California, Colorado, Nevada, Oregon,
Utah and Washington. Loans secured by properties located in other states were
serviced through one or more subservicers which were paid a fee per loan and a
participation in
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<PAGE> 37
certain other fees paid by the borrowers. The Company will implement in fiscal
1997 a new servicing system which will provide the Company the capability to
service in house all loans originated or purchased by it regardless of the state
in which the mortgaged property is located. See "-- Loan Servicing."
BUSINESS STRATEGY
The Company's strategy is to continue to build on its position as a leading
lender to credit-impaired borrowers. The expansion of the Company's business
over the last three years has been driven by the growth in the volume of loans
originated and purchased by the Company and by the Company's ability to continue
to access the capital markets to facilitate the sale of these loans through
securitizations. The Company intends to pursue its growth strategy by (i)
continuing to expand its retail loan office network, wholesale correspondent
program and independent broker network, (ii) increasing its servicing portfolio
and servicing capabilities, (iii) continuing to enhance its corporate and
operating infrastructure and (iv) diversifying its funding sources. An important
long-term goal of the Company's business strategy is to continue to build its
excess servicing receivable, mortgage servicing rights and residual assets. The
Company believes that its investments in these assets yield attractive cash on
cash returns. In addition, the Company believes its cash flow profile will
change over time as the rate of loan production growth moderates and as the size
of its servicing portfolio and its Excess Spread Receivables increase. In
particular, the Company intends to employ the following strategies:
Geographic Diversification. The Company plans to continue the
geographic expansion of its loan production. During fiscal 1996, the
Company expanded its retail loan office network into the Midwest and East
and continued to expand its wholesale correspondent network. The Company
intends to continue focusing on its expansion in the Midwest and East and
to expand its loan purchasing capabilities by building new relationships
with loan correspondents and, with the acquisition of One Stop, independent
mortgage brokers nationwide with the goal of increasing market share in
these areas.
Diversification of Loan Production Channels. At the beginning of
fiscal 1994, the Company originated virtually all of its mortgage loans
through its retail loan office network. Since that time, the Company has
been pursuing a strategy of diversifying its loan production. The Company
has developed a wholesale correspondent program and has recently added a
network of independent brokers as a production source when it acquired One
Stop. The Company intends to increase production through each of these
channels and to diversify the loans it originates and purchases to include
more "A-," "B" and "C" credit grade loans.
Increase Servicing Portfolio; Increase Margins and Develop
Subservicing Capabilities. The Company plans to build the size of its
servicing portfolio to provide a stable, and ultimately a significant,
source of recurring revenue. On June 30, 1996, the Company's servicing
portfolio was $1.25 billion, up 105% from $609 million at the end of the
prior year. The Company expects to increase the size of its loan servicing
portfolio by continuing to increase loan originations and purchases and
completing new securitizations. To service this greater volume and to
provide the Company with the capability of servicing its entire portfolio,
the Company is investing in a new servicing system which is expected to be
on line prior to the end of fiscal 1997. This new operation is expected to
increase margins in the Company's servicing operations and to provide the
Company with the capability of subservicing for other mortgage bankers, a
potential new revenue source.
Continue to Enhance Corporate and Operational Management and
Infrastructure. From June 30, 1994 to June 30, 1996, the Company's
revenues and net income grew 255% and 485%, respectively, and its employee
base grew from 303 employees at June 30, 1994 to 672 employees at June 30,
1996. To support this significantly larger operation, the Company has
invested in additional corporate and operating management and
infrastructure. The Company has also expanded its telemarketing operations,
including a predictive dialer system which is expected to be fully
operational in fall 1996.
Continue to Diversify Funding Sources. The Company intends to
continue to expand and diversify its funding sources by adding additional
warehouse and residual financing facilities and seeking to increase the
advance rates on existing and new facilities. In addition, the Company
intends to obtain
S-37
<PAGE> 38
higher credit ratings by improving its financial condition and operating
results. The Company believes that higher credit ratings, as well as
obtaining higher advance rates on warehouse and residual facilities, should
improve the Company's cash flow over time. In particular, higher credit
ratings could facilitate the Company's use of letters of credit in lieu of
cash in overcollateralization accounts, and the Company's obtaining debt
financing at a lower cost. In addition, the Company intends to improve its
liquidity by exploring alternatives, including: (i) whole loan sales, (ii)
monetization of the excess servicing receivable asset (including sale of
interest-only strips), and (iii) use of senior/subordinated securitization
structures which may be more cash flow efficient than buying monoline
insurance. The Company also believes it will improve its cash flow by
improving the efficiency of its servicing operations and realizing overall
operating leverage over time as cash expenses grow at a slower rate than
cash receipts.
MORTGAGE LOAN PRODUCTION
The Company's principal loan product is a non-conforming home equity loan
with a fixed principal amount and term to maturity which is typically secured by
a first mortgage on the borrower's residence with either a fixed or adjustable
rate. Non-conforming home equity loans are loans made to homeowners whose
borrowing needs may not be met by traditional financial institutions due to
credit exceptions or other factors and that cannot be marketed to agencies such
as Ginnie Mae, Fannie Mae and Freddie Mac. In addition, the Company offers
junior mortgages and other products in order to meet a wide variety of borrower
needs. In fiscal 1996, the Company obtained its loans through two primary
channels: its retail loan office network, through which loans are originated by
the Company out of its 50 retail loan offices located in 17 states, and its
wholesale correspondent program, through which loans are purchased from mortgage
bankers and other financial institutions. With the acquisition of One Stop on
August 28, 1996, the Company expanded its loan production channels to include a
network of independent mortgage brokers, from which loans are submitted to One
Stop for funding or purchase.
The following table illustrates the sources of the Company's loan
production, excluding loans originated or purchased by One Stop during fiscal
1996 in the aggregate amount of $320 million:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
----------------------------------
1994 1995 1996
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Retail loans:
Total dollar amount...................................... $130,200 $148,200 $220,900
Number of loans.......................................... 3,373 3,734 4,792
Average loan amount...................................... $ 38.6 $ 39.7 $ 46.0
Average initial combined loan to value................... 52% 55% 60%
Weighted average interest rate........................... 10.3% 11.8% 11.0%
Wholesale correspondent program:
Total dollar amount...................................... $ 19,700 $206,800 $628,200
Number of loans.......................................... 265 2,314 7,166
Average loan amount...................................... $ 74.3 $ 89.4 $ 87.7
Average initial combined loan to value................... NM 65% 66%
Weighted average interest rate........................... NM 11.4% 11.7%
Total loans:
Total dollar amount...................................... $149,900 $355,000 $849,100
Number of loans.......................................... 3,638 6,048 11,958
Average loan amount...................................... $ 41.2 $ 58.7 $ 71.0
Average initial combined loan to value................... 52% 61% 64%
Weighted average interest rate........................... 10.3% 11.6% 11.5%
</TABLE>
Retail Loan Office Network. The Company originates home equity mortgage
loans through its network of retail loan offices which, at August 31, 1996,
consisted of 50 retail loan offices located in 17 states. The Company is
aggressively pursuing a strategy of expanding its retail loan office network
beyond the 36 offices
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<PAGE> 39
located in California and the other Western states. Of the Company's 50 retail
loan offices, seven are located in the Midwest and seven are located along the
East coast. The Company believes that it has significant additional expansion
opportunities in these and other areas.
The Company selects areas in which to introduce or expand its retail
presence on the basis of selected demographic statistics, marketing analyses and
other criteria developed by the Company. Typically, new office locations have
become profitable within 90 days of opening.
The Company's expansion of its retail loan office network has resulted in
significant increases in retail loan production over the last three fiscal
years. The Company originated $130 million, $148 million and $221 million of
mortgage loans through this network in fiscal 1994, 1995 and 1996, respectively.
The Company generates applications for loans through its retail loan office
network principally through a multimedia advertising program, which includes the
use of direct mailings to homeowners, radio and television advertising,
yellow-page listings and telemarketing. The Company believes that its
advertising campaigns establish name recognition and serve to distinguish the
Company from its competitors. The Company continually monitors the sources of
its applications to determine the most effective methods and manner of
advertising.
The Company's advertising invites prospective borrowers to call its
headquarters office through the Company's toll-free telephone numbers. On the
basis of an initial screening conducted at the time of the call, the Company's
customer service representative makes a preliminary determination of whether the
customer and the property meet the Company's lending criteria, schedules an
appointment with an appraiser and refers the customer to the most conveniently
located retail loan office.
The Company's loan officer at the local retail loan office assists the
applicant in completing the loan application, orders a credit report from an
independent, nationally recognized credit reporting agency and performs various
other tasks in connection with the completion of the loan package. The loan
package is then forwarded to the Company's headquarters office for review by
underwriters and for loan approval. If the loan package is approved, the loan is
funded by the Company. The Company's loan officers are trained to structure
loans that meet the applicant's needs, while satisfying the Company's lending
guidelines. If an applicant does not meet the guidelines for the loan applied
for, a different loan that may also serve the applicant's needs is usually
suggested.
Through its retail loan office network, the Company also takes applications
from prospective borrowers who respond to the Company's advertising but fall
outside the Company's target market. These loans may be brokered to other
institutional lenders or to private investors. In these cases, the Company
receives brokerage commissions on loans actually funded.
Wholesale Correspondent Program. The Company purchases closed loans from
mortgage bankers and other financial institutions on a continuous or "flow"
basis and through bulk purchases. In fiscal 1996, 74% of the Company's loan
production came from these sources. The Company believes that its wholesale
correspondent program represents a cost effective means of increasing loan
production. Although the Company purchases mortgage loans from a variety of
sources, one correspondent represented approximately 32% of total mortgage loans
purchased in fiscal 1996.
Independent Broker Network. On August 28, 1996, the Company acquired One
Stop, and thereby expanded its mortgage loan production sources to include a
network of independent mortgage brokers. Under this program, the independent
mortgage broker identifies the potential applicant, assists the applicant in
completing the loan application and submits the application with the other
documents constituting the completed loan package to One Stop for underwriting
and loan approval. Prior to its acquisition by the Company, a substantial
portion of the loans originated or purchased by One Stop were "A-," "B," or "C"
loans. Beginning in September 1996, One Stop intends to increase the percentage
of "C-" and "D" loans it originates and purchases. All loans originated by One
Stop are underwritten in accordance with the Company's underwriting guidelines.
Once approved, the loan is funded or purchased by One Stop directly.
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<PAGE> 40
Consistent underwriting, quick response times and personal service are
critical to successfully producing loans through independent mortgage brokers.
To meet these requirements, One Stop operates out of 24 offices to service the
needs of the independent brokers and loan applicants. One Stop strives to
provide quick response time to the loan application (generally within 24 hours).
In addition, loan consultants and loan processors are available in the offices
to answer questions, assist in the loan application process and facilitate the
ultimate funding of the loan.
Underwriting. The Company underwrites every loan it originates and
re-underwrites each loan it purchases, in each case, either utilizing its staff
consisting at August 31, 1996 of 157 full-time appraisers, or a
Company-qualified contract appraiser. The Company's underwriting guidelines are
designed to assess the adequacy of the real property as collateral for the loan
and the borrower's creditworthiness. An assessment of the adequacy of the real
property as collateral for the loan is primarily based upon an appraisal of the
property and a calculation of the ratio (the "combined loan-to-value ratio") of
all mortgages existing on the property (including the loan applied for) to the
appraised value of the property at the time of origination. As a lender that
specializes in loans made to credit-impaired borrowers, the Company ordinarily
makes home equity mortgage loans to borrowers with credit histories or other
factors that would typically disqualify them from consideration for a loan from
traditional financial institutions. Consequently, the Company's underwriting
guidelines generally require substantially lower combined loan-to-value ratios
than would typically be the case if the borrower could qualify for a loan from a
traditional financial institution. Creditworthiness is assessed by examination
of a number of factors, including calculation of debt-to-income ratios, which is
the sum of the borrower's normal monthly expenses divided by the borrowers's
monthly income before taxes and other payroll deductions, an examination of the
borrower's credit history through standard credit reporting bureaus, and by
evaluating the borrower's payment history with respect to existing mortgages, if
any, on the property.
The underwriting of a mortgage loan to be originated or purchased by the
Company includes a review of the completed loan package, which includes the loan
application, a current appraisal, a preliminary title report and a credit
report. All loan applications and all closed loans offered to the Company for
purchase must be approved by the Company in accordance with its underwriting
criteria. On an exception basis, and approval of the Company's underwriters,
home equity mortgage loans may be made that do not conform to the Company's
guidelines but only with the approval of a senior underwriter or by an executive
officer of the Company. The Company regularly reviews its underwriting
guidelines and makes changes when appropriate to respond to market conditions,
because of the poor performance of loans representing a particular loan product
or to respond to changes in laws or regulations. In September 1996, the Company
changed its underwriting guidelines to eliminate one loan purchase product known
as the "no documentation -- salaried employee" loan product in the "C-" and "D"
credit grades because of what management believed to be the higher than average
delinquency rates experienced on such loans, raised the maximum combined
loan-to-value ratios for its "A-" credit grade loans to conform to market
conditions and lowered the combined loan-to-value ratios for its "C-" and "D"
credit grade loans made in certain judicial foreclosure states in recognition of
the greater length of time it takes in such states to complete the foreclosure
process.
All appraisals in connection with loans originated by the Company through
its retail loan office network are performed by Company appraisers. The
Company's appraisers determine a property's value by reference to the sales
prices of comparable properties recently sold, adjusted to reflect the condition
of the property as determined through inspection. Loans purchased as part of the
Company's wholesale correspondent program are reviewed by Company appraisers or
Company-qualified contract appraisers, to assure that they meet the Company's
standards. All of the Company's appraisers are full-time employees of the
Company and compensated by salary and a bonus that is not dependent on
completion of loan transactions.
The Company requires title insurance coverage issued on an ALTA form of
title insurance on all properties securing mortgage loans it originates or
purchases. The loan originator and its assignees are generally named as the
insured. Title insurance policies indicate the lien position of the mortgage
loan and protect the Company against loss if the title or lien position is not
as indicated. The applicant is also required to maintain hazard and, in certain
instances, flood insurance, in an amount sufficient to cover the new loan and
any senior mortgage, subject to the maximum amount available under the National
Flood Insurance Program.
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<PAGE> 41
Quality Control. The Company's quality control program is intended to (i)
monitor and improve the overall quality of loan production generated by the
Company's retail loan office network and its wholesale correspondent program or
loans presented or purchased from its independent broker network and (ii)
identify and communicate to management existing or potential underwriting and
loan packaging problems or areas of concern. The quality control file review
examines compliance with the Company's underwriting guidelines and federal and
state regulations. This is accomplished by focusing on: (i) the accuracy of all
credit and legal information; (ii) a collateral analysis which may include a
desk or field re-appraisal of the property and review of the original appraisal;
(iii) employment and/or income verification; and (iv) legal document review to
ensure that the necessary documents are in place.
Credit Grades. The Company believes that it originates a greater
proportion of lower credit quality loans ("C-" and "D" loans) than other lenders
who lend to credit-impaired borrowers and as a result has historically
experienced delinquency rates that are higher than those generally prevailing in
its industry. However, the Company has not historically experienced significant
loan losses because its loan portfolio has been characterized by relatively low
combined loan-to-value ratios. The weighted average initial combined
loan-to-value ratio of loans in its servicing portfolio at June 30, 1994, 1995
and 1996 was 56%, 59% and 63%, respectively. The increase in the weighted
average combined loan-to-value ratio at June 30, 1996 reflected a changing mix
in the mortgage loans in the servicing portfolio to include a greater proportion
of first mortgages and higher credit grade loans.
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<PAGE> 42
The following chart generally outlines certain parameters of the credit
grades of the Company's underwriting guidelines at September 10, 1996:
<TABLE>
<CAPTION>
"A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE
- ------------------------ ----------------- ----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
GENERAL Has good credit Pays the majority Marginal credit Marginal credit Designed to
REPAYMENT but might have of accounts on history which is history not provide a
some minor time but has some offset by other offset by other borrower with
delinquency. 30- and/or 60-day positive positive poor credit
delinquency. attributes. attributes. history an
opportunity to
correct past
credit problems
through lower
monthly payments.
- ------------------------------------------------------------------------------------------------------------------
EXISTING Current at Current at Can have multiple Must be paid in Must be paid from
MORTGAGE application time application time 30-day full from loan loan proceeds.
LOANS and a maximum of and a maximum of delinquencies and proceeds and no Rating not a
two 30-day four 30-day one 60-day more than 120 factor.
delinquencies in delinquencies in delinquency and days delinquent.
the past 12 the past 12 one 90-day
months. months. delinquency in
the past 12
months; currently
not more than 90
days delinquent.
- ------------------------------------------------------------------------------------------------------------------
NON-MORTGAGE Major credit and Major credit and Major credit and Major and minor Major credit
CREDIT installment debt installment debt installment debt credit delinquency is
should be current can exhibit some can exhibit some delinquency is acceptable.
but may exhibit minor 30- and/or minor 60- and/or acceptable, but
some minor 30-day 60-day 90-day must demonstrate
delinquency. delinquency. delinquency. some payment
regularity.
Minor credit may Minor credit may Minor credit may
exhibit some exhibit up to 90- exhibit more
minor day delinquency. serious
delinquency. delinquency.
- ------------------------------------------------------------------------------------------------------------------
BANKRUPTCY Charge-offs, Discharged more Discharged more Discharged prior Current
FILINGS judgments, liens, than two years than two years to closing. bankruptcy must
and former with with be paid through
bankruptcies are reestablished reestablished loan.
unacceptable. credit. credit.
- ------------------------------------------------------------------------------------------------------------------
DEBT SERVICE-TO- Generally not to Generally not to Generally not to Generally not to Generally not to
INCOME RATIO exceed 45%. exceed 50%. exceed 50%. exceed 55%. exceed 60%.
- ------------------------------------------------------------------------------------------------------------------
MAXIMUM COMBINED
LOAN-TO-
VALUE RATIO:
OWNER Generally 85% for Generally 80% for Generally 70% for Generally 65% for Generally 65% for
OCCUPIED a 1 to 4 family a 1 to 4 family a 1 to 4 family a 1 to 4 family a 1 to 4 family
dwelling; 70% for dwelling; 65% for dwelling; 65% for dwelling. dwelling.
a condominium. a condominium. a condominium.
NON-OWNER Generally 70% for Generally 65% for Generally 65% for N/A N/A
OCCUPIED a 1 to 2 family a 1 to 2 family a 1 to 2 family
dwelling; 65% for dwelling; 60% for dwelling; 60% for
a 3 to 4 family. a 3 to 4 family. a 3 to 4 family.
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 43
The following tables present certain information on the Company's loan
originations through its retail loan office network and loan purchases through
its wholesale correspondent program during fiscal 1995 and fiscal 1996:
LOAN ORIGINATIONS AND PURCHASES IN FISCAL 1995
<TABLE>
<CAPTION>
DOLLAR
AMOUNT PERCENT OF WEIGHTED AVERAGE COMBINED WEIGHTED AVERAGE
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE(1)
- ------------ ------------ ----------- ------------------------- ----------------
<S> <C> <C> <C> <C>
A- $111,808,000 31% 63% 10.6%
B 55,338,000 16 65 11.1
C 70,515,000 20 59 11.7
C- 53,635,000 15 62 12.2
D 63,629,000 18 58 13.3
------------ ---- --- ---- -
Total $354,925,000 100% 61 11.6
============ ====
</TABLE>
LOAN ORIGINATIONS AND PURCHASES IN FISCAL 1996
<TABLE>
<CAPTION>
DOLLAR
AMOUNT PERCENT OF WEIGHTED AVERAGE COMBINED WEIGHTED AVERAGE
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE(1)
- ------------ ------------ ----------- ------------------------- ----------------
<S> <C> <C> <C> <C>
A- $224,943,000 27% 68% 10.2%
B 143,700,000 17 68 10.6
C 139,329,000 16 63 11.5
C- 106,067,000 12 63 12.1
D 235,018,000 28 61 13.1
------------ ---- --- ---- -
Total $849,057,000 100% 65 11.5
============ ====
</TABLE>
- ---------------
(1) Calculated with respect to the interest rate at the time the loan is
originated or purchased by the Company, as applicable.
SECURITIZATION OF LOANS
The primary funding strategy of the Company is to securitize and sell
mortgage loans originated or purchased by the Company. Securitization is a cost
competitive source of capital compared to other debt financing sources available
to the Company. Through June 30, 1996, the Company had completed 17
securitizations totaling $1.3 billion. The Company's operations have been
restructured in recent years specifically for the purpose of efficiently
originating, purchasing, underwriting and servicing loans for securitization in
order to meet the requirements of rating agencies, credit enhancers and
investors. The Company generally seeks to complete a securitization once each
quarter. The Company applies the net proceeds of the securitization to pay down
its warehouse facilities in order to make these facilities available for future
funding of mortgage loans.
In a securitization, the Company sells the loans that it has purchased or
originated to a real estate mortgage investment conduit ("REMIC") trust for a
cash purchase price and an interest in the loans securitized (in the form of
"excess servicing"). The cash purchase price is raised through an offering of
senior pass-through certificates by the trust. Following the securitization, the
purchasers of the senior certificates receive the principal collected and the
investor pass-through interest rate on the certificate balance, while the
Company receives the excess servicing. The excess servicing is typically a
certificated security in the form of a residual certificate, which generally
represents the excess servicing on the loans. The excess servicing represents,
over the estimated life of the loans, the excess of the weighted average
interest rate on the pool of loans sold over the sum of the investor pass
through rate, normal servicing fee and the monoline insurance fee. The net
present value of that excess (determined based on certain prepayment and loss
assumptions) less transaction expenses is recorded as excess servicing gain or
loss at the time of the closing of the securitization.
The purchasers of the senior certificates receive a credit-enhanced
security. The Company's securitizations have been enhanced generally through two
sources: (i) subordination of an amount of excess servicing
S-43
<PAGE> 44
retained by the Company and (ii) an insurance policy provided by an
AAA/Aaa-rated monoline insurance company. As a result, each offering of senior
certificates receives ratings of AAA from Standard & Poor's and Aaa from Moody's
Investors Service.
Each pooling and servicing agreement that the Company has entered into in
connection with its securitizations requires either the establishment of a
reserve account that may initially be funded by cash deposited by the Company or
the overcollateralization of the REMIC trust. The Company's interest in each
overcollateralization amount and reserve account is reflected on the Company's
Consolidated Financial Statements as "residual assets." If payment defaults
exceed the amount of the overcollateralization or the reserve account, as
applicable, the monoline insurance company policy will pay any further losses
experienced by holders of the senior interests in the related REMIC trust. To
date, there have been no claims on any monoline insurance company policy
obtained in any of the Company's securitizations.
In connection with its securitizations, the Company typically enters into
an agreement pursuant to which it agrees to sell loans to the trust in the
future at an agreed-upon price (the "pre-funding"). The pre-funding locks in the
price agreed upon with investors on the pricing date (typically five business
days prior to the closing date of the securitization) for a period of generally
30 days. In a pre-funding arrangement, the Company typically delivers
approximately 75% of the loans sold at the closing and the remainder generally
within 30 days after the closing.
LOAN SERVICING
Servicing includes collecting and remitting loan payments, accounting for
principal and interest, contacting delinquent borrowers, handling borrower
defaults and liquidating foreclosed properties. The Company retains the
servicing rights to substantially all of the loans it originates or purchases.
The following table sets forth certain information regarding the Company's
servicing portfolio for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
------------------------------------
1994 1995 1996
-------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Loans added to the servicing portfolio............ $149,900 $355,000 $ 849,100
Servicing portfolio (period end).................. 381,800 608,700 1,250,407
Loan service revenue (1).......................... 6,099 8,246 18,185
</TABLE>
- ---------------
(1) For a description of loan service revenue, see Note 1 to Consolidated
Financial Statements.
In fiscal 1996 the Company directly serviced all loans in its servicing
portfolio which were secured by mortgaged properties located in Arizona,
California, Colorado, Nevada, Oregon, Utah and Washington. Loans secured by
properties located in other states were serviced through one or more
subservicers which were paid a fee per loan and a participation in certain other
fees paid by the borrowers. The Company is in the process of implementing a new
servicing system which will provide the Company the capability to service
in-house all loans originated or purchased by it regardless of the state in
which the mortgaged property is located. This new servicing system is expected
to be implemented in fiscal 1997. The Company's new servicing system will also
provide the Company the capability of subservicing on behalf of other mortgage
lenders. The Company intends to offer this service in fiscal 1998. The Company
believes that the successful implementation of its new servicing system will
provide it with improved margins on its servicing and potentially a new source
of servicing revenue.
The pooling and servicing agreements between the Company and the REMIC
trusts established in connection with securitizations typically require the
Company to advance interest (but not principal) on delinquent loans to the
holders of the senior interests in the related REMIC trust to the extent the
Company deems such advances of interest to be ultimately recoverable. No
advances are made for interest if the Company deems that the advances are not
ultimately recoverable and no advances are made for payments of principal.
Realized losses on the loans are paid out of the related reserve account or paid
out of principal and interest payments on overcollateralized amounts as
applicable, and if necessary, from the related monoline insurance company
policy.
S-44
<PAGE> 45
The pooling and servicing agreements also typically provide that the
Company may be terminated as servicer by the monoline insurance company which
insures the senior interests in the related REMIC trust (or by the trustee with
the consent of the monoline insurance company) upon certain events of default,
including the Company's failure to perform its obligations under the pooling and
servicing agreement, the rate of over 90-day delinquency (including properties
acquired on foreclosure and not sold) exceeding specified limits, losses on
foreclosure exceeding certain limits, any payment being made by the monoline
insurance company under its policy, and certain events of bankruptcy or
insolvency. Serviced loans subject to such agreements represented approximately
84% (by dollar volume) of the Company's servicing portfolio at June 30, 1996. At
June 30, 1996, four REMIC trusts representing approximately 23% (by dollar
volume) of the Company's servicing portfolio exceeded the foregoing delinquency
rate, although the servicing rights of the Company have not been terminated. See
"Risk Factors -- Delinquencies; Negative Impact on Cash Flow; Right to Terminate
Normal Servicing."
The Company receives a servicing fee based on a percentage of the declining
principal balance of each loan serviced. Servicing fees are collected by the
Company out of the borrower's monthly payments. In addition, the Company, as
servicer, generally receives all late and assumption charges paid by the
borrower, as well as other miscellaneous fees for performing various loan
servicing functions. The Company also generally receives any prepayment fees
paid by borrowers.
The Company's servicing portfolio is subject to reduction by normal monthly
payments, by prepayment and by foreclosure. It is the Company's strategy to
build and retain its servicing portfolio. In general, revenue from the Company's
loan servicing portfolio may be adversely affected as interest rates decline and
loan prepayments increase. This effect has historically been partially offset by
increases in prepayment fee income received from borrowers. In some states in
which the Company currently operates, prepayment fees may be limited or
prohibited by applicable law. In addition, the Company's ability to collect
prepayment fees under certain circumstances will be restricted in future periods
under federal regulations which went into effect in 1995. See "-- Regulation."
The following table illustrates the mix of credit grades in the Company's
servicing portfolio as of June 30, 1996:
<TABLE>
<CAPTION>
DOLLAR AMOUNT % OF WEIGHTED AVERAGE COMBINED WEIGHTED AVERAGE ORIGINAL
CREDIT GRADE OF LOAN TOTAL INITIAL LOAN-TO-VALUE INTEREST RATE
- ------------ -------------- ----- ------------------------- -------------------------
<S> <C> <C> <C> <C>
A- $ 308,901,000 25% 66% 10.4%
B 185,892,000 15 67 10.8
C 192,051,000 15 62 11.6
C- 144,565,000 12 62 12.1
D 291,592,000 23 60 12.9
Other 127,406,000 10 55 12.2
-------------- ---- --- ---- -
Total $1,250,407,000 100% 63 11.6
============== ====
</TABLE>
COLLECTIONS, DELINQUENCIES AND FORECLOSURES
The Company sends borrowers a monthly billing statement ten days prior to
the monthly payment due date. Although borrowers generally make loan payments
within ten to fifteen days after the due date (the "grace period"), if a
borrower fails to pay the monthly payment within the grace period, the Company
commences collection efforts by notifying the borrower of the delinquency. (In
the case of borrowers in the "C-" and "D" credit grades, collection efforts
begin approximately six days after the due date.) If the loan remains unpaid,
the Company will contact the borrower to determine the cause of the delinquency
and to obtain a commitment to cure the delinquency at the earliest possible
time.
As a general matter, if efforts to obtain payment have not been successful,
a pre-foreclosure notice will be sent to the borrower shortly after the due date
of the next subsequently scheduled installment, providing 30 days' notice of
impending foreclosure action. During the 30-day notice period, collection
efforts continue. However, if no substantial progress has been made in
collecting delinquent payments from the borrower,
S-45
<PAGE> 46
foreclosure proceedings will begin. Generally, the Company will have commenced
foreclosure proceedings when a loan is 45 to 60 days delinquent.
Servicing and collection practices change over time in accordance with,
among other things, the Company's business judgment, changes in portfolio
performance and applicable laws and regulations.
Loans originated or purchased by the Company are secured by mortgages,
deeds of trust, security deeds or deeds to secure debt, depending upon the
prevailing practice in the state in which the property securing the loan is
located. Depending on local law, foreclosure is effected by judicial action or
nonjudicial sale, and is subject to various notice and filing requirements. In
general, the borrower, or any person having a junior encumbrance on the real
estate, may cure a monetary default by paying the entire amount in arrears plus
other designated costs and expenses incurred in enforcing the obligation during
a statutorily prescribed reinstatement period. Generally, state law controls the
amount of foreclosure expenses and costs, including attorneys' fees, which may
be recovered by a lender. After the reinstatement period has expired without the
default having been cured, the borrower or junior lienholder no longer has the
right to reinstate the loan and must pay the loan in full to prevent the
scheduled foreclosure sale.
Although foreclosure sales are typically public sales, frequently no
third-party purchaser bids in excess of the lender's lien because of the
difficulty of determining the exact status of title to the property, the
possible deterioration of the property during the foreclosure proceedings and a
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus, the Company often purchases the property from the trustee or
referee for an amount equal to the principal amount outstanding under the loan,
accrued and unpaid interest and the expenses of foreclosure. Depending upon
market conditions, the ultimate proceeds of the sale may not equal the Company's
investment in the property.
The following table sets forth delinquency and foreclosure experience of
loans originated and/or purchased included in the Company's servicing portfolio
for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
------------------------------
1994 1995 1996
------- ------ -------
<S> <C> <C> <C>
Percentage of dollar amount of delinquent loans to
loans serviced (period end)(1)(2)(3).................
One month............................................ 3.8% 3.9% 4.9%
Two months........................................... 1.6 1.5 1.8
Three or more months(3):
Not foreclosed(4)................................. 6.7 5.0 8.0
Foreclosed........................................ 3.6 1.5 1.0
---- ---- ----
Total........................................ 15.7% 11.9% 15.7%
---- ---- ----
---- ---- ----
Percentage of dollar amount of loans foreclosed to
loans serviced (period end)(2)....................... 3.0% 1.2% 1.2%
Number of loans foreclosed............................. 215 159 221
Principal amount at time of foreclosure of foreclosed
loans
(in thousands)....................................... $11,528 $6,675 $14,349
</TABLE>
- ---------------
(1) Delinquent loans are loans for which more than one payment is due.
(2) The delinquency and foreclosure percentages are calculated on the basis of
the total dollar amount of mortgage loans originated or purchased by the
Company and, in each case, serviced by the Company, or the Company and any
subservicers, as applicable, as of the end of the periods indicated.
(3) At June 30, 1996, the dollar volume of loans delinquent more than 90 days in
the Company's four REMIC trusts formed during the period from December 1994
to September 1995 exceeded the permitted limit in the related pooling and
servicing agreements. The higher delinquency rates could result in the
termination of the Company's normal servicing rights with respect to the
loans in these trusts, although to date no servicing rights have been
terminated, negatively affect the Company's cash flows and adversely
influence the Company's assumptions underlying the excess servicing gain
(see "Risk Factors -- Delinquencies; Negative Impact on Cash Flow; Right to
Terminate Normal Servicing").
(4) Represents loans which are in foreclosure but as to which foreclosure
proceedings have not concluded.
S-46
<PAGE> 47
The Company's servicing portfolio has grown over the periods presented.
However, because foreclosures and losses typically occur months or years after a
loan is originated, data relating to delinquencies, foreclosures and losses as a
percentage of the current portfolio can understate the risk of future
delinquencies, losses or foreclosures.
COMPETITION
In addition to competing with other consumer finance lenders, mortgage
bankers and mortgage brokers, the Company competes with financial institutions
that have substantially greater financial resources than the Company. Although
some traditional financial institutions are aggressively promoting and pricing
home equity loans and attempting to increase the percentage of their portfolios
consisting of consumer real estate loans, the Company does not believe that
these trends have had a material impact on its competitive position. The Company
competes by emphasizing customer service on a timely basis to attract borrowers
whose needs are not generally met by traditional financial institutions and by
placing a greater emphasis on the equity value of the property securing the
loan. Nevertheless, there can be no assurance that the Company will not face
increased competition from such institutions. Further, a number of the Company's
competitors have recently increased their access to the capital markets, which
helps foster their growth and therefore increases competition.
REGULATION
The operations of the Company are subject to extensive regulation,
supervision and licensing by federal, state and local government authorities.
Regulated matters include, without limitation, loan origination, credit
activities, maximum interest rates and finance and other charges, disclosure to
customers, the terms of secured transactions, the collection, repossession and
claims-handling procedures utilized by the Company, multiple qualification and
licensing requirements for doing business in various jurisdictions and other
trade practices.
The Company's loan origination activities are subject to the laws and
regulations in each of the states in which those activities are conducted. The
Company's activities as a lender are also subject to various federal laws
including, among others, the Truth in Lending Act ("TILA"), the Real Estate
Settlement Procedures Act, the Equal Credit Opportunity Act of 1974, as amended
("ECOA"), the Home Mortgage Disclosure Act and the Fair Credit Reporting Act of
1970, as amended ("FCRA").
TILA and Regulation Z promulgated thereunder contain disclosure
requirements designed to provide consumers with uniform, understandable
information with respect to the terms and conditions of loans and credit
transactions in order to give them the ability to compare credit terms. TILA
also guaranties consumers a three-day right to cancel certain credit
transactions including loans of the type originated by the Company. Management
of the Company believes that it is in compliance with TILA in all material
respects.
In September 1994, the Riegle Community Development and Regulatory
Improvement Act of 1994 (the "Riegle Act") was enacted. Among other things, the
Riegle Act made certain amendments to TILA. The TILA Amendments, which became
effective in October 1995, generally apply to mortgage loans with (i) total
points and fees upon origination in excess of the greater of eight percent of
the loan amount or $400 or (ii) an annual percentage rate of more than ten
percentage points higher than comparably maturing U.S. Treasury securities.
Loans covered by the TILA Amendments are known as "Section 32 Loans."
The TILA Amendments impose additional disclosure requirements on lenders
originating Section 32 Loans and prohibit lenders from originating Section 32
Loans that are underwritten solely on the basis of the borrower's home equity
without regard to the borrower's ability to repay the loan. In accordance with
TILA Amendments, the Company applies underwriting criteria that take into
consideration the borrower's ability to repay to all Section 32 Loans.
The TILA Amendments also prohibit lenders from including prepayment fee
clauses in Section 32 Loans to borrowers with a debt-to-income ratio in excess
of 50%. In addition, a lender that refinances a Section 32 Loan previously made
by such lender will not be able to enforce any prepayment penalty clause
contained in such refinanced loan. The Company reported $1.9 million, $2.0
million and $3.2 million in prepayment fee revenue in fiscal 1994, 1995 and
1996, respectively. The Company will continue to collect prepayment fees on
loans originated prior to the effectiveness of the TILA Amendments and on
non-Section 32 Loans as well as on Section 32 Loans in permitted circumstances
following the effectiveness of the TILA Amendments. The
S-47
<PAGE> 48
TILA Amendments impose other restrictions on Section 32 Loans, including
restrictions on balloon payments and negative amortization features, which the
Company does not believe will have a material impact on its operations.
The Company is also required to comply with the ECOA, which prohibits
creditors from discriminating against applicants on the basis of race, color,
sex, age or marital status. Regulation B promulgated under ECOA restricts
creditors from obtaining certain types of information from loan applicants. It
also requires certain disclosures by the lender regarding consumer rights and
requires lenders to advise applicants of the reasons for any credit denial. In
instances where the applicant is denied credit or the rate or charge for a loan
increases as a result of information obtained from a consumer credit agency,
another statute, the FCRA requires the lender to supply the applicant with a
name and address of the reporting agency. The Company is also subject to the
Real Estate Settlement Procedures Act and is required to file an annual report
with the Department of Housing and Urban Development pursuant to the Home
Mortgage Disclosure Act.
In the course of its business, the Company may acquire properties as a
result of foreclosure. There is a risk that hazardous or toxic waste could be
found on such properties. In such event, the Company could be held responsible
for the cost of cleaning up or removing such waste, and such cost could exceed
the value of the underlying properties.
The Company is also subject to various other federal and state laws
regulating the issuance and sale of securities, relationships with entities
regulated by the Employee Retirement Income Security Act of 1974, as amended,
and other aspects of its business.
The laws, rules and regulations applicable to the Company are subject to
regular modification and change. There are currently proposed various laws,
rules and regulations which, if adopted, could impact the Company. There can be
no assurance that these proposed laws, rules and regulations, or other such
laws, rules or regulations, will not be adopted in the future which could make
compliance much more difficult or expensive, restrict the Company's ability to
originate, purchase, broker or sell loans, further limit or restrict the amount
of commissions, interest and other charges earned on loans originated or sold by
the Company, or otherwise adversely affect the business or prospects of the
Company.
EMPLOYEES
At June 30, 1996, the Company employed 672 persons. The Company has
satisfactory relations with its employees.
PROPERTIES
The executive and administrative offices of the Company are located at 3731
Wilshire Boulevard, Los Angeles, California, and consist of approximately
101,000 square feet. The lease on these premises extends through July 31, 2000.
The Company intends to relocate its corporate executive offices to Downtown Los
Angeles in May 1997 under a lease that will expire in May 2007 and intends to
sublease its current facility for the remainder of the term of its lease. The
executive and administrative offices of One Stop are located at 200 Baker
Street, Costa Mesa, California, and consist of approximately 19,544 square feet.
The lease on these premises extends through November 8, 1998.
The Company and One Stop also lease space for their loan offices. These
facilities aggregate approximately 135,000 square feet and are leased under
terms which vary as to duration. In general, the leases expire between 1996 and
2001, and provide for rent escalations tied to either increases in the lessor's
operating expenses or fluctuations in the consumer price index in the relevant
geographical area.
LEGAL PROCEEDINGS
The Company is involved in litigation arising in the normal course of
business. The Company believes that any liability with respect to such legal
actions, individually or in the aggregate, is not likely to be material to the
Company's consolidated financial position or results of operations.
S-48
<PAGE> 49
MANAGEMENT
The following table sets forth certain information as of August 15, 1996
with respect to the current directors and executive officers of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
------------------------------------ --- -----------------------------------------------
<S> <C> <C>
DIRECTORS:
Gary K. Judis....................... 58 Chairman of the Board, Chief Executive Officer
and President
Cary H. Thompson.................... 40 Chief Operating Officer and Director
Gregory J. Witherspoon.............. 49 Executive Vice President, Chief Financial
Officer and Director
Bobbie J. Burroughs................. 58 Executive Vice President, Secretary and
Director
Neil B. Kornswiet................... 39 Executive Vice President and Director
Joseph R. Cerrell................... 60 Director
Dennis Holt......................... 59 Director
Melvyn Kinder, Ph.D................. 58 Director
OTHER EXECUTIVE OFFICERS AND KEY
EMPLOYEES:
Allan B. Polin...................... 66 Executive Vice President -- Loan Administration
Mark E. Elbaum...................... 33 Senior Vice President -- Finance
Mark E. Costello.................... 45 Senior Vice President -- Mortgage Banking
Barbara Polsky...................... 42 Senior Vice President and General Counsel
James F. Gardunio................... 45 Senior Vice President -- Chief Credit Officer
</TABLE>
All officers are appointed by and serve at the discretion of the Board of
Directors.
GARY K. JUDIS is the Chairman of the Board, Chief Executive Officer and
President of the Company. Mr. Judis joined the Company as its President and
Chief Executive Officer in 1979 upon the merger of the Company with Capitol Home
Loan Company, a mortgage brokerage company founded by Mr. Judis in 1966. In
1981, then Governor Jerry Brown appointed Mr. Judis to the special task force on
second trust deed financing. In 1975, Mr. Judis was appointed to Los Angeles
Mayor Tom Bradley's blue ribbon commission on redlining.
CARY H. THOMPSON has served as a Director of the Company since January 1992
and joined the Company as its Chief Operating Officer in March 1996. From May
1994 to March 1996, Mr. Thompson served as Managing Director -- Head of United
States Financial Institutions Group for NatWest Markets. From June 1989 to May
1994, Mr. Thompson was Senior Vice President -- Head of West Coast Financial
Institutions Group for Oppenheimer & Co. Mr. Thompson is also on the Board of
Directors of Fidelity National Financial, Inc., a title insurance company.
GREGORY J. WITHERSPOON is a Certified Public Accountant and has been an
Executive Vice President of the Company since August 1994 and Chief Financial
Officer since 1987. From 1988 to 1994, Mr. Witherspoon served as Senior Vice
President -- Finance and Administration of the Company. Mr. Witherspoon joined
the Company in 1987 as its Controller. From 1984 to 1987, Mr. Witherspoon was an
independent business consultant.
BOBBIE J. BURROUGHS joined the Company in 1959 and has been Secretary of
the Company since 1965. Ms. Burroughs served as a Senior Vice President of the
Company since 1980 and was appointed to the position of Executive Vice President
in 1995. From 1979 to 1980, Ms. Burroughs was a Vice President of the Company
and from 1965 to 1979, she served as the Assistant to the President. From 1962
to 1965, Ms. Burroughs served as the Manager of the Escrow Department of the
Company.
S-49
<PAGE> 50
JOSEPH R. CERRELL has been a Director of the Company since January 1992.
Mr. Cerrell founded and for more than the past five years has been the Chairman
of Cerrell Associates, Inc., a political communications firm, with offices in
Los Angeles, Sacramento and Washington, D.C. Mr. Cerrell is past chairman and
president of the American Association of Political Consultants and a past
president of the International Association of Political Consultants. He is an
Executive Vice President of Palumbo & Cerrell, Inc., a Washington, D.C. public
affairs company, and an adjunct professor at the University of Southern
California's Unruh Institute of Politics and Government.
DENNIS HOLT was elected a Director of the Company in January, 1996. Mr.
Holt founded and is the President and Chief Executive Officer of Western
International Media Corporation, a media management company.
MELVYN KINDER, PH.D. was elected a Director of the Company in August, 1996.
Dr. Kinder is a renowned clinical psychologist recognized for his innovative
work in social, family and professional relations. Dr. Kinder maintains a
private practice in Los Angeles and also serves as co-director of Westbridge
Psychiatric Medical Group in Los Angeles.
NEIL B. KORNSWIET was elected a Director in August 1996. Mr. Kornswiet
founded One Stop Mortgage, Inc. in August 1995 and was its Chairman and
President from September 1995 through its sale to the Company in August 1996.
From 1992 to 1995, Mr. Kornswiet was President of Quality Mortgage, a privately
held mortgage banking company. From 1983 to 1992, Mr. Kornswiet was a lawyer
specializing in consumer credit and other regulatory matters for financial
institutions and mortgage banking companies.
ALLAN B. POLIN joined the Company in 1985 as a Special Assistant to the
Chairman of the Board. Later that year, he became Vice President -- Loan
Administration of Aames Home Loan. In October 1992 he became Senior Vice
President -- Loan Administration of Aames Home Loan and in October 1995, he
became Executive Vice President -- Loan Administration of Aames Home Loan, the
position which he currently holds.
MARK E. ELBAUM is a Certified Public Accountant and joined the Company as
Vice President -- Finance in September of 1992. Mr. Elbaum was made Senior Vice
President -- Finance in October, 1995. From 1985 until joining the Company, Mr.
Elbaum was an auditor with Price Waterhouse LLP, serving as an Audit Manager
since July 1990.
MARK E. COSTELLO joined the Company in March of 1995 as Vice
President -- Mortgage Banking for Aames Capital Corporation and was promoted to
Senior Vice President in October, 1995. Prior to joining Aames, he was Director
of Wholesale Lending for Advanta Mortgage Corporation. From 1980 to 1993, Mr.
Costello was a Vice President with Citibank, New York, in mortgage and related
consumer and wholesale banking disciplines.
BARBARA POLSKY joined the Company in May of 1996 as Senior Vice President
and General Counsel. Prior to joining the Company, Ms. Polsky was a partner in
the law firm of Manatt, Phelps & Phillips, where she specialized in financial
institution and corporate securities matters. From September, 1992 to March,
1994, Ms. Polsky was a partner in the law firm of Hughes Hubbard & Reed.
JAMES F. GARDUNIO joined the Company in August of 1996 as Chief Credit
Officer. From 1994 until joining the Company, Mr. Gardunio was Chief Credit
Officer of Mercantile National Bank. From 1989 to 1994, Mr. Gardunio was Chief
Credit Officer of California Federal Bank. From 1987 to 1989, Mr. Gardunio was a
Senior Credit Officer at Wells Fargo Bank. Prior to the merger of Wells Fargo
Bank and Crocker National Bank, Mr. Gardunio was a Senior Credit Officer at
Crocker National Bank from 1982 to 1987.
S-50
<PAGE> 51
PRINCIPAL STOCKHOLDERS
The following table sets forth as of August 30, 1996, certain information
relating to the ownership of the Company's Common Stock by (i) each person known
by the Company to be the beneficial owner of more than 5% of the outstanding
shares of the Company Common Stock, (ii) each of the Company's directors and
executive officers and (iii) all of the Company's executive officers and
directors as a group. Except as may be indicated in the footnotes to the table
and subject to applicable community property laws, each of such persons has the
sole voting and investment power with respect to the shares owned. Beneficial
ownership has been determined in accordance with Rule 13d-3 under the Exchange
Act. Under this Rule, certain shares may be deemed to be beneficially owned by
more than one person (such as where persons share voting power or investment
power). In addition, shares are deemed to be beneficially owned by a person if
the person has the right to acquire the shares (for example, upon exercise of an
option) within 60 days of the date as of which the information is provided; in
computing the percentage ownership of any person, the amount of shares
outstanding is deemed to include the amount of shares beneficially owned by such
person (and only such person) by reason of these acquisition rights. As a
result, the percentage of outstanding shares of any person as shown in the
following table does not necessarily reflect the person's actual voting power at
any particular date. The address of each individual listed is in care of the
Company, 3731 Wilshire Boulevard, Los Angeles, California 90010.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENT OF CLASS
---------------- ----------------
<S> <C> <C>
Funds and institutional accounts affiliated with FMR Corp. ... 997,050(1) 6.1%
82 Devonshire Street
Boston, MA 02109
Gary K. Judis................................................. 1,345,353(2) 8.5%
Bobbie J. Burroughs........................................... 36,585(3) *
Joseph R. Cerrell............................................. 17,749(4) *
Mark E. Costello.............................................. 1,625(5) *
Mark E. Elbaum................................................ 17,677(6) *
Dennis F. Holt................................................ -- --
Melvyn Kinder................................................. 7,500 *
Neil B. Kornswiet............................................. 1,647,940 10.4%
Allan B. Polin................................................ 22,350(7) *
Barbara S. Polsky............................................. 7,500(8) *
Cary H. Thompson.............................................. 272,059(9) 1.7%
Gregory W. Witherspoon........................................ 163,543(10) 1.0%
All executive officers and directors as a group (12
persons).................................................... 3,539,831(11) 22.4%
</TABLE>
- ---------------
* Less than one percent.
(1) Does not include 637,495 shares of Common Stock into which $17,850,000
principal amount of the Company's 5.5% Convertible Subordinated Debentures
due 2006 beneficially owned by such funds and institutional accounts could
be converted. This information was obtained from a Schedule 13G filed with
the Securities and Exchange Commission on August 12, 1996.
(2) Includes 116,649 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days of
August 30, 1996.
(3) Includes 36,500 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days of
August 30, 1996.
(4) Includes 11,500 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days after
August 30, 1996 and 3,249 shares of Common Stock held in the name of the
Cerrell & Associates, Inc. Employee Profit Sharing Plan, of which Mr.
Cerrell is a Trustee and participant.
(5) Includes 1,625 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days after
August 30, 1996.
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(6) Includes 16,665 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days after
August 30, 1996.
(7) Includes 22,200 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days after
August 30, 1996.
(8) Includes 7,500 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days after
August 30, 1996.
(9) Includes 257,460 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days after
August 30, 1996.
(10) Includes 34,250 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days after
August 30, 1996.
(11) Includes 501,849 shares of Common Stock underlying options which are
currently exercisable or which will become exercisable within 60 days after
August 30, 1996.
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<PAGE> 53
DESCRIPTION OF THE NOTES
GENERAL
The Notes are to be issued under an Indenture, dated as of ,
1996, as supplemented by a Supplemental Indenture, to be dated as of
, 1996 (as so supplemented, the "Indenture"), each between the
Company and The Chase Manhattan Bank, as Trustee (the "Trustee").
The following summary of certain provisions of the Indenture does not
purport to be complete and is subject to, and is qualified in its entirety by
reference to, all the provisions of the Indenture, including the definitions of
certain terms therein and those terms made a part thereof by the Trust Indenture
Act of 1939, as amended. Reference is made to the "Description of Debt
Securities" contained in the Prospectus (the "Original Note Description") for a
description of certain terms of the Indenture. To the extent the Original Note
Description is inconsistent with the following summary, such summary supersedes
the Original Note Description. See "-- Certain Definitions" for the meaning of
certain terms used in this summary.
Principal of, and premium, if any, and interest on the Notes will be
payable, and the Notes may be exchanged or transferred, at the office or agency
of the Company in the Borough of Manhattan, the City of New York (which
initially shall be the corporate trust office of the Trustee, at 450 West 33rd
Street, New York, New York 10001), except that, at the option of the Company,
payment of interest may be made by check mailed to the address of the Holders as
such address appears in the Note register.
The Notes will be issued only in fully registered form, without coupons, in
denominations of $1,000 and any integral multiple of $1,000. No service charge
shall be made for any registration of transfer or exchange of Notes, but the
Company may require payment of a sum sufficient to cover any transfer tax or
other similar governmental charge payable in connection therewith.
TERMS OF THE NOTES
The Notes will be unsecured senior obligations of the Company, limited to
$150 million aggregate principal amount, and will mature on , 2003.
The Notes will bear interest at the rate per annum shown on the cover page
hereof from , 1996, or from the most recent date to which interest
has been paid or provided for, payable semiannually to Holders of record at the
close of business on the or immediately preceding the
interest payment date on and of each year, commencing
, 1997. The Company will pay interest on overdue principal at 1% per
annum in excess of such rate, and it will pay interest on overdue installments
of interest at such higher rate to the extent lawful. Interest on the Notes will
be computed on the basis of a 360 day year of twelve 30 day months.
SUBSIDIARY GUARANTIES
The Notes will be unconditionally guaranteed (a "Subsidiary Guaranty") by
all Restricted Subsidiaries of the Company other than Special Purpose
Subsidiaries (together, the "Subsidiary Guarantors", and each of them, a
"Subsidiary Guarantor"). Each Subsidiary Guarantor's obligations under its
Subsidiary Guaranty will be unsecured senior obligations of such Subsidiary
Guarantor, and will be joint and several with the obligations of each other
Subsidiary Guarantor under its Subsidiary Guaranty of the Notes. There are no
restrictions on the ability of any of such Restricted Subsidiaries to transfer
funds to the Company in the form of cash dividends, loans or advances. The
Company is a holding company and substantially all of its assets and liabilities
are held, and its operations are conducted, by such Restricted Subsidiaries,
consequently, separate financial statements of the Subsidiary Guarantors are not
presented because management has determined that they would not be material to
investors.
The Indenture will include a covenant by the Company to cause each existing
and future Subsidiary (other than Special Purpose Subsidiaries) to execute a
Subsidiary Guaranty, unless such Subsidiary is designated an "Unrestricted
Subsidiary" in accordance with the terms of the Indenture. The obligations of
each Subsidiary Guarantor under its Subsidiary Guaranty will be limited so as to
reduce the risk that they
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<PAGE> 54
would be found to constitute a fraudulent conveyance under applicable law. See
"Risk Factors -- Fraudulent Conveyances and Preferential Transfers."
The Indenture will provide that no Restricted Subsidiary may consolidate
with or merge with or into (whether or not such Restricted Subsidiary is the
surviving Person) another Person, whether or not affiliated with such Restricted
Subsidiary, unless (i) subject to the provisions of the following paragraph, the
Person formed by or surviving any such consolidation or merger (if other than
such Restricted Subsidiary) assumes all the obligations of such Restricted
Subsidiary, pursuant to a supplemental indenture, in form and substance
satisfactory to the Trustee, under the Indenture, (ii) immediately after giving
effect to such transaction, no Default or Event of Default exists, (iii) such
Restricted Subsidiary, or any Person formed by or surviving any such
consolidation or merger, would have Consolidated Net Worth (immediately after
giving effect to such transaction) equal to or greater than the Consolidated Net
Worth of such Restricted Subsidiary immediately preceding the transaction, and
(iv) the Company would be permitted, immediately after giving effect to such
transaction, to incur at least $1.00 of additional Indebtedness pursuant to
paragraph (a) in the covenant described below under the caption " -- Certain
Covenants -- Limitations on Indebtedness"; provided that the foregoing
provisions will not restrict the ability of a Restricted Subsidiary to
consolidate or merge with the Company or another Wholly-Owned Restricted
Subsidiary.
The Indenture will provide that, in the event of a sale or other
disposition of all of the assets of any Restricted Subsidiary (other than to or
with the Company or a Wholly-Owned Restricted Subsidiary), by way of merger,
consolidation or otherwise, or a sale or other disposition of all of the Capital
Stock of any Restricted Subsidiary (other than to the Company or a Wholly-Owned
Restricted Subsidiary), then such Restricted Subsidiary (in the event of a sale
or other disposition, by way of such a merger, consolidation or otherwise, of
all of the Capital Stock of such Restricted Subsidiary) or the corporation
acquiring the property (in the event of a sale or other disposition of all of
the assets of such Restricted Subsidiary) will be released and relieved of any
obligations under its Subsidiary Guaranty; provided that the Net Proceeds of
such sale or other disposition are applied in accordance with the applicable
provisions of the Indenture. In addition, the Indenture will provide that, in
the event the Company designates a Restricted Subsidiary to be an Unrestricted
Subsidiary, then such Restricted Subsidiary will be released and relieved of any
obligations under its Subsidiary Guaranty; provided that such designation is
conducted in accordance with the applicable provisions of the Indenture. See
" -- Certain Covenants -- Limitation on Restricted Payments" and " -- Certain
Definitions -- Unrestricted Subsidiary".
RANKING
The Indebtedness evidenced by the Notes will be senior unsecured
obligations of the Company, and will rank pari passu in right of payment with
all existing and future Senior Indebtedness of the Company and senior in right
of payment to all existing and future subordinated Indebtedness of the Company,
including the Convertible Debentures in an aggregate principal amount of $115
million. The obligations of the Subsidiary Guarantors under the Subsidiary
Guaranties will be senior unsecured obligations of the respective Subsidiary
Guarantors. The Notes effectively will be subordinated to all existing and
future secured Indebtedness of the Company, and each Guarantor's obligations
under its Subsidiary Guaranty effectively will be subordinated to all existing
and future secured Indebtedness of such Subsidiary. Secured Indebtedness
includes Permitted Warehouse Indebtedness, the amount of which is unlimited
under the Indenture. See "-- Certain Covenants -- Limitation on Indebtedness"
and "-- Certain Definitions -- Permitted Warehouse Indebtedness" and "Risk
Factors -- Leverage."
As of September 20, 1996, after giving effect to the issuance of the Notes,
the outstanding secured Indebtedness of the Company and its Subsidiaries would
have been approximately $120 million, of which $82 million is Permitted
Warehouse Indebtedness.
OPTIONAL REDEMPTION
Except as described in the following paragraph, the Notes will not be
redeemable at the option of the Company prior to , 2000. Thereafter,
the Notes will be redeemable, at the Company's option, in whole or in part, at
any time or from time to time, upon not less than 30 nor more than 60 days'
prior notice
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<PAGE> 55
mailed by first-class mail to each Holder's registered address, at the following
redemption prices (expressed in percentages of principal amount), plus accrued
interest to the redemption date (subject to the right of Holders of record on
the relevant record date to receive interest due on the relevant interest
payment date), if redeemed during the 12-month period commencing on
of the years set forth below:
<TABLE>
<CAPTION>
REDEMPTION
PERIOD PRICE
- ----------------------------------------------------------- ----------
<S> <C>
2000 %
2001
2002 100
</TABLE>
In addition, at any time and from time to time prior to , 1999,
the Company may redeem in the aggregate up to 30% of the original principal
amount of the Notes with the proceeds of one or more Public Equity Offerings, at
a redemption price (expressed as a percentage of principal amount) of % plus
accrued interest to the redemption date (subject to the right of Holders of
record on the relevant record date to receive interest due on the relevant
interest payment date); provided, however, that at least $100 million aggregate
principal amount of the Notes must remain outstanding after each such
redemption.
In the case of any partial redemption, selection of the Notes for
redemption will be made by the Trustee on a pro rata basis, by lot or by such
other method as the Trustee in its sole discretion shall deem to be fair and
appropriate, although no Note of $1,000 in original principal amount or less
shall be redeemed in part. If any Note is to be redeemed in part only, the
notice of redemption relating to such Note shall state the portion of the
principal amount thereof to be redeemed. A new Note in principal amount equal to
the unredeemed portion thereof will be issued in the name of the Holder thereof
upon cancellation of the original Note.
REPURCHASE AT THE OPTION OF HOLDERS
Change of Control. Upon the occurrence of any of the following events (each
a "Change of Control"), each Holder shall have the right to require that the
Company repurchase such Holder's Notes at a purchase price in cash equal to 101%
of the principal amount thereof plus accrued and unpaid interest to the date of
purchase (subject to the right of Holders of record on the relevant record date
to receive interest due on the relevant interest payment date):
(i) Any "person" (as such term is used in Sections 13(d) and 14(d) of the
Exchange Act) is or becomes the "beneficial owner" (as defined in Rules 13d-3
and 13d-5 under the Exchange Act, except that such person shall be deemed to
have "beneficial ownership" of all shares that any such person has the right to
acquire, whether such right is exercisable immediately or only after the passage
of time), directly or indirectly, of more than 35% of the total voting power of
the Voting Stock of the Company (for the purposes of this clause (i), such
person shall be deemed to beneficially own any Voting Stock of a corporation
held by another corporation (a "parent corporation"), if such person is the
beneficial owner (as defined above for such person), directly or indirectly, of
more than 35% of the voting power of the Voting Stock of such parent
corporation);
(ii) during any period of two consecutive years, individuals who at the
beginning of such period constituted the Board of Directors (together with any
new directors whose election by such Board of Directors or whose nomination for
election by the stockholders of the Company was approved by a vote of 66 2/3% of
the directors of the Company then still in office who were either directors at
the beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority of the
Board of Directors then in office; or
(iii) the merger or consolidation of the Company with or into another
Person or the merger of another Person with or into the Company, or the sale of
all or substantially all the assets of the Company to another Person, and, in
the case of any such merger or consolidation, the securities of the Company that
are outstanding immediately prior to such transaction and which represent 100%
of the aggregate voting power of the Voting Stock of the Company are changed
into or exchanged for cash, securities or property, unless pursuant to such
transaction such securities are changed into or exchanged for, in addition to
any other consideration, securities of the surviving corporation that represent
immediately after such transaction, at least
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<PAGE> 56
a majority of the aggregate voting power of the Voting Stock of the surviving
corporation; provided, however, that this clause (iii) shall not apply to any
such merger, consolidation or sale of assets if, immediately after the
consummation of such transaction and giving effect thereto, the Notes are rated
Baa3 (or the equivalent) or higher by Moody's Investors Service and BBB- (or the
equivalent) or higher by Standard & Poor's Ratings Group.
Within 30 days following any Change of Control, the Company shall mail a
notice to each Holder with a copy to the Trustee stating: (i) that a Change of
Control has occurred and that such Holder has the right to require the Company
to purchase such Holder's Notes at a purchase price in cash equal to 101% of the
principal amount thereof plus accrued and unpaid interest, if any, to the date
of purchase (subject to the right of Holders of record on the relevant record
date to receive interest on the relevant interest payment date), (ii) the
circumstances and relevant facts regarding such Change of Control (including
information with respect to pro forma results of operations, cash flow and
capitalization after giving effect to such Change of Control), (iii) the
repurchase date (which shall be no earlier than 30 days nor later than 60 days
from the date such notice is mailed), and (iv) the instructions determined by
the Company, consistent with the covenant described hereunder, that a Holder
must follow in order to have its Notes purchased.
The Company shall comply, to the extent applicable, with the requirements
of Section 14(e) of the Exchange Act and any other securities laws or
regulations in connection with the repurchase of Notes pursuant to the covenant
described hereunder. To the extent that the provisions of any securities laws or
regulations conflict with the provisions of the covenant described hereunder,
the Company shall comply with the applicable securities laws and regulations and
shall not be deemed to have breached its obligations under the covenant
described hereunder by virtue thereof.
Management has no present intention to engage in a transaction involving a
Change of Control, although it is possible that the Company would decide to do
so in the future. Subject to the limitations discussed below, the Company could,
in the future, enter into certain transactions, including acquisitions,
refinancings or other recapitalizations, that would not constitute a Change of
Control under the Indenture, but that could increase the amount of indebtedness
outstanding at such time or otherwise affect the Company's capital structure or
credit ratings. Restrictions on the ability of the Company and its Restricted
Subsidiaries to incur additional Indebtedness are contained in the covenants
described under " -- Certain Covenants -- Limitation on Indebtedness", and
" -- Limitation on Liens." Such restrictions can only be waived with the consent
of the Holders of a majority in principal amount of the Notes then outstanding.
Except for the limitations contained in such covenants, however, the Indenture
will not contain any covenants or provisions that may afford Holders of the
Notes protection in the event of a highly leveraged transaction.
Future indebtedness of the Company may contain prohibitions on the
occurrence of certain events that would constitute a Change of Control or
require such indebtedness to be repurchased upon a Change of Control. Moreover,
the exercise by the Holders of their right to require the Company to repurchase
the Notes could cause a default under such indebtedness, even if the Change of
Control itself does not, due to the financial effect of such repurchase on the
Company or otherwise. Finally, the Company's ability to pay cash to the Holders
of Notes following the occurrence of a Change of Control may be limited by the
Company's then existing financial resources. There can be no assurance that
sufficient funds will be available when necessary to make any required
repurchases. The provisions under the Indenture relative to the Company's
obligation to make an offer to repurchase the Notes as a result of a Change of
Control may be waived or modified with the written consent of the Holders of a
majority in principal amount of the Notes.
Asset Sales. The Indenture will provide that the Company will not, and will
not permit any of its Restricted Subsidiaries to, engage in any Asset Sale in
excess of $1 million unless (i) the Company (or the Restricted Subsidiary, as
the case may be) receives consideration at the time of such Asset Sale at least
equal to the fair market value of the assets or Capital Stock issued, sold or
otherwise disposed of, and (ii) at least 85% of the consideration therefor
received by the Company or such Restricted Subsidiary is in the form of cash or
Temporary Cash Investments; provided that the amount of (x) any liabilities (as
shown on the Company's or such Restricted Subsidiary's most recent balance sheet
or in the notes thereto, excluding contingent liabilities and trade payables),
of the Company or such Restricted Subsidiary (other than liabilities
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<PAGE> 57
that are by their terms subordinated to the Notes or any Subsidiary Guaranty)
that are assumed by the transferee of any such assets and (y) any notes or other
obligations received by the Company or any such Restricted Subsidiary from such
transferee that are promptly, but in no event more than 30 days after receipt,
converted by the Company or such Subsidiary into cash (to the extent of the cash
received), will be deemed to be cash for purposes of this provision.
Within 180 days after the receipt of any Net Proceeds from an Asset Sale,
the Company may apply such Net Proceeds (a) to permanently reduce Specified
Senior Indebtedness of the Company or a Restricted Subsidiary, or (b) to an
Investment, the making of a capital expenditure or the acquisition of other
tangible assets, in each case, in or with respect to a Related Business. Any Net
Proceeds from Asset Sales that are not applied or invested as provided in the
preceding sentence of this paragraph will be deemed to constitute "Excess
Proceeds." When the aggregate amount of Excess Proceeds exceeds $5 million, the
Company will be required to make an offer to all Holders of Notes (an "Asset
Sale Offer") to purchase the maximum principal amount of Notes that may be
purchased out of the Excess Proceeds, at an offer price in cash in an amount
equal to 100% of the principal amount thereof plus accrued and unpaid interest
thereon to the date of purchase, in accordance with the procedures set forth in
the Indenture. To the extent that the aggregate amount of Notes tendered
pursuant to an Asset Sale Offer is less than the Excess Proceeds, the Company
may use any remaining Excess Proceeds for general corporate purposes. If the
aggregate principal amount of Notes surrendered by Holders thereof exceeds the
amount of Excess Proceeds, the Trustee shall select the Notes to be purchased on
a pro rata basis. Upon completion of such Asset Sale Offer, the amount of Excess
Proceeds shall be reset at zero.
The Asset Sale Offer will remain open for a period of 20 Business Days
following its commencement and no longer, except to the extent that a longer
period is required by applicable law (the "Asset Sale Offer Period"). No later
than five Business Days after the termination of the Asset Sale Offer Period
(the "Asset Sale Purchase Date"), the Company will purchase the principal amount
of Notes required to be purchased pursuant to this covenant (the "Asset Sale
Offer Amount") or, if less than the Asset Sale Offer Amount has been tendered,
all Notes tendered in response to the Asset Sale Offer. Payment for any Notes so
purchased will be made in the same manner as interest payments are made.
If the Asset Sale Purchase Date is on or after an interest payment record
date and on or before the related interest payment date, any accrued and unpaid
interest will be paid to the Person in whose name a Note is registered at the
close of business on such record date, and no additional interest will be
payable to Holders who tender Notes pursuant to the Asset Sale Offer.
On or before the Asset Sale Purchase Date, the Company will, to the extent
lawful, accept for payment, on a pro rata basis to the extent necessary, the
Asset Sale Offer Amount of Notes or portions thereof tendered pursuant to the
Asset Sale Offer, or if less than the Asset Sale Offer Amount has been tendered,
all Notes tendered, and will deliver to the Trustee an Officers' Certificate
stating that such Notes or portions thereof were accepted for payment by the
Company in accordance with the terms of this covenant. The Company, the
Depositary (as hereinafter defined) or the Paying Agent, as the case may be,
will promptly (but in any case not later than five days after the Asset Sale
Purchase Date) mail or deliver to each tendering Holder an amount equal to the
purchase price of the Notes tendered by such Holder and accepted by the Company
for purchase, and the Company will promptly issue a new Note, and the Trustee,
upon delivery of an Officers' Certificate from the Company will authenticate and
mail or deliver such new Note to such Holder, in a principal amount equal to any
unpurchased portion of any Note surrendered. Any Note not so accepted will be
promptly mailed or delivered by the Company to the Holder thereof. The Company
will publicly announce the results of the Asset Sale Offer on the Asset Sale
Purchase Date.
The Company shall comply, to the extent applicable, with the requirements
of Section 14(e) of the Exchange Act and any other securities laws or
regulations in connection with the repurchase of Notes pursuant to the covenant
described hereunder. To the extent that the provisions of any securities laws or
regulations conflict with the provisions of the covenant described hereunder,
the Company shall comply with the applicable securities laws and regulations and
shall not be deemed to have breached its obligations under the covenant
described hereunder by virtue thereof.
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<PAGE> 58
CERTAIN COVENANTS
Set forth below are descriptions of certain covenants set forth in the
Indenture.
Limitation on Indebtedness. (a) The Company shall not, and shall not
permit any of its Restricted Subsidiaries, to Incur, directly or indirectly, any
Indebtedness or issue any Disqualified Stock; provided, however, that the
Company and each Restricted Subsidiary may Incur Indebtedness if, on the date of
such Incurrence and after giving effect thereto, (i) no Default or Event of
Default has occurred and is continuing or would result therefrom and (ii) the
Consolidated Leverage Ratio does not exceed 2.0 to 1.0.
(b) The foregoing provisions shall not apply to:
(1) Incurrence of Permitted Warehouse Indebtedness by the Company or
any of its Restricted Subsidiaries, and any Guaranty by the Company of such
Indebtedness Incurred by a Restricted Subsidiary, provided, however, that
to the extent any such Indebtedness of the Company or a Restricted
Subsidiary ceases to constitute Permitted Warehouse Indebtedness, to such
extent such Indebtedness shall be deemed to be Incurred by the Company or
such Restricted Subsidiary, as the case may be, at the time;
(2) Incurrence by the Company or any of its Restricted Subsidiaries of
intercompany Indebtedness owing to the Company or any of its Restricted
Subsidiaries; provided, however, that (i) any subsequent issuance or
transfer of any Capital Stock which results in any such Indebtedness being
held by a Person other than a Restricted Subsidiary and (ii) any sale or
transfer of any such Indebtedness to a Person that is not either the
Company or a Restricted Subsidiary shall be deemed, in each case, to
constitute the Incurrence of such Indebtedness by the Company or such
Subsidiary, as the case may be;
(3) Incurrence by the Company and its Restricted Subsidiaries of
Indebtedness under the Notes and the Subsidiary Guaranties;
(4) Incurrence by the Company and its Restricted Subsidiaries of
Indebtedness outstanding on the Issue Date (other than Indebtedness
described in clause (1), (2) or (3) of this covenant),
(5) Incurrence by the Company or a Restricted Subsidiary, as the case
may be, of Refinancing Indebtedness in respect of Indebtedness Incurred
pursuant to paragraph (a) or pursuant to clause (3) or (4) or this clause
(5);
(6) Incurrence by the Company or a Restricted Subsidiary of Hedging
Obligations directly related to (i) Indebtedness of the Company or a
Restricted Subsidiary Incurred in conformity with the provisions of the
Indenture, (ii) Receivables held by the Company or its Restricted
Subsidiaries pending sale or securitization, (iii) Receivables of the
Company or its Restricted Subsidiaries that have been sold pursuant to a
Warehouse Facility, (iv) Receivables that the Company or the Restricted
Subsidiary reasonably expects to purchase or commit to purchase, finance or
accept as collateral, (v) Excess Spread Receivables and other assets owned
or financed by the Company or its Restricted Subsidiaries in the ordinary
course of business, provided, however, that, in the case of each of the
foregoing clauses (i) through (v), such Hedging Obligations are eligible to
receive hedge accounting treatment in accordance with GAAP as applied by
the Company and its Restricted Subsidiaries on the Issue Date; and
(7) Incurrence by the Company and its Restricted Subsidiaries of
Indebtedness in an aggregate principal amount which, together with the
principal amount of all other Indebtedness of the Company and its
Restricted Subsidiaries outstanding on the date of such Incurrence (other
than Indebtedness permitted by clauses (1) through (6) above or paragraph
(a)) does not exceed $10 million.
Notwithstanding the foregoing, no Restricted Subsidiary that is not a
Guarantor shall incur, directly or indirectly, any Indebtedness.
Limitation on Issuance of Preferred Stock. The Company shall not permit any
Restricted Subsidiary to Incur, directly or indirectly, any Preferred Stock,
except Preferred Stock issued to and held by the Company
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<PAGE> 59
or any Wholly-Owned Restricted Subsidiary, provided, however, that any
subsequent issuance or transfer of any Capital Stock that results in any such
Restricted Subsidiary ceasing to be a Wholly-Owned Restricted Subsidiary or any
subsequent transfer of such Preferred Stock (other than to the Company or any
other Wholly-Owned Restricted Subsidiary) shall be deemed, in each case, to
constitute the Incurrence of such Preferred Stock by the issuer thereof.
Limitation on Liens. The Company shall not, and shall not permit any
Restricted Subsidiary to, directly or indirectly, Incur or permit to exist any
Lien of any nature whatsoever on any of its properties (including Capital Stock
of a Subsidiary), whether owned at the Issue Date or thereafter acquired, other
than Permitted Liens.
Limitation on Restricted Payments. (a) The Company shall not, and shall
not permit any Restricted Subsidiary, directly or indirectly, to make a
Restricted Payment if, at the time the Company or such Restricted Subsidiary
makes such Restricted Payment: (i) a Default or an Event of Default shall have
occurred and be continuing (or would result therefrom), (ii) the Company is not
able to Incur an additional $1.00 of Indebtedness pursuant to paragraph (a) of
the covenant described under " -- Limitation on Indebtedness", or (iii) the
aggregate amount of such Restricted Payment and all other Restricted Payments
since the Issue Date would exceed the sum of: (A) 25% of the Consolidated Net
Income accrued during the period (treated as one accounting period) from the
beginning of the fiscal quarter during which the Issue Date occurs to the end of
the most recent fiscal quarter prior to the date of such Restricted Payment for
which financial statements are available (or, in case such Consolidated Net
Income shall be a deficit, minus 100% of such deficit); (B) the aggregate Net
Cash Proceeds received by the Company from the issuance or sale subsequent to
the Issue Date of its Capital Stock (other than Disqualified Stock) or its debt
securities at the time such debt securities have been converted into such
Capital Stock (other than an issuance or sale to a Subsidiary of the Company);
and (C) to the extent that any Restricted Investment that was made after the
date of the Indenture is sold for cash or otherwise liquidated for, or repaid
in, cash, the lesser of (x) the cash return of capital with respect to such
Restricted Investment (less the cost of disposition, if any) and (y) the initial
amount of such Restricted Investment.
(b) While no Default or Event of Default exists, the provisions of the
foregoing paragraph (a) shall not prohibit: (i) any purchase or redemption of
Capital Stock of the Company made by exchange for, or out of the proceeds of the
substantially concurrent sale of, Capital Stock of the Company (other than
Disqualified Stock and other than Capital Stock issued or sold to a Subsidiary
of the Company); provided, however, that (A) such purchase or redemption shall
be excluded in the calculation of the amount of Restricted Payments and (B) the
Net Cash Proceeds from such sale shall be excluded from the calculation of
amounts under clause (3)(B) of paragraph (a) above, (ii) any purchase,
repurchase, redemption, defeasance or other acquisition or retirement for value
of Subordinated Obligations made by exchange for, or out of the proceeds of the
substantially concurrent sale of, Refinancing Indebtedness of the Company which
is permitted to be Incurred pursuant to the covenant described under
" -- Limitation on Indebtedness", (iii) dividends paid within 60 days after the
date of declaration thereof if at such date of declaration such dividend would
have complied with the covenant described hereunder, and (iv) any payments made
to holders of the Convertible Debentures in connection with the conversion
thereof into Capital Stock of the Company in an amount not in excess of the
Discounted Present Value of all payments of interest that would have been made
in respect thereof from the conversion date to the first date on which the
Company is entitled to redeem such debentures, if such debentures remained
outstanding and were redeemed on such date.
Limitation on Restrictions on Distributions from Restricted
Subsidiaries. The Company shall not, and shall not permit any Restricted
Subsidiary to, directly or indirectly, create or otherwise cause or permit to
exist or become effective any consensual encumbrance or restriction on the
ability of any Restricted Subsidiary (a) to pay dividends or make any other
distributions on its Capital Stock to the Company or a Restricted Subsidiary or
pay any Indebtedness owed to the Company, (b) to make any loans or advances to
the Company or (c) to transfer any of its property or assets to the Company,
except: (i) any encumbrance or restriction pursuant to an agreement in effect at
or entered into on the Issue Date, (ii) any encumbrance or restriction with
respect to (x) a Restricted Subsidiary acquired or formed after the Issue Date
pursuant to an agreement in effect at or entered into on or prior to the date on
which such Subsidiary was acquired or (y) a Restricted
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Subsidiary which is designated as such after the Issue Date pursuant to an
agreement in effect at or entered into on or prior to the date such Subsidiary
was designated a Restricted Subsidiary (in each case, other than an agreement
entered into in connection with, or in anticipation of, the transaction or
series of related transactions pursuant to which such Subsidiary became a
Subsidiary or was acquired by the Company or received such designation) and
outstanding on such date, (iii) in the case of clause (c) above, any such
encumbrance or restriction consisting of customary non-assignment provisions in
leases governing leasehold interests to the extent such provisions restrict the
transfer of the lease or the property leased thereunder, and (iv) in the case of
clause (c) above, restrictions contained in security agreements or mortgages
otherwise permissible under the Indenture securing Indebtedness of a Restricted
Subsidiary.
Limitation on Affiliate Transactions. (a) The Company shall not, and shall
not permit any Restricted Subsidiary to, enter into or permit to exist any
transaction (including the purchase, sale, lease or exchange of any property,
employee compensation arrangements or the rendering of any service) with any
Affiliate of the Company (an "Affiliate Transaction") unless (1) the terms
thereof are no less favorable to the Company or such Restricted Subsidiary than
those that could be obtained at the time of such transaction in arm's-length
dealings with a Person who is not such an Affiliate, (2) if such Affiliate
Transaction involves an amount in excess of $1.0 million, the terms thereof (i)
are set forth in writing and (ii) have been approved by a majority of the
disinterested members of the Board of Directors and (3) if such Affiliate
Transaction involves an amount in excess of $5.0 million, have been determined
by a nationally recognized investment banking firm to be fair, from a financial
standpoint, to the Company and its Restricted Subsidiaries.
(b) The provisions of the foregoing paragraph (a) shall not prohibit (i)
any Restricted Payment permitted to be paid pursuant to the covenant described
under " -- Limitation on Restricted Payments" or any Permitted Investment, (ii)
any issuance of securities, or other payments, compensation, benefits, awards or
grants in cash, securities or otherwise pursuant to, or the funding of,
employment arrangements, stock options and stock ownership plans approved by the
Board of Directors, (iii) the grant of stock options or similar rights to
employees and directors of the Company pursuant to plans approved by the Board
of Directors, (iv) loans or advances to employees in the ordinary course of
business in accordance with the past practices of the Company or its Restricted
Subsidiaries, but in any event not to exceed $500,000 in aggregate principal
amount outstanding at any one time, (v) the payment of reasonable fees to
directors of the Company and its Restricted Subsidiaries who are not employees
of the Company or its Restricted Subsidiaries, (vi) any Affiliate Transaction
between the Company and a Wholly-Owned Restricted Subsidiary or between Wholly-
Owned Restricted Subsidiaries, (vii) any Indebtedness permitted by paragraph
(b)(2) of the covenant described under Limitation on Indebtedness and (viii) any
Affiliate Transaction between any Restricted Subsidiary doing business in the
United Kingdom and a Subsidiary wholly-owned by it directly related to the
origination, purchase, funding, sale or securitization of Receivables in the
ordinary course of business of such Subsidiary.
Limitation on Merger, Consolidation or Sale of Assets. The Company shall
not consolidate with or merge with or into, or convey, transfer or lease, in one
transaction or a series of related transactions, all or substantially all its
assets to, any Person, unless: (i) the resulting, surviving or transferee Person
(the "Successor Company") shall be a Person organized and existing under the
laws of the United States of America, any State thereof or the District of
Columbia and the Successor Company (if not the Company) shall expressly assume,
by an indenture supplemental thereto, executed and delivered to the Trustee, in
form satisfactory to the Trustee, all the obligations of the Company under the
Notes and the Indenture, (ii) immediately after giving effect to such
transaction (and treating any Indebtedness which becomes an obligation of the
Successor Company or any Subsidiary as a result of such transaction as having
been Incurred by such Successor Company or such Subsidiary at the time of such
transaction), no Default shall have occurred and be continuing, (iii)
immediately after giving effect to such transaction, the Successor Company would
be able to Incur an additional $1.00 of Indebtedness pursuant to paragraph (a)
of the covenant described under " -- Limitation on Indebtedness", (iv)
immediately after giving effect to such transaction, the Successor Company shall
have Consolidated Net Worth in an amount that is not less than the Consolidated
Net Worth of the Company prior to such transaction, and (v) the Company shall
have delivered
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to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating
that such consolidation, merger or transfer and such supplemental indenture (if
any) comply with the Indenture.
The Successor Company shall be the successor to the Company and shall
succeed to, and be substituted for, and may exercise every right and power of,
the Company under the Indenture, but the predecessor Company, in the case of a
lease, shall not be released from the obligation to pay the principal of and
interest on the Notes.
Limitation on Lines of Business. The Company will not, and will not permit
any Restricted Subsidiary, to engage in any line of business which is not a
Related Business.
Limitation on Investment Company Status. The Company shall not take any
action, or otherwise permit to exist any circumstance, that would require the
Company to register as an "investment company" under the Investment Company Act
of 1940, as amended.
Reports. Notwithstanding that the Company may not be required to remain
subject to the reporting requirements of Section 13 or 15(d) of the Exchange
Act, the Company shall file with the SEC and provide the Trustee and Holders
with such annual reports, quarterly reports and such other information,
documents and reports as are specified in Sections 13 and 15(d) of the Exchange
Act and applicable to a U.S. corporation subject to such Sections, such
information, documents and other reports to be so filed and provided at the
times specified for the filing of such information, documents and reports under
such Sections.
DEFAULTS
An Event of Default is defined in the Indenture as (i) a default in the
payment of interest on the Notes when due, continuing for 30 days or more, (ii)
a default in the payment of principal of any Note when due at its Stated
Maturity, upon optional redemption, upon required repurchase, upon declaration
of acceleration or otherwise, (iii) the failure by the Company to comply with
its obligations in the covenants described above under "Repurchase at the Option
of Holders -- Change of Control" or "-- Asset Sales" or under " -- Certain
Covenants" under " -- Limitation on Indebtedness," " -- Limitation on Liens,"
" -- Limitation on Restricted Payments," " -- Limitation on Restrictions on
Distributions from Subsidiaries," " -- Limitation on Affiliate Transactions,"
"-- Limitations on Merger, Consolidation or Sale of Assets," -- "Limitations on
Lines of Business," " -- Limitation on Investment Company Status" or
" -- Reports," (iv) the failure by the Company to comply for 30 days after
notice with its other agreements contained in the Indenture, (v) Indebtedness of
the Company or any Recourse Subsidiary is not paid within any applicable grace
period after maturity or is accelerated by the holders thereof because of a
default and the total amount of such Indebtedness unpaid or accelerated exceeds
$5 million (the "cross acceleration provision"), (vi) certain events of
bankruptcy, insolvency or reorganization of the Company or a Recourse Subsidiary
(the "bankruptcy provisions") or (vii) any judgment or decree for the payment of
money in excess of $5 million is rendered against the Company or a Recourse
Subsidiary, and such judgment is not discharged, waived or stayed within 60 days
(the "judgment default provision").
If an Event of Default occurs and is continuing, the Trustee or the Holders
of at least 25% in principal amount of the outstanding Notes may declare the
principal of and accrued but unpaid interest on all the Notes to be due and
payable. Upon such a declaration, such principal and interest shall be due and
payable immediately. If an Event of Default relating to certain events of
bankruptcy, insolvency or reorganization of the Company occurs and is
continuing, the principal of and interest on all the Notes will ipso facto
become and be immediately due and payable without any declaration or other act
on the part of the Trustee or any holders of the Notes. Under certain
circumstances, the Holders of a majority in principal amount of the outstanding
Notes may rescind any such acceleration with respect to the Notes and its
consequences.
If any Event of Default occurs by reason of any willful action (or
inaction) taken (or not taken) by or on behalf of the Company with the intention
of avoiding payment of the premium that the Company would have had to pay if the
Company then had elected to redeem the Notes pursuant to the optional redemption
provisions of the Notes, an equivalent premium shall also become and be
immediately due and payable upon the acceleration of the Notes. If any Event of
Default occurs prior to , 2000 by reason of any willful
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action (or inaction) taken (or not taken) by or on behalf of the Company with
the intention of avoiding the prohibition on redemption of the Notes prior to
such date, then the premium specified in the Indenture shall also become and be
immediately due and payable upon the acceleration of the Notes.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default occurs and is continuing, the Trustee will
be under no obligation to exercise any of the rights or powers under the
Indenture at the request or direction of any of the Holders of the Notes unless
such Holders have offered to the Trustee reasonable indemnity or security
against any loss, liability or expense. Except to enforce the right to receive
payment of principal, premium (if any) or interest when due, no Holder of a Note
may pursue any remedy with respect to the Indenture or the Notes unless (i) such
Holder has previously given the Trustee notice that an Event of Default is
continuing, (ii) Holders of at least 25% in principal amount of the outstanding
Notes have requested the Trustee to pursue the remedy, (iii) such Holders have
offered the Trustee reasonable security or indemnity against any loss, liability
or expense, (iv) the Trustee has not complied with such request within 60 days
after the receipt thereof and the offer of security or indemnity and (v) the
Holders of a majority in principal amount of the outstanding Notes have not
given the Trustee a direction inconsistent with such request within such 60-day
period. Subject to certain restrictions, the Holders of a majority in principal
amount of the outstanding Notes are given the right to direct the time, method
and place of conducting any proceeding for any remedy available to the Trustee
or of exercising any trust or power conferred on the Trustee. The Trustee,
however, may refuse to follow any direction that conflicts with law or the
Indenture or that the Trustee determines is unduly prejudicial to the rights of
any other Holder of a Note or that would involve the Trustee in personal
liability.
The Indenture provides that if a Default occurs and is continuing and is
known to the Trustee, the Trustee must mail to each Holder of the Notes notice
of the Default within 60 days after it occurs. Except in the case of a Default
in the payment of principal of or interest on any Note, the Trustee may withhold
notice if and so long as a committee of its trust officers determines that
withholding notice is not opposed to the interest of the Holders of the Notes.
In addition, the Company is required to deliver to the Trustee, within 120 days
after the end of each fiscal year, a certificate indicating whether the signers
thereof know of any Default that occurred during the previous year. The Company
also is required to deliver to the Trustee, within 30 days after the occurrence
thereof, written notice of any event which would constitute certain Defaults,
their status and what action the Company is taking or proposes to take in
respect thereof.
AMENDMENTS AND WAIVERS
Subject to certain exceptions, the Indenture may be amended with the
consent of the Holders of a majority in principal amount of the Notes then
outstanding (including consents obtained in connection with a tender offer or
exchange for the Notes) and any past default or compliance with any provisions
may also be waived with the consent of the Holders of a majority in principal
amount of the Notes then outstanding. However, without the consent of each
Holder of an outstanding Note affected thereby, no amendment or waiver may,
among other things, (i) reduce the amount of Notes whose Holders must consent to
an amendment, (ii) reduce the rate of or extend the time for payment of interest
on any Note, (iii) reduce the principal of or extend the Stated Maturity of any
Note, (iv) reduce the premium payable upon the redemption of any Note or change
the time at which any Note may be redeemed as described under " -- Optional
Redemption" above, (v) make any Note payable in money other than that stated in
the Note, (vi) impair the right of any Holder of the Notes to receive payment of
principal of and interest on such Holder's Notes on or after the due dates
therefor or to institute suit for the enforcement of any payment on or with
respect to such Holder's Notes, (vii) release any Restricted Subsidiary from its
Subsidiary Guaranty (except in connection with any such Subsidiary being
designated an Unrestricted Subsidiary, to the extent permissible under the
Indenture), or (viii) make any change in the amendment provisions which require
each Holder's consent or in the waiver provisions.
Without the consent of any Holder of the Notes, the Company and Trustee may
amend the Indenture (i) to cure any ambiguity, omission, defect or
inconsistency, (ii) to provide for the assumption by a successor corporation of
the obligations of the Company under the Indenture, (iii) to provide for
uncertificated Notes in addition to or in place of certificated Notes (provided
that the uncertificated Notes are issued in registered
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form for purposes of Section 163(f) of the Code, or in a manner such that the
uncertificated Notes are described in Section 163(f)(2)(B) of the Code), (iv) to
add the guaranty of a Restricted Subsidiary with respect to the Notes, (v) to
secure the Notes, (vi) to add to the covenants of the Company or any Restricted
Subsidiary for the benefit of the Holders of the Notes, (vii) to surrender any
right or power conferred upon the Company or any Restricted Subsidiary or (viii)
to make any change that does not adversely affect the rights of any Holder of
the Notes.
The consent of the Holders of the Notes is not necessary under the
Indenture to approve the particular form of any proposed amendment. It is
sufficient if such consent approves the substance of the proposed amendment.
After an amendment under the Indenture becomes effective, the Company is
required to mail to Holders of the Notes a notice briefly describing such
amendment. However, the failure to give such notice to all Holders of the Notes,
or any defect therein, will not impair or affect the validity of the amendment.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company
or any Subsidiary Guarantor, as such, will have any liability for any
obligations of the Company or the Subsidiary Guarantors under the Notes, the
Indenture or for any claim based on, in respect of, or by reason of, such
obligations or their creation. Each Holder of Notes by accepting a Note waives
and releases all such liability. The waiver and release are part of the
consideration for issuance of the Notes. Such waiver may not be effective to
waive liabilities under the federal securities laws and it is the view of the
SEC that such a waiver is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have all of its
obligations discharged with respect to the outstanding Notes ("Legal
Defeasance") except for (i) the rights of Holders of outstanding Notes to
receive payments in respect of the principal of, and premium, if any, and
interest on such Notes when such payments are due from the trust referred to
below, (ii) the Company's obligations with respect to the Notes concerning
issuing temporary Notes, registration of Notes, mutilated, destroyed, lost or
stolen Notes and the maintenance of any office or agency for payment and money
for security payments held in trust, (iii) the rights, powers, trust, duties and
immunities of the Trustee, and the Company's obligations in connection therewith
and (iv) the Legal Defeasance provisions of the Indenture. In addition, the
Company may, at its option and at any time, elect to have the obligations of the
Company released with respect to certain covenants that are described in the
Indenture ("Covenant Defeasance") and thereafter any omission to comply with
such obligations will not constitute a Default or Event of Default with respect
to the Notes. In the event Covenant Defeasance occurs, certain events (not
including nonpayment, bankruptcy, receivership, rehabilitation and insolvency
events) described under "Events of Default" will no longer constitute an Event
of Default with respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance and for
such defeasance to take effect, (i) the Company must irrevocably deposit with
the Trustee, in trust, for the benefit of the Holders of the Notes, unencumbered
cash in U.S. dollars or unencumbered non-callable Government Securities, or a
combination thereof, in such amounts as will be sufficient, in the opinion of a
nationally recognized firm of independent public accountants, to pay the
principal of, and premium, if any, and interest on the outstanding Notes on the
stated maturity or on the applicable redemption date, as the case may be, and
the Company must specify whether the Notes are being defeased to maturity or to
a particular redemption date, (ii) in the case of Legal Defeasance, the Company
will have delivered to the Trustee an opinion of counsel in the United States
reasonably acceptable to the Trustee confirming that (A) the Company has
received from, or there has been published by, the Internal Revenue Service a
ruling or (B) since the date of the Indenture, there has been a change in the
applicable federal income tax law, in either case to the effect that, and based
thereon such opinion of counsel will confirm that, the Holders of the
outstanding Notes will not recognize income, gain or loss for federal income tax
purposes as a result of such Legal Defeasance and will be subject to federal
income
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tax on the same amounts, in the same manner and at the same times as would have
been the case if such Legal Defeasance had not occurred, (iii) in the case of
Covenant Defeasance, the Company will have delivered to the Trustee an opinion
of counsel in the United States reasonably acceptable to the Trustee confirming
that the Holders of the outstanding Notes will not recognize income, gain or
loss for federal income tax purposes as a result of such Covenant Defeasance and
will be subject to federal income tax on the same amounts, in the same manner
and at the same times as would have been the case if such Covenant Defeasance
had not occurred, (iv) no Default or Event of Default will have occurred and be
continuing (A) on the date of such deposit (other than a Default or Event of
Default resulting from the borrowing of funds to be applied to such deposit) and
(B) insofar as Defaults or Events of Default from bankruptcy or insolvency
events are concerned, at any time during the period ending on the 91st day after
the date of deposit, (v) such Legal Defeasance or Covenant Defeasance will not
result in a breach or violation of, or constitute a default under any material
agreement or instrument (other than the Indenture) to which the Company or any
of its Subsidiaries is a party or by which the Company or any of its
Subsidiaries is bound, (vi) the Company must have delivered to the Trustee an
opinion of counsel to the effect that on the 91st day following the deposit, the
trust funds will not be subject to the effect of any applicable bankruptcy,
insolvency, reorganization or similar laws affecting creditors' rights
generally, (vii) the Company must deliver to the Trustee an Officers'
Certificate stating that the deposit was not made by the Company with the intent
of preferring the Holders of Notes over the other creditors of the Company with
the intent of defeating, hindering, delaying or defrauding creditors of the
Company or others, and (viii) the Company must deliver to the Trustee an
Officers' Certificate and an opinion of counsel, each stating that all
conditions precedent provided for relating to the Legal Defeasance or the
Covenant Defeasance have been complied with.
TRANSFER AND EXCHANGE
A Holder may transfer or exchange Notes in accordance with the Indenture.
The Registrar and the Trustee may require a Holder, among other things, to
furnish appropriate endorsements and transfer documents and the Company may
require a Holder to pay any taxes and fees required by law or permitted by the
Indenture. The Company is not required to transfer or exchange any Note selected
for redemption. Also, the Company is not required to transfer or exchange any
Note for a period of 15 days before a selection of Notes to be redeemed.
The registered Holder of a Note will be treated as the owner of it for all
purposes.
CONCERNING THE TRUSTEE
The Chase Manhattan Bank is to be the Trustee under the Indenture and has
been appointed by the Company as Registrar and Paying Agent with regard to the
Notes.
The Holders of a majority in principal amount of the outstanding Notes will
have the right to direct the time, method and place of conducting any proceeding
for exercising any remedy available to the Trustee, subject to certain
exceptions. The Indenture provides that if an Event of Default occurs (and is
not cured), the Trustee will be required, in the exercise of its power, to use
the degree of care of a prudent man in the conduct of his own affairs. Subject
to such provisions, the Trustee will be under no obligation to exercise any of
its rights or powers under the Indenture at the request of any Holder of Notes,
unless such Holder shall have offered to the Trustee security and indemnity
satisfactory to it against any loss, liability or expense and then only to the
extent required by the terms of the Indenture.
BOOK-ENTRY, DELIVERY AND FORM
The Notes will initially be issued in the form of one or more Global Notes
(the "Global Note"). The Global Note will be deposited on the Issue Date with,
or on behalf of, The Depository Trust Company (the "Depositary") and registered
in the name of Cede & Co., as nominee of the Depositary (such nominee being
referred to herein as the "Global Note Holder").
The Company has been advised by the Depositary that the Depositary is a
limited-purpose trust company that was created to hold securities for its
participating organizations (collectively, the "Participants" or the
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"Depositary's Participants") and to facilitate the clearance and settlement of
transactions in such securities between Participants through electronic
book-entry changes in accounts of its Participants. The Depositary's
Participants include securities brokers and dealers (including the
Underwriters), banks and trust companies, clearing corporations and certain
other organizations. Access to the Depositary's system is also available to
other entities such as banks, brokers, dealers and trust companies
(collectively, the "Indirect Participants" or the "Depositary's Indirect
Participants") that clear through or maintain a custodial relationship with a
Participant, either directly or indirectly. Persons who are not Participants may
beneficially own securities held by or on behalf of the Depositary only through
the Depositary's Participants or the Depositary's Indirect Participants.
The Company expects that pursuant to procedures established by the
Depositary (i) upon deposit of the Global Note, the Depositary will credit the
accounts of Participants designated by the Underwriters with portions of the
principal amount of the Global Note and (ii) ownership of the Notes evidenced by
the Global Note will be shown on, and the transfer of ownership thereof will be
effected only through, records maintained by the Depositary (with respect to the
interests of the Depositary's Participants), the Depositary's Participants and
the Depositary's Indirect Participants. Prospective purchasers are advised that
the laws of some states require that certain persons take physical delivery in
definitive form of securities that they own. Consequently, the ability to
transfer Notes evidenced by the Global Note will be limited to such extent.
So long as the Global Note Holder is the registered owner of any Notes, the
Global Note Holder will be considered the sole Holder under the Indenture of any
Notes evidenced by the Global Note for the purposes of receiving payment on the
Notes, receiving notices, and for all other purposes under the Indenture and the
Notes. Beneficial owners of Notes evidenced by the Global Note will not be
considered the owners or Holders thereof under the Indenture for any purpose,
including with respect to the giving of any directions, instructions or
approvals to the Trustee thereunder. Neither the Company nor the Trustee will
have any responsibility or liability for any aspect of the records of the
Depositary or for maintaining, supervising or reviewing any records of the
Depositary relating to the Notes. Accordingly, each person owning a beneficial
interest in the Global Note must rely on the procedures of the Depositary, and,
if such person is not a Participant, on the procedures of the Participant
through which such person owns its interest, to exercise any rights of a holder
under the Indenture. The Company understands that under existing industry
practices, in the event that the Company requests any action of holders or that
an owner of a beneficial interest in the Global Note desires to give or take any
action which a holder is entitled to give or take under the Indenture, the
Depositary would authorize the Participants holding the relevant beneficial
interest to give or take such action and such Participants would authorize
beneficial owners owning through such Participants to give or take such action
or would otherwise act upon the instructions of beneficial owners owning through
them.
Payments in respect of the principal of, and premium, if any, and interest
on any Notes registered in the name of the Global Note Holder on the applicable
record date will be payable by the Trustee to or at the direction of the Global
Note Holder in its capacity as the registered Holder under the Indenture. Under
the terms of the Indenture, the Company and the Trustee may treat the persons in
whose names Notes, including the Global Note, are registered as the owners
thereof for the purpose of receiving such payments. Consequently, neither the
Company nor the Trustee has or will have any responsibility or liability for the
payment of such amounts to beneficial owners of the Notes. The Company believes,
however, that it is currently the policy of the Depositary to immediately credit
the accounts of the relevant Participants with such payments, in amounts
proportionate to their respective holdings of beneficial interests in the
relevant security as shown on the records of the Depositary. Payments by the
Depositary's Participants and the Depositary's Indirect Participants to the
beneficial owners of Notes will be governed by standing instructions and
customary practice and will be the responsibility of the Depositary's
Participants or the Depositary's Indirect Participants.
If (i) the Company notifies the Trustee in writing that the Depositary is
no longer willing or able to act as a depositary and the Company is unable to
locate a qualified successor within 90 days, (ii) the Company, at its option,
notifies the Trustee in writing that it elects to cause the issuance of Notes in
certificated form, or (iii) there shall have occurred and be continuing a
Default or an Event of Default with respect to any of the Notes represented by
the Global Note, then, upon surrender by the Global Note Holder of its Global
Note,
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Notes in certificated form will be issued to each person that the Global Note
Holder and the Depositary identify as being the beneficial owner of the related
Notes.
Neither the Company nor the Trustee will be liable for any delay by the
Global Note Holder or the Depositary in identifying the beneficial owners of
Notes and the Company and the Trustee may conclusively rely on, and will be
protected in relying on, instructions from the Global Note Holder or the
Depositary for all purposes.
GOVERNING LAW
The Indenture provides that it and the Notes will be governed by, and
construed in accordance with, the laws of the State of New York.
CERTAIN DEFINITIONS
"Additional Assets" means any property or assets (other than Indebtedness
and Capital Stock) used or useful in a Related Business.
"Affiliate" of any specified Person means any other Person, directly or
indirectly, controlling or controlled by or under direct or indirect common
control with such specified Person. For the purposes of this definition,
"control" when used with respect to any Person means the power to direct the
management and policies of such Person, directly or indirectly, whether through
the ownership of voting securities, by contract or otherwise; provided that a
Person shall be deemed to have such power with respect to the Company if such
Person is the beneficial owner of Capital Stock representing 5% or more of the
total voting power of the Voting Stock (on a fully diluted basis) of the Company
or of rights or warrants to purchase such Capital Stock (whether or not
currently exercisable). The terms "controlling" and "controlled" have meanings
correlative to the foregoing.
"Asset Sale" means (a) any sale, lease, transfer or other disposition (or
series of related sales, leases, transfers or dispositions) by the Company or
any Restricted Subsidiary, including any disposition by means of a merger,
consolidation or similar transaction (other than as permitted under " -- Certain
Covenants -- Limitations on Merger, Consolidation or Sale of Assets" or
"-- Subsidiary Guaranties") (each referred to for the purposes of this
definition as a "disposition"), of (i) any shares of Capital Stock of a
Restricted Subsidiary (other than directors' qualifying shares or shares
required by applicable law to be held by a Person other than the Company or a
Restricted Subsidiary), (ii) all or substantially all the assets of any division
or line of business of the Company or any Restricted Subsidiary, (iii) any other
assets of the Company or any Restricted Subsidiary outside of the ordinary
course of business of the Company or such Restricted Subsidiary or (iv) any
Excess Spread Receivable (other than, in the case of (i), (ii), (iii) or (iv)
above, (x) a disposition by a Restricted Subsidiary to the Company or a
Wholly-Owned Restricted Subsidiary or by the Company to a Wholly-Owned
Restricted Subsidiary, or (y) for purposes of the provisions described under "--
Repurchase at the Option of Holders -- Asset Sales" only, a disposition that
constitutes a Restricted Payment permitted by the covenant described under
"-- Certain Covenants -- Limitation on Restricted Payments"), or (b) any
issuance of Capital Stock by any of the Company's Restricted Subsidiaries,
except any such issuance to the Company or any Wholly-Owned Restricted
Subsidiary.
"Average Life" means, as of the date of determination, with respect to any
Indebtedness, the quotient obtained by dividing (i) the sum of the products of
numbers of years from the date of determination to the dates of each successive
scheduled principal payment of such Indebtedness multiplied by the amount of
such payment by (ii) the sum of all such payments.
"Board of Directors" means the Board of Directors of the Company or any
committee thereof duly authorized to act on behalf of such Board.
"Business Day" means each day which is not a Legal Holiday.
"Capital Lease Obligations" means an obligation that is required to be
classified and accounted for as a capital lease for financial reporting purposes
in accordance with GAAP; and the amount of Indebtedness
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represented by such obligation shall be the capitalized amount of such
obligation determined in accordance with GAAP; and the Stated Maturity thereof
shall be the date of the last payment of rent or any other amount due under such
lease prior to the first date upon which such lease may be terminated by the
lessee without payment of a penalty.
"Capital Stock" of any Person means any and all shares, interests, rights
to purchase, warrants, options, participations or other equivalents of or
interests in (however designated) equity of such Person, including any Preferred
Stock, but excluding any debt securities convertible into such equity.
"Code" means the Internal Revenue Code of 1986, as amended.
"Consolidated Leverage Ratio" as of any date of determination means the
ratio of (i) the aggregate amount of all consolidated Indebtedness of the
Company and its Restricted Subsidiaries, excluding (A) Permitted Warehouse
Indebtedness and Guaranties thereof permitted to be Incurred pursuant to clause
(b)(1) of the covenant described under "-- Certain Covenants -- Limitation on
Indebtedness" and (B) Hedging Obligations permitted to be Incurred pursuant to
clause (b)(6) of such covenant to (ii) the Consolidated Net Worth of the Company
less, on any date of determination prior to September 30, 1997, the par value of
outstanding Capital Stock, if any, issued upon conversion of the Convertible
Debentures and any paid-in capital or capital surplus attributable to such
conversion.
"Consolidated Net Income" means, for any period, the net income of the
Company and its consolidated Subsidiaries; provided, however, that there shall
not be included in such Consolidated Net Income: (i) any net income of any
Person if such Person is not a Restricted Subsidiary, except that (A) subject to
the exclusion contained in clause (iv) below, the Company's equity in the net
income of any such Person for such period shall be included in such Consolidated
Net Income up to the aggregate amount of cash actually distributed by such
Person during such period to the Company or a Restricted Subsidiary as a
dividend or other distribution (subject, in the case of a dividend or other
distribution paid to a Restricted Subsidiary, to the limitations contained in
clause (iii) below) and (B) the Company's equity in a net loss of any such
Person for such period shall be included in determining such Consolidated Net
Income, (ii) any net income (or loss) of any Person acquired by the Company or a
Subsidiary in a pooling of interests transaction for any period prior to the
date of such acquisition, (iii) any net income of any Restricted Subsidiary if
such Restricted Subsidiary is subject to restrictions, directly or indirectly,
on the payment of dividends or the making of distributions by such Restricted
Subsidiary, directly or indirectly, to the Company, except that (A) the
Company's equity in the net income of any such Restricted Subsidiary for such
period shall be included in such Consolidated Net Income to the extent that cash
could have been distributed by such Restricted Subsidiary during such period to
the Company or another Restricted Subsidiary as a dividend or other distribution
(subject, in the case of a dividend or other distribution paid to another
Restricted Subsidiary, to the limitation contained in this clause) and (B) the
Company's equity in a net loss of any such Restricted Subsidiary for such period
shall be included in determining such Consolidated Net Income, (iv)
extraordinary gains or losses, (v) any gain (but not loss) realized upon the
sale or other disposition of any asset of the Company or its consolidated
Subsidiaries (including pursuant to any sale-leaseback transaction) that is not
sold or otherwise disposed of in the ordinary course of business and any gain
(but not loss) realized upon the sale or other disposition of Capital Stock of
any Person, and (vi) the cumulative effect of a change in accounting principles.
Notwithstanding the foregoing, for the purposes of the covenant described under
"-- Certain Covenants -- Limitation on Restricted Payments" only, there shall be
excluded from Consolidated Net Income any dividends, repayments of loans or
advances or other transfers of assets from any Person to the Company or a
Restricted Subsidiary to the extent such dividends, repayments or transfers
increase the amount of Restricted Payments permitted under such covenant
pursuant to clause (a)(3)(C) thereof.
"Consolidated Net Worth" means (i) the total of the amounts shown on the
balance sheet of the Company and its Restricted Subsidiaries, determined on a
consolidated basis in accordance with GAAP, as of the end of the most recent
fiscal quarter of the Company for which financial statements are available, as
(a) the par or stated value of all outstanding Capital Stock of the Company plus
(b) paid-in capital or capital surplus relating to such Capital Stock plus (c)
any retained earnings or earned surplus, less (d) any accumulated deficit, less
(ii) the sum of (A) any amounts attributable to Disqualified Stock, (B) all
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investments (other than Temporary Cash Investments) in Subsidiaries that are not
consolidated Subsidiaries and in Persons that are not Subsidiaries, and (C) all
write-ups (other than write-ups resulting from foreign currency translations and
write-ups of tangible assets of a going concern business made within 12 months
after the acquisition of such business) subsequent to the date of the Indenture
in the book value of any asset owned by such Person or a consolidated Subsidiary
of such Person plus (iii) after-tax write-offs of up to $15 million in
capitalized prepaid financing costs as a result of the acquisition by the
Company of One Stop.
"Convertible Debentures" means the Company's 5 1/2% Convertible
Subordinated Debentures due March 15, 2006 that are outstanding on the Issue
Date.
"Currency Agreement" means in respect of a Person any foreign exchange
contract, currency swap agreement or other similar agreement to which such
Person is a party or a beneficiary designed to protect such Person against
fluctuations in currency exchange rates.
"Default" means any event which is, or after notice or lapse of time or
both would be, an Event of Default.
"Discounted Present Value" means, with respect to any payments of interest
on the Convertible Debentures from the conversion date (the "Conversion Date")
to the first date on which the Company is entitled to redeem such debentures
under the terms of such securities (the "Scheduled Payments"), the amount
obtained by discounting all Scheduled Payments from their respective scheduled
due dates to the Conversion Date, in accordance with accepted financial practice
and at a discount factor (applied on the same periodic basis as that on which
interest on the Convertible Debentures is payable) equal to the Reinvestment
Yield with respect to such Scheduled Payments. For purposes of this definition,
"Reinvestment Yield" means the yield to maturity implied by (a) the yields
reported, as of 10:00 A.M. (New York City time) on the second Business Day
preceding the Conversion Date on the display designated "Page 678" on the
Telerate Access Service (or such other display as Page 678 on the Telerate
Access Service) for actively traded U.S. Treasury securities having a maturity
equal to the Average Life of the Scheduled Payments as of the Conversion Date,
or (b) if such yields are not reported as of such time or the yields reported as
of such time are not ascertainable, the Treasury Constant Maturity Series Yields
reported, for the latest day for which such yields have been so reported as of
the second Business Day preceding the Conversion Date with respect to such
Scheduled Payments, in Federal Reserve Statistical Release H.15 (519) (or any
comparable successor publication) for actively traded U.S. Treasury securities
having a constant maturity equal to the Average Life of such Scheduled Payments
as of the Conversion Date. Such implied yield will be determined, if necessary,
by (i) converting U.S. Treasury bill quotations to bond-equivalent yields in
accordance with accepted financial practice and (ii) interpolating linearly
between (A) the actively traded U.S. Treasury security with the duration closest
to and greater than the Average Life and (B) the actively traded U.S. Treasury
security with the duration closest to and less than the Average Life.
"Disqualified Stock" means, with respect to any Person, any Capital Stock
which by its terms (or by the terms of any security into which it is convertible
or for which it is exchangeable) or upon the happening of any event (i) matures
or is mandatorily redeemable pursuant to a sinking fund obligation, upon
occurrence of a contingency, or otherwise, (ii) is convertible or exchangeable
for Indebtedness or Disqualified Stock or (iii) is redeemable at the option of
the holder thereof, in each case in whole or in part on or prior to the first
anniversary of the Stated Maturity of the Notes.
"Eligible Excess Spread Receivables" means Excess Spread Receivables
resulting from a sale of Receivables after September 30, 1996; provided,
however, that Eligible Excess Spread Receivables shall not include any Excess
Spread Receivables created as the result of the securitization or sale of other
Excess Spread Receivables.
"Excess Spread" means, over the life of a "pool" of Receivables that have
been sold by a Person to a trust or other Person in a securitization or sale,
the rights retained by such Person or its Restricted Subsidiaries at or
subsequent to the closing of such securitization or sale with respect to such
"pool," including any rights to receive cash flows attributable to such pool and
any servicing rights retained by such Person.
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"Excess Spread Receivables" of a Person means the right to Excess Spread
capitalized on such Person's consolidated balance sheet (the amount of which
shall be the present value of the Excess Spread, calculated in accordance with
GAAP).
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect from time to time, including those set forth (i) in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants, (ii) statements and pronouncements of
the Financial Accounting Standards Board, (iii) in such other statements by such
other entity as approved by a significant segment of the accounting profession,
and (iv) the rules and regulations of the SEC governing the inclusion of
financial statements (including pro forma financial statements) in periodic
reports required to be filed pursuant to Section 13 of the Exchange Act,
including opinions and pronouncements in staff accounting bulletins and similar
written statements from the accounting staff of the SEC and releases of the
Emerging Issues Task Force.
"Guaranty" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness or other obligation of any
Person and any obligation, direct or indirect, contingent or otherwise, of such
Person (i) to purchase or pay (or advance or supply funds for the purchase or
payment of) such Indebtedness or other obligation of such Person (whether
arising by virtue of partnership arrangements, or by agreements to keep-well, to
purchase assets, goods, securities or services, to take-or-pay or to maintain
financial statement conditions or otherwise) or (ii) entered into for the
purpose of assuring in any other manner the obligee of such Indebtedness or
other obligation of the payment thereof or to protect such obligee against loss
in respect thereof (in whole or in part); provided, however, that the term
"Guaranty" shall not include endorsements for collection or deposit in the
ordinary course of business. The term "Guaranty" used as a verb has a
corresponding meaning. The term "Guarantor" shall mean any Person Guaranteeing
any obligation.
"Hedging Obligations" of any Person means the obligations of such Person
pursuant to any Interest Rate Agreement, Currency Agreement or other agreement
designed to mitigate risks of fluctuations in value of assets owned, financed or
sold, or of liabilities incurred or assumed, in either case in the ordinary
course of business of the Company or its Restricted Subsidiaries.
"Holder" or "Noteholder" means the Person in whose name a Note is
registered on the Registrar's books.
"Incur" means issue, assume, Guaranty, incur or otherwise become liable
for; provided, however, that any Indebtedness of a Person existing at the time
such Person becomes a Subsidiary (whether by merger, consolidation, acquisition
or otherwise) shall be deemed to be Incurred by such Subsidiary at the time it
becomes a Subsidiary. The term "Incurrence" when used as a noun shall have a
correlative meaning. The accretion of principal of a non-interest bearing or
other discount security shall be deemed the Incurrence of Indebtedness.
"Indebtedness" means, with respect to any Person on any date of
determination (without duplication), (i) the principal of and premium (if any)
in respect of (A) indebtedness of such Person for money borrowed and (B)
indebtedness evidenced by notes, debentures, bonds or other similar instruments
for the payment of which such Person is responsible or liable, (ii) all Capital
Lease Obligations of such Person, (iii) all obligations of such Person issued or
assumed as the deferred purchase price of property, all conditional sale
obligations of such Person and all obligations of such Person under any title
retention agreement (but excluding trade accounts payable and expense accruals
arising in the ordinary course of business), (iv) all obligations of such Person
for the reimbursement of any obligor on any letter of credit, banker's
acceptance or similar credit transaction (other than obligations with respect to
letters of credit securing obligations (other than obligations described in (i)
through (iii) above) entered into in the ordinary course of business of such
Person to the extent such letters of credit are not drawn upon or, if and to the
extent drawn upon, such drawing is reimbursed no later than the tenth Business
Day following receipt by such Person of a demand for reimbursement following
payment on the letter of credit), (v) the amount of all obligations of such
Person with respect to the redemption, repayment or other repurchase of any
Disqualified Stock (but excluding any
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accrued dividends), (vi) all Warehouse Indebtedness, (vii) all obligations of
the type referred to in clauses (i) through (vi) of other Persons and all
dividends of other Persons for the payment of which, in either case, such Person
is responsible or liable, directly or indirectly, as obligor, guarantor or
otherwise, including by means of any Guaranty, (viii) all obligations of the
type referred to in clauses (i) through (vii) of other Persons secured by any
Lien on any property or asset of such Person (whether or not such obligation is
assumed by such Person), the amount of such obligation being deemed to be the
lesser of the value of such property or assets or the amount of the obligation
so secured and (ix) to the extent not otherwise included in this definition,
Hedging Obligations of such Person. Except in the case of Warehouse Indebtedness
(the amount of which shall be determined in accordance with the definition
thereof) the amount of Indebtedness of any Person at any date shall be the
outstanding balance at such date of all unconditional obligations as described
above and the maximum liability, upon the occurrence of the contingency giving
rise to the obligation, of any contingent obligations at such date.
Notwithstanding the foregoing, any securities issued in a securitization by a
special purpose owner trust or similar entity formed by or on behalf of a Person
and to which Receivables have been sold or otherwise transferred by or on behalf
of such Person or its Subsidiaries shall not be treated as Indebtedness of such
Person or its Subsidiaries under the Indenture, regardless of whether such
securities are treated as indebtedness for tax purposes, provided (1) neither
the Company nor any of its Restricted Subsidiaries (other than a Special Purpose
Subsidiary) (a) provides credit support of any kind (including any undertaking,
agreement or instrument that would constitute Indebtedness), or (b) is directly
or indirectly liable (as a guarantor or otherwise), and (2) no default with
respect to which (including any rights that the holders thereof may have to take
enforcement action against an Unrestricted Subsidiary) would permit (upon
notice, lapse of time or both) any holder of any other Indebtedness of the
Company or any of its Restricted Subsidiaries to declare a default on such other
Indebtedness or cause the payment thereof to be accelerated or payable prior to
its stated maturity.
"Interest Rate Agreement" means any interest rate swap agreement, interest
rate cap agreement, repurchase agreement, futures contract or other financial
agreement or arrangement designed to protect the Company or any Restricted
Subsidiary against fluctuations in interest rates.
"Investment" in any Person means, in a single transaction or series of
related transactions, any direct or indirect advance, loan (other than advances
to customers in the ordinary course of business that are recorded as trade
accounts on the balance sheet of the lender) or other extensions of credit
(including any advance, loan or other extension of credit by way of Guarantee or
similar arrangement) or capital contribution to (by means of any transfer of
cash or other property to others or any payment for property or services for the
account or use of others), or any purchase or acquisition of Capital Stock,
Indebtedness or other similar instruments issued by such Person. For purposes of
the definition of "Unrestricted Subsidiary", the definition of "Restricted
Payment" and the covenant described under " -- Certain Covenants -- Limitation
on Restricted Payments", (i) "Investment" shall include the portion
(proportionate to the Company's equity interest in such Subsidiary) of the fair
market value of the net assets of any Subsidiary of the Company at the time that
such Subsidiary is designated an Unrestricted Subsidiary; provided, however,
that upon a redesignation of such Subsidiary as a Restricted Subsidiary, the
Company shall be deemed to continue to have a permanent "Investment" in an
Unrestricted Subsidiary equal to an amount (if positive) equal to (x) the
Company's "Investment" in such Subsidiary at the time of such redesignation less
(y) the portion (proportionate to the Company's equity interest in such
Subsidiary) of the fair market value of the net assets of such Subsidiary at the
time of such redesignation; and (ii) any property transferred to or from an
Unrestricted Subsidiary or other Person shall be valued at its fair market value
at the time of such transfer, in each case as determined in good faith by the
Board of Directors.
"Issue Date" means the date on which the Notes are originally issued.
"Lien" means, with respect to any Person, any mortgage, pledge, security
interest, encumbrance, lien or charge of any kind on the assets of such Person
(including (i) any conditional sale or other title retention agreement or lease
in the nature thereof, and (ii) any claim (whether direct or indirect through
subordination or other structural encumbrance against any Excess Spread
Receivables sold or otherwise transferred by such Person to a buyer, unless such
Person is not liable for any losses thereon).
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"Net Cash Proceeds", with respect to any issuance or sale of Capital Stock,
or debt securities means the cash proceeds of such issuance or sale net of
attorneys' fees, accountants' fees, underwriters' or placement agents' fees,
discounts or commissions and brokerage, consultant and other fees actually
incurred in connection with such issuance or sale and net of taxes paid or
payable as a result thereof.
"Net Proceeds" from an Asset Sale means cash payments received therefrom
(including, any cash payments received by way of deferred payment of principal
pursuant to a note or installment receivable or otherwise, but only as and when
received, but excluding any other consideration received in the form of
assumption by the acquiring Person of Indebtedness or other obligations
relating, to such properties or assets or received in any other noncash form) in
each case net of (i) all legal, title and recording tax expenses, commissions
and other fees and expenses incurred, and all Federal, state, provincial,
foreign and local taxes required to be accrued as a liability under GAAP, as a
consequence of such Asset Sale, (ii) all payments made on any Indebtedness which
is secured by any assets subject to such Asset Sale, in accordance with the
terms of any Lien upon or other security agreement of any kind with respect to
such assets, or which must by its terms, or in order to obtain a necessary
consent to such Asset Sale, or by applicable law be, repaid out of the proceeds
from such Asset Sale, and (iii) the deduction of appropriate amounts provided by
the seller as a reserve, in accordance with GAAP, against any liabilities
associated with the property or other assets disposed in such Asset Sale and
retained by the Company or any Restricted Subsidiary after such Asset Sale.
"Non-Recourse Debt" means Indebtedness (i) as to which neither the Company
nor any of its Restricted Subsidiaries (a) provides a Guaranty or other credit
enhancement of any kind (including any undertaking, agreement or instrument that
would constitute Indebtedness), or (b) is directly or indirectly liable (as the
primary obligor or otherwise), and (ii) no default with respect to which
(including any rights that the holders thereof may have to take enforcement
action against an Unrestricted Subsidiary) would permit (upon notice, lapse of
time or both) any holder of any other Indebtedness of the Company or any of its
Restricted Subsidiaries (other than the Notes and the Subsidiary Guaranties or,
for purposes of the definition of "Unrestricted Subsidiary" only, any
Indebtedness outstanding on the Issue Date) to declare a default on such other
Indebtedness or cause the payment thereof to be accelerated or payable prior to
its stated maturity; and (iii) as to which the lenders have been notified in
writing that they will not have any recourse to the stock or assets of the
Company or any of its Restricted Subsidiaries.
"Permitted Investment" means an Investment by the Company or any Restricted
Subsidiary (i) in a Wholly-Owned Restricted Subsidiary or a Person that will,
upon the making of such Investment, become a Wholly-Owned Restricted Subsidiary,
provided, however, that the primary business of such Wholly-Owned Subsidiary is
a Related Business, (ii) in another Person if as a result of such Investment
such other Person is merged or consolidated with or into, or transfers or
conveys all or substantially all its assets to, the Company or a Wholly-Owned
Restricted Subsidiary; provided, however, that such Person's primary business is
a Related Business, (iii) comprised of Temporary Cash Investments, (iv)
comprised of receivables owing to the Company or any Restricted Subsidiary if
created or acquired in the ordinary course of business and payable or
dischargeable in accordance with customary trade terms, (v) comprised of
payroll, travel and similar advances to cover matters that are expected at the
time of such advances ultimately to be treated as expenses for accounting
purposes and that are made in the ordinary course of business, (vi) comprised of
stock, obligations or securities received in settlement of debts created in the
ordinary course of business and owing to the Company or any Restricted
Subsidiary or in satisfaction of judgments, (vii) in any Person to the extent
such Investment represents the non-cash portion of the consideration received
for an Asset Sale as permitted pursuant to the covenant described under
"-- Repurchase at the Option of Holders -- Asset Sales", (viii) in Subsidiaries
of the Company in an aggregate amount not in excess of $25 million, (ix)
comprised of Receivables of the Company or any of its Wholly-Owned Restricted
Subsidiaries, or (x) comprised of Excess Spread Receivables arising from a
securitization or sale of Receivables by the Company or any of its Wholly-Owned
Restricted Subsidiaries.
"Permitted Liens" means, with respect to any Person, (a) pledges or
deposits by such Person under worker's compensation laws, unemployment insurance
laws or similar legislation, or good faith deposits in connection with bids,
tenders, contracts (other than for the payment of Indebtedness) or leases to
which such Person is a party, or deposits to secure public or statutory
obligations of such Person or deposits of cash or
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United States government bonds to secure surety or appeal bonds to which such
Person is a party, or deposits as security for contested taxes or import duties
or for the payment of rent, in each case Incurred in the ordinary course of
business; (b) Liens imposed by law, such as carriers', warehousemen's and
mechanics' Liens, in each case for sums not yet due or being contested in good
faith by appropriate proceedings or other Liens arising out of judgments or
awards against such Person with respect to which such Person shall then be
proceeding with an appeal or other proceedings for review; (c) Liens for
property taxes not yet subject to penalties for non-payment or which are being
contested in good faith and by appropriate proceedings; (d) Liens in favor of
issuers of surety bonds or letters of credit issued pursuant to the request of
and for the account of such Person in the ordinary course of its business;
provided, however, that such letters of credit do not constitute Indebtedness;
(e) minor survey exceptions, minor encumbrances, easements or reservations of,
or rights of others for, licenses, rights of way, sewers, electric lines,
telegraph and telephone lines and other similar purposes, or zoning or other
restrictions as to the use of real property or Liens incidental to the conduct
of the business of such Person or to the ownership of its properties which were
not Incurred in connection with Indebtedness and which do not in the aggregate
materially adversely affect the value of said properties or materially impair
their use in the operation of the business of such Person; (f) Liens securing
Indebtedness Incurred to finance the construction, purchase or lease of, or
repairs, improvements or additions to, property of such Person (but excluding
Capital Stock of another Person), provided, however, that the Lien may not
extend to any other property owned by such Person or any of its Subsidiaries at
the time the Lien is Incurred, and the Indebtedness secured by the Lien may not
be Incurred more than 180 days after the latest of the acquisition, completion
of construction, repair, improvement, addition or commencement of full operation
of the property subject to the Lien; (g) Liens on Receivables owned by the
Company or a Restricted Subsidiary, as the case may be, to secure Indebtedness
permitted under the provisions described in clause (b)(1) under "-- Certain
Covenants -- Limitation on Indebtedness"; (h) Liens on Excess Spread Receivables
(or on the Capital Stock of any Subsidiary of such Person substantially all the
assets of which are Excess Spread Receivables); provided, however, that, (x) any
such Liens may only encumber Eligible Excess Spread Receivables, in an amount
not to exceed 75% of the excess, if any, of (i) the total amount of Eligible
Excess Spread Receivables, determined on a consolidated basis in accordance with
GAAP, as of the creation of such Lien over (ii) an amount equal to 150% of all
unsecured Senior Indebtedness of the Company and its Restricted Subsidiaries as
of the time of creation of such Lien; and (y) the balance of Eligible Excess
Spread Receivables not permitted to be encumbered by the foregoing proviso (x)
shall remain unencumbered by any Lien; (i) Liens existing on the Issue Date; (j)
Liens on property or shares of Capital Stock of another Person at the time such
other Person becomes a Subsidiary of such Person; provided, however, that such
Liens are not created, incurred or assumed in connection with, or in
contemplation of, such other Person becoming such a Subsidiary; provided
further, however, that such Lien may not extend to any other property owned by
such Person or any of its Subsidiaries; (k) Liens on property at the time such
Person or any of its Subsidiaries acquires the property, including, any
acquisition by means of a merger or consolidation with or into such Person or a
Subsidiary of such Person; provided, however, that such Liens are not created,
incurred or assumed in connection with, or in contemplation of, such
acquisition; provided further, however, that the Liens may not extend to any
other property owned by such Person or any of its Subsidiaries; (1) Liens
securing Indebtedness or other obligations of a Subsidiary of such Person owing
to such Person or a Restricted Subsidiary of such Person; (m) Liens (other than
on any Excess Spread Receivables) securing Hedging Obligations; (n) Liens on
cash or other assets (other than Excess Spread Receivables) securing Warehouse
Indebtedness of the Company or its Restricted Subsidiaries; and (o) Liens to
secure any Refinancing (or successive Refinancings) as a whole, or in part, of
any Indebtedness permitted under the Indenture to be Incurred and secured by any
Lien referred to in the foregoing clauses (f), (i), (j) and (k); provided,
however, that (x) such new Lien shall be limited to all or part of the same
property that secured the original Lien (plus improvements to or on such
property) and (y) the Indebtedness secured by such Lien at such time is not
increased to any amount greater than the sum of (A) the outstanding, principal
amount or, if greater, committed amount of the Indebtedness described under
clauses (f), (i), (j) or (k), as the case may be, at the time the original Lien
became a Permitted Lien and (B) an amount necessary to pay any fees and
expenses, including premiums, related to such refinancing, refunding, extension,
renewal or replacement. Notwithstanding the foregoing, "Permitted Liens" will
not include any Lien described in clauses (f), (j) or (k) above to the extent
such Lien applies to any Additional Assets acquired directly or indirectly from
Net Proceeds pursuant
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to the covenant described under "-- Certain Covenants -- Limitation on Sale of
Assets and Subsidiary Stock".
"Permitted Warehouse Indebtedness" means Warehouse Indebtedness in
connection with a Warehouse Facility; provided, however, that (i) the assets as
to which such Warehouse Indebtedness relates are or, prior to any funding under
the related Warehouse Facility with respect to such assets, were eligible to be
recorded as held for sale on the consolidated balance sheet of the Company in
accordance with GAAP, (ii) such Warehouse Indebtedness will be deemed to be
Permitted Warehouse Indebtedness (a) in the case of a Purchase Facility, only to
the extent the holder of such Warehouse Indebtedness has no contractual recourse
to the Company and its Restricted Subsidiaries to satisfy claims in respect of
such Permitted Warehouse Indebtedness in excess of the realizable value of the
Receivables financed thereby, and (b) in the case of any other Warehouse
Facility, only to the extent of the lesser of (A)the amount advanced by the
lender with respect to the Receivables financed under such Warehouse Facility,
and (B) the principal amount of such Receivables and (iii) any such Indebtedness
has not been outstanding in excess of 364 days.
"Person" means any individual, corporation, partnership, joint venture,
association, joint-stock company, limited liability company, trust,
unincorporated organization, government or any agency or political subdivision
thereof or any other entity.
"Preferred Stock", as applied to the Capital Stock of any Person, means
Capital Stock of any class or classes (however designated) which is preferred as
to the payment of dividends, or as to the distribution of assets upon any
voluntary or involuntary liquidation or dissolution of such Person, over shares
of Capital Stock of any other class of such corporation.
"Principal" of a Note means the principal of the Note plus the premium, if
any, payable on the Note which is due or overdue or is to become due at the
relevant time.
"Public Equity Offering" means an underwritten primary public offering of
common stock of the Company pursuant to an effective registration statement
under the Securities Act.
"Purchase Facility" means any Warehouse Facility in the form of a purchase
and sale facility pursuant to which the Company or a Restricted Subsidiary of
the Company sells Receivables to a financial institution and retains a right of
first refusal upon the subsequent resale of such Receivables by such financial
institution.
"Receivables" means consumer and commercial loans, leases and receivables
purchased or originated by the Company or any Restricted Subsidiary in the
ordinary course of business; provided, however, that for purposes of determining
the amount of a Receivable at any time, such amount shall be determined in
accordance with GAAP, consistently applied, as of the most recent practicable
date.
"Recourse Subsidiary" means any Subsidiary that either (i) is a Restricted
Subsidiary or (ii) has outstanding any Indebtedness other than Non-Recourse
Debt.
"Refinance" means, in respect of any Indebtedness, to refinance, extend,
renew, refund, repay, prepay, redeem, defease or retire, or to issue other
Indebtedness in exchange or replacement for, such Indebtedness. "Refinanced" and
"Refinancing" shall have correlative meanings.
"Refinancing Indebtedness" means Indebtedness that Refinances any
Indebtedness of the Company or any Subsidiary existing on the Issue Date or
Incurred in compliance with the Indenture including Indebtedness that Refinances
Refinancing Indebtedness; provided, however, that (i) such Refinancing
Indebtedness has a Stated Maturity no earlier than the Stated Maturity of the
Indebtedness being Refinanced, (ii) such Refinancing Indebtedness has an Average
Life at the time such Refinancing Indebtedness is Incurred that is equal to or
greater than the Average Life of the Indebtedness being Refinanced and (iii)
such Refinancing Indebtedness has an aggregate principal amount (or if Incurred
with original issue discount, an aggregate issue price) that is equal to or less
than the aggregate principal amount (or if Incurred with original issue
discount, the aggregate accreted value) then outstanding or committed (plus fees
and expenses, including any premium and defeasance costs) under the Indebtedness
being Refinanced; provided further, however, that Refinancing Indebtedness shall
not include (x) Indebtedness of a Subsidiary that Refinances Indebtedness of the
Company or another Subsidiary or (y) Indebtedness of the Company or a Restricted
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Subsidiary that Refinances Indebtedness of an Unrestricted Subsidiary; provided
further, however, that, if such Indebtedness Refinances any Subordinated
Obligations, such Refinancing Indebtedness shall be subordinated to the Notes to
at least the same extent as such Subordinated Obligations are so subordinated.
"Related Business" means any consumer or commercial finance business or any
financial service business.
"Restricted Investment" means any Investment other than a Permitted
Investment.
"Restricted Payment" with respect to any Person means (i) the declaration
or payment of any dividends or any other distributions of any sort in respect of
its Capital Stock (including any payment in connection with any merger or
consolidation involving such Person) or similar payment to the direct or
indirect holders of its Capital Stock (other than (A) dividends or distributions
payable solely in its Capital Stock (other than Disqualified Stock), and (B)
dividends or distributions payable solely to the Company or a Restricted
Subsidiary, (ii) the purchase, redemption or other acquisition or retirement for
value of any Capital Stock of the Company held by any Person or of any Capital
Stock of a Subsidiary held by any Affiliate of the Company (other than a
Subsidiary), including the exercise of any option to exchange any Capital Stock
(other than into Capital Stock of the Company that is not Disqualified Stock),
(iii) the purchase, repurchase, redemption, defeasance or other acquisition or
retirement for value, prior to scheduled maturity, scheduled repayment or
scheduled sinking fund payment of any Subordinated Obligations (other than the
purchase, repurchase or other acquisition of Subordinated Obligations purchased
in anticipation of satisfying a sinking fund obligation, principal installment
or final maturity, in each case due within one year of the date of acquisition)
or (iv) the making of any Restricted Investment.
"Restricted Subsidiary" means any Subsidiary of the Company that is not an
Unrestricted Subsidiary.
"SEC" means the Securities and Exchange Commission.
"Senior Indebtedness" means all Indebtedness of any Person that is not
subordinated in right of payment to any other Indebtedness or other obligations
of such Person.
"Special Purpose Subsidiary" means a Restricted Subsidiary formed in
connection with a securitization (i) all the Capital Stock of which (other than
directors' qualifying shares and shares held by other Persons to the extent such
shares are required by applicable law to be held by a Person other than the
Company or a Restricted Subsidiary) is owned by the Company or one or more
Restricted Subsidiaries, (ii) that has no assets other than Excess Spread
Receivables created in such securitization, (iii) that conducts no business
other than holding such Excess Spread Receivables, and (iv) that has no
Indebtedness.
"Specified Senior Indebtedness" means (i) Indebtedness of any Person,
whether outstanding on the Issue Date or thereafter Incurred and (ii) accrued
and unpaid interest (including interest accruing on or after the filing of any
petition in bankruptcy or for reorganization relating to the Company to the
extent post filing interest is allowed in such proceeding) in respect of (A)
indebtedness of such Person for money borrowed and (B) indebtedness evidenced by
notes, debentures, bonds or other similar instruments for the payment of which
such Person is responsible or liable unless, in the case of either clause (i) or
(ii), in the instrument creating or evidencing the same or pursuant to which the
same is outstanding, it is provided that such obligations are subordinate in
right of payment to the Notes; provided, however, that Specified Senior
Indebtedness shall not include (1) any obligation of such Person to any
Subsidiary of such Person, (2) any liability for Federal, state, local or other
taxes owed or owing by such Person, (3) any accounts payable or other liability
to trade creditors arising in the ordinary course of business (including
guaranties thereof or instruments evidencing such liabilities), (4) any
obligation in respect of Capital Stock of such Person or (5) that portion of any
Indebtedness which at the time of Incurrence is Incurred in violation of the
Indenture.
"Stated Maturity" means, with respect to any security, the date specified
in such security as the fixed date on which the final payment of principal of
such security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency unless such contingency has occurred).
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<PAGE> 75
"Subordinated Obligation" means any unsecured Indebtedness of the Company
(whether outstanding on the Issue Date or thereafter Incurred) which is
subordinate or junior in right of payment to the Notes pursuant to a written
agreement to that effect.
"Subsidiary" means, in respect of any Person, any corporation, association,
partnership or other business entity of which more than 50% of the total voting
power of shares of Capital Stock or other interests (including partnership
interests) entitled (without regard to the occurrence of any contingency) to
vote in the election of directors, managers or trustees thereof is at the time
owned or controlled, directly or indirectly, by (i) such Person, (ii) such
Person and one or more Subsidiaries of such Person or (iii) one or more
Subsidiaries of such Person.
"Temporary Cash Investments" means any of the following: (i) any
investment, maturing within 180 days of the date of acquisition thereof, in
direct obligations of the United States of America or any agency thereof or
obligations guaranteed as to principal and interest by the United States of
America or any agency thereof, (ii) investments in time deposit accounts,
certificates of deposit and money market deposits maturing within 180 days of
the date of acquisition thereof issued by a bank or trust company that is not an
Affiliate of the Company and which is organized under the laws of the United
States of America, any state thereof or any foreign country recognized by the
United States, and which bank or trust company has capital, surplus and
undivided profits aggregating in excess of $50,000,000 (or the foreign currency
equivalent thereof) and has outstanding debt which is rated "A" (or its
equivalent) or higher by at least one nationally recognized statistical rating
organization (as defined in Rule 436 under the Securities Act) or any
money-market fund sponsored by a registered broker dealer or mutual fund
distributor, (iii) repurchase obligations with a term of not more than 30 days
for underlying securities of the types described in clause (i) above entered
into with a bank meeting the qualifications described in clause (ii) above, (iv)
investments in commercial paper, maturing not more than 90 days after the date
of acquisition, issued by a corporation (other than an Affiliate of the Company)
organized and in existence under the laws of the United States of America or any
foreign country recognized by the United States of America with a rating at the
time as of which any investment therein is made of "P-1" (or its equivalent) or
higher according to Moody's Investors Service or "A-1" (or its equivalent) or
higher according to Standard & Poor's Ratings Group, and (v) investments in
securities with maturities of six months or less from the date of acquisition
issuer fully guaranteed by any state, commonwealth or territory of the United
States of America, or by any political subdivision or taxing authority thereof,
and rated "A"(or its equivalent) or higher by Standard & Poor's Ratings Group or
"A-2" (or its equivalent) or higher by Moody's Investors Service.
"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at
the time of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of
the Company (including any newly acquired or newly formed Subsidiary) to be an
Unrestricted Subsidiary unless (a) such Subsidiary or any of its Subsidiaries
owns any Capital Stock or Indebtedness of, or holds any Lien on any property of,
the Company or any other Subsidiary of the Company that is not a Subsidiary of
the Subsidiary to be so designated or (b) any such Subsidiary has outstanding
any Indebtedness other than Non-Recourse Debt; provided, however, that either
(A) the Subsidiary to be so designated has total assets of $1,000 or less or (B)
if such Subsidiary has assets greater than $1,000, such designation would be a
permitted Restricted Investment under the covenant described under "-- Certain
Covenants -- Limitation on Restricted Payments." The Board of Directors may
designate any Unrestricted Subsidiary to be a Restricted Subsidiary; provided,
however, that immediately after giving effect to such designation (x) the
Company could Incur $1.00 of additional Indebtedness under paragraph (a) of the
covenant described under "-- Certain Covenants -- Limitation on Indebtedness"
and (y) no Default shall have occurred and be continuing or would result
therefrom. Any such designation by the Board of Directors shall be evidenced by
the Company to the Trustee by promptly filing with the Trustee a copy of the
board resolution giving effect to such designation and an Officers' Certificate
certifying that such designation complied with the foregoing provisions.
"U.S. Government Obligations" means direct obligations (or certificates
representing an ownership interest in such obligations) of the United States of
America (including any agency or instrumentality
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<PAGE> 76
thereof) for the payment of which the full faith and credit of the United States
of America is pledged and which are not callable at the issuer's option.
"Voting Stock" of a Person means all classes of Capital Stock of other
interests (including partnership interests) of such Person then outstanding and
normally entitled (without regard to the occurrence of any contingency) to vote
in the election of directors, managers or trustees thereof.
"Warehouse Facility" means any funding arrangement with a financial
institution or other lender or purchaser, to the extent (and only to the extent)
funding thereunder is used exclusively to finance or refinance the purchase or
origination of Receivables by the Company or a Restricted Subsidiary of the
Company for the purpose of (i) pooling such Receivables prior to securitization
or (ii) sale, in each case in the ordinary course of business, including
Purchase Facilities.
"Warehouse Indebtedness" means the greater of (x) the consideration
received by the Company or its Restricted Subsidiaries under a Warehouse
Facility and (y) in the case of a Purchase Facility, the book value of the
Receivables financed under such Warehouse Facility until such time as such
Receivables are (i) securitized, (ii) repurchased by the Company or its
Restricted Subsidiaries or (iii) sold by the counterparty under the Warehouse
Facility to a Person who is not an Affiliate of the Company.
"Wholly-Owned Restricted Subsidiary" means a Restricted Subsidiary all the
Capital Stock of which (other than directors' qualifying shares and shares held
by other Persons to the extent such shares are required by applicable law to be
held by a Person other than the Company or a Restricted Subsidiary) is owned by
the Company or one or more Wholly-Owned Restricted Subsidiaries.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of the material federal income tax consequences
under the Internal Revenue Code of 1986, as amended (the "Code"), of holding and
disposing of the Notes. The summary is based upon laws, regulations, rulings and
judicial decisions now in effect, all of which are subject to change (possibly
on a retroactive basis). The summary applies only to a beneficial owner of a
Note that is (i) a citizen or resident of the United States, (ii) a corporation
created or organized under the laws of the United States or any State thereof
(including the District of Columbia) or (iii) a person otherwise subject to
United States federal income taxation on its worldwide income (a "U.S. holder").
Except as expressly indicated, this summary deals only with Notes held as
capital assets and addresses only initial purchasers. This summary does not
discuss all aspects of federal income taxation that may be relevant to investors
in light of their personal investment circumstances or to certain types of
holder subject to special treatment under the federal income tax laws (for
example, dealers in securities, tax-exempt organizations, insurance companies,
banks, purchasers that hold Notes as a hedge against currency risks or as part
of a straddle with other investments or as part of a "synthetic security" or
other integrated investment comprised of a Note and one or more other
investments, or purchasers that have a "functional currency" other than the U.S.
Dollar), and does not discuss the consequences to a holder under state, local or
foreign tax laws. The Company has not sought a formal legal opinion from its tax
counsel regarding the material federal income tax consequences under the Code of
holding and disposing of the Notes. Prospective investors are advised to consult
their own tax advisors regarding the federal, state, local and other tax
considerations of holding and disposing of the Notes.
STATED INTEREST
A U.S. holder of a Note will generally be required to report as ordinary
income for federal income tax purposes interest received or accrued on the Note
in accordance with the holder's method of tax accounting.
SALE, EXCHANGE OR RETIREMENT OF NOTES
Upon the sale, exchange or retirement (including redemption) of a Note, a
U.S. holder of a Note generally will recognize gain or loss in an amount equal
to the difference between the amount of cash and the fair market value of any
property received on the sale, exchange or retirement of the Note (other than in
respect of accrued and unpaid interest on the Note) and such U.S. holder's
adjusted tax basis in the Note. If a
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<PAGE> 77
U.S. holder holds the Note as a capital asset, such gain or loss will be capital
gain or loss, except to the extent of any accrued market discount (see "Market
Discount" below), and will be long-term capital gain or loss if the Note has
been held for more than one year at the time of sale, exchange or retirement.
ORIGINAL ISSUE DISCOUNT; MARKET DISCOUNT; PREMIUM
The Notes will not be issued with original issue discount (as defined in
Section 1273(a) of the Code); however, U.S. holders should consult their tax
advisors concerning the reporting of income from market discount (under the
rules of Sections 1276 through 1278 of the Code) or the amortization of premium
(under the rules of Section 171 of the Code) in the event a Note is considered
to have been purchased at a purchase price greater or less than its remaining
stated principal amount.
INFORMATION REPORTING AND BACKUP WITHHOLDING
For each calendar year in which the Notes are outstanding, the Company is
required to provide the Internal Revenue Service (the "IRS") with certain
information, including the U.S. holder's name, address and taxpayer
identification number, the aggregate amount of principal and interest paid
during the calendar year and the amount of tax withheld, if any. This
obligation, however, generally does not apply with respect to a U.S. holder that
is a corporation or comes within certain other exempt categories and, when
required, demonstrates this fact.
A U.S. holder of a Note subject to the reporting requirements described
above may be subject to backup withholding at the rate of 31% with respect to
interest and principal paid on the Notes, unless such U.S. holder provides a
correct taxpayer identification number, certifies as to no loss of exemption
from backup withholding and otherwise complies with applicable requirements of
the backup withholding rules. A U.S. holder of a Note who does not provide the
Company with his correct taxpayer identification number may be subject to
penalties imposed by the IRS. Any amount paid as backup withholding will be
creditable against the U.S. holder's income tax liability, provided that the
required information is furnished to the IRS.
S-77
<PAGE> 78
UNDERWRITING
Under the terms and subject to the conditions of the Underwriting
Agreement, the Company has agreed to sell to the Underwriters and each of the
Underwriters has severally but not jointly agreed to purchase from the Company
the following respective principal amount of the Notes:
<TABLE>
<CAPTION>
PRINCIPAL AMOUNT
UNDERWRITER OF THE NOTES
--------------------------------------------------------------------- ----------------
<S> <C>
Bear, Stearns & Co. Inc. ............................................ $
Donaldson, Lufkin & Jenrette Securities Corporation..................
NatWest Capital Markets Limited......................................
----------------
Total...................................................... $150,000,000
=============
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent and that the
Underwriters will be obligated to purchase all of the Notes if any are
purchased. The Underwriting Agreement provides that, in the event of default by
an Underwriter, in certain circumstances, the purchase commitment of the
non-defaulting Underwriter may be increased or the Underwriting Agreement may be
terminated.
The Company has been advised that the Underwriters propose to offer the
Notes to the public at the public offering price set forth on the cover page of
this Prospectus Supplement and to certain dealers at such price less a
concession of % of the principal amount per Note, and the Underwriters and
such dealers may allow a discount of % of the principal amount per Note on
sales to certain and other dealers. After the initial public offering, the
public offering price and concession and discount to dealers may be changed by
the Underwriters.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, and to contribute
to payments which the Underwriters may be required to make in respect thereof.
The Notes are a new issue of securities with no established trading market
and the Company does not intend to apply for listing of the Notes on any
national securities exchange. The Underwriters have advised the Company that
they presently intend to act as market makers for the Notes. The Underwriters,
however, are not obligated to make a market in the Notes and any such market
making may be discontinued at any time without notice. No assurance can be given
as to the liquidity of the trading market for the Notes or that an active
trading market for the Notes will develop. If an active market does not develop,
the market price and liquidity of the Notes may be adversely affected.
NatWest Capital Markets Limited ("NatWest"), a United Kingdom broker-dealer
and a member of the Securities and Futures Authority Limited, has agreed that,
as part of the distribution of the Notes offered hereby and subject to certain
exceptions, it will not offer or sell any Notes within the United States, its
territories or possessions or to persons who are citizens thereof or residents
therein. The Underwriting Agreement does not limit the sale of the Notes offered
hereby outside of the United States.
NatWest has also represented and agreed that (i) it has not offered or sold
and will not offer or sell any Notes to persons in the United Kingdom prior to
admission of the Notes to listing in accordance with Part IV of the Financial
Services Act 1986 (the "Act") except to persons whose ordinary activities
involve them in acquiring, holding, managing or disposing of investments (as
principal or agent) for the purpose of their business or otherwise in
circumstances which have not resulted and will not result in an offer to the
public in the United Kingdom within the meaning of the Public Offers of
Securities Regulations 1995 or the Act, (ii) it has complied and will comply
with all applicable provisions of the Act with respect to anything done by it in
relation to the Notes in, from or otherwise involving the United Kingdom and
(iii) it has only issued or passed on, and will only issue or pass on, in the
United Kingdom any document received by it in connection with the issue of the
Notes, other than any document which consists of or any part of listing
particulars, supplementary listing particulars or any other document required or
permitted to be published by listing rules under Part IV of the Act, to a person
who is of a kind described in Article 11(3) of the Financial Services Act 1986
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<PAGE> 79
(Investment Advertisements) (Exemptions) Order 1996 or is a person to whom the
document may otherwise lawfully be issued or passed on.
The Underwriters have informed the Company that they do not expect
discretionary sales by the Underwriters to exceed 5% of the principal amount of
Notes being offered hereby.
Bear, Stearns & Co. Inc. and an affiliate of NatWest have each provided,
and expect in the future to provide, investment banking and/or other advisory
services to the Company and its subsidiaries.
National Westminster Bank, N.A. ("NWB"), an affiliate of NatWest, has
provided a $150 million warehousing line of credit to the Company that is
secured by loans originated or purchased by the Company pending their
securitization. Such line of credit generally bears interest at the rate of
0.875% over one-month LIBOR and expires on January 1, 1997, although it is
renewable by NWB on a quarterly basis. NWB has also provided a $50 million
credit facility that is secured by certain excess servicing receivables in
certificated form (the "Residual Facility"). Until February 1997 this is a
revolving facility that bears interest at the rate of 2.5% over one-month LIBOR
during the amortizing term; thereafter until August 1999 it bears interest at
the rate of 4.5% over the one-month LIBOR. The Residual Facility contains
provisions which give NWB the right to stop further funding under the Residual
Facility and to require repayment of the entire outstanding Residual Facility
after the completion of this offering or the completion of the Concurrent
Offering. NWB has stated that it does not currently intend to exercise these
rights upon completion of either of the two offerings. If NWB were to exercise
its right to require repayment of the Residual Facility, the Company may use
proceeds from this offering to repay the Residual Facility. See "Use of
Proceeds." The Company expects that at the closing of this offering it will have
drawn approximately $30 million under the Residual Facility and therefore Bear,
Stearns & Co. Inc. will act as a qualified independent underwriter as set forth
in Rules 2710(c)(8) and 2720(c)(3) of the Conduct Rules of the National
Association of Securities Dealers, Inc., with respect to this offering.
LEGAL MATTERS
Certain legal matters relating to this offering are being passed upon for
the Company by Troop Meisinger Steuber & Pasich, LLP., Los Angeles, California.
Certain legal matters will be passed upon for the Underwriters by Gibson, Dunn &
Crutcher L.L.P., Los Angeles, California.
EXPERTS
The audited consolidated financial statements of the Company incorporated
in this Prospectus Supplement by reference to the Company's Annual Report on
Form 10-K for the year ended June 30, 1996, and the audited supplementary
consolidated financial statements of the Company incorporated in this Prospectus
Supplement by reference to the Company's Current Report on Form 8-K/A dated
September 16, 1996, have been so incorporated in reliance on the report of Price
Waterhouse LLP, independent accountants, given on the authority of said firm as
experts in auditing and accounting. The audited consolidated financial
statements of One Stop Mortgage, Inc. incorporated in this Prospectus Supplement
by reference to the Company's Current Report on Form 8-K dated September 12,
1996, have been so incorporated in reliance on the report of KPMG Peat Marwick
LLP, independent accountants, given on the authority of said firm as experts in
auditing and accounting.
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<PAGE> 80
AAMES FINANCIAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Audited Consolidated Financial Statements
Report of Independent Accountants................................................... F-2
Consolidated Balance Sheets......................................................... F-3
Consolidated Statements of Income................................................... F-4
Consolidated Statements of Stockholders' Equity..................................... F-5
Consolidated Statements of Cash Flows............................................... F-6
Notes to Consolidated Financial Statements.......................................... F-7
Audited Supplementary Consolidated Financial Statements
Report of Independent Accountants................................................... F-18
Supplementary Consolidated Balance Sheets........................................... F-19
Supplementary Consolidated Statements of Income..................................... F-20
Supplementary Consolidated Statements of Stockholders' Equity....................... F-21
Supplementary Consolidated Statements of Cash Flows................................. F-22
Notes to Supplementary Consolidated Financial Statements............................ F-23
</TABLE>
F-1
<PAGE> 81
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
Aames Financial Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of stockholders' equity and of cash flows
represent fairly, in all material respects, the financial position of Aames
Financial Corporation and its Subsidiaries (the "Company") at June 30, 1996 and
1995, and the results of their operations and their cash flows for each of the
three years in the period ended June 30, 1996, 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.
As discussed in Note 1 to the Consolidated Financial Statements, the Company
adopted an accounting standard that changed its method of accounting for
mortgage servicing rights for the year ended June 30, 1996.
Price Waterhouse LLP
Los Angeles, California
August 12, 1996
F-2
<PAGE> 82
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1995 1996
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents....................................... $ 20,359,000 $ 18,216,000
Loans held for sale, at cost which approximates market.......... 24,132,000 67,327,000
Accounts receivable, less allowance for doubtful accounts of
$360,000
and $473,000.................................................. 6,090,000 8,600,000
Excess servicing receivable (Note 2)............................ 42,078,000 129,113,000
Mortgage servicing rights....................................... 10,902,000
Residual assets................................................. 14,882,000 44,676,000
Equipment and improvements, net (Note 3)........................ 2,063,000 5,612,000
Prepaid and other............................................... 5,019,000 9,551,000
------------ ------------
Total assets.......................................... $114,623,000 $293,997,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Borrowings (Note 4)............................................. $ 23,144,000 $138,045,000
Revolving warehouse facilities (Note 4)......................... 11,026,000
Accounts payable and accrued expenses........................... 6,141,000 8,976,000
Accrued compensation and related expenses....................... 1,703,000 3,949,000
Income taxes payable (Note 5)................................... 3,588,000 21,831,000
------------ ------------
Total liabilities..................................... 34,576,000 183,827,000
Commitments and Contingencies (Note 6)
Stockholders' equity
Preferred stock, par value $.001 per share 1,000,000 shares
authorized; none outstanding...............................
Common Stock, par value $.001 per share 15,000,000 and
50,000,000 shares authorized; 13,221,000 and 13,501,900
shares outstanding (Note 9)................................ 14,000 14,000
Additional paid-in capital.................................... 61,864,000 63,628,000
Retained earnings............................................. 18,169,000 46,528,000
------------ ------------
Total stockholders' equity............................ 80,047,000 110,170,000
------------ ------------
Total liabilities and stockholders' equity............ $114,623,000 $293,997,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 83
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
--------------------------------------------
1994 1995 1996
----------- ----------- ------------
<S> <C> <C> <C>
Revenue:
Excess servicing gain (Note 2)................... $ 8,101,000 $22,954,000 $ 78,274,000
Commissions...................................... 16,432,000 15,799,000 19,880,000
Loan service..................................... 6,099,000 8,246,000 18,185,000
Fees and other................................... 5,595,000 7,940,000 12,069,000
----------- ---------- ----------
Total revenue................................. 36,227,000 54,939,000 128,408,000
----------- ---------- ----------
Expenses:
Compensation and related expenses (Note 6)....... 13,616,000 17,610,000 33,241,000
Sales and advertising costs...................... 7,891,000 9,906,000 18,362,000
General and administrative expenses.............. 5,415,000 7,067,000 13,926,000
Interest expense (Note 4)........................ 322,000 3,205,000 9,348,000
----------- ---------- ----------
Total expenses................................ 27,244,000 37,788,000 74,877,000
----------- ---------- ----------
Income before income taxes......................... 8,983,000 17,151,000 53,531,000
Provision for income taxes (Note 5)................ 3,684,000 7,117,000 22,483,000
----------- ---------- ----------
Net income......................................... $ 5,299,000 $10,034,000 $ 31,048,000
=========== ========== ==========
Net income per share
Primary....................................... $ 0.61 $ 1.11 $ 2.20
=========== ========== ==========
Fully diluted................................. 0.61 1.11 2.09
=========== ========== ==========
Weighted average number of shares outstanding
Primary....................................... 8,751,000 9,021,000 14,096,000
=========== ========== ==========
Fully diluted................................. 8,751,000 9,021,000 15,465,000
=========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 84
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL PAID-IN RETAINED
COMMON STOCK CAPITAL EARNINGS TOTAL
------------ ------------------ ----------- ------------
<S> <C> <C> <C> <C>
As of June 30, 1993.............. $ 6,000 $ 9,522,000 $ 6,322,000 $ 15,850,000
Issuance of common stock....... 3,000 12,260,000 12,263,000
Dividends...................... (1,743,000) (1,743,000)
Net income..................... 5,299,000 5,299,000
------------ ------------------ ----------- ------------
As of June 30, 1994.............. 9,000 21,782,000 9,878,000 31,669,000
Issuance of common stock....... 5,000 40,082,000 40,087,000
Dividends...................... (1,743,000) (1,743,000)
Net income..................... 10,034,000 10,034,000
------------ ------------------ ----------- ------------
As of June 30, 1995.............. 14,000 61,864,000 18,169,000 80,047,000
Issuance of common stock....... 1,764,000 1,764,000
Dividends...................... (2,689,000) (2,689,000)
Net income..................... 31,048,000 31,048,000
------------ ------------------ ----------- ------------
As of June 30, 1996.............. $ 14,000 $ 63,628,000 $46,528,000 $110,170,000
=========== ============= ========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 85
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
-------------------------------------------------
1994 1995 1996
------------- ------------- -------------
<S> <C> <C> <C>
Operating activities:
Net income.................................. $ 5,299,000 $ 10,034,000 $ 31,048,000
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation and amortization............ 466,000 606,000 1,048,000
Deferred income taxes.................... (69,000) 3,972,000 15,369,000
Excess servicing gain.................... (9,690,000) (33,891,000) (103,975,000)
Excess servicing amortization............ 2,693,000 4,402,000 16,940,000
Mortgage servicing rights originated..... (11,759,000)
Mortgage servicing rights amortization... 857,000
Loans originated or purchased............ (190,200,000) (387,600,000) (895,834,000)
Proceeds from sale of loans.............. 180,235,000 373,609,000 852,639,000
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable.................... (1,415,000) (2,663,000) (2,510,000)
Prepaid and other...................... (900,000) (2,217,000) (4,532,000)
Residual assets........................ (4,228,000) (8,691,000) (29,794,000)
Increase (decrease) in:
Accounts payable and accrued
expenses............................ 2,755,000 534,000 3,150,000
Accrued compensation and related
expenses............................ 435,000 581,000 2,246,000
Income taxes payable................... 762,000 (2,051,000) 2,874,000
------------- ------------- -------------
Net cash used in operating activities......... (13,857,000) (43,375,000) (122,233,000)
------------- ------------- -------------
Investing activities:
Purchases of property and equipment......... (870,000) (988,000) (4,597,000)
------------- ------------- -------------
Net cash used in investing activities......... (870,000) (988,000) (4,597,000)
------------- ------------- -------------
Financing activities:
Proceeds from sale of stock or exercise of
options.................................. 12,263,000 40,087,000 1,764,000
Proceeds from borrowing..................... 2,900,000 23,000,000 115,000,000
Amounts outstanding under warehouse
facilities............................... 9,675,000 (9,675,000) 11,026,000
Dividends paid.............................. (1,743,000) (1,743,000) (2,689,000)
Payments on bank notes and long-term debt... (240,000) (3,460,000) (414,000)
------------- ------------- -------------
Net cash provided by financing activities..... 22,855,000 48,209,000 124,687,000
------------- ------------- -------------
Net increase (decrease) in cash............... 8,128,000 3,846,000 (2,143,000)
Cash and cash equivalents at beginning of
period...................................... 8,385,000 16,513,000 20,359,000
------------- ------------- -------------
Cash and cash equivalents at end of period.... $ 16,513,000 $ 20,359,000 $ 18,216,000
============= ============= =============
Supplemental disclosures:
Interest paid............................... $ 333,000 $ 3,225,000 $ 6,633,000
Taxes paid.................................. 2,991,000 4,843,000 4,354,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 86
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OPERATIONS
Aames Financial Corporation, a Delaware corporation ("Aames"), and its
subsidiaries (collectively, the "Company") engage in the consumer finance
business by offering mortgage loans to homeowners through 47 offices located in
16 states at year end. The Company also functions as an insurance agent and
mortgage trustee through certain of its subsidiaries. The Company's market is
borrowers who have significant equity in their homes but whose borrowing needs
are not being met by traditional financial institutions. The Company's business
includes originating (funding and brokering), purchasing, selling and servicing
mortgage loans primarily secured by single family residences (i.e., one-to-four
family). Loans originated by the Company are primarily extended on the basis of
the equity in the borrower's property and, to a lesser extent, the
creditworthiness of the borrower. The aggregate outstanding balances of loans
serviced by the Company was $609 million and $1.25 billion at June 30, 1995 and
June 30, 1996, respectively (which include $152 million and $337 million of
loans at June 30, 1995 and June 30, 1996, respectively, serviced for the Company
by unaffiliated subservicers under subservicing agreements).
The Company's ability to continue to originate and purchase loans is
dependent, in part, upon its ability to securitize and sell loans in the
secondary market in order to generate cash proceeds for new originations and
purchases. The value of and market for the Company's loans are dependent upon a
number of factors, including general economic conditions, interest rates and
governmental regulations. Adverse changes in such factors may affect the
Company's ability to purchase or sell loans for acceptable prices within
reasonable periods of time.
A prolonged, substantial reduction in the size of the secondary market for
loans of the types originated and purchased by the Company may adversely affect
the Company's ability to securitize and sell loans with a consequent adverse
impact on the Company's profitability and ability to fund future originations
and purchases which could have a material adverse effect on the Company's
financial position and results of operations.
In addition, in order to gain access to the secondary market, the Company
has relied on monoline insurance companies to provide financial guarantee
insurance on the senior interests in the real estate mortgage investment conduit
("REMIC") trusts established by the Company. Any substantial reduction in the
size or availability of the secondary market for the Company's loans or the
unwillingness of monoline insurance companies to provide financial guarantee
insurance for the senior interests in REMIC trusts could have a material adverse
effect on the Company's financial position and results of operations.
PRINCIPLES OF ACCOUNTING AND CONSOLIDATION
The consolidated financial statements of the Company include the accounts
of Aames and its wholly-owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent 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.
CASH IN TRUST
The Company services loans on behalf of customers. In such capacity,
certain monies are collected and placed in segregated trust accounts, which
totaled $10.9 million and $26.8 million at June 30, 1995 and
F-7
<PAGE> 87
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
June 30, 1996, respectively. These accounts and corresponding liabilities are
not included in the accompanying balance sheet.
EQUIPMENT AND IMPROVEMENTS
Equipment and improvements are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are being recorded utilizing
straight-line and accelerated methods over the following estimated useful lives:
<TABLE>
<S> <C>
Furniture........................................... Five to seven years
Leasehold Improvements.............................. Shorter of five years or lease term
Equipment Under Capital Leases...................... Five years
Automobiles......................................... Five years
Data Processing Equipment........................... Five years
</TABLE>
REVENUE RECOGNITION
The Company derives its revenue principally from servicing spreads,
commissions from the origination of the loans, insurance commissions, closing
fees, prepayment fees and fees charged for services such as appraisals and
underwriting. Loans originated through the Company's retail branch network or
purchased from correspondents are funded by the Company for pooling and sale in
the secondary market and placed with private investors or brokered to other
financial institutions. Revenue from loans pooled and sold in the secondary
market is recognized when such loan pools are sold. Revenue from loans funded by
private investors is recognized as income when escrow closes on the loan and the
funds are disbursed. The Company retains the right to service all loans funded
by the Company or placed with private investors. The Company receives a fee for
servicing such loans based on a fixed percentage of the declining principal
balance. A servicing spread is retained by the Company from the monthly payments
received from borrowers, a portion of which is accounted for as a normal
servicing fee. Loans brokered to other financial institutions are sold on a
servicing-released basis.
During the loan origination process, the Company negotiates fees,
commissions and payment terms to accommodate the borrower's immediate and
long-term cash flow needs. To the extent negotiation of the commission rate
leads to a higher or lower interest rate on the loan, this will generally have
an inverse effect on the servicing spread retained by the Company. Such
negotiations result in a wide range of loan servicing spreads retained by the
Company.
Commission revenue on loan originations and related direct origination
costs are deferred until the related loan is sold. Upon sale of the loan, the
deferred commissions are recognized as commission revenue in the Consolidated
Statements of Income and deferred origination costs are recognized in the
applicable expense classification.
The accounting practice employed by the Company, whereby it accounts for a
portion of the servicing spread as a normal servicing fee, has the effect of
normalizing the loan servicing revenues recognized by the Company derived from
the long-term servicing of loans originated or purchased by the Company and
pooled and sold in the secondary market on a servicing-retained basis, or placed
with private investors. An excess loan servicing gain or loss is recorded to
account for the difference between the servicing spread retained by the Company
and the normal servicing fee that is determined by the Company taking into
account several factors including industry practices. The net present value of
that difference (based on certain prepayment and other assumptions to determine
an expected life of the loan) is recorded as an excess servicing gain or loss
when the loan is sold in a pool or funded by private investors. The excess
servicing gain included in the Consolidated Statements of Income includes these
amounts reduced by direct transaction costs. For loans sold in the secondary
market, the excess servicing gain includes provisions for credit risk
obligations retained by the
F-8
<PAGE> 88
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company. The excess servicing receivable included in the Consolidated Balance
Sheets results from the recordation of such initial gains on an aggregate basis
adjusted for amortization.
As the Company receives cash in the form of the servicing spread it retains
(including the normal servicing fee), the excess servicing receivable is reduced
in proportion to and over the expected lives of the related loans giving effect
to the prepayment assumption utilized in its determination. On a quarterly
basis, the Company reviews its prepayment and other assumptions in relation to
its actual experience and current rates of prepayment prevalent in the industry.
The excess servicing receivable is written down when a shortfall in the net
present value of the estimated remaining future excess servicing fee revenue
becomes apparent. The excess servicing receivable is not increased as a result
of slower than estimated prepayment experience. The Company receives prepayment
fees on certain loans if they are paid off before maturity.
MORTGAGE SERVICING RIGHTS
The Company elected to adopt Statement of Financial Accounting Standard No.
122, "Accounting for Mortgage Servicing Rights" ("SFAS No. 122"), which amends
the prior mortgage banking standard for fiscal 1996. SFAS No. 122 prohibits
retroactive application to fiscal years prior to adoption. Accordingly, certain
information appearing in the Company's financial statements for fiscal 1995 and
before are based on the prior standard and such results are not directly
comparable to the results for fiscal 1996. Under SFAS No. 122 the Company
recognizes mortgage servicing rights ("MSR's") as assets separate from the
mortgage loans to which the MSR's relate based on their respective fair values.
In the past, the Company had allocated the entire cost of originating or
purchasing a mortgage loan to the carrying value of such mortgage loans. MSR's
are amortized over the lives of the loans to which the MSR's relate, reducing
servicing income in future periods.
To the extent that a portion of the total cost of originating or purchasing
mortgage loans has been allocated to the MSR's, relatively greater gains were
recognized on the securitization and sale of mortgage loans because of the
reduction of the Company's basis in such loans. The effect of adopting SFAS No.
122 was to increase the net income of the Company for the fiscal year ended June
30, 1996 by $5.7 million or $.37 per fully diluted weighted average share.
In order to determine the fair value of the MSR's, the Company estimates
the expected future net servicing revenue based on common industry assumptions
(since market prices for MSR's under comparable servicing sales contracts are
not available to the Company), as well as on the Company's historical
experience.
INCOME TAXES
Taxes are provided on substantially all income and expense items included
in earnings, regardless of the period in which such items are recognized for tax
purposes. The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns. In estimating future tax consequences, the Company
generally considers all expected future events other than enactments of changes
in the tax law or rates.
RISK MANAGEMENT
The Company employs certain risk management strategies to minimize its risk
from interest rate fluctuations during the period between the time it originates
or purchases loans and the time such loans are sold in the secondary market. The
Company sells its loans in the secondary market on a quarterly basis, thus
limiting the period of its interest rate risk exposure. These securitizations
are structured to allow the Company to sell a specified amount of certain loans
for a limited time in the future at an agreed upon price. In addition, the
Company regularly reviews the interest rates on its loan products and makes
adjustments to rates to reflect
F-9
<PAGE> 89
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
market conditions. Additionally, the Company employs a hedging strategy whereby
it enters into agreements to sell securities not yet purchased that correlate to
securities that are used to index sales of the Company's loans in the secondary
market. Gains or losses on these transactions are included in the excess
servicing gain at the time the underlying loans are sold. At June 30, 1996, the
Company had open hedging positions with a notional balance of $40.0 million.
CASH AND CASH EQUIVALENTS
Cash equivalents, consisting primarily of short-term investments, are
considered cash equivalents if they were purchased with an original maturity of
three months or less. At June 30, 1996, the Company had $2.2 million held in a
restricted account in connection with the sale of a loan pool. These funds were
released to the Company in July 1996.
LOANS HELD FOR SALE
Loans held for sale are carried at the lower of aggregate cost or market
value. Market value is determined by current investor yield requirements.
RESIDUAL ASSETS
In connection with its securitization transactions, the Company initially
deposits with a trustee cash or the required overcollateralization amount of
loans, and subsequently deposits a portion of the servicing spread collected on
the related loans. The amounts set aside ($14.9 million at June 30, 1995 and
$44.7 million at June 30, 1996) are available for distribution to investors in
the event of certain shortfalls in amounts due to investors. These amounts are
subject to increase up to maximum subordination amounts as specified in the
related securitization documents. Cash amounts on deposit are invested in
certain instruments as permitted by the related securitization documents. To the
extent amounts on deposit exceed specified levels, distributions are made to the
Company and, at the termination of the related REMIC trust, any remaining
amounts on deposit are distributed to the Company.
DEBT ISSUANCE
At June 30, 1996, the Company had an unamortized balance of debt issuance
costs of $3.8 million related to the issuance of $23.0 million of 10.5% Senior
Notes due 2002 and the issuance of $115 million of 5.5% Convertible Subordinated
Debentures due 2006. This balance is included in "Prepaid and other" on the
Consolidated Balance Sheets and is amortized into interest expense over the life
of the related debt.
EARNINGS PER SHARE
Earnings per share of common stock is computed using the weighted average
number of shares of common stock outstanding during each period, after giving
effect to the assumed exercise of certain stock options and warrants, and in
addition, for fully diluted earnings per share, the conversion of shares related
to the Company's 5.5% Convertible Subordinated Debentures due 2006.
In May 1996, the Company's $.001 par value common stock was split
three-for-two. All references in the accompanying Consolidated Balance Sheets,
Consolidated Statements of Income and of Stockholders Equity, and Notes to
Consolidated Financial Statements to the number of common shares and share
amounts have been restated to reflect the stock split.
RECLASSIFICATIONS
Certain amounts related to 1994 and 1995 have been reclassified to conform
to the 1996 presentation.
F-10
<PAGE> 90
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 EXCESS SERVICING RECEIVABLE
The excess servicing receivable represents the net present value of the
difference between the servicing spread retained by the Company and the normal
servicing fee determined by the Company taking into account several factors
including industry practices. The amount is amortized over the estimated lives
of the loans to which the excess servicing receivable relates.
The activity in the excess servicing receivable is summarized as follows:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
--------------------------------------------
1994 1995 1996
----------- ----------- ------------
<S> <C> <C> <C>
Balance, beginning of year................. $ 5,592,000 $12,589,000 $ 42,078,000
Excess servicing gain...................... 9,690,000 33,891,000 103,975,000
Amortization of receivable................. (2,693,000) (4,402,000) (16,940,000)
----------- ----------- ------------
Balance, end of year....................... $12,589,000 $42,078,000 $129,113,000
=========== =========== ============
</TABLE>
The Company discounts the cash flows on the related loans sold based upon
the rates charged to borrowers on such loans adjusted for credit risk
obligations retained by the Company. The Company had reserves of $959,000, $3.4
million and $10.2 million at June 30, 1994, 1995 and 1996, respectively, related
to these credit risk obligations, which are netted against the excess servicing
receivable. The weighted average rates used to discount the cash flows were
13.7%, 14.5% and 14.7% for the years ended June 30, 1994, 1995 and 1996,
respectively. The excess servicing receivable is amortized using the same
discount rate used to determine the original excess servicing gain recorded.
On a quarterly basis, the Company analyzes its prepayment assumptions in
relation to actual prepayment experience on a disaggregated basis, based on loan
origination date and type of loan (fixed or adjustable), to determine whether
actual prepayment experience has had any impact on the carrying value of the
excess servicing receivable.
NOTE 3 EQUIPMENT AND IMPROVEMENTS
Equipment and improvements comprise the following:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
---------------------------
1995 1996
----------- -----------
<S> <C> <C>
Data processing equipment................................. $ 1,654,000 $ 4,727,000
Furniture and fixtures.................................... 1,460,000 2,791,000
Leasehold improvements.................................... 133,000 169,000
Equipment under capital leases............................ 796,000 806,000
Automobiles............................................... 195,000 256,000
----------- -----------
Total........................................... 4,238,000 8,749,000
Accumulated depreciation and amortization................. (2,175,000) (3,137,000)
----------- -----------
Net..................................................... $ 2,063,000 $ 5,612,000
=========== ===========
</TABLE>
F-11
<PAGE> 91
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 BORROWING AND REVOLVING WAREHOUSE FACILITIES
Borrowings consist of the following:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
----------------------------
1995 1996
----------- ------------
<S> <C> <C>
5.5% Subordinated Convertible Debentures due 2006
convertible to 4.1 million shares of $.001 par value
common stock at $28 per share. The Subordinated
Convertible Debentures are subordinated to all existing
and future senior debt of the Company (as defined in
the Indenture)......................................... $115,000,000
10.5% Senior Notes due 2002, collateralized by certain
residual certificates. Principal payments of $5,750,000
in each of calendar years 1999 through 2002............ $23,000,000 23,000,000
Obligations under capital leases......................... 144,000 45,000
------------ -----------
Total borrowings............................... $23,144,000 $138,045,000
============ ===========
</TABLE>
Amounts outstanding under revolving warehouse facilities:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
---------------------------
1995 1996
----------- -----------
<S> <C> <C>
Warehouse facility with investment bank collateralized by
mortgages/deeds of trust; expires January 1, 1997 with
interest at 0.0875% over applicable LIBOR rate; total
credit
available $150 million. Applicable LIBOR rate was 5.5%
at
June 30, 1996........................................... $11,026,000
Revolving warehouse facility with commercial banks
collateralized by mortgages/deeds of trust; due in
December 1996 with interest at .875% over applicable
LIBOR rate; total credit available $100 million.
Applicable LIBOR rate was 5.5% at June 30, 1996.........
----------- -----------
Total amounts outstanding under revolving
warehouse facilities.......................... $11,026,000
=========== ===========
</TABLE>
Maturities on borrowings are as follows:
<TABLE>
<CAPTION>
OBLIGATIONS
OBLIGATIONS UNDER CAPITAL
FISCAL YEARS ENDED UNDER CAPITAL LEASES -- NET
JUNE 30, LEASES OF INTEREST BORROWINGS TOTAL -- NET
- ------------------ ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
1997......................... $47,000 $45,000 $ 45,000
1998.........................
1999......................... $ 5,750,000 5,750,000
2000......................... 5,750,000 5,750,000
2001......................... 5,750,000 5,750,000
Thereafter................... 120,750,000 120,750,000
------- ------- ------------ ------------
Total.............. $47,000 $45,000 $138,000,000 $138,045,000
======= ======= ============ ============
</TABLE>
EQUIPMENT UNDER LEASES
Equipment under capital leases is comprised of various computer and
equipment items. Accumulated amortization of $685,000 and $758,000 relating to
this equipment has been recorded as of June 30, 1995 and 1996, respectively.
F-12
<PAGE> 92
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5 INCOME TAXES
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
-----------------------------------------
1994 1995 1996
---------- ---------- -----------
<S> <C> <C> <C>
Current:
Federal....................................... $2,939,000 $2,154,000 $ 6,344,000
State......................................... 814,000 992,000 2,187,000
----------- ---------- ----------
3,753,000 3,146,000 8,531,000
Deferred:
Federal....................................... (86,000) 2,891,000 10,212,000
State......................................... 17,000 1,080,000 3,740,000
----------- ---------- ----------
Total............................... (69,000) 3,971,000 13,952,000
----------- ---------- ----------
$3,684,000 $7,117,000 $22,483,000
=========== ========== ==========
</TABLE>
For 1994, 1995 and 1996, the Company's effective income tax rate is
computed using the appropriate statutory rates with no significant differences.
The financial statement balances at June 30, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE
30,
--------------------------
1995 1996
---------- -----------
<S> <C> <C>
Current taxes payable (receivable)
Federal.................................................. $ (596,000) $ 2,668,000
State.................................................... (321,000) 706,000
----------- ----------
Total.................................................... (917,000) 3,374,000
----------- ----------
Deferred taxes payable
Federal.................................................. 3,240,000 13,451,000
State.................................................... 1,265,000 5,006,000
----------- ----------
Total.................................................... 4,505,000 18,457,000
----------- ----------
Total tax liabilities............................ $3,588,000 $21,831,000
=========== ==========
</TABLE>
F-13
<PAGE> 93
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax liabilities (assets) are comprised of the following:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
---------------------------
1995 1996
----------- -----------
<S> <C> <C>
Deferred tax liabilities:
Excess servicing........................................ $ 5,891,000 $16,851,000
Depreciation............................................ 216,000 412,000
Mortgage servicing rights............................... 5,015,000
----------- -----------
Total deferred tax liabilities.......................... 6,107,000 22,278,000
----------- -----------
Deferred tax assets:
State taxes............................................. (790,000) (2,471,000)
Vacation accrual........................................ (233,000) (298,000)
Allowance for doubtful accounts......................... (212,000) (218,000)
Other accruals.......................................... (367,000) (834,000)
----------- -----------
Total deferred tax assets................................. (1,602,000) (3,821,000)
----------- -----------
Net deferred tax liabilities.............................. $ 4,505,000 $18,457,000
=========== ===========
</TABLE>
NOTE 6 COMMITMENTS AND CONTINGENCIES
The Company leases office space under operating leases expiring at various
dates through July 2001. In addition, in February 1996, the Company entered into
an operating lease for an airplane, which expires February 2006. Total rent
expense related to operating leases amounted to $1.4 million, $1.5 million and
$2.8 million, for the years ended June 30, 1994, 1995 and 1996, respectively.
Certain leases have provisions for renewal options and/or rental increases at
specified increments or in relation to increases in the Consumer Price Index (as
defined). As of June 30, 1996, listed below are future minimum rental payments
required under non-cancelable operating leases that have initial or remaining
terms in excess of one year:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
- ---------------------------
<S> <C> <C>
1997.................................................................... $ 3,560,000
1998.................................................................... 3,144,000
1999.................................................................... 2,893,000
2000.................................................................... 2,658,000
2001.................................................................... 1,427,000
Thereafter.............................................................. 4,158,000
-----------
$17,840,000
===========
</TABLE>
LITIGATION
The Company is involved in certain litigation arising in the normal course
of its business. The Company believes that any liability with respect to such
legal actions, individually or in the aggregate, is not likely to be material to
the Company's consolidated financial position or results of operations.
EMPLOYMENT AGREEMENTS
The Chief Executive Officer has an employment agreement with the Company
expiring on December 31, 1996, which provides for a base salary plus a bonus
equal to 7.5% of the Company's adjusted pre-tax income. The Chief Executive
Officer entered into a new employment agreement with the Company which expires
on June 30, 2001. The new agreement provides for, commencing January 1, 1997, a
base salary, a performance
F-14
<PAGE> 94
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
bonus measured against a target return on equity and a discretionary bonus. In
addition, certain options were granted thereunder. (See "Note 9 -- Notes to
Consolidated Financial Statements.") Under the new agreement, in the event of a
termination without cause or in the event of certain changes in control, the
Company shall pay three years base salary, plus an amount equal to his
performance bonuses over the preceding twelve quarters provided, however, if the
termination occurs after January 1, 2000, then he shall receive three years base
salary plus an amount equal to his performance bonus over the previous eight
quarters.
The Chief Operating Officer has an employment agreement with the Company
expiring on June 30, 2001, which provides for a base salary and a performance
bonus measured against a target return on equity. In addition, certain options
were granted thereunder. (See "Note 9 -- Notes to Consolidated Financial
Statements.") The agreement also provides that, in the event of a termination
without cause or in the event of certain changes in control, the Company shall
pay two years base salary plus an amount equal to his performance bonus over the
previous eight quarters.
NOTE 7 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments as of June 30, 1996 is made by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts 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.
<TABLE>
<CAPTION>
ESTIMATED
CARRYING AMOUNT FAIR VALUE
--------------- ------------
<S> <C> <C>
Cash and cash equivalents.............................. $ 18,216,000 $ 18,216,000
Loans held for sale.................................... 67,327,000 71,434,000
Excess servicing receivable............................ 129,113,000 129,113,000
Mortgage servicing rights.............................. 10,902,000 10,902,000
Amounts outstanding under revolving warehouse
facilities........................................... 11,026,000 11,026,000
Borrowings............................................. 138,045,000 139,035,000
</TABLE>
The fair value estimates as of June 30, 1996 are based on pertinent
information available to management as of the respective dates. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since those dates and,
therefore, current estimates of fair value may differ significantly from the
amounts presented herein.
The following describes the methods and assumptions used by the Company in
estimating fair values:
Cash and cash equivalents are based on the carrying amount which is a
reasonable estimate of the fair value.
Loans held for sale are based on current investor yield requirements.
Amounts outstanding under revolving warehouse facilities are short-term
in nature and generally bear market rates of interest.
Excess servicing receivable and mortgage servicing rights are based on
the expected future cashflows using common industry assumptions as well
as the Company's historical experience.
F-15
<PAGE> 95
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of the Company's borrowings are estimated based on the
quoted market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities.
NOTE 8 401(K) RETIREMENT SAVINGS PLAN
The Company sponsors a 401 (k) Retirement Savings Plan, a defined
contribution plan. Substantially all employees are eligible to participate in
the plan after reaching the age of 21 and completion of six months of service.
Contributions are made from employees' elected salary deferrals. Employer
contributions are determined at the beginning of the plan year at the option of
the employer. For fiscal years 1994, 1995 and 1996, the Company's contribution
to the plan aggregated $39,000, $46,000 and $252,000, respectively.
NOTE 9 STOCKHOLDERS' EQUITY
Under the Company's 1991 Stock Incentive Plan, a total of 750,000 shares
have been reserved for issuance. At June 30, 1996, options to exercise 694,499
have been granted at prices ranging from $4.50 to $11.92 per share; 303,550 of
these shares have been granted to the Company's Chief Executive Officer at
prices ranging from $5.50 to $11.92 per share.
Under the Company's 1995 Stock Incentive Plan, a total of 1.1 million
shares have been reserved for issuance. At June 30, 1996, options to exercise
979,451 shares have been granted at prices ranging from $11.92 to $41.87 per
share. Of these shares, 141,188 have been granted to the Company's Chief
Executive Officer at $30.00 per share and 767,250 have been granted to the
Company's Chief Operating Officer at prices ranging from $11.92 to $21.50 per
share. Additionally, the Chief Operating Officer was granted a non-qualified
stock option of 447,300 shares at $30.00. These 447,300 shares are not
exercisable while he is an officer of the Company.
During the fiscal year ended June 30, 1996, 152,115 shares have been
exercised at prices ranging from $5.00 to $11.92 per share.
Options to exercise 40,084 shares were granted to outside directors at
prices ranging from $5.50 to $21.50 per share. The Company has outstanding
20,055 warrants to purchase common stock at $6.00 per share. These are
exercisable and have certain registration rights. During the fiscal year ended
June 30, 1996, a total of 4,333 shares granted to a director were exercised at a
price of $5.50 per share. In addition, 129,945 warrants were exercised during
the fiscal year ended June 30, 1996 at a price of $6.00 per share.
On May 6, 1996 the Company declared a three-for-two split of the Company's
common stock, payable May 17, 1996 to stockholders of record on May 6, 1996. The
split was affected as a dividend of one share of common stock on every two
shares of common stock. After giving effect to this stock split, the Company has
13.5 million shares outstanding at June 30, 1996. All share and per share data
in the accompanying financial statements are presented to give retroactive
effect to the stock split.
On June 13, 1995, the Company completed the sale of 3.0 million shares of
common stock in a public offering. The proceeds to the Company from the
offering, net of expenses, were $40.0 million. On July 1, 1993, the Company
completed the sale of 1.7 million shares of common stock (including 325,000
shares owned by the Chief Executive Officer) in a public offering. The proceeds
to the Company from the offering, net of expenses, were $12.3 million.
The Company's bank agreements generally limit the Company's ability to pay
dividends. In addition, the Company's $23.0 million of 10.5% Senior Notes due
2002 places certain restrictions on additional indebtedness based on the
Company's net worth.
F-16
<PAGE> 96
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RIGHTS AGREEMENT
In June 1996, the Board of Directors of the Company declared a dividend
distribution of one preferred stock purchase right ("Right") on each share of
the Company's common stock outstanding on July 12, 1996. Each Right, when
exercisable, entitles the holder to purchase from the Company one one-hundredth
of a share of Preferred Stock, par value $0.001 per share, of the Company at a
price of $100.00, subject to adjustments in certain cases to prevent dilution.
The Rights will become exercisable (with certain limited exceptions
provided in the Rights agreement) following the 10th day after (a) a person or
group announces acquisition of 15 percent or more of the Company's Common Stock,
(b) a person or group announces commencement of a tender offer, the consummation
of which would result in ownership by the person or group of 15 percent or more
of the Company's common stock, (c) the filing of a registration statement for
any such exchange offer under the Securities Act of 1933, as amended, or (d) the
Company's board of continuing directors determines that a person is an "adverse
person," as defined in the Rights agreement.
NOTE 10 QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------------
SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30
------------ ----------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Fiscal 1996
Revenue.................................. $ 22,832 $28,263 $ 33,215 $44,098
Income before income taxes............... 9,758 11,623 13,667 18,483
Net Income............................... 5,658 6,741 7,935 10,714
Earnings per share -- Fully diluted...... $ 0.41 $ 0.49 $ 0.53 $ 0.63
Fiscal 1995
Revenue.................................. $ 12,427 $12,654 $ 14,363 $15,495
Income before income taxes............... 3,686 3,957 4,130 5,378
Net income............................... 2,172 2,315 2,400 3,147
Earnings per share -- fully diluted...... $ 0.25 $ 0.27 $ 0.27 $ 0.32
</TABLE>
NOTE 11 SUBSEQUENT EVENT
On August 12, 1996, the Company entered into an agreement to acquire One
Stop Mortgage, Inc., in a transaction to be accounted for as a pooling of
interests. Aames will issue 2.3 million shares of its common stock in exchange
for all of the outstanding common stock of One Stop Mortgage, Inc. and will
assume stock options granted to key employees of One Stop Mortgage, Inc.
covering 375,000 shares of One Stop Mortgage, Inc. At June 30, 1996, One Stop
Mortgage, Inc. had total assets of approximately $127 million.
F-17
<PAGE> 97
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
Aames Financial Corporation
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of stockholders' equity and of cash flows
present fairly, in all material respects the financial position of Aames
Financial Corporation and its Subsidiaries (the "Company") at June 30, 1996 and
1995, and the results of their operations and their cash flows for each of the
three years in the period ended June 30, 1996, 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.
As discussed in Note 1 to the consolidated financial statements, the Company
adopted an accounting standard that changed its method of accounting for
mortgage servicing rights for the year ended June 30, 1996.
As described in Note 1 on August 28, 1996, the Company merged with One Stop
Mortgage Inc. in a transaction accounted for as a pooling of interests. The
accompanying supplementary consolidated financial statements give retroactive
effect of the merger.
In our opinion, based upon our audits and the report of other auditors, the
accompanying supplementary consolidated balance sheet and the related
supplementary consolidated statements of income, of stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Aames Financial Corporation and its subsidiaries (the "Company") at June 30,
1996 and the results of their operations and their cash flows for each of the
three years in the period ended June 30, 1996, 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 did not audit the
financial statements of One Stop Mortgage, Inc., which statements reflect total
assets of $127 million at June 30, 1996, and total revenues of $7 million for
the year ended June 30, 1996. Those statements were audited by other auditors
whose report thereon has been furnished to us, and our opinion expressed herein,
insofar as it relates to the amounts included for One Stop Mortgage, Inc., is
based solely on the report of the other auditors. 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 and the report of
other auditors provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Los Angeles, California
August 28, 1996
F-18
<PAGE> 98
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1995 1996
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents....................................... $ 20,359,000 $ 23,941,000
Loans held for sale, at cost which approximates market.......... 24,132,000 186,189,000
Accounts receivable, less allowance for doubtful accounts of
$360,000
and $473,000.................................................. 6,090,000 9,685,000
Excess servicing receivable..................................... 42,078,000 129,113,000
Mortgage servicing rights....................................... 10,902,000
Residual assets................................................. 14,882,000 44,676,000
Equipment and improvements, net................................. 2,063,000 6,674,000
Prepaid and other............................................... 5,019,000 10,295,000
------------ ------------
Total assets.......................................... $114,623,000 $421,475,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Borrowings...................................................... $ 23,144,000 $138,045,000
Revolving warehouse facilities.................................. 112,363,000
Accounts payable and accrued expenses........................... 6,141,000 11,859,000
Accrued compensation and related expenses....................... 1,703,000 3,948,000
Income taxes payable............................................ 3,588,000 21,831,000
------------ ------------
Total liabilities..................................... 34,576,000 288,046,000
------------ ------------
Commitments and Contingencies (Note 6)
Stockholders' equity:
Preferred Stock, par value $.001 per share, 1,000,000 shares
authorized; none outstanding...............................
Common Stock, par value $.001 per share 15,000,000 and
50,000,000 shares authorized; 13,221,000, and 15,896,900
shares outstanding......................................... 14,000 16,000
Additional paid-in capital.................................... 61,864,000 88,142,000
Retained earnings............................................. 18,169,000 45,271,000
------------ ------------
Total stockholders' equity............................ 80,047,000 133,429,000
------------ ------------
Total liabilities and stockholders' equity............ $114,623,000 $421,475,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-19
<PAGE> 99
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED
JUNE 30,
--------------------------------------------
1994 1995 1996
----------- ----------- ------------
<S> <C> <C> <C>
Revenue:
Excess servicing gain............................ $ 8,101,000 $22,954,000 $ 85,465,000
Commissions...................................... 16,432,000 15,799,000 19,880,000
Loan service..................................... 6,099,000 8,246,000 18,185,000
Fees and other................................... 5,595,000 7,940,000 15,345,000
------------ ----------- -----------
Total revenue................................. 36,227,000 54,939,000 138,875,000
------------ ----------- -----------
Expenses:
Compensation and related expenses................ 13,616,000 17,610,000 38,052,000
Sales and advertising costs...................... 7,891,000 9,906,000 18,362,000
General and administrative expenses.............. 5,415,000 7,067,000 17,791,000
Interest expense................................. 322,000 3,205,000 12,371,000
------------ ----------- -----------
Total expenses................................ 27,244,000 37,788,000 86,576,000
------------ ----------- -----------
Income before income taxes......................... 8,983,000 17,151,000 52,299,000
Provision for income taxes......................... 3,684,000 7,117,000 22,508,000
------------ ----------- -----------
Net income......................................... $ 5,299,000 $10,034,000 $ 29,791,000
============ =========== ===========
Net income per share
Primary.......................................... $ 0.61 $ 1.11 $ 1.78
============ =========== ===========
Fully Diluted.................................... 0.61 1.11 1.71
============ =========== ===========
Weighted average number of shares outstanding
Primary.......................................... 8,751,000 9,021,000 16,766,000
============ =========== ===========
Fully Diluted.................................... 8,751,000 9,021,000 18,135,000
============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-20
<PAGE> 100
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL RETAINED
COMMON STOCK PAID-IN CAPITAL EARNINGS TOTAL
------------ --------------- ----------- ------------
<S> <C> <C> <C> <C>
As of June 30, 1993................ $ 6,000 $ 9,522,000 $ 6,322,000 $ 15,850,000
Issuance of common stock......... 3,000 12,260,000 12,263,000
Dividends........................ (1,743,000) (1,743,000)
Net income....................... 5,299,000 5,299,000
------------ --------------- ----------- ------------
As of June 30, 1994................ 9,000 21,782,000 9,878,000 31,669,000
Issuance of common stock......... 5,000 40,082,000 40,087,000
Dividends........................ (1,743,000) (1,743,000)
Net income....................... 10,034,000 10,034,000
------------ --------------- ----------- ------------
As of June 30, 1995................ 14,000 61,864,000 18,169,000 80,047,000
Issuance of common stock......... 2,064,000 2,064,000
Shares issued in merger
transaction................... 2,000 (2,000)
Dividends........................ (2,689,000) (2,689,000)
Issuance of common stock
warrants...................... 24,216,000 24,216,000
Net income....................... 29,791,000 29,791,000
------------ --------------- ----------- ------------
As of June 30, 1996................ $ 16,000 $88,142,000 $45,271,000 $133,429,000
=========== =========== ========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE> 101
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
---------------------------------------------------
1994 1995 1996
------------- ------------- ---------------
<S> <C> <C> <C>
Operating activities:
Net income................................ $ 5,299,000 $ 10,034,000 $ 29,791,000
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation and amortization.......... 466,000 606,000 1,275,000
Deferred income taxes.................. (69,000) 3,972,000 15,369,000
Excess servicing gain.................. (9,690,000) (33,891,000) (103,975,000)
Excess servicing amortization.......... 2,693,000 4,402,000 16,940,000
Mortgage servicing rights originated... (11,759,000)
Mortgage servicing rights
amortization......................... 857,000
Loans originated or purchased.......... (190,200,000) (387,600,000) (1,215,596,000)
Proceeds from sale of loans............ 180,235,000 373,609,000 1,052,580,000
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable............... (1,415,000) (2,663,000) (3,595,000)
Prepaid and other................. (900,000) (2,217,000) (5,276,000)
Residual assets................... (4,228,000) (8,691,000) (29,794,000)
Increase (decrease) in:
Accounts payable and accrued
expenses........................ 2,755,000 534,000 5,718,000
Accrued compensation and related
expenses........................ 435,000 581,000 2,246,000
Income taxes payable.............. 762,000 (2,051,000) 2,874,000
--------------- ------------- -------------
Net cash used in operating activities....... (13,857,000) (43,375,000) (241,634,000)
--------------- ------------- -------------
Investing activities:
Purchases of property and equipment....... (870,000) (988,000) (4,611,000)
--------------- ------------- -------------
Net cash used in investing activities....... (870,000) (988,000) (4,611,000)
--------------- ------------- -------------
Financing activities:
Proceeds from sale of stock or exercise of
options................................ 12,263,000 40,087,000 26,278,000
Proceeds from borrowing................... 2,900,000 23,000,000 115,000,000
Amounts outstanding under warehouse
facilities............................. 9,675,000 (9,675,000) 112,363,000
Dividends paid............................ (1,743,000) (1,743,000) (2,689,000)
Payments on bank notes and long-term
debt................................... (240,000) (3,460,000) (414,000)
--------------- ------------- -------------
Net cash provided by financing activities... 22,855,000 48,209,000 250,538,000
--------------- ------------- -------------
Net increase (decrease) in cash............. 8,128,000 3,846,000 3,582,000
Cash and cash equivalents at beginning of
period.................................... 8,385,000 16,513,000 20,359,000
--------------- ------------- -------------
Cash and cash equivalents at end of
period.................................... $ 16,513,000 $ 20,359,000 $ 23,941,000
=============== ============= =============
Supplemental disclosures:
Interest paid............................. $ 333,000 $ 3,225,000 $ 6,633,000
Taxes paid................................ 2,991,000 4,843,000 4,354,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE> 102
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
MERGER AND BASIS OF PRESENTATION
On August 28, 1996, Aames Financial Corporation, a Delaware corporation
("Aames"), acquired One Stop Mortgage, Inc., a Wyoming corporation ("One Stop"),
in a merger transaction. Aames exchanged 2.3 million shares of its common stock
for all of the outstanding common stock of One Stop and assumed the outstanding
employee stock options covering 375,000 shares of Aames common stock. The merger
transaction has been accounted for as a pooling of interests. On or about
November 15, 1996, Aames will restate its historical financial statements to
reflect the pooling-of-interests transaction. These restated financial
statements will resemble the Supplementary Consolidated Financial Statements in
all material respects. These supplementary consolidated financial statements are
presented to provide the reader with an understanding of the combined historical
results of Aames and One Stop.
OPERATIONS
Aames and its subsidiaries (collectively, the "Company") engage in the
consumer finance business by offering or purchasing mortgage loans for
homeowners throughout the United States. The Company also functions as an
insurance agent and mortgage trustee through certain of its subsidiaries. The
Company's market is borrowers who have significant equity in their homes but
whose borrowing needs are not being met by traditional financial institutions.
The Company's business includes originating (funding and brokering), purchasing,
selling and servicing mortgage loans primarily secured by single-family (i.e.,
one-to-four family) residences. Loans originated or purchased by the Company are
primarily extended on the basis of the equity in the borrower's property and, to
a lesser extent, the creditworthiness of the borrower. The aggregate outstanding
balances of loans serviced by the Company was $609 million and $1.37 billion at
June 30, 1995 and June 30, 1996, respectively (which include $152 million and
$456 million of loans at June 30, 1995 and June 30, 1996, respectively, serviced
for the Company by unaffiliated subservicers under subservicing agreements).
The Company's ability to continue to originate and purchase loans is
dependent, in part, upon its ability to securitize and sell loans in the
secondary market in order to generate cash proceeds for new originations and
purchases. The value of and market for the Company's loans are dependent upon a
number of factors, including general economic conditions, interest rates and
governmental regulations. Adverse changes in such factors may affect the
Company's ability to purchase or sell loans for acceptable prices within a
reasonable period of time.
A prolonged, substantial reduction in the size of the secondary market for
loans of the types originated and purchased by the Company may adversely affect
the Company's ability to securitize and sell loans with a consequent adverse
impact on the Company's profitability and ability to fund future originations
and purchases which could have a material adverse effect on the Company's
financial position and results of operations.
In addition, in order to gain access to the secondary market, the Company
has relied on monoline insurance companies to provide financial guarantee
insurance on the senior interests in the real estate mortgage investment conduit
("REMIC") trusts established by the Company. Any substantial reduction in the
size or availability of the secondary market for the Company's loans or the
unwillingness of monoline insurance companies to provide financial guarantee
insurance for the senior interests in REMIC trusts could have a material adverse
effect on the Company's financial position and results of operations.
PRINCIPLES OF CONSOLIDATION
The supplementary consolidated financial statements include the accounts of
the Company. All significant intercompany accounts and transactions have been
eliminated in consolidation. As previously
F-23
<PAGE> 103
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
discussed, these Supplementary Consolidated Financial Statements reflect how
Aames' Consolidated Financial Statements will look following the restatement to
reflect the merger with One Stop.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent 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.
CASH IN TRUST
The Company services loans on behalf of customers. In such capacity,
certain monies are collected and placed in segregated trust accounts, which
totaled $10.9 million and $26.8 million at June 30, 1995 and June 30, 1996,
respectively. These accounts and corresponding liabilities are not included in
the accompanying balance sheet.
EQUIPMENT AND IMPROVEMENTS
Equipment and improvements are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are being recorded utilizing
straight-line and accelerated methods over the following estimated useful lives:
<TABLE>
<S> <C>
Furniture............................................ Five to seven years
Leasehold improvements............................... Shorter of five years or lease term
Equipment under capital leases....................... Five years
Automobiles.......................................... Five years
Data processing equipment............................ Five years
</TABLE>
REVENUE RECOGNITION
The Company derives its revenue principally from servicing spreads,
premiums on sales, commissions from the origination of the loans, insurance
commissions, closing fees, prepayment fees and fees charged for services such as
appraisals and underwriting. Loans originated through the Company's retail
branch network or purchased from correspondents, investment banks or brokers are
funded by the Company for pooling and sale in the secondary market, brokered to
other financial institutions on a servicing-released basis or placed with
private investors. Revenue from loans pooled and sold in the secondary market is
recognized when such loans are sold. Revenue from loans funded by private
investors is recognized as income when escrow closes on the loan and the funds
are disbursed. Revenue from loans brokered and financial institutions is
recognized at the date of settlement and is based upon the difference between
the selling price and the carrying value of the related loans sold. The Company
retains the right to service all loans securitized by the Company, held by the
Company or placed with private investors. The Company receives a fee for
servicing such loans based on a fixed percentage of the declining principal
balance. A servicing spread is retained by the Company from the monthly payments
made by the borrowers, a portion of which is accounted for as a normal servicing
fee. Loans brokered to other financial institutions are sold on a
servicing-released basis.
Included in excess servicing gain for June 30, 1996 is $4.6 million of
gains on whole loan sales on a servicing-released basis.
During the loan origination process, the Company, its brokers and
correspondents negotiate fees, commissions and payment terms to accommodate the
borrower's immediate and long-term cash flow needs. To the extent negotiation of
the commission rate leads to a higher or lower interest rate on the loan, this
will
F-24
<PAGE> 104
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
generally have an inverse effect on the servicing spread retained by the
Company. Such negotiations result in a wide range of loan servicing spreads
retained by the Company.
Commission revenue on retail loan originations and related direct
origination costs are deferred until the related loan is sold. Upon sale of the
loan, the deferred commissions are recognized as commission revenue in the
Consolidated Statements of Income and deferred origination costs are recognized
in the applicable expense classification.
The accounting practice employed by the Company, whereby it accounts for a
portion of the servicing spread as a normal servicing fee has the effect of
normalizing the loan servicing revenues recognized by the Company derived from
the long-term servicing of loans originated or purchased by the Company and
pooled and sold in the secondary market on a servicing-retained basis, or placed
with private investors. An excess loan servicing gain or loss is recorded to
account for the difference between the servicing spread retained by the Company
and the normal servicing fee that is determined by the Company taking into
account several factors including industry practices. The net present value of
that difference (based on certain prepayment and other assumptions to determine
an expected life of the loan) is recorded as an excess servicing gain or loss
when the loan is sold in a pool or funded by private investors. The gain on sale
included in the Consolidated Statements of Income includes these amounts reduced
by direct transaction costs. For loans sold in the secondary market, the gain on
sale of receivables includes provisions for credit risk obligations retained by
the Company. The excess servicing receivable included in the Consolidated
Balance Sheets results from the recordation of such initial gains on an
aggregate basis adjusted for amortization.
As the Company receives cash in the form of the servicing spread it retains
(including the normal servicing fee), the excess servicing receivable is reduced
in proportion to and over the expected lives of the related loans giving effect
to the prepayment assumption utilized in its determination. On a quarterly
basis, the Company reviews its prepayment and other assumptions in relation to
its actual experience and current rates of prepayment prevalent in the industry.
The excess servicing receivable is written down when a shortfall in the net
present value of the estimated remaining future excess servicing fee revenue
becomes apparent. The excess servicing receivable is not increased as a result
of slower than estimated prepayment experience. The Company receives prepayment
fees on certain loans if they are paid off before maturity.
MORTGAGE SERVICING RIGHTS
The Company elected to adopt Statement of Financial Accounting Standard No.
122, "Accounting for Mortgage Servicing Rights" ("SFAS 122"), which amends the
prior mortgage banking standard for fiscal year 1996. SFAS 122 prohibits
retroactive application to fiscal years prior to adoption. Accordingly, certain
information appearing in the Company's financial statements for fiscal 1995 and
before are based on the prior standard and such results are not directly
comparable to the results for fiscal 1996. Under SFAS 122 the Company recognizes
mortgage servicing rights ("MSR's") as assets separate from the mortgage loans
to which the MSR's relate based on their respective fair values. In the past,
the Company had allocated the entire cost of originating or purchasing a
mortgage loan to the carrying value of such mortgage loans. MSR's are amortized
over the lives of the loans to which the MSR's relate, reducing servicing income
in future periods.
To the extent that a portion of the total cost of originating or purchasing
mortgage loans has been allocated to the MSR's, relatively greater gains were
recognized on the securitization and sale of mortgage loans because of the
reduction of the Company's basis in such loans. The effect of adopting SFAS 122
was to increase the net income of the Company for the fiscal year ended June 30,
1996 by $5.7 million or $.31 per weighted average share.
F-25
<PAGE> 105
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In order to determine the fair value of the MSR's the Company estimates the
expected future net servicing revenue based on common industry assumptions
(since market prices for MSR's under comparable servicing sales contracts are
not available to the Company), as well as on the Company's historical
experience.
INCOME TAXES
Taxes are provided on substantially all income and expense items included
in earnings, regardless of the period in which such items are recognized for tax
purposes. The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns. In estimating future tax consequences, the Company
generally considers all expected future events other than enactments of changes
in the tax law or rates.
RISK MANAGEMENT
The Company employs certain risk management strategies to minimize its risk
from interest rate fluctuations during the period between the time it originates
or purchases loans and the time such loans are sold in the secondary market. The
Company securitizes the majority of its loans in the secondary market on a
quarterly basis, thus limiting the period of its interest rate risk exposure.
These securitizations are structured to allow the Company to sell a specified
amount of certain loans for a limited time in the future at an agreed upon
price. In addition, the Company regularly reviews the interest rates on its loan
products and makes adjustments to rates to reflect market conditions.
Additionally, the Company employs a hedging strategy whereby it enters into
agreements to sell securities not yet purchased that correlate to securities
that are used to index sales of the Company's loans in the secondary market.
Gains or losses on these transactions are included in the excess servicing gain
at the time the underlying loans are sold. At June 30, 1996, the Company had
open hedging positions with a notional balance of $70.0 million.
CASH AND CASH EQUIVALENTS
Cash equivalents, consisting primarily of short-term investments, are
considered cash equivalents if they were purchased with an original maturity of
three months or less. At June 30, 1996, the Company had $2.2 million held in a
restricted account in connection with the sale of a loan pool. These funds were
released to the Company in July 1996.
LOANS HELD FOR SALE
Loans held for sale are carried at the lower of aggregate cost or market
value. Market value is determined by current investor yield requirements.
RESIDUAL ASSETS
In connection with its loan securitization transactions, the Company
initially deposits with a trustee, cash or the required overcollateralization
amount of loans, and subsequently deposits a portion of the servicing spread
collected on the related loans. The amounts set aside ($14.9 million at June 30,
1995 and $44.7 million at June 30, 1996) are available for distribution to
investors in the event of certain shortfalls in amounts due to investors. These
amounts are subject to increase up to maximum subordination amounts as specified
in the related securitization documents. Cash amounts on deposit are invested in
certain instruments as permitted by the related securitization documents. To the
extent amounts on deposit exceed specified levels, distributions are made to the
Company and, at the termination of the related REMIC trust, any remaining
amounts on deposit are distributed to the Company.
F-26
<PAGE> 106
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DEBT ISSUANCE COSTS
At June 30, 1996, the Company had an unamortized balance of debt issuance
costs of $3.8 million related to the issuance of $23 million of 10.5% Senior
Notes due 2002 and the issuance of $115 million of 5.5% Convertible Subordinated
Debentures due 2006. This balance is included in "Prepaid assets and other" on
the Consolidated Balance Sheets and is amortized into interest expense over the
life of the related debt. See Note 4 regarding One Stop debt issue costs.
EARNINGS PER SHARE
Earnings per share of common stock is computed using the weighted average
number of shares of common stock outstanding during each period, after giving
effect to the shares of common stock issued in connection with the merger the
assumed exercise of certain stock options and warrants, and in addition, for
fully diluted earnings per share, the conversion of shares related to the
Company's 5.5% Convertible Subordinated Debentures due 2006.
In May, 1996 the Company's $0.001 par value common stock was split 3 for 2.
All references in the accompanying Consolidated Balance Sheets, Consolidated
Statements of Income and of Stockholders Equity, and Notes to Consolidated
Financial Statements to the number of common shares and share amounts have been
restated to reflect the stock split.
RECLASSIFICATIONS
Certain amounts related to 1994 and 1995 have been reclassified to conform
to the 1996 presentation.
NOTE 2 EXCESS SERVICING RECEIVABLE
The excess servicing receivable represents the net present value of the
difference between the servicing spread retained by the Company and the normal
servicing fee determined by the Company taking into account several factors
including industry practices. The amount is amortized over the estimated lives
of the loans to which the excess servicing receivable relates.
The activity in the excess servicing receivable is summarized as follows:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
--------------------------------------------
1994 1995 1996
----------- ----------- ------------
<S> <C> <C> <C>
Balance, beginning of year................. $ 5,592,000 $12,589,000 $ 42,078,000
Excess servicing gain...................... 9,690,000 33,891,000 103,975,000
Amortization of receivable................. (2,693,000) (4,402,000) (16,940,000)
------------ ----------- -----------
Balance, end of year....................... $12,589,000 $42,078,000 $129,113,000
============ =========== ===========
</TABLE>
The Company discounts the cash flows on the related loans sold based upon
the rates charged to borrowers on such loans adjusted for credit risk
obligations retained by the Company. The Company had reserves of $959,000, $3.4
million and $10.2 million at June 30, 1994, 1995 and 1996, respectively, related
to these credit risk obligations, which are netted against the excess servicing
receivable. The weighted average rates used to discount the cash flows were
13.7%, 14.5% and 14.7% for the years ended June 30, 1994, 1995, and 1996,
respectively. The excess servicing receivable is amortized using the same
discount rate used to determine the original excess servicing gain recorded.
On a quarterly basis, the Company analyzes its prepayment assumptions in
relation to actual prepayment experience on a disaggregated basis, based on loan
origination date and type of loan (fixed or adjustable), to determine whether
actual prepayment experience has had any impact on the carrying value of the
excess servicing receivable.
F-27
<PAGE> 107
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3 EQUIPMENT AND IMPROVEMENTS
Equipment and improvements comprise the following:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
---------------------------
1995 1996
----------- -----------
<S> <C> <C>
Furniture and fixtures.................................... $ 1,460,000 $ 4,007,000
Data processing equipment................................. 1,654,000 4,727,000
Leasehold improvements.................................... 133,000 241,000
Equipment under capital leases............................ 796,000 806,000
Automobiles............................................... 195,000 256,000
----------- -----------
Total........................................... 4,238,000 10,037,000
Accumulated depreciation and amortization................. (2,175,000) (3,363,000)
----------- -----------
Net....................................................... $ 2,063,000 $ 6,674,000
=========== ===========
</TABLE>
NOTE 4 BORROWINGS
The Subordinated Convertible Debentures are Subordinated to all existing
and future senior debt of the Company (as defined in the Indenture).
Borrowings consist of the following:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
----------------------------
1995 1996
----------- ------------
<S> <C> <C>
5.5% Subordinated Convertible Debentures due 2006
convertible into 4.1 million shares of common stock of
the Company at a conversion price of $28 per share..... $115,000,000
10.5% Senior Notes due 2002, collateralized by certain
residual certificates. Principal payments of $5,750,000
in each of calendar years 1999 through 2002............ $23,000,000 23,000,000
Obligations under capital leases......................... 144,000 45,000
----------- ------------
$23,144,000 $138,045,000
=========== ============
Warehouse Agreements consist of the following:
Warehouse agreement with investment bank collateralized
by mortgages/deeds of trust; expires January 1, 1997
with interest at 0.875% over applicable LIBOR rate;
total credit available $150,000,000. Applicable
LIBOR rate was 5.5% at June, 1996................... $ $ 11,026,000
Revolving warehouse facility with commercial banks
collateralized by mortgages/deeds of trust; due in
December 1996 with interest at 0.875% over
applicable LIBOR rate; total credit available $100
million. Applicable LIBOR rate was 5.5% at June 30,
1996................................................
----------- ------------
$ $ 11,026,000
=========== ============
</TABLE>
F-28
<PAGE> 108
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1995 1996
------------ ------------
<S> <C> <C>
$250,000,000 revolving warehouse line of credit with an
investment bank secured by the loans held for sale. Interest
accrues based on LIBOR, which varies based on the outstanding
balance of the line of credit. Matures September 1996......... $ $122,765,000
$5,000,000 unsecured working capital note with an investment
bank due September 1996. Interest accrues at 12% and paid
monthly. Principal due at maturity............................ 2,000,000
$50,000,000 residual line of credit with an investment bank
secured by residual interests in securitizations of the
Company loans. Interest accrues based on LIBOR, which varies
based on the outstanding line of credit. Matures September
1996..........................................................
Prepaid commitment fee related to issuance of common stock
warrants to investment bank, net of amortization of
$788,000...................................................... (23,428,000)
------------ ------------
One Stop credit facilities.................................... 101,337,000
------------ ------------
Total warehouse lines of credit............................... $ $112,364,000
============ ============
</TABLE>
In June 1996, concurrent with the completion of three new financing
agreements, One Stop issued warrants for the purchase of the number of shares of
common stock equivalent to 25% of the then outstanding shares of One Stop. These
warrants have a 10-year term and are immediately exercisable at a price of $1.00
per share. The excess of the fair market value of the warrant on the date of
grant over the exercise price ($24,216,000) has been recorded as a prepaid
commitment fee and included as a reduction to the related debt amounts with a
corresponding credit to additional paid-in capital. Such commitment fee is being
amortized to expenses using the straight-line method over the remaining terms
(30 to 36 months) to maturity of the related debt. The Company has received
notification that the investment banker intends to terminate all the One Stop
financing arrangements as a result of, and subsequent to, the merger with Aames.
Upon termination of the financing arrangements, the remaining unamortized
prepaid commitment fee of $23.4 million would be fully expensed.
Maturities on long-term liabilities are as follows:
<TABLE>
<CAPTION>
OBLIGATIONS
OBLIGATIONS UNDER
UNDER CAPITAL
FISCAL YEARS ENDED CAPITAL LEASES -- NET NOTES
JUNE 30, LEASES OF INTEREST PAYABLE TOTAL -- NET
- ------------------ ----------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
1997............................ $47,000 $ 45,000 $ 45,000
1998............................
1999............................ 5,750,000 5,750,000
2000............................ 5,750,000 5,750,000
2001............................ 5,750,000 5,750,000
Thereafter...................... 120,750,000 120,750,000
------- ------- ------------ ------------
$47,000 $ 45,000 $ 138,000,000 $138,045,000
======= ======= ============ ============
</TABLE>
EQUIPMENT UNDER CAPITAL LEASES
Equipment under capital leases is comprised of computer, office and
telephone equipment. Accumulated amortization of $685,000 and $758,000 relating
to this equipment has been recorded as of June 30, 1995 and 1996, respectively.
F-29
<PAGE> 109
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5 INCOME TAXES
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED JUNE 30,
-------------------------------------------
1994 1995 1996
----------- ----------- -----------
<S> <C> <C> <C>
Current:
State..................................... $ 814,000 $ 992,000 $ 2,212,000
Federal................................... 2,939,000 2,154,000 6,344,000
----------- ---------- ----------
3,753,000 3,146,000 8,556,000
----------- ---------- ----------
Deferred:
State..................................... 17,000 1,080,000 3,740,000
Federal................................... (86,000) 2,891,000 10,212,000
----------- ---------- ----------
(69,000) 3,971,000 13,952,000
----------- ---------- ----------
$ 3,684,000 $ 7,117,000 $22,508,000
=========== ========== ==========
</TABLE>
For 1994, 1995, and 1996, the Company's effective income tax rate is
computed using the appropriate statutory rates with no significant differences.
The financial statement balances at June 30, 1995 and 1996 are as follows:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Current taxes payable (receivable)
Federal................................................. $ (596,000) $ 2,668,000
State................................................... (321,000) 706,000
----------- ----------
Total........................................... (917,000) 3,374,000
----------- ----------
Deferred taxes payable
Federal................................................. 3,240,000 13,451,000
State................................................... 1,265,000 5,005,000
----------- ----------
Total........................................... 4,505,000 18,456,000
----------- ----------
Total tax liabilities................................... $ 3,588,000 $21,830,000
=========== ==========
</TABLE>
Deferred tax liabilities (assets) are comprised of the following:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Excess servicing.......................................... $ 5,891,000 $16,850,000
Depreciation.............................................. 216,000 412,000
Mortgage servicing rights................................. 5,015,000
----------- -----------
Total deferred tax liabilities.................. 6,107,000 22,277,000
----------- -----------
State taxes............................................... (790,000) (2,471,000)
Vacation accrual.......................................... (233,000) (298,000)
Allowance for doubtful accounts........................... (212,000) (218,000)
Other accruals............................................ (367,000) (834,000)
----------- -----------
Total deferred tax assets....................... (1,602,000) (3,821,000)
----------- -----------
Valuation allowance
Net deferred tax liabilities.............................. $ 4,505,000 $18,456,000
=========== ===========
</TABLE>
F-30
<PAGE> 110
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases office space under operating leases expiring at various
dates through July 2000. In addition, in February 1996 the Company entered into
an operating lease for an airplane, which expires February 2006. Total rent
expense related to operating leases amounted to $1,411,000, $1,516,000, and
$3,152,000, for the years ended June 30, 1994, 1995 and 1996, respectively.
Certain leases have provisions for renewal options and/or rental increases at
specified increments or in relation to increases in the Consumer Price Index (as
defined). As of June 30, 1996, listed below are future minimum rental payments
required under non-cancelable operating leases that have initial or remaining
terms in excess of one year:
<TABLE>
<CAPTION>
FISCAL YEARS ENDING
JUNE 30,
- -------------------
<S> <C> <C>
1997.................................................................... $ 4,112,000
1998.................................................................... 3,442,000
1999.................................................................... 2,908,000
2000.................................................................... 2,658,000
2001.................................................................... 1,427,000
Thereafter.............................................................. 4,157,000
-----------
$18,704,000
===========
</TABLE>
LITIGATION
The Company is involved in certain litigation arising in the normal course
of its business. The Company believes that any liability with respect to such
legal actions, individually or in the aggregate, is not likely to be material to
the Company's consolidated financial position or results of operations.
EMPLOYMENT AGREEMENTS
The Chief Executive Officer has an employment agreement with the Company
expiring on December 31, 1996, which provides for a base compensation plus a
bonus equal to 7.5% of the Company's adjusted pre-tax income. The Chief
Executive Officer entered into a new employment agreement with the Company which
expires on June 30, 2001. The new agreement provides for, commencing January 1,
1997, a base salary, a performance bonus measured against a target return on
equity and a discretionary bonus. In addition, certain options were granted
thereunder. Under the new agreement, in the event of a termination without cause
or in the event of certain changes in control the Company shall pay three years
base salary, plus an amount equal to his performance bonuses over the preceding
twelve quarters, provided, however, if the termination occurs after January 1,
2000, than he shall receive three years base salary plus an amount equal to his
performance bonus over the previous eight quarters.
The Chief Operating Officer has an employment agreement with the Company
expiring on June 30, 2001, which provides for a base salary and a performance
bonus measured against a target return on equity. In addition, certain options
were granted thereunder. The agreement also provides that, in the event of a
termination without cause or in the event of certain changes in control, the
Company shall pay two years base salary plus an amount equal to his performance
bonus over the previous eight quarters.
The Chief Executive Officer of One Stop has an employment agreement with
the Company expiring on August 2001, subject to extension which provides for a
base salary and a performance bonus equal to 7.5% of One Stop's adjusted pre-tax
income. The agreement also provides that, in the event of a termination without
cause or in the event of certain changes in control, the Company shall pay three
years base salary plus an amount equal to his performance bonus over the
previous twelve quarters.
F-31
<PAGE> 111
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments as of June 30, 1996 is made by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is necessarily required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts 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.
<TABLE>
<CAPTION>
CARRYING AMOUNT ESTIMATED FAIR VALUE
--------------- --------------------
<S> <C> <C>
Cash and cash equivalents.......................... $ 23,941,000 $ 23,941,000
Loans held for sale................................ 186,189,000 198,507,000
Excess servicing receivable........................ 129,113,000 129,113,000
Mortgage servicing rights.......................... 10,902,000 10,902,000
Amounts outstanding under warehouse facilities..... 135,791,000 135,791,000
Borrowings......................................... 138,045,000 139,035,000
</TABLE>
The fair value estimates as of June 30, 1996 are based on pertinent
information available to management as of the respective dates. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since those dates and,
therefore, current estimates of fair value may differ significantly from the
amounts presented herein.
The following describes the methods and assumptions used by the Company in
estimating fair values:
Cash and cash equivalents are based on the carrying amount which is a
reasonable estimate of the fair value. Loans held for sale are based on
current investor yield requirements.
Amounts outstanding under warehouse facilities are short term in
nature and generally bear market rates of interest.
Excess servicing receivable and mortgage servicing rights are based on
the expected future cash flows using common industry assumptions as well as
the Company's historical experience.
The fair value of the Company's borrowings are estimated based on the
quoted market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities.
NOTE 8 401(K) RETIREMENT SAVINGS PLAN
The Company sponsors a 401(k) Retirement Savings Plan, a defined
contribution plan. Substantially all employees are eligible to participate in
the plan after reaching the age of 21 and completion of six months of service.
Contributions are made from employees' elected salary deferrals. Employer
contributions are determined at the beginning of the plan year at the option of
the employer. For fiscal years 1994, 1995, and 1996, the Company's contribution
to the plan aggregated $39,000, $46,000, and $252,000, respectively.
NOTE 9 STOCKHOLDERS' EQUITY
Under the Company's 1991 Stock Incentive Plan a total of 750,000 shares
have been reserved for issuance. At June 30, 1996, options to exercise 694,499
shares have been granted at prices ranging from $4.50 to $11.92 per share;
303,550 of these shares have been granted to the Company's Chief Executive
Officer at prices ranging from $5.50 to $11.92 per share.
F-32
<PAGE> 112
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under the Company's 1995 Stock Incentive Plan, a total of 1.1 million
shares have been reserved for issuance. At June 30, 1996, options to exercise
979,451 have been granted at prices ranging from $11.92 to $41.87 per share.
141,188 have been granted to the Company's Chief Executive Officer at $30.00 per
share and 767,250 have been granted to the Company's Chief Operating Officer at
prices ranging from $11.92 to $21.50 per share. Additionally the Chief Operating
Officer was granted a non-qualified stock option of 447,300 shares at $30.00 per
share. These 447,300 shares are not exercisable while he is an officer of the
Company.
During the fiscal year ended June 30, 1996, 152,115 shares have been
exercised at prices ranging from $5.00 to $11.92 per share.
Under the terms of the merger with One Stop, the Company agreed to assume
the obligations for outstanding employee stock options of One Stop for 375,000
shares with prices ranging from $.29 to $32.13.
Options to exercise 40,084 shares were granted to outside directors at
prices ranging from $5.50 to $21.50 per share. The Company has outstanding
20,055 warrants to purchase common stock at $6.00 per share. These are
exercisable and have certain registration rights. During the fiscal year ended
June 30, 1996, 4,333 shares granted to a director were exercised at a price of
$5.50 per share. In addition, $129,945 warrants were exercised during the fiscal
year ended June 30, 1996 at a price of $6.00 per share.
In May 1996, the Company declared a three-for-two split of the Company's
common stock, payable May 17, 1996 to stockholders of record on May 6, 1996. The
split was affected as a dividend of one share of common stock on every two
shares of common stock. After giving effect to this stock split, the Company has
13.5 million shares outstanding at June 30, 1996. All share and per share data
in the accompanying financial statements are presented to give retroactive
effect to the stock split.
On June 13, 1995, the Company completed the sale of 3.0 million shares of
common stock in a public offering. The proceeds to the Company from the
offering, net of expenses, were $40.0 million. On July 1, 1993, the Company
completed the sale of 1.7 million shares of common stock (including 325,000
shares owned by the Chief Executive Officer) in a public offering. The proceeds
to the Company from the offering, net of expenses, were $12.3 million.
The Company's bank agreements generally limit the Company's ability to pay
dividends. In addition, the Company's $23.0 million of 10.5% Senior Notes due
2002 places certain restrictions on additional indebtedness based on the
Company's net worth.
RIGHTS AGREEMENT
In June, 1996, the Board of Directors of the Company declared a dividend
distribution of one preferred stock purchase right ("Right") on each share of
the Company's common stock outstanding on July 12, 1996. Each Right, when
exercisable, entitles the holder to purchase from the Company one one-hundredth
of a share of Preferred Stock, par value $0.001 per share, of the Company at a
price of $100.00, subject to adjustments in certain cases to prevent dilution.
The Rights will become exercisable (with certain limited exceptions
provided in the Rights agreement) following the 10th day after (a) a person or
group announces acquisition of 15 percent or more of the Company's common stock,
(b) a person or group announces commencement of a tender offer, the consummation
of which would result in ownership by the person or group of 15 percent or more
of the Company's common stock, (c) the filing of a registration statement for
any such exchange offer under the Securities Act of 1933, as amended, or (d) the
Company's board of continuing directors determines that a person is an "adverse
person," as defined in the Rights agreement.
F-33
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PROSPECTUS
$300,000,000
AAMES LOGO
AAMES FINANCIAL CORPORATION
DEBT SECURITIES AND COMMON STOCK
------------------------
This Prospectus relates to the public offering by Aames Financial
Corporation, a Delaware corporation ("Aames" or the "Company"), of its unsecured
debt securities which may be issued from time to time in one or more series (the
"Debt Securities") and shares of its Common Stock, par value $0.001 per share
(the "Common Stock"), with an aggregate public offering price of up to
$300,000,000. The Debt Securities and the Common Stock are collectively referred
to herein as the "Securities."
In the case of Debt Securities, the specific title, the aggregate principal
amount, the purchase price, the maturity, the rate (or method of calculation)
and time of payment of interest, if any, the right of the Company, if any, to
defer payment of interest on the Debt Securities and the maximum length of such
deferral period, any redemption or sinking fund provisions, any conversion
provisions, any subordination terms, any covenants and any other specific term
of the Debt Securities will be set forth in a supplement to this Prospectus
(each, a "Prospectus Supplement"). In the case of Common Stock, the specific
number of shares and the issuance price per share will be set forth in the
Prospectus Supplement. The Prospectus Supplement will also disclose whether the
Securities will be listed on a national securities exchange and if they are not
to be listed, the possible effects thereof on their marketability. If so
specified in the Prospectus Supplement, Securities may be issued, in whole or in
part, in book-entry form. The Risk Factors applicable to any offering of the
Securities will be contained in the Prospectus Supplement.
Securities may be sold directly, through agents from time to time, through
underwriters and/or dealers or through a combination of such methods. If any
agent of the Company or any underwriter is involved in the sale of the
Securities, the name of such agent or underwriter and any applicable commission
or discount will be set forth in the Prospectus Supplement. See "Plan of
Distribution."
This Prospectus may not be used to consummate sales of Securities unless
accompanied by a Prospectus Supplement.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR BY ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
REVIEWED OR PASSED UPON THE ACCURACY OR PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
The date of this Prospectus is September 23, 1996
<PAGE> 114
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-3 (the "Registration Statement) under the Securities Act with respect to the
Common Stock offered hereby. This Prospectus, which constitutes part of the
Registration Statement does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further
information with respect to the Company and the Common Stock offered hereby,
reference is hereby made to such Registration Statement, and the exhibits and
schedules thereto which may be obtained from the Commission's principal office
in Washington, D.C., upon payment of the fees prescribed by the Commission.
Statements contained in this Prospectus as to the contents of any contract,
agreement or other document are not necessarily complete, and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement of which this Prospectus forms a part.
The Company is subject to the reporting requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files periodic reports and other information with the Securities and
Exchange Commission (the "Commission"). For further information with respect to
the Company, reference is hereby made to such reports and other information
which can be inspected and copied at the public reference facilities maintained
by the Commission at Room 1025, 450 Fifth Street, N.W., Washington, D.C. 20549,
and at the Commission's Regional Offices located at Seven World Trade Center,
13th Floor, New York, New York 10048 and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies may also be obtained at
prescribed rates from the Public Reference Section of the Commission at Room
1024, 450 Fifth Street, N.W., Washington, D.C. 20549. In addition, reports,
proxy statements and other information concerning the Company can also be
inspected at the offices of the New York Stock Exchange, Inc., 20 Broad Street,
New York, New York 10005, on which exchange the Company's Common Stock is
listed.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents heretofore filed by the Company with the Commission
pursuant to the Exchange Act are incorporated by reference into this Prospectus:
(1) the Company's Annual Report on Form 10-K for the fiscal year ended
June 30, 1996; and
(2) the Company's Current Reports on Form 8-K dated July 10, 1996,
August 7, 1996, August 13, 1996 and September 12, 1996 (including
Form 8-K/A dated September 16, 1996).
All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or
15(d) of the Exchange Act after the date of this Prospectus and prior to the
termination of the offering of the securities covered by this Prospectus shall
be deemed to be incorporated by reference herein and to be part hereof from the
date of filing of such documents. Any statement contained herein or in a
document, all or a portion of which is incorporated or deemed to be incorporated
by reference herein, shall be deemed to be modified or superseded for purposes
of this Prospectus to the extent that a statement contained herein or in any
other subsequently filed document which also is or is deemed to be incorporated
by reference herein modifies or supersedes such statement. Any statement so
modified or superseded shall not be deemed, except as so modified or superseded,
to constitute a part of this Prospectus.
The Company hereby undertakes to provide without charge to each person to
whom a copy of this Prospectus has been delivered, upon the oral or written
request of any such person, a copy of any or all of the documents incorporated
herein by reference (other than exhibits to such documents, unless such exhibits
are expressly incorporated by reference into such documents). Written requests
for such copies should be directed to the Company's Secretary at 3731 Wilshire
Boulevard, 10th Floor, Los Angeles, California 90010, or made by telephone at
(213) 351-6100.
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<PAGE> 115
THE COMPANY
Aames Financial Corporation (the "Company"), founded in 1954, is a consumer
finance company engaged in the business of originating, purchasing, selling and
servicing home equity mortgage loans secured by single family residences. The
Company's principal market is credit-impaired borrowers who have significant
equity in their homes but whose borrowing needs are not being met by traditional
financial institutions due to credit exceptions or other factors. The Company
focuses its efforts on collateral lending and believes that it originates and
purchases a greater proportion of lower credit grade loans ("C-" and "D" loans)
than most other lenders to credit-impaired borrowers. These lower credit grade
loans are characterized by lower combined loan-to-value ratios and higher
average interest rates than higher credit grade loans ("A-," "B" and "C" loans).
The Company believes lower credit-quality borrowers represent an underserved
niche of the home equity loan market and present an opportunity to earn a
superior return for the risks assumed. Although the Company has historically
experienced delinquency rates that are higher than those prevailing in its
industry, management believes the Company's historical loan losses are generally
lower than those experienced by most other lenders to credit-impaired borrowers
because of the lower combined loan-to-value ratios on the Company's lower credit
grade loans. The mortgage loans originated and purchased by the Company are
generally used by borrowers to consolidate indebtedness or to finance other
consumer needs rather than to purchase homes. Consequently, the Company believes
that it is not as dependent as traditional mortgage bankers on levels of home
sales or refinancing activity prevailing in its markets.
The Company originates and purchases loans through three production
channels. The Company has historically originated its loans through its retail
loan office network. In 1994, the Company diversified its production channels to
include a wholesale correspondent program which consisted initially of
purchasing loans from other mortgage bankers and financial institutions
underwritten in accordance with the Company's guidelines. In fiscal 1996, this
program was expanded to include the purchase of loans in bulk from other
mortgage bankers and financial institutions. On August 28, 1996, the Company
acquired One Stop Mortgage, Inc. ("One Stop"), which further diversified the
Company's production channels to include the originations and purchase of
mortgage loans from a network of independent mortgage brokers. While the Company
intends to continue focusing on its traditional niche in the "C-" and "D" credit
grade loans, the Company also intends to continue to diversify the loans it
originates and purchases through its three production channels to include more
"A-," "B" and "C" credit grade loans. The Company underwrites every loan it
originates and re-underwrites and reviews appraisals on all loans it purchases.
Substantially all of the mortgage loans originated and purchased by the
Company are sold in the secondary market through public securitizations in order
to enhance profitability, maximize liquidity and reduce the Company's exposure
to fluctuations in interest rates. In a securitization, the Company recognizes a
gain on the sale of loans securitized upon the closing of the securitization,
but does not receive the excess servicing, which is payable over the actual life
of the loans securitized. The excess servicing represents, over the estimated
life of the loans, the excess of the weighted average interest rate on the pool
of loans sold over the sum of the investor pass-through rate, normal servicing
fee and the monoline insurance fee. The net present value of that excess
(determined based on certain prepayment and loss assumptions) less transaction
expenses is recorded as excess servicing gain or loss at the time of the closing
of the securitization. The Company securitized and sold in the secondary market
$107 million, $317 million and $791 million of loans in the years ended June 30,
1994, 1995 and 1996, respectively. Each of the Company's securitizations has
been credit-enhanced by insurance provided by a monoline insurance company to
receive ratings of "Aaa" by Moody's Investors Service and "AAA" from Standard &
Poor's.
The Company retains the servicing rights (collecting loan payments and
handling borrower defaults) to substantially all of the loans it originates or
purchases. At June 30, 1996, the Company had a servicing portfolio of $1.25
billion, 27% of which was serviced by subservicers. In fiscal 1996, the Company
serviced directly all loans in its servicing portfolio which were secured by
mortgaged properties located in Arizona, California, Colorado, Nevada, Oregon,
Utah and Washington. Loans secured by properties located in other states were
serviced through one or more subservicers which were paid a fee per loan and a
participation in certain other fees paid by the borrowers. The Company will
implement in fiscal 1997 a new servicing system
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<PAGE> 116
which will provide the Company the capability to service in house all loans
originated or purchased by it regardless of the state in which the mortgaged
property is located
The Company is a Delaware corporation with the principal executive offices
located at 3731 Wilshire Boulevard, 10th floor, Los Angeles, California 90010,
telephone number (213) 351-6100.
USE OF PROCEEDS
The primary purpose of this Offering is to provide the Company with
additional capital to fund its growth, including increasing the amount of loans
the Company can fund and hold for pooling and sale in the secondary market,
general corporate purposes, and for the possible acquisition of other related
businesses as opportunities arise. Although the Company from time to time
considers acquisitions and other opportunities for future growth, the Company
has not entered into any arrangement, agreement, or understanding with respect
to future acquisitions. Pending their ultimate application, the net proceeds
will be invested in high quality, short-term, interest-bearing investments and
deposit accounts.
RATIO OF EARNINGS TO FIXED CHARGES
The Company's ratio of earnings to fixed charges represents the ratio of
(i) the sum of income before taxes plus interest expense to (ii) interest
expense. The ratio of earning to fixed charges for each of the five fiscal years
ended June 30, 1992, 1993, 1994, 1995 and 1996 was 25:1, 41:1, 29:1, 6.4:1 and
6.7:1, respectively.
DESCRIPTION OF DEBT SECURITIES
GENERAL
The Debt Securities will be issued under an Indenture (the "Indenture")
between the Company and the trustee named in the applicable Prospectus
Supplement as trustee (the "Trustee"). The statements under this caption are
brief summaries of certain provisions contained in the Indenture, do not purport
to be complete and are qualified in their entirety by reference to the
Indenture, a copy of which is an exhibit to and incorporated in the Registration
Statement. Terms used but not defined under this caption have the meanings given
to them in the Indenture.
The following description of the terms of the Debt Securities sets forth
certain general terms and provisions of the Debt Securities to which any
Prospectus Supplement may relate. The particular terms of any Debt Securities
and the extent, if any, to which such general provisions do not apply to such
Debt Securities will be described in the Prospectus Supplement relating to such
Debt Securities.
The Indenture does not limit the amount of Debt Securities that may be
issued thereunder, and the Indenture provides that Debt Securities of any series
may be issued thereunder up to the aggregate principal amount which may be
authorized from time to time by the Company's board of directors ("Board of
Directors").
Debt Securities of a series may be issuable in registered form with or
without coupons ("Registered Securities"), in bearer form with or without
coupons attached ("Bearer Securities") or in the form of one or more global
securities in registered or bearer form (each a "Global Security"). Bearer
Securities, if any, will be offered only to non-United States persons and to
offices located outside the United States of certain United States financial
institutions. Reference is made to the Prospectus Supplement for a description
of the following terms, where applicable, of each series of Debt Securities in
respect of which this Prospectus is being delivered: (1) the title of such Debt
Securities; (2) the limit, if any, on the aggregate principal amount or
aggregate initial public offering price of such Debt Securities; (3) the
priority of payment of such Debt Securities; (4) the price or prices (which may
be expressed as a percentage of the aggregate principal amount thereof) at which
the Debt Securities will be issued; (5) the date or dates on which the principal
of the Debt Securities will be payable; (6) the rate or rates (which may be
fixed or variable) per annum at which such Debt Securities will bear interest,
if any, or the method of determining the same; (7) the date or dates from
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<PAGE> 117
which such interest, if any, on the Debt Securities will accrue, the date or
dates on which such interest, if any, will be payable, the date or dates on
which payment of such interest, if any, will commence and the date, if any,
specified in the Debt Security as the "Regular Record Date" for such interest
payment dates; (8) the extent to which any of the Debt Securities will be
issuable in temporary or permanent global form, and the manner in which any
interest payable on a temporary or permanent global Debt Security will be paid;
(9) each office or agency where, subject to the terms of the applicable
Indenture, the Debt Securities may be presented for registration of transfer or
exchange; (10) the place or places where the principal of (and premium, if any)
and interest, if any, on the Debt Securities will be payable; (11) the date or
dates, if any, after which such Debt Securities may be redeemed or purchased in
whole or in part, at the option of the Company, or may be required to be
purchased or redeemed at the option of the holder, and the redemption or
repayment price or prices thereof; (12) the denomination or denominations in
which such Debt Securities are authorized to be issued; (13) any index used to
determine the amount of payments of principal of, premium, if any, and interest
on the Debt Securities; (14) whether any of the Debt Securities are to be
issuable as Bearer Securities and/or Registered Securities, and if issuable as
Bearer Securities, any limitations on issuance of such Bearer Securities and any
provisions regarding the transfer or exchange of such Bearer Securities
(including exchange for registered Debt Securities of the same series); (15) the
payment of any additional amounts with respect to the Debt Securities; (16)
information with respect to book-entry procedures not currently set forth in the
Indenture; (17) any additional covenants or Events of Default not currently set
forth in the Indenture; and (18) any other terms of such Debt Securities.
EVENTS OF DEFAULT, WAIVERS, ETC.
An Event of Default with respect to Debt Securities of any series is
defined in the Indenture as (i) default in the payment of the principal of or
premium, if any, on any Debt Security of such series when due, (ii) default in
the payment of interest upon any Debt Security of such series when due and the
continuance of such default for a period of 30 days, (iii) default in the
observance or performance of any other covenant or agreement of the Company or
any Guarantor in the Debt Securities of such series or the Indenture and
continuance of such default for 30 days after written notice, (iv) certain
events of bankruptcy, insolvency or reorganization of the Company or any
Guarantor or (v) any other Event of Default provided with respect to Debt
Securities of any series.
If any Event of Default (other than certain events of bankruptcy,
insolvency or reorganization) with respect to any series of Debt Securities for
which there are Debt Securities outstanding under the Indenture occurs and is
continuing, either the applicable Trustee or the holders of not less than 25% in
aggregate principal amount of the Debt Securities of such series may declare the
principal amount of all Debt Securities of that series to be immediately due and
payable. If any Event of Default arising from certain events of bankruptcy,
insolvency or reorganization of the Company or any Guarantor occurs, the
principal amount of all Debt Securities of that series shall be ipso facto
immediately due and payable. The holders of a majority in aggregate principal
amount of the Debt Securities of any series outstanding under the Indenture may
waive the consequences of an Event of Default resulting in acceleration of such
Debt Securities, but only if all Events of Default have been remedied and all
payments due (other than those due as a result of acceleration) have been made.
If an Event of Default occurs and is continuing, the Trustee may in its
discretion, or at the written request of holders of not less than a majority in
aggregate principal amount of the Debt Securities of any series outstanding
under the Indenture and upon reasonable indemnity against the costs, expenses
and liabilities to be incurred in compliance with such request and subject to
certain other conditions set forth in the Indenture, proceed to protect the
rights of the holders of all the Debt Securities of such series. If the Trustee
fails within 60 days after its receipt of such a written request and offer of
indemnity to institute any such proceeding, any holder of a Debt Security who
has previously given notice to the Trustee of a continuing Event of Default may
institute such a proceeding. The holders of a majority in aggregate principal
amount of Debt Securities of any series outstanding under the Indenture may
waive any past default under the Indenture with respect to such series except a
default in the payment of principal of, premium, if any, or interest on the Debt
Securities of such series and except for the waiver of a covenant or provision
that, pursuant to the Indenture, cannot be modified or amended without the
consent of holders of all such Debt Securities then outstanding.
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The Indenture provides that in the event of an Event of Default specified
in clause (i) or (ii) of the first paragraph under "Events of Default, Waivers,
Etc.," the Company will, upon demand of the applicable Trustee, pay to it, for
the benefit of the holder of any such Debt Security, the whole amount then due
and payable on such Debt Security for principal, premium, if any, and interest.
The Indenture further provides that if the Company fails to pay such amount
forthwith upon such demand, the applicable Trustee may, among other things,
institute a judicial proceeding for the collection thereof.
The Indenture also provide that notwithstanding any other provision of the
Indenture, each holder of any Debt Security of any series will have the right to
institute suit for the enforcement of any payment of principal of, premium, if
any, and interest on such Debt Security when due and that such right may not be
impaired without the consent of such holder.
The Company is required to file annually with the Trustee a written
statement of officers as to the existence or non-existence of defaults under the
Indenture or the Debt Securities.
GUARANTEE
The Indenture provides that one or more guarantors (the "Guarantors") may
guaranty the performance and punctual payment when due, whether at stated
maturity, by acceleration or otherwise, of all obligations of the Company under
the Debt Securities of any series and the Indenture (a "Guarantee"). The
liability of any Guarantor under a Guarantee is independent of and not in
consideration of or contingent upon the liability of the Company or any other
party obligated under the Debt Securities or the Indenture, and a separate
action or actions may be brought or prosecuted against any such Guarantor,
whether or not any action is brought or prosecuted against the Company or any
other party obligated under the Debt Securities or the Indenture or whether the
Company or any other party obligated under the Debt Securities or the Indenture
is joined in any such action or actions. Such Guarantee, however, will be
limited to an amount not to exceed the maximum amount that can be Guaranteed by
such Guarantor without rendering the Guarantee, as it relates to such Guarantor,
voidable under Section 548 of the Federal Bankruptcy Code or any applicable
provisions of comparable state law.
The Guarantee of any Guarantor is a continuing guaranty and will remain in
full force and effect until payment in full of all of the guaranteed
obligations.
REGISTRATION AND TRANSFER
Unless otherwise indicated in the applicable Prospectus Supplement, Debt
Securities will be issued only as Registered Securities. If Bearer Securities
are issued, the United States Federal income tax consequences and other special
considerations, procedures and limitations applicable to such Bearer Securities
will be described in the Prospectus Supplement relating thereto.
Unless otherwise indicated in the applicable Prospectus Supplement, Debt
Securities issued as Registered Securities will be without coupons. Debt
Securities issued as Bearer Securities will have interest coupons attached,
unless issued as zero coupon securities.
Registered Securities (other than a Global Security) may be presented for
transfer (with the form of transfer endorsed thereon duly executed) or exchanged
for other Debt Securities of the same series at the office of the security
registrar appointed by the Company (the "Security Registrar") specified
according to the terms of the applicable Indenture. The Company has agreed in
the Indenture that, with respect to Registered Securities having the City of New
York as a place of payment, the Company will appoint a Security Registrar or a
co-security registrar, as may be appropriate (the "Co-Security Registrar"),
located in the City of New York for such transfer or exchange. Unless otherwise
provided in the applicable Prospectus Supplement, such transfer or exchange
shall be made without service charge, but the Company may require payment of any
taxes or other governmental charges as described in the applicable Indenture.
Provisions relating to the exchange of Bearer Securities for other Debt
Securities of the same series (including, if applicable, Registered Securities)
will be described in the applicable Prospectus Supplement. In no event, however,
will Registered Securities be exchangeable for Bearer Securities.
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GLOBAL SECURITIES
Debt Securities of a series may be issued in whole or in part in the form
of one or more Global Securities that will be deposited with, or on behalf of, a
depositary (the "Depositary") identified in the Prospectus Supplement relating
to such series. Global Securities may be issued in either registered or bearer
form and in either temporary or permanent form. Unless and until it is exchanged
in whole or in part for the individual Debt Securities represented thereby, a
Global Security may not be transferred except as a whole by the Depositary for
such Global Security to a nominee of such Depositary or by a nominee of such
Depositary to such Depositary or another nominee of such Depositary or by the
Depositary or any nominee to a successor Depositary or any nominee of such
successor.
The specific terms of the depositary arrangement with respect to a series
of Debt Securities and certain limitations and restrictions relating to a series
of Debt Securities in the form of one or more Global Securities will be
described in the Prospectus Supplement relating to such series. The Company
anticipates that the following provisions will generally apply to depositary
arrangements.
Upon the issuance of a Global Security, the Depositary for such Global
Security or its nominee will credit, on its book-entry registration and transfer
system, the respective principal amounts of the individual Debt Securities
represented by such Global Security to the accounts of persons that have
accounts with such Depositary. Such accounts shall be designated by the
underwriters or agents with respect to such Debt Securities. Ownership of
beneficial interests in a Global Security will be limited to persons that have
accounts with the applicable Depositary ("participants") or persons that may
hold interests through participants. Ownership of beneficial interests in such
Global Security will be shown on, and the transfer of that ownership will be
effected only through, records maintained by the applicable Depositary or its
nominee (with respect to interests of participants) and the records of
participants (with respect to interests of persons other than participants). The
laws of some states require that certain purchasers of securities take physical
delivery of such securities in definitive form. Such limits and such laws may
impair the ability to transfer beneficial interests in a Global Security.
So long as the Depositary for a Global Security, or its nominee, is the
registered owner of such Global Security, such Depositary or such nominee, as
the case may be, will be considered the sole owner or holder of the Debt
Securities represented by such Global Security for all purposes under the
Indenture governing such Debt Securities. Except as provided below, owners of
beneficial interests in a Global Security will not be entitled to have any of
the individual Debt Securities of the series represented by such Global Security
registered in their names, will not receive or be entitled to receive physical
delivery of any such Debt Securities of such series in definitive form and will
not be considered the owners or holders thereof under the Indenture governing
such Debt Securities.
Payments of principal of, premium, if any, and interest on individual Debt
Securities represented by a Global Security registered in the name of a
Depositary or its nominee will be made to the Depositary or its nominee, as the
case may be, as the registered owner of the Global Security representing such
Debt Securities. None of the Company, the Trustee for such Debt Securities, any
person authorized by the Company to pay the principal of, premium, if any, or
interest on any Debt Securities or any coupons appertaining thereto on behalf of
the Company ("Paying Agent"), and the Security Registrar for such Debt
Securities will have any responsibility or liability for any aspect of the
records relating to or payments made on account of beneficial ownership
interests of the Global Security for such Debt Securities or for maintaining,
supervising or reviewing any records relating to such beneficial ownership
interests.
Subject to certain restrictions relating to Bearer Securities, the Company
expects that the Depositary for a series of Debt Securities or its nominee, upon
receipt of any payment of principal, premium or interest in respect of a
permanent Global Security representing any of such Debt Securities, will credit
participants' accounts immediately with payments in amounts proportionate to
their respective beneficial interests in the principal amount of such Global
Security for such Debt Securities as shown on the records of such Depositary or
its nominee. The Company also expects that payments by participants to owners of
beneficial interests in such Global Security held through such participants will
be governed by standing instructions and customary practices, as is now the case
with securities held for the accounts of customers in bearer form or registered
in
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"street name." Such payments will be the responsibility of such participants.
With respect to owners of beneficial interests in a temporary Global Security
representing Bearer Securities, receipt by such beneficial owners of payments of
principal, premium or interest in respect thereof will be subject to additional
restrictions.
If the Depositary for a series of Debt Securities is at any time unwilling,
unable or ineligible to continue as depositary and a successor depositary is not
appointed by the Company within 90 days, the Company will issue individual Debt
Securities of such series in definitive form in exchange for the Global Security
representing such series of Debt Securities. In addition, the Company may at any
time and in its sole discretion, subject to any limitations described in the
Prospectus Supplement relating to such Debt Securities, determine not to have
any Debt Securities of a series represented by one or more Global Securities
and, in such event, will issue individual Debt Securities of such series in
definitive form in exchange for the Global Security or Securities representing
such series of Debt Securities. Further, if the Company so specifies with
respect to the Debt Securities of a series, an owner of a beneficial interest in
a Global Security representing Debt Securities of such series may, on terms
acceptable to the Company, the Trustee and the Depositary for such Global
Security, receive Debt Securities of such series in definitive form in exchange
for such beneficial interests, subject to any limitations described in the
Prospectus Supplement relating to such Debt Securities. In any such instance, an
owner of a beneficial interest in a Global Security will be entitled to physical
delivery in definitive form of Debt Securities of the series represented by such
Global Security equal in principal amount to such beneficial interest and to
have such Debt Securities registered in its name (if the Debt Securities of such
series are issuable as Registered Securities). Debt Securities of such series so
issued in definitive form will be issued (i) as Registered Securities in
denominations, unless otherwise specified by the Company, of $1,000 and integral
multiples thereof if the Debt Securities of such series are issuable as
Registered Securities, (ii) as Bearer Securities in the denomination, unless
otherwise specified by the Company, of $5,000 if the Debt Securities of such
series are issuable as Bearer Securities or (iii) as either Registered or Bearer
Securities, if the Debt Securities of such series are issuable in either form.
Certain restrictions may apply, however, on the issuance of a Bearer Security in
definitive form in exchange for an interest in a Global Security.
PAYMENT AND PAYING AGENTS
Unless otherwise indicated in an applicable Prospectus Supplement, payment
of principal of and premium, if any, on Registered Securities will be made at
the office of such Paying Agent or Paying Agents as the Company may designate
from time to time. At the option of the Company, payment of any interest may be
made by check mailed to the address of the person entitled thereto as such
address shall appear in the applicable security register kept by the Company
("Security Register"). Unless otherwise indicated in an applicable Prospectus
Supplement, payment of any installment of interest on Registered Securities will
be made to the person in whose name such Debt Security is registered at the
close of business on the Regular Record Date for such payment.
Unless otherwise indicated in an applicable Prospectus Supplement, payment
of principal of, premium, if any, and any interest on Bearer Securities will be
payable, subject to any applicable laws and regulations, at the offices of such
Paying Agents outside the United States as the Company may designate from time
to time or, at the option of the holder, by check mailed to any address outside
the United States or by transfer to an account maintained by the payee with a
bank located outside the United States. Unless otherwise indicated in an
applicable Prospectus Supplement, payment of interest on Bearer Securities will
be made only against surrender of the coupon relating to such interest payment
date. No payment with respect to any Bearer Security will be made at any office
or agency of the Company in the United States or by check mailed to any address
in the United States or by transfer to an account maintained with a bank located
in the United States.
CONSOLIDATION, MERGER OR SALE OF ASSETS
The Indenture provides that neither the Company nor any Guarantor may,
without the consent of the holders of the Debt Securities outstanding under the
Indenture, consolidate with, merge into or transfer all or substantially all of
the property and assets of any division or line of business to any single
person, unless
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<PAGE> 121
(i) any such successor assumes the Company's or such Guarantor's obligations on
the applicable Debt Securities and under the Indenture, (ii) after giving effect
thereto, no Event of Default shall have happened and be continuing and (iii) the
Company has delivered to the Trustee an officers' certificate and an opinion of
counsel each stating that such consolidation, merger, conveyance or transfer and
the supplemental indenture pursuant to which the successor assumes the Company's
or such Guarantor's obligations on the applicable Debt Securities comply with
Article 10 of the Indenture and that all conditions precedent therein provided
for relating to such transaction have been complied with. Accordingly, unless
otherwise specified in an applicable Prospectus Supplement, any such
consolidation, merger or transfer of assets substantially as an entirety that
meets the conditions described above would not create any Event of Default which
would entitle holders of the Debt Securities, or the Trustee on their behalf, to
take any of the actions described above under "Events of Default, Waivers, Etc."
Additionally, upon any such consolidation or merger, or any such conveyance or
transfer of the properties and assets of the Company or any Guarantor
substantially as an entirety, the successor person formed by such consolidation
or into which the Company or such Guarantor is merged or to which such
conveyance or transfer is made shall succeed to, and be substituted for, and may
exercise every right and power of, the Company or such Guarantor under the
Indenture with the same effect as if such successor person had been named as the
Company or such Guarantor. In the event of any such conveyance or transfer, the
Company as the predecessor corporation and such Guarantor shall be relieved of
all obligations and covenants under the Indenture and may be dissolved, wound up
and liquidated at any time thereafter.
LEVERAGED AND OTHER TRANSACTIONS
The Indenture contains no provisions which would afford holders of the Debt
Securities protection in the event of a highly leveraged or other transaction
involving the Company which could adversely affect the holders of Debt
Securities. Provisions, if any, applicable to any such transaction will be
described in an applicable Prospectus Supplement.
MODIFICATION OF THE INDENTURE; WAIVER OF COVENANTS
The Indenture provides that, with the consent of the holders of not less
than a majority in aggregate principal amount of the outstanding Debt Securities
of each affected series, modifications and alterations of the Indenture may be
made which affect the rights of the holders of such Debt Securities, except that
no such modification or alteration may be made without the consent of the holder
of each Debt Security so affected which would, among other things, (i) change
the maturity of the principal of, or of any installment of interest (or premium,
if any) on, any Debt Security issued pursuant to the Indenture, or reduce the
principal amount thereof or any premium thereon or the rate of interest thereon,
or change the method of calculation of interest or the currency of payment of
principal or interest (or premium, if any) on, or reduce the minimum rate of
interest thereon, or impair the right to institute suit for the enforcement of
any such payment on or with respect to any such Debt Security or (ii) reduce the
above-stated percentage in principal amount of outstanding Debt Securities
required to modify or alter the Indenture.
The Indenture also provides that, without the consent of any holder of Debt
Securities, the Company, when authorized by a resolution of its Board of
Directors, and the Trustee, at any time and from time to time, may enter into
one or more supplemental Indenture to the Indenture to (i) evidence the
succession of another corporation or person to the Company or any Guarantor, as
the case may be, in the Indenture and in the Debt Securities, (ii) evidence and
provide for a successor Trustee, (iii) add to the covenants of the Company or
any Guarantor for the benefit of the holders of Debt Securities of all or any
series or to surrender any right or power conferred upon the Company or any
Guarantor in the Indenture, (iv) cure any ambiguity, correct or supplement any
provision which may be inconsistent or make any other provisions with respect to
matters or questions arising under the Indenture, provided the interests of the
holders of Debt Securities of any series are not adversely affected, (v) add any
additional Events of Default, (vi) make certain changes with respect to Bearer
Securities which do not adversely affect the interests of the holders of Debt
Securities of any series, (vii) add to, change or eliminate any provision of the
Indenture; provided that such addition, change or elimination (a) becomes
effective only when there is no Debt Security outstanding of a series created
prior to the execution of such supplemental indenture which is adversely
affected or (b) does not apply to any
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<PAGE> 122
outstanding Debt Securities, (viii) establish the form or terms of Debt
Securities of any series as permitted under the Indenture, (ix) evidence any
changes to corporate Trustee eligibility authorized by the Trust Indenture Act
of 1939, as amended (the "Trust Indenture Act"), or (x) add to or change or
eliminate any provision of the Indenture as necessary to comply with the Trust
Indenture Act provided such action does not adversely affect the interests of
the holders of Debt Securities of any series.
GOVERNING LAW
The Indenture and the Debt Securities will be governed by, and construed in
accordance with, the laws of the State of New York.
REGARDING THE TRUSTEE
The Indenture contains certain limitations on the right of the Trustee, if
and when the Trustee becomes a creditor of the Company (or any other obligor
upon the Debt Securities), regarding the collection of such claims against the
Company (or any such other obligor). Except as provided in the following
sentence, the Indenture does not prohibit the Trustee from serving as trustee
under any other indenture to which the Company may be a party from time to time
or from engaging in other transactions with the Company. If the Trustee acquires
any conflicting interest and there is a default with respect to any series of
Debt Securities, it must eliminate such conflict or resign.
DESCRIPTION OF CAPITAL STOCK
The total number of shares that the Company is authorized to issue is
51,000,000, consisting of 50,000,000 shares of Common Stock, par value $0.001
per share, and 1,000,000 shares of Preferred Stock, par value $0.001 per share.
The following statements are brief summaries of certain provisions relating to
the Company's capital stock.
COMMON STOCK
The holders of Common Stock are entitled to one vote for each share held of
record on all matters to be voted on by the stockholders. The holders of Common
Stock are entitled to receive ratably dividends when, as and if declared by the
Board of Directors out of funds legally available therefor. In the event of a
liquidation, dissolution or winding up of the Company, the holders of Common
Stock are entitled, subject to the rights of holders of Preferred Stock issued
by the Company, if any, to share ratably in all assets remaining available for
distribution to them after payment of liabilities and after provision is made
for each class of stock, if any, having preference over the Common Stock.
The holders of Common Stock, as such, have no conversion, preemptive or
other subscription rights and there are no redemption provisions applicable to
the Common Stock. All the outstanding shares of Common Stock are, and the shares
of Common Stock to be issued on conversion of the Debentures offered hereby will
be, validly issued, fully paid and nonassessable.
The Company distributes periodic reports and other information, including
notices of annual meetings and special meetings of the stockholders of the
Company, to recordholders of Common Stock to the addresses indicated on the
Company's stock records.
PREFERRED STOCK
The Board of Directors has the authority to issue the authorized and
unissued Preferred Stock in one series with such designations, rights and
preferences as may be determined from time to time by the Board of Directors.
Accordingly, the Board of Directors is empowered, without stockholder approval,
to issue Preferred Stock with dividend, liquidation, conversion, voting or other
rights which adversely affect the voting power or other rights of the holders of
the Common Stock. In the event of issuance, the Preferred Stock could be
utilized under certain circumstances as a way of discouraging, delaying or
preventing an acquisition or change in control of the Company. The Company does
not currently intend to issue any shares of its Preferred Stock.
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<PAGE> 123
ANTI-TAKEOVER PROVISIONS
The Company's Certificate of Incorporation and Bylaws include a number of
provisions which may have the effect of discouraging persons from pursuing
non-negotiated takeover attempts. These provisions include a classified Board of
Directors, the inability of stockholders to take action by written consent
without a meeting, the inability of stockholders to call for a special meeting
of stockholders under certain circumstances without the approval of the Board
and the inability of stockholders to remove directors without cause.
The Company's employment arrangements with its Chief Executive Officer,
Chief Operating Officer, Executive Vice President and President of One Stop, and
certain other senior executives provide for the payment of multiple years of
compensation and acceleration of stock options in the event of certain changes
in control.
Each share of the Company's outstanding Common Stock also evidences one
stock purchase right (a "Right") pursuant to the terms and conditions of a
Stockholders' Rights Plan adopted by the Company in June 1996 (the "Rights
Plan"). In general, the Rights will not be exercisable, or transferable, apart
from the Common Stock, until the tenth day after a person or group (other than
an "Exempt Person" as defined in the Rights Plan) either: (i) acquires
beneficial ownership of 15% or more of the outstanding Common Stock; or (ii)
commences a tender offer or an exchange offer, to acquire beneficial ownership
of 15% or more of the outstanding Common Stock; or (iii) who previously acquired
15% or more of the Common Stock in a transaction approved by the Board of
Directors increases its ownership of Common Stock by more than 1%; or (iv) files
a registration statement with the SEC with respect to an exchange offer to
acquire 15% or more of the Common Stock; or (v) who beneficially owns 10% or
more of the outstanding Common Stock is declared an "Adverse Person" by the
Board of Directors
Following an event described above, each Right will be converted into a
right to purchase from the Company, for the Exercise price, that number of one
one-hundredth (1/100th) of a share of Preferred Stock (or, in certain
circumstances, Common Stock, cash, property, or other securities of the Company)
having a market value of twice the Exercise Price. Further, if after the Rights
become exercisable, the Company or a majority of its assets or earning power is
acquired by merger, consolidation, transfer, sale or otherwise, each Right will
be converted into the right to purchase that number of shares of common stock of
the surviving entity or (in certain circumstances) its parent corporation,
having a market value of twice the Exercise Price. In general, no Adverse
Person, nor the person or group whose purchase transaction or tender or exchange
offer triggers the exercisability of the Rights, nor any of that person's or
group's transferees, may exercise Rights held by them.
Each Right, at the option of the holder of the Right, also may be exercised
without the payment of cash. In such case, the Right's holder will receive
securities having a value equal to the difference between the value of the
securities that would have been issuable upon payment of the exercise price and
the exercise price.
At any time prior to the tenth day following an event described in (i)
through (v), above, the Board of Directors may redeem all outstanding Rights at
a price of $0.001 per Right, and may amend the Rights Agreement and the Rights
in any and all respects. The Rights will expire at the earliest date of their
redemption or June 20, 2006.
SECTION 203 OF THE DELAWARE LAW
The Company is a Delaware corporation and is subject to Section 203 of the
Delaware General Corporation Law the ("DGCL"). Section 203 of the DGCL prevents
an "interested stockholder" (defined generally as a person owning 15% or more of
a corporation's outstanding voting stock or an affiliate of such person) from
engaging in a "business combination" (as defined) with a Delaware corporation
for three years following the date such person became an interested stockholder
unless (i) before such person became an interested stockholder, the board of
directors of the corporation approved the transaction in which the interested
stockholder became an interested stockholder or approved the business
combination; (ii) upon consummation of the transaction that resulted in the
interested stockholder becoming an interested stockholder, the interested
stockholder owns at least 85% of the voting stock of the corporation outstanding
at the
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<PAGE> 124
time the transaction commenced (excluding stock held by directors who are also
officers of the corporation and employee stock plans that do not provide
employees with the right to determine confidentially whether shares held subject
to the plan will be tendered in a tender or exchange offer); or (iii) following
the transaction in which such person became an interested stockholder, the
business combination is approved by the board of directors of the corporation
and authorized at a meeting of stockholders by vote of the holders of two-thirds
of the outstanding voting stock of the corporation not owned by the interested
stockholder. Under Section 203 of the DGCL, the restrictions described above
also do not apply to certain business combinations proposed by an interested
stockholder following the announcement or notification of one of certain
extraordinary transactions involving the corporation and a person who had not
been an interested stockholder during the previous three years or became an
interested stockholder with the approval of a majority of the corporation's
directors. The provisions of Section 203 of the DGCL requiring a supermajority
vote of disinterested shares to approve certain corporate transactions could
enable a minority of the Company's stockholders to exercise veto power over such
transactions.
TRANSFER AGENT
The Company's transfer agent and registrar for its Common Stock is Wells
Fargo Bank, N.A.
PLAN OF DISTRIBUTION
The Company may sell the Securities to one or more underwriters for public
offering and sale by them or may sell the Securities to investors directly or
through agents. Any such underwriter or agent involved in the offer and sale of
Securities will be named in the applicable Prospectus Supplement. The Company
has reserved the right to sell Securities directly to investors on its own
behalf in those jurisdictions where and in such manner as it is authorized to do
so.
Underwriters may offer and sell Securities at a fixed price or prices,
which may be changed, at market prices prevailing at the time of sale, at prices
related to such prevailing market prices or at negotiated prices. The Company
also may, from time to time, authorize dealers, acting as the Company's agents,
to offer and sell Securities upon the terms and conditions as are set forth in
the applicable Prospectus Supplement. In connection with the sale of Securities,
underwriters may receive compensation from the Company in the form of
underwriting discounts or commissions and may also receive commissions from
purchasers of the Securities for whom they may act as agent. Underwriters may
sell Securities to or through dealers, and such dealers may receive compensation
in the form of discounts, concessions or commissions from the underwriters
and/or commissions from the purchasers for whom they may act as agent.
Any underwriting compensation paid by the Company to underwriters or agents
in connection with the offering of Securities, and any discounts, concessions or
commissions allowed by underwriters to participating dealers, will be set forth
in the applicable Prospectus Supplement. Dealers and agents participating in the
distribution of Securities may be deemed to be underwriters, and any discounts
and commissions received by them and any profit realized by them on resale of
the Securities may be deemed to be underwriting discounts and commissions.
Underwriters, dealers and agents may be entitled, under agreements entered into
with the Company, to indemnification against and contribution toward certain
civil liabilities.
No Securities may be sold without delivery of the applicable Prospectus
Supplement describing the method and terms of each offering of any such
Securities.
LEGAL MATTERS
The validity of the Securities offered hereby will be passed upon for the
Company by Barbara S. Polsky, Esq., Senior Vice President, General Counsel of
the Registrant.
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<PAGE> 125
EXPERTS
The audited consolidated financial statements of the Company incorporated
in this Prospectus by reference to the Company's Annual Report on Form 10-K for
the year ended June 30, 1996, and the audited supplemental consolidated
financial statements of the Company incorporated in this Prospectus by reference
to the Company's Current Report on Form 8-K/A dated September 16, 1996, have
been so incorporated in reliance on the report of Price Waterhouse LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting. The audited financial statements of One Stop Mortgage,
Inc. incorporated in this Prospectus by reference to the Company's Current
Report on Form 8-K dated September 12, 1996, have been so incorporated in
reliance on the report of KPMG Peat Marwick LLP, independent accountants, given
on the authority of said firm as experts in auditing and accounting.
------------------------
NO DEALER, SALESPERSON OR ANY OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE
ANY INFORMATION OR MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS, OR ANY PROSPECTUS SUPPLEMENT, AND
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED. THIS PROSPECTUS AND ANY PROSPECTUS SUPPLEMENT DO NOT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN
IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE
SUBSEQUENT TO THE DATE HEREOF.
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<PAGE> 126
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NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS SUPPLEMENT IN CONNECTION WITH THE OFFERING DESCRIBED HEREIN AND, IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS
SUPPLEMENT DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER
TO BUY, ANY SECURITIES OTHER THAN THOSE SPECIFICALLY OFFERED HEREBY IN ANY
JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR
SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS
SUPPLEMENT NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN
IMPLICATION THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS
PROSPECTUS SUPPLEMENT OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUPPLEMENT
Prospectus Supplement Summary......... S-3
Risk Factors.......................... S-12
Use of Proceeds....................... S-23
Capitalization........................ S-24
Selected Consolidated Financial
Data................................ S-25
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... S-27
Business.............................. S-36
Management............................ S-49
Principal Stockholders................ S-51
Description of the Notes.............. S-53
Certain Federal Income Tax
Consequences........................ S-76
Underwriting.......................... S-78
Legal Matters......................... S-79
Experts............................... S-79
Index to Consolidated Financial
Statements and Supplementary
Consolidated Financial Statements... F-1
PROSPECTUS
Available Information................. 2
Incorporation of Certain Documents by
Reference........................... 2
The Company........................... 3
Use of Proceeds....................... 4
Ratio of Earnings to Fixed Charges.... 4
Description of Debt Securities........ 4
Description of Capital Stock.......... 10
Plan of Distribution.................. 12
Legal Matters......................... 12
Experts............................... 13
</TABLE>
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$150,000,000
AAMES LOGO
AAMES FINANCIAL
CORPORATION
% SENIOR
NOTES DUE 2003
-------------------------------------------
PROSPECTUS SUPPLEMENT
-------------------------------------------
BEAR, STEARNS & CO. INC.
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
NATWEST CAPITAL MARKETS LIMITED
, 1996
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