<PAGE> 1
As Filed pursuant to Rule 424(b)(2)
under the Securities Act of 1933
Registration No. 333-12065
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. THIS
PROSPECTUS 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.
PROSPECTUS SUPPLEMENT ISSUED SEPTEMBER 23, 1996 (SUBJECT TO COMPLETION)
(TO PROSPECTUS DATED SEPTEMBER 23, 1996)
1,500,000 SHARES
LOGO AAMES FINANCIAL CORPORATION
COMMON STOCK
------------------------
All of the shares of Common Stock (the "Common Stock") offered hereby are
being sold by Aames Financial Corporation (the "Company"). The Company's Common
Stock is traded on the New York Stock Exchange under the symbol "AAM." On
September 19, 1996, the last reported sale price of the Common Stock was $54.25.
See "Price Range of Common Stock and Dividend Policy."
Concurrently with this offering, the Company is separately offering
$150,000,000 principal amount of Senior Notes due 2003 (the "Senior Notes" and
the offering of such Senior Notes, the "Concurrent Offering"). The consummation
of this offering is not conditioned upon the consummation of the Concurrent
Offering.
------------------------
SEE "RISK FACTORS" COMMENCING ON PAGE S-10 OF THIS PROSPECTUS SUPPLEMENT
FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE
PURCHASERS OF THE COMMON STOCK OFFERED HEREBY.
------------------------
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.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share(3).................................... $ $ $
- ------------------------------------------------------------------------------------------------------
Total(4)........................................ $ $ $
- ------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------
</TABLE>
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated to be
$ .
(3) Includes certain Preferred Stock Purchase Rights of Registrant, exercisable
upon the occurrence of certain events. See "Description of Capital
Stock -- Anti-Takeover Provisions."
(4) The Company has granted the Underwriters a 30-day option to purchase up to
225,500 additional shares of Common Stock on the same terms, solely to cover
over-allotments, if any. If the Underwriters exercise the option in full,
the total Price to Public, Underwriting Discounts and Commissions and
Proceeds to Company will be $ , $ and $ ,
respectively. See "Underwriting."
------------------------
The shares of Common Stock are offered by the Underwriters subject to prior
sale, when, as and if delivered to and accepted by them, subject to approval of
certain legal matters by counsel for the Underwriters. The Underwriters reserve
the right to withdraw, cancel or modify such offer and reject orders in whole or
in part. It is expected that delivery of share certificates will be made in New
York, New York on or about October , 1996.
NATWEST SECURITIES LIMITED
BEAR, STEARNS & CO. INC.
OPPENHEIMER & CO., INC.
SMITH BARNEY INC.
THE DATE OF THIS PROSPECTUS SUPPLEMENT IS , 1996
<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 COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE OR OTHERWISE. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
FOR UNITED KINGDOM PURCHASERS: THE COMMON STOCK MAY NOT BE OFFERED OR SOLD
IN THE UNITED KINGDOM OTHER THAN TO PERSONS WHOSE ORDINARY ACTIVITIES INVOLVE
THEM IN ACQUIRING, HOLDING, MANAGING OR DISPOSING OF INVESTMENTS, WHETHER AS
PRINCIPAL OR AGENT (EXCEPT IN CIRCUMSTANCES THAT DO NOT CONSTITUTE AN OFFER TO
THE PUBLIC WITHIN THE MEANING OF THE PUBLIC OFFERS OF SECURITIES REGULATIONS
1995 OR THE FINANCIAL SERVICES ACT 1986), AND THIS PROSPECTUS SUPPLEMENT MAY
ONLY BE ISSUED OR PASSED ON TO ANY PERSON IN THE UNITED KINGDOM IF THAT PERSON
IS OF A KIND DESCRIBED IN ARTICLE 11(3) OF THE FINANCIAL SERVICES ACT OF 1986
(INVESTMENT ADVERTISEMENTS) (EXEMPTIONS) ORDER 1996.
<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 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-10 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 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 originations over the three
years ended June 30, 1996. The Company originated $130 million, $148 million and
S-3
<PAGE> 4
$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. Beginning in
September 1996, all loans originated by One Stop will be 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, California, Colorado, Nevada, Oregon,
Utah and Washington. Loans secured by properties located in other
S-4
<PAGE> 5
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 83.8% 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 Operations -- One-Time Charges"
and the Supplementary Consolidated Financial Statements of pages F-19 through
F-34.
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.
S-5
<PAGE> 6
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. 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
$650 million, and has entered into a $50.0 million credit facility secured by
certain excess servicing receivables. On September 17, 1996, the Company
completed a $525 million securitization of mortgage loans, including $200
million in loans originated or purchased by One Stop.
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered.......................... 1,500,000 shares
Common Stock to be outstanding after the
offering.................................... 17,329,824 shares(1)
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."
Concurrent Offering........................... Concurrently with the offering of the Common
Stock, the Company is separately offering
$150,000,000 principal amount of Senior Notes
due 2003.
NYSE Symbol................................... AAM
</TABLE>
- ---------------
(1) Does not include 2,516,305 shares of Common Stock issuable upon exercise of
outstanding options and warrants. See Note 9 to Consolidated Financial
Statements.
S-6
<PAGE> 7
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:
Return on average common equity....... NM 36% 18% 27% 33%
Return on average managed
receivables(2)...................... 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....... 0 0 19,700 206,800 628,200
-------- -------- -------- -------- ----------
Total(3)......................... $ 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 $1,250,400
Weighted average commission rate on
retail loan originations(4)......... 13.0% 14.0% 12.0% 9.4% 7.7%
Weighted average interest rate(4)..... 12.7% 11.2% 10.3% 11.6% 11.5%
Weighted average initial combined
loan-to-value ratio(4)(5):
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>
S-7
<PAGE> 8
<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)(6)(7).................. 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(8)........... 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) Represents net income divided by the average servicing portfolio for the
fiscal year.
(3) Does not include loans originated or purchased by One Stop during fiscal
1996 in the aggregate amount of $320 million.
(4) Computed on loans originated or purchased, as the case may be, during the
period.
(5) 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.
(6) 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.
(7) 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").
(8) 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.
S-8
<PAGE> 9
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 $200 million of
loans originated or purchased by One Stop, and intends to continue to include in
the Company's future securitizations One Stop's loans. 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-34 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-9
<PAGE> 10
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.
NEGATIVE CASH FLOWS AND CAPITAL NEEDS
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. 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 existing
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 securitization, 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.
As a result of the limitations described above, the Company may be
restricted in the amount and type of future debt it may issue.
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. 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
S-10
<PAGE> 11
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 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 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 this will in fact occur.
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
S-11
<PAGE> 12
$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.
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 commitment of $700 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 of the Company's loans, or the unwillingness of the
monoline insurance companies to provide financial guarantee 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 servicing retained 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
S-12
<PAGE> 13
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 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 No. 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 No. 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.
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
S-13
<PAGE> 14
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 in the Company's future securitizations One Stop's loans.
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. Beginning in September 1996, 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. Once approved, the loan is funded or purchased by One
Stop directly. This change in underwriting guidelines 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" and the Supplementary Consolidated Financial Statements
at pages F-19 and F-34.
S-14
<PAGE> 15
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 will
continue 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.
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.
S-15
<PAGE> 16
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 December 31, 1996, a bonus equal
to 7.5% of the Company's pre-tax income (prior to bonuses and prior to any
extraordinary 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.
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
S-16
<PAGE> 17
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 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.
S-17
<PAGE> 18
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.
S-18
<PAGE> 19
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of the
1,500,000 shares being offered hereby, after deducting the estimated
underwriting discount and offering expenses, are estimated to be approximately
$77,463,000 (or approximately $89,120,000, if the Underwriters' over-allotment
option is exercised in full).
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 invested in high quality, short-term, interest-bearing investments and
deposit accounts.
S-19
<PAGE> 20
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
-------------------------------------
AS PRO FORMA
ADJUSTED AS ADJUSTED
ACTUAL (1)(2) (2)(3)
-------- -------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash...................................................... $ 18,216 $ 95,679 240,979
Loans held for sale....................................... 67,327 67,327 67,327
WAREHOUSE FACILITIES:
Amounts outstanding under warehouse facilities.......... 11,026 11,026 11,026
LONG-TERM DEBT:
10.5% Senior Notes due 2002............................. 23,000 23,000 23,000
% Senior Notes due 2003............................. -- -- 150,000
Capitalized lease obligations........................... 45 45 45
5.5% Convertible Subordinated Debentures due 2006....... 115,000 115,000 115,000
-------- -------- --------
Total long-term debt............................ 138,045 138,045 288,045
-------- -------- --------
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(4)....................................... 14 15 15
Additional paid-in capital.............................. 63,628 141,091 141,091
Retained earnings....................................... 46,528 46,528 46,528
-------- -------- --------
Total stockholders' equity.............................. 110,170 187,634 187,634
-------- -------- --------
Total capitalization............................ $248,215 $325,679 $ 475,680
======== ======== ========
</TABLE>
- ---------------
(1) As adjusted to give effect to the receipt of the estimated net proceeds from
the sale of the Common Stock offered hereby (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 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-34.
(3) Gives effect to the receipt of the estimated net proceeds from the sale of
the Senior Notes in the Concurrent Offering (net of estimated aggregate
offering expenses of $4.7 million) and the net proceeds from the sale of the
Common Stock offered hereby.
(4) Does not include 6,623,448 shares of Common Stock issuable upon exercise of
outstanding options and warrants and conversion of the Company's 5.5%
Convertible Subordinated Debentures due 2006.
S-20
<PAGE> 21
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The following table sets forth the range of high and low last sale prices
per share for the Common Stock on the NASDAQ National Market from July 1, 1993
through October, 1995, and thereafter on the New York Stock Exchange, and the
amount of cash dividends per share paid for the periods indicated. All sale
prices and per share cash dividends (i) through May 3, 1993 have been adjusted
to reflect a four-for-three stock split effected on that date, and (ii) through
May 17, 1996 have been adjusted to reflect a three-for-two stock split effected
on that date.
<TABLE>
<CAPTION>
CASH
DIVIDENDS
HIGH LOW PAID
---- --- ---------
<S> <C> <C> <C>
Year ended June 30, 1995
First Quarter............................................... $ 6 3/8 $ 5 1/8 .05
Second Quarter.............................................. 6 5 1/8 .05
Third Quarter............................................... 8 7/8 5 1/4 .05
Fourth Quarter.............................................. 12 1/8 7 7/8 .05
Year ended June 30, 1996
First Quarter............................................... $19 1/2 $11 1/2 .05
Second Quarter.............................................. 24 1/2 16 1/8 .05
Third Quarter............................................... 25 1/8 16 1/4 .05
Fourth Quarter.............................................. 37 24 1/8 .05
</TABLE>
As of September 15, 1996, the Company had 110 stockholders of record, and
the Company believes that it had in excess of 5,500 beneficial owners of its
Common Stock.
Since its initial public offering on December 3, 1991, the Company has
consistently paid quarterly cash dividends on its Common Stock. The Company
declared and subsequently paid an aggregate of $.20 per share in dividends for
the fiscal year ended June 30, 1996 representing approximately 8.7% of its net
income for the period. The Company intends to continue to pay dividends in an
amount determined by the Board of Directors. The Board of Directors of the
Company reviews the Company's dividend policy at least annually in light of the
earnings, cash position and capital needs of the Company, general business
conditions and other relevant factors. In addition, the Company's ability to pay
dividends is limited under certain bank and other credit agreements.
S-21
<PAGE> 22
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
No. 122. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations." 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-34.
<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:
Return on average common equity........................ NM 36% 18% 27% 33%
Return on average managed receivables(2)............... 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....................... 0 0 19,700 206,800 628,200
-------- -------- -------- -------- ----------
Total(3)....................................... $ 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 $1,250,400
Weighted average commission rate on retail loan
originations(4)..................................... 13.0% 14.0% 12.0% 9.4% 7.7%
Weighted average interest rate(4)...................... 12.7% 11.2% 10.3% 11.6% 11.5%
Weighted average initial combined loan-to-value
ratio(4)(5):
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>
S-22
<PAGE> 23
<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)(6)(7).......................................... 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(8)........................... 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) Represents net income divided by the average servicing portfolio for the
fiscal year.
(3) Does not include loans originated or purchased by One Stop during fiscal
1996 in the aggregate amount of $320 million.
(4) Computed on loans originated or purchased, as the case may be, during the
period.
(5) 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.
(6) 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.
(7) 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").
(8) 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.
S-23
<PAGE> 24
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
S-24
<PAGE> 25
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 IN THOUSANDS)
DOLLARS PERCENTAGE DOLLARS PERCENTAGE DOLLARS PERCENTAGE
------- ---------- ------- ---------- ------- ----------
<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 54,939 100 128,408 100
====== ==== ====== ==== ======= ====
Expenses:
Compensation and related
expenses...................... 13,616 37.5 17,610 32.2 33,241 25.8
Sales and advertising costs...... 7,891 21.7 9,906 18.1 18,362 14.2
General and administrative
expenses...................... 5,415 14.9 7,067 12.9 13,926 10.7
Interest expense................. 322 0.9 3,205 5.8 9,348 7.3
------ ---- ------ ---- ------- ----
Total expenses........... 27,244 75 37,788 69 74,877 58
------ ---- ------ ---- ------- ----
Income before income taxes....... 8,983 24.8 17,151 31.2 53,531 41.7
Income taxes..................... 3,684 10.2 7,117 12.9 22,483 17.5
------ ---- ------ ---- ------- ----
Net income............... 5,299 14.6 10,034 18.3 31,048 24.2
====== ==== ====== ==== ======= ====
</TABLE>
S-25
<PAGE> 26
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
S-26
<PAGE> 27
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.
S-27
<PAGE> 28
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.
S-28
<PAGE> 29
LIQUIDITY
The table below summarizes cash flow generated by 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........................................... 0 (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 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
S-29
<PAGE> 30
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 $125 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 26, 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. 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."
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
S-30
<PAGE> 31
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 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 guarantees. 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, 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. 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 -- 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
S-31
<PAGE> 32
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.
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
S-32
<PAGE> 33
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-33
<PAGE> 34
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
S-34
<PAGE> 35
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
("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. 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-35
<PAGE> 36
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
S-36
<PAGE> 37
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 originated and purchased by it. 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.
S-37
<PAGE> 38
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.
S-38
<PAGE> 39
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.
S-39
<PAGE> 40
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 or proceeds and no Rating not a
two 30-day four 30-day one 60-day or more than 120 factor.
delinquencies in delinquencies in delinquency and days delinquent.
the past 12 the past 12 one 90-day
months. months. delinquency;
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 dwelling dwelling dwelling. dwelling.
residence; 70% residence; 65% residence; 65%
for a for a for a
condominium. condominium. 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>
S-40
<PAGE> 41
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%
============ ====
</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%
============ ====
</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-41
<PAGE> 42
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 1,250,400
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-42
<PAGE> 43
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
CREDIT GRADE OF LOAN TOTAL 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%
============== ====
</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-43
<PAGE> 44
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:
Not foreclosed(3)(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-44
<PAGE> 45
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 guarantees 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-45
<PAGE> 46
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-46
<PAGE> 47
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-47
<PAGE> 48
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-48
<PAGE> 49
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 (13
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.
S-49
<PAGE> 50
(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.
S-50
<PAGE> 51
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below (the "Underwriters") for whom NatWest Securities
Limited ("NatWest"), Bear, Stearns & Co. Inc., Oppenheimer & Co., Inc. and Smith
Barney Inc. are acting as representatives (the "Representatives") have severally
agreed to purchase from the Company the following respective number of shares of
Common Stock at the initial public offering price less the underwriting
discounts and commissions set forth on the cover page of this Prospectus
Supplement:
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
--------------------------------------------------------------------- ----------------
<S> <C>
NatWest Securities Limited...........................................
Bear, Stearns & Co. Inc. ............................................
Oppenheimer & Co., Inc. .............................................
Smith Barney Inc. ...................................................
Total......................................................
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent. The Underwriters are
obligated to purchase all shares of Common Stock offered if any of such shares
are purchased.
The Company has been advised that the Underwriters propose to offer the
shares of Common Stock directly to the public at the public offering price set
forth on the cover page hereof, and to certain selected dealers (which may
include the Underwriters) at such price less a selling concession not in excess
of $ per share. The Underwriters may allow and such dealers may reallow a
concession not in excess of $ per share to certain other dealers. After
commencement of the offering to the public, the public offering price and other
selling terms may be changed by the Representatives. The Underwriters have
informed the Company that they do not intend to confirm sales of shares of
Common Stock to any accounts over which they have discretionary authority.
The Company has granted to the Underwriters an option, exercisable not
later than 30 days after the date of this Prospectus Supplement, to purchase up
to 225,000 additional shares of Common Stock at the public offering price, less
the underwriting discounts and commissions set forth on the cover page hereof,
solely to cover over-allotments. To the extent that the Underwriters exercise
such option, each of the Underwriters will be committed, subject to certain
conditions, to purchase a number of option shares proportionate to such
Underwriter's initial commitment.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, and to contribute
to payments that the Underwriters may be required to make in respect thereof.
The Company and certain other owners of Common Stock have also agreed that
none of them will, without the prior written consent of NatWest, on behalf of
the Underwriters, offer, sell, grant any options to purchase (other than under
the Company's employee stock plan) or otherwise dispose of any shares of Common
Stock, for a period of 30 days after the date of this Prospectus Supplement. See
"Shares Available for Future Sale."
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
shares of Common Stock offered hereby and subject to certain exceptions, it will
not offer or sell any shares of Common Stock 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 shares of
Common Stock 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 Common Stock to persons in the United Kingdom
prior to admission of the Common Stock 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
S-51
<PAGE> 52
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 complies and will comply with all applicable provisions of the
Act with respect to anything done by it in relation to the Common Stock 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 Common Stock, 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 (Investment Advertisements)
(Exemptions) Order 1996 or is a person to whom the document may otherwise
lawfully be issued or passed on.
NatWest, Bear, Stearns & Co. Inc., Oppenheimer & Co., Inc. and Smith Barney
Inc. 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 $100 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 1.1%
over one-month LIBOR and expires on June 15, 1995, 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.
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.
In connection with the offering, certain of the Underwriters and selling
group members, if any, or their respective affiliates may engage in passive
market making transactions in the Common Stock on the Nasdaq National Market in
accordance with Rule 10b-6A under the Exchange Act during the two business day
period prior to the commencement of offers or sales of the Common Stock offered
hereby. The passive market making transactions must comply with applicable
volume and price limits and be identified as such. In general, a passive market
maker may display its bid at a price not in excess of the highest independent
bid for the security; if all independent bids are lowered below the passive
market maker's bid, however, such bid must be lowered when certain purchase
limits are exceeded.
LEGAL MATTERS
Certain legal matters relating to this offering are being passed upon for
the Company by Barbara S. Polsky, Esq., Senior Vice President, General Counsel,
of the Company. 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 and the
audited supplementary combined 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, 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.
S-52
<PAGE> 53
AAMES FINANCIAL CORPORATION
INDEX TO 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> 54
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> 55
AAMES FINANCIAL CORPORATION
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 10,000,000 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> 56
AAMES FINANCIAL CORPORATION
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 outstanding shares
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> 57
AAMES FINANCIAL CORPORATION
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> 58
AAMES FINANCIAL CORPORATION
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> 59
AAMES FINANCIAL CORPORATION
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> 60
AAMES FINANCIAL CORPORATION
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> 61
AAMES FINANCIAL CORPORATION
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> 62
AAMES FINANCIAL CORPORATION
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 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> 63
AAMES FINANCIAL CORPORATION
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> 64
AAMES FINANCIAL CORPORATION
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>
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> 65
AAMES FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5 INCOME TAXES
The provision for income taxes consisted of the following: for 1994, 1995
and 1996, the Company's effective income tax rate is computed using the
appropriate statutory rates with no significant differences.
<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> 66
AAMES FINANCIAL CORPORATION
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> 67
AAMES FINANCIAL CORPORATION
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 and borrowings
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> 68
AAMES FINANCIAL CORPORATION
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> 69
AAMES FINANCIAL CORPORATION
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> 70
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> 71
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 10,000,000 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> 72
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> 73
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> 74
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> 75
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> 76
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
discussed, these supplemental 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> 77
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 No. 122"), which amends
the prior mortgage banking standard for fiscal year 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 $.31 per weighted average share.
F-25
<PAGE> 78
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> 79
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 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> 80
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 Agreement).
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> 81
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>
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> 82
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> 83
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> 84
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
Notes payable...................................... 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 and notes payable are
short term in nature and/or 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> 85
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
<PAGE> 86
PROSPECTUS
$300,000,000
[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> 87
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.
2
<PAGE> 88
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
3
<PAGE> 89
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
4
<PAGE> 90
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.
5
<PAGE> 91
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.
6
<PAGE> 92
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
7
<PAGE> 93
"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
8
<PAGE> 94
(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
9
<PAGE> 95
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.
10
<PAGE> 96
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
11
<PAGE> 97
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.
12
<PAGE> 98
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.
13
<PAGE> 99
------------------------------------------------------
------------------------------------------------------
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED OR
INCORPORATED BY REFERENCE HEREIN, IN CONNECTION WITH THIS OFFERING AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE COMPANY OR ANY OTHER PERSON. THIS PROSPECTUS SUPPLEMENT
DOES NOT CONSTITUTE AN OFFER TO SELL, OR SOLICITATION OF AN OFFER TO BUY, ANY OF
THESE SECURITIES 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 ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
OR INCORPORATED BY REFERENCE HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO ITS
DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUPPLEMENT
Prospectus Supplement Summary......... S-3
Risk Factors.......................... S-10
Use of Proceeds....................... S-19
Capitalization........................ S-20
Price Range of Common Stock and
Dividend Policy..................... S-21
Selected Consolidated Financial
Data................................ S-22
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... S-24
Business.............................. S-34
Management............................ S-47
Principal Stockholders................ S-49
Underwriting.......................... S-51
Legal Matters......................... S-52
Experts............................... S-52
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>
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
1,500,000 SHARES
LOGO
AAMES FINANCIAL
CORPORATION
COMMON STOCK
------------------------
NATWEST SECURITIES LIMITED
BEAR, STEARNS & CO. INC.
OPPENHEIMER & CO., INC.
SMITH BARNEY INC.
PROSPECTUS SUPPLEMENT
, 1996
------------------------------------------------------
------------------------------------------------------
