<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 1998
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 For the transition period from
_____to _____
COMMISSION FILE NUMBER 0-19604
AAMES FINANCIAL CORPORATION
[Exact name of Registrant as specified in its charter]
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<S> <C>
DELAWARE 95-4340340
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[State or other jurisdiction of [I.R.S. Employer
incorporation or organization] Identification No.]
</TABLE>
350 SOUTH GRAND AVENUE, LOS ANGELES, CA 90071-3459
--------------------------------------------------
[Address of Registrant's principal executive offices including zip code]
(323) 210-5000
--------------
[Registrant's telephone number,
including area code]
NO CHANGES
----------
[Former name, former address and former fiscal year,
if changed since last report]
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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At November 4, 1998, Registrant had 31,015,893 shares of common stock
outstanding.
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TABLE OF CONTENTS
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ITEM NO. PAGE NO.
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PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets at September 30, 1998 and June 30, 1998 3
Consolidated Statements of Income for the three months ended
September 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for the three months ended
September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 7-41
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 41
Item 2 - Changes in Securities 41
Item 3 - Defaults Upon Senior Securities 41
Item 4 - Submission of Matters to a Vote of Security Holders 41
Item 5 - Other Information 41
Item 6 - Exhibits and Reports on Form 8-K 41
Signature Page 42
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2
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AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
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<CAPTION>
SEPTEMBER 30 JUNE 30,
1998 1998
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(Unaudited) (Audited)
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ASSETS
Cash and cash equivalents $ 5,625,000 $ 12,322,000
Loans held for sale, at lower of cost or market 222,845,000 198,202,000
Accounts receivable 58,488,000 51,072,000
Interest-only strips, estimated at fair market value 378,475,000 359,600,000
Mortgage servicing rights 35,460,000 32,090,000
Residual assets 210,581,000 194,561,000
Equipment and improvements, net 14,034,000 13,939,000
Prepaid and other 15,876,000 17,020,000
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Total assets $ 941,384,000 $ 878,806,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Borrowings 306,990,000 286,990,000
Revolving warehouse facilities 179,948,000 141,012,000
Accounts payable and accrued expenses 57,922,000 49,964,000
Income taxes payable 51,461,000 55,437,000
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Total liabilities 596,321,000 533,403,000
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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;
31,015,800 and 30,962,600 shares outstanding 31,000 31,000
Additional paid-in capital 250,095,000 249,851,000
Retained earnings 94,937,000 95,521,000
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Total stockholders' equity 345,063,000 345,403,000
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Total liabilities and stockholders' equity $ 941,384,000 $ 878,806,000
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
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AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
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<CAPTION>
THREE MONTHS ENDED
------------------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
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Revenue:
Gain on sale of loans $38,892,000 $44,721,000
Net unrealized gain on valuation
of interest-only strips 5,196,000 5,029,000
Commissions 9,988,000 5,855,000
Loan service 9,225,000 9,782,000
Fees and other 13,676,000 12,525,000
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Total revenue $76,977,000 $77,912,000
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Expenses:
Compensation and related expenses 23,794,000 21,759,000
Production expenses 10,930,000 5,797,000
General and administrative expenses 13,389,000 8,085,000
Interest expense 12,881,000 10,098,000
Provision for loan losses 15,210,000 8,570,000
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Total expenses 76,204,000 54,309,000
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Income before income taxes 773,000 23,603,000
Provision for income taxes 325,000 10,522,000
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Net income $ 448,000 $13,081,000
=========== ===========
Net income per share
Basic $0.01 $0.47
=========== ===========
Diluted $0.01 $0.40
=========== ===========
Dividends per share $0.03 $0.03
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Weighted average number
of shares outstanding
Basic 30,977,000 27,767,000
=========== ===========
Diluted 31,265,000 35,333,000
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</TABLE>
The accompanying notes are an integral part of these financial statements.
4
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AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
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<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------------------
1998 1997
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Operating activities:
Net income $ 448,000 $ 13,081,000
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses 15,210,000 8,570,000
Net charge-offs for loans (8,628,000) (4,208,000)
Depreciation and amortization 1,224,000 899,000
Deferred income taxes - 5,233,000
Gain on sale of loans (54,323,000) (45,526,000)
Net unrealized gain on valuation of interest-only strips (5,196,000) (5,029,000)
Amortization of interest-only strip 34,062,000 22,500,000
Mortgage servicing rights originated (6,195,000) (4,861,000)
Mortgage servicing rights amortization 2,824,000 1,914,000
Changes in assets and liabilities:
Loans originated or purchased (725,057,000) (523,139,000)
Proceeds from sale of loans 700,414,000 562,410,000
Decrease (Increase) in:
Accounts receivable (7,416,000) (2,306,000)
Prepaid and other 1,144,000 (1,202,000)
Residual assets (16,020,000) (18,497,000)
Increase (decrease) in:
Accounts payable and accrued expenses 7,958,000 634,000
Income taxes payable (3,976,000) 4,110,000
------------ ------------
Net cash (used in) operating activities (63,527,000) 14,583,000
------------ ------------
Investing activities:
Purchases of property and equipment (1,319,000) (981,000)
------------ ------------
Net cash (used in) investing activities (1,319,000) (981,000)
------------ ------------
Financing activities:
Proceeds from sale of stock or exercise of options 235,000 62,000
Proceeds from borrowing 20,000,000 -
Amounts outstanding under warehouse facilities 38,936,000 (33,000,000)
Dividends paid (1,022,000) (916,000)
------------ ------------
Net cash provided by (used in ) financing activities 58,149,000 (33,854,000)
------------ ------------
Net increase (decrease) in cash and cash equivalents (6,697,000) (20,252,000)
Cash and cash equivalents at beginning of period 12,322,000 26,902,000
------------ ------------
Cash and cash equivalents at end of period $ 5,625,000 $ 6,650,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
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AAMES FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The consolidated financial statements of Aames Financial
Corporation, a Delaware corporation, and its subsidiaries (collectively, the
"Company") included herein have been prepared by the Company, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted.
The consolidated financial statements include the accounts of the
Company and all of its subsidiaries after eliminating all significant
intercompany transactions and reflect all normal, recurring adjustments which
are, in the opinion of management, necessary to present a fair statement of the
results of operations of the Company for the interim periods reported. The
results of operations for the Company for the three months ended September 30,
1998 are not necessarily indicative of the results expected for the full fiscal
year.
NOTE 2: RECLASSIFICATIONS
Certain amounts related to fiscal year 1998 have been reclassified
to conform to the fiscal year 1999 presentation.
NOTE 3: SUBSIDIARY GUARANTORS
In October 1996, the Company completed an offering of its 9.125%
Senior Notes due 2003 which were guaranteed by all of the Company's operating
subsidiaries, all of which are wholly-owned. The guarantees are joint and
several, full, complete and unconditional. There are no restrictions on the
ability of such subsidiaries to transfer funds to the Company in the form of
cash dividends, loans or advances. The Company is a holding company with limited
assets or operations other than its investments in its subsidiaries. Separate
financial statements of the guarantors are not presented because the aggregate
total assets, net earnings and net equity of such subsidiaries are substantially
equivalent to the total assets, net earnings and net equity of the Company on a
consolidated basis.
6
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and
results of operations of the Company should be read in conjunction with the
Company's Consolidated Financial Statements
included in Item 1 of this Form 10-Q.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
This Report contains statements that constitute "forward-looking
statements" within the meaning of Section 21E of the Exchange Act and Section
27A of the Securities Act. The words "expect," "estimate," "anticipate,"
"predict," "believe," and similar expressions and variations thereof are
intended to identify forward-looking statements. Such statements appear in a
number of places in this filing and include statements regarding the intent,
belief or current expectations of the Company, its directors or officers with
respect to, among other things (a) market conditions in the securitization,
capital, credit and whole loan markets and their future impact on the Company's
operations, (b) trends affecting the Company's liquidity position, including,
but not limited to, its access to warehouse and other credit facilities and its
ability to effect whole loan sales, (c) the impact of the various cash savings
plans and other restructuring strategies being considered by the Company, (d)
the Company's on-going search for a strategic partner, including its discussions
with a potential investor, (e) trends affecting the Company's financial
condition and results of operations, (f) the Company's plans to address the Year
2000 problem and (g) the Company's business and liquidity strategies. The
stockholders of the Company are cautioned not to put undue reliance on such
forward-looking statements. Such forward-looking statements are not guarantees
of future performance and involve risks and uncertainties. Actual results may
differ materially from those projected in this Report, for the reasons, among
others, discussed under the captions, "- Overview -- Market Conditions,"
"-Business Strategies," "- Recent Events," and "- Risk Factors." The Company
undertakes no obligation to publicly revise these forward-looking statements to
reflect events or circumstances that arise after the date hereof. Readers should
carefully review the factors referred to above and the other documents the
Company files from time to time with the Securities and Exchange Commission,
including the Company's Annual Report on Form 10-K for the fiscal year ended
June 30, 1998, the quarterly reports on Form 10-Q filed by the Company during
the remainder of fiscal 1999, and any current reports on Form 8-K filed by the
Company.
OVERVIEW - MARKET CONDITIONS
Global conditions in the capital and credit markets became
extraordinarily negative during the quarter ended September 30, 1998 and had an
adverse impact on the subprime home equity finance sector generally and the
Company specifically. These market pressures have negatively impacted the
Company's securitization gains, severely restricted the Company's access to
credit facilities, precluded access to public equity and debt markets and has
adversely affected the premiums received in the whole loan market.
7
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As identified in the Company's annual report on Form 10-K for the year ended
June 30, 1998, the Company's gain on sale from its $650 million securitization
completed in September 1998 was significantly reduced due to the loss on its
hedge position which was not offset by enhanced securitization execution. The
weak asset-backed market has continued through the date of this Report. The
deterioration in market conditions has also limited the availability of credit
facilities for the subprime home equity finance sector generally. See "-
Business Strategies," "- Liquidity" and "- Risk Factors -- Dependance on Funding
Sources." These market conditions have had a significant impact on the Company's
liquidity and financial condition. While the Company retains access to warehouse
and other credit facilities with borrowing limits aggregating in excess of $1.0
billion, changes in advance rates recently imposed by some of the lenders have
effectively limited the Company to a single $300 million committed warehouse
line. This line in the amount of $300 million expires on April 8, 1999. Although
this line is subject to renewal, the Company believes that without a change in
market conditions or a change in the Company's liquidity position, it is
unlikely that the renewal will be forthcoming. Although the Company is currently
seeking additional credit facilities, current market conditions have severely
hampered the Company's ability to obtain additional warehouse or residual
facilities. Further, the Company's liquidity constraints have been exacerbated
by the drop in home equity stock prices and the consequent unavailability of the
public equity and debt markets. The Company has attempted to address these
liquidity constraints by employing its previously disclosed strategy of
evaluating the market conditions, cash flow and profitability of the whole loan
sales relative to the securitization market and selling its loans in the whole
loan market. However, the weakness in the asset-backed market has caused other
subprime lenders to rely on the whole loan market for their loan disposition
strategy. This has created an abundance in the supply of loans in that market
which has resulted in lowering the prices paid (in some cases to prices lower
than the Company's cost of producing loans) and tightening the underwriting
guidelines applied by the whole loan purchasers. The Company has raised its
prices and modified its underwriting guidelines in response to these changes
which it believes will have the effect of decreasing loan production in the
current quarter. See "-Business Strategies".
As a company that operates on a negative cash flow basis, the
Company depends on the securitization market, the credit and capital markets and
the whole loan market for its liquidity. See "- Liquidity." Without or with
limited access to the securitization, credit and capital markets and with the
decreased profitability of the whole loan market, the Company's liquidity
position is weak. If the Company cannot obtain additional credit lines secured
by its interest-only strips and residual assets or additional equity capital in
the next 30 days, it may have to engage in extraordinary transactions, such as
seeking subservicing arrangements that include the obligation to make servicing
advances or strategic asset sales, to provide the liquidity necessary to
operate, albeit on a much smaller scale. Management believes that any such
transaction would have a material adverse effect on the Company's results of
operations. However, there can be no assurance that any such extraordinary
transaction will be consummated. See "- Recent Events" and "- Risk Factors --
Strategic Alternatives." Furthermore, the Company's long-term liquidity position
depends on the availability of warehouse lines. Further, provisions in the
Company's primary warehouse line require the Company to maintain a certain level
of profitability over two consecutive quarters. The reduced profitability of the
first fiscal quarter combined with a potential loss in the second fiscal quarter
may violate these provisions. If the Company is unable to receive the necessary
waivers and is deemed to be in default under the line, the line could be
terminated. If the Company were unable to secure replacement lines, it would
have
8
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to cease loan production operations which would negatively impact profitability
and jeopardize the Company's ability to continue to operate as a going concern.
BUSINESS STRATEGIES
In light of current market conditions in the securitization markets,
the Company will not effect a securitization in its second quarter. In addition,
the Company may not be able to effect a securitization in the near future unless
market conditions improve dramatically. The Company, therefore, will be
dependent on the whole loan market for its loan disposition strategy. The
Company has negotiated a forward commitment with an affiliate of its primary
warehouse lender for the sale of its loans servicing released in the aggregate
amount of $500 million. This commitment expires on May 4, 1999. The Company
intends to continue to evaluate the overall market, and, as conditions improve,
utilize the securitization market. Further, in response to pressures in the
whole loan market, the Company increased its pricing and modified the
underwriting guidelines for its loan products. Although these changes will
reduce the Company's loan volume, they should improve the Company's ability to
maximize the returns of the whole loan market. Sales of home equity loans for
cash will mitigate the Company's negative cash flow from operations. Gains
associated with whole loan sales for cash are generally at levels lower the
those recognized when such loans are securitized. Further, prices currently
being paid by whole loan purchasers are less than the Company's cost of
production. Accordingly, sales of loans in the whole loan market are expected to
result in a loss in the quarter ended December 31, 1998. Additionally, so long
as the Company sells whole loans on a servicing released basis, the Company will
no longer grow the servicing portfolio.
In response to current market conditions, the Company has
implemented and has under discussion certain cash savings plans. The Company has
eliminated the Company's quarterly cash dividend and during October 1998, the
Company ceased operations in the United Kingdom. Further, the Company has slowed
further expansion plans in its retail and broker office network. The Company is
in the process of analyzing its office network to determine whether closing less
profitable offices would be appropriate.
RECENT EVENTS
The Company has retained Donaldson, Lufkin & Jenrette Securities
Corporation ("DLJ") as a financial advisor to develop strategic alternatives for
the Company. Since its engagement in June, 1997, DLJ has contacted a number of
major financial institutions to explore potential transactions with the Company.
Although a number of these institutions undertook detailed due diligence, none
have made an offer to effect a transaction. The Company is currently in
discussions with a private equity fund (the "Fund") concerning an up to $100
million equity investment in the Company. If such a transaction were to occur,
it would result in a substantial dilution to current stockholders at a price
well below the trading price of the Company's Common Stock on the New York Stock
Exchange at the time this Report was prepared. The Fund has not completed due
diligence, and the Company and the Fund have not entered into a definitive
agreement to consummate the transaction. The parties intend to proceed with due
diligence, subject to certain restrictions on the Company's ability to solicit,
negotiate or discuss alternative strategic transactions with third parties for a
period of time ending no later than December 31, 1998. In connection with these
discussions, the Company has agreed to reimburse the Fund for its out-of-pocket
expenses and the payment of certain fees (including a fee payable in certain
circumstances if the Company consummates an alternative strategic transaction.
Given the preliminary nature of the discussions and the conditions involved,
investors should not place undue reliance on the existence of these discussions.
There can be no assurance that the Fund will in fact make an offer to the
Company that the Company will find acceptable, that an agreement will be entered
into or that a transaction will in fact ever occur. Further, it is not expected
that a transaction with the Fund, even if an agreement were reached, could be
consummated in time to address the short term liquidity requirements of the
Company discussed in other parts of this Report. However, the Company believes
that the transaction contemplated would address the Company's long term
liquidity requirements, and the fact that the Company is in discussions with the
Fund may help facilitate a solution to the Company's short term liquidity
requirements. The Company does not ordinarily disclose developments with respect
to potential strategic transactions before agreements are entered into and
undertakes no obligation to update the disclosures contained herein with respect
to developments after the date hereof.
9
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GENERAL
The Company is a consumer finance company primarily engaged, through
its subsidiaries, in the business of originating, purchasing, selling, and
servicing home equity mortgage loans secured by single family residences. Upon
its formation in 1991, the Company acquired Aames Home Loan, a home equity
lender founded in 1954. In August 1996, the Company acquired One Stop Mortgage,
Inc. ("One Stop") which originates mortgage loans primarily through a broker
network. In late fiscal 1997, the Company began originating small commercial
loans on a limited basis that it currently sells on a whole loan basis servicing
released. In response to current market conditions, the Company has temporarily
curtailed the funding of commercial loan originations.
The Company's principal market is borrowers whose financing needs
are not being met by traditional mortgage lenders for a variety of reasons,
including the need for specialized loan products or credit histories that may
limit such borrowers' access to credit. The Company believes these borrowers
continue to represent an underserved niche of the home equity loan market and
present an opportunity to earn a superior return for the risk assumed. The
residential mortgage loans originated and purchased by the Company, which
include fixed and adjustable rate loans, are generally used by borrowers to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes.
The Company originates and purchases loans nationally through three
production channels - retail, broker and correspondent. For the quarter ended
September 30, 1998, the Company originated and purchased $725 million of
mortgage loans. The Company underwrites and appraises every loan it originates
and generally reviews appraisals and re-underwrites all loans it purchases. In
March 1998, the Company augmented its retail production by establishing One Stop
Retail Direct ("Retail Direct"). Unlike the Company's traditional retail
network, which uses a centralized marketing approach, Retail Direct uses a
decentralized marketing approach at the branch level.
The Company retains the servicing on the loans it originates or
purchases and securitizes. The Company completed the transfer-in-house of $1.64
billion of loans previously subserviced for the Company by third parties in the
15 month period ending September 30, 1998. Of the Company's $4.44 billion
servicing portfolio, only 1.0% was subserviced by a third party at September 30,
1998. Of the Company's $3.40 billion servicing portfolio at September 30, 1997,
45% was subserviced by a third party at that date. See "- Expenses."
As a fundamental part of its business and financing strategy, the
Company sells its loans to third party investors in the secondary market. The
Company maximizes opportunities in its loan
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disposition transactions by disposing of its loan production through a
combination of securitizations and whole loan sales, depending on market
conditions, profitability and cash flows. For a discussion of the impact of
current market conditions on the Company's loan disposition strategies, see
"- Overview -- Market Conditions" and "- Business Strategies." The Company sold
$696 million and $543 million of loans in the quarter ending September 30, 1998
and 1997, respectively.
The following table presents the volume of loans originated and
purchased by the Company and the portfolio serviced by the Company during the
periods presented:
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THREE MONTHS ENDED
SEPTEMBER 30,
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(IN THOUSANDS)
1998 1997
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Loans originated and purchased:
Broker Network(1)........................................... $ 350,801 $ 261,834
Retail(2)................................................... 228,177 133,546
Correspondent............................................... 146,079 127,759
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Total....................................................... $ 725,057 $ 523,139
========= ==========
Servicing portfolio at period end........................... $4,441,000(3) $3,402,000
</TABLE>
(1) Includes commercial loans.
(2) Includes loans brokered to institutional investors for 1997.
(3) Includes $35.4 million of loans subserviced for others by the Company
on an interim basis.
Total originations increased 39% to $725 million for the quarter
ended September 30, 1998 from $523 million for the quarter ended September 30,
1997. The Company's core operations, retail and broker, increased 47% to $579
million from $395 million for the quarters ended September 30, 1998 and 1997,
respectively. The growth in core originations was due to the planned geographic
expansion in the retail and broker units. The Company's retail originations were
$228 million for the quarter ended September 30, 1998 compared to $134 million
for the quarter ended September 30, 1997. Origination volume for the broker
network reached $351 million for the quarter ended September 30, 1998 compared
to $262 million for the quarter ended September 30, 1997. Correspondent
purchases were $146 million for the quarter ended September 30, 1998 compared to
$128 million for the quarter ended September 30, 1997.
At September 30, 1998, the Company operated 95 retail loan offices
serving 33 states (including the District of Columbia), compared to 60 offices
serving 26 states at September 30, 1997. At September 30, 1998, One Stop
operated 51 branches serving 46 states (including the District of Columbia),
compared to 40 branches serving 35 states at September 30, 1997. At September
30, 1998, Retail Direct operated 14 offices serving 10 states. See "- Business
Strategies."
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CERTAIN ACCOUNTING CONSIDERATIONS
Accounting for Securitizations. Although the Company's loan
disposition strategy relies on a combination of securitization transactions and
whole loan sales, the Company sold a significant portion of its loan production
in a securitization transaction during the quarter ended September 30, 1998. See
"- Business Strategies." In a securitization, the Company conveys loans that it
has originated or purchased to a separate entity (such as a trust or trust
estate) in exchange for cash proceeds and an interest in the loans securitized
represented by the non-cash gain on sale of loans. The cash proceeds are raised
through an offering of the pass-through certificates or bonds evidencing the
right to receive principal payments on the securitized loans and the interest
rate on the certificate balance or on the bonds. The non-cash gain on sale of
loans represents the difference between the proceeds (including premiums) from
the sale, net of related transaction costs, and the allocated carrying amount of
the loans sold. The allocated carrying amount is determined by allocating the
original amount of loans (including premiums paid on loans purchased) between
the portion sold and any retained interests (interest-only strip), based on
their relative fair values at the date of transfer. The interest-only strip
represents, over the estimated life of the loans, the present value of the
excess of the weighted average coupon on each pool of loans sold over the sum of
the interest rate paid to investors, the contractual servicing fee (currently
.50%) and a monoline insurance fee, if any, adjusted for the reserve for loan
losses. Unrealized gains or losses include the recognition of an unrealized gain
or loss which represents the initial difference between the allocated carrying
amount and the fair market value of the interest-only strip at the date of sale.
Each agreement that the Company has entered into in connection with its
securitizations requires either the overcollateralization of the trust or the
establishment of a reserve account that may initially be funded by cash
deposited by the Company. The Company's interest in each overcollateralization
amount and reserve account is reflected on the Company's Consolidated Financial
Statements as "residual assets" and is recorded as of the time such amounts are
received by the trust.
The Company determines the present value of the cash flows at the
time each securitization transaction closes using certain estimates made by
management at the time the loans are sold. These estimates include: (i) future
rate of prepayment; (ii) discount rate used to calculate present value; and
(iii) the provision for credit losses on loans sold. There can be no assurance
of the accuracy of management's estimates.
Rate of Prepayment. The estimated life of the securitized
loans depends on the assumed annual prepayment rate which is a
function of estimated voluntary (full and partial) and
involuntary (liquidations) prepayments. The prepayment rate
represents management's expectations of future prepayment
rates based on prior and expected loan performance, the type
of loans in the relevant pool (fixed or adjustable rate), the
production channel which produced the loan, prevailing
interest rates, the presence of prepayment penalties, the
loan-to-value ratios and the credit grades of the loans
included in the securitization and other industry data. The
rate of prepayment may be affected by a variety of economic
and other factors. Generally, a declining interest rate
environment will result in prepayments on higher credit grade
loans. For the
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quarters ended September 30, 1998 and 1997, prepayment rates
held constant over the life of the pool used in the valuation
of the interest-only strips ranged from 26% to 30.5%. These
rates represent a weighted average loan life of approximately
2.6 to 3.8 for both periods. See "- Revenue" and "- Risk
Factors -- Prepayment Risk."
Discount Rate. In order to determine the fair value of the
cash flow from the interest-only strips, the Company discounts
the cash flows based upon rates prevalent in the market.
Currently, the Company uses the weighted average interest
rates of the loans included in the pool as the best estimate
available of an appropriate discount rate to determine fair
value.
Provision for Credit Losses on Loans Sold. In determining the
provision for credit losses on loans securitized, the Company
uses assumptions that it believes are reasonable based on
information from its prior securitizations and the
loan-to-value ratios and credit grades of the loans included
in the current securitizations. At September 30, 1998, the
Company had reserves of $56.8 million related to these credit
risks, or 1.4% of the outstanding balance of loans securitized
as of that date. Losses averaged .80% and .51% of the average
servicing portfolio for the quarters ended September 30, 1998
and 1997, respectively. The weighted average loan-to-value
ratio of the loans serviced by the Company was 72.8% as of
September 30, 1998.
The interest-only strips are amortized over the expected lives of
the related loans and a corresponding reduction in servicing fee income is
recorded. The interest-only strips are recorded at estimated fair value and are
marked to market through a charge (or credit) to earnings. On a quarterly basis,
the Company reviews the fair value of the interest-only strips by analyzing its
prepayment and other assumptions in relation to its actual experience and
current rates of prepayment prevalent in the industry and may adjust its rate of
amortization or take a charge to earnings through an adjustment to net
unrealized gain or loss on valuation of interest-only strips. In its regular
quarterly review of its interest-only strip, the Company considered the
historical performance of its securitized loan pools, the recent prepayment
experience of those pools and the rate of amortization and determined that the
pools were performing in line with management's expectations and that no
adjustment was warranted at September 30, 1998. See "- Risk Factors -- Credit
Risk" and "- Revenue."
Additionally, upon sale or securitization of servicing retained
mortgages, the Company capitalizes the fair value of originated mortgage
servicing rights ("OMSRs") assets separate from the loan. 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
over the period of estimated net future servicing fee income. The Company
periodically reviews the valuation of capitalized servicing fees receivable.
This review is performed on a disaggregated basis for the predominant risk
characteristics of the underlying loans which are loan type and origination
date.
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<PAGE> 14
New Accounting Developments. On October 23, 1998, the FASB issued a
draft guide, in question and answer format, entitled: "A Guide to Implementation
of Statement 125 on accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, Questions and Answers, Second Edition" (the
"Q&A"). The Q&A indicates that two methods have arisen in practice for
accounting for credit enhancements, an item which the Company records as
"residual assets." These methods are the cash-in method and the cash-out method.
The cash-in method treats credit enhancements (pledged loans or cash) as
belonging to the Company. As such, these assets are recorded at their face value
as of the time they are received by the trust. The cash-out method treats credit
enhancements as assets owned by the related securitization trust. As such, these
assets are treated as part of the interest-only strip and are recorded at a
discounted value for the period between when collected by the trust and released
to the Company. The draft Q&A indicates that if no true market exists for credit
enhancement assets, the cash-out method should be used to measure the fair value
of credit enhancements. The draft Q&A remains subject to a comment period and
further amendments prior to becoming final.
The Company has historically used the cash-in method to account for
its residual assets. It is the Company's belief that the cash-in method of
accounting is appropriate and has been an acceptable accounting convention used
by many in the subprime home equity finance sector and other industries. The
Company has not yet completed the calculations necessary to determine what the
ultimate impact of the cash-out method would have on the carrying value of its
residual assets or how the change would be recorded. At September 30, 1998, the
amount of residual assets included in the Company's balance sheet is $211
million. If the FASB does not modify its current position as reflected in the
draft guide to Financial Accounting Standard 125, the Company believes that a
change to the cash-out method will result in a material write-down of its
interest-only strips and a loss in the quarter in which the write-down is
recorded.
RESULTS OF OPERATIONS-THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
The following table sets forth information regarding the components
of the Company's revenue and expenses for the three months ended September 30,
1998 and 1997:
14
<PAGE> 15
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
1998 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Revenue:
Gain on sale of loans.......................................................... $ 38,892 $ 44,721
Net unrealized gain on valuation of interest-only
strips ................................................................... 5,196 5,029
Commissions.................................................................... 9,988 5,855
Loan service:
Servicing spread............................................................... 3,369 6,170
Prepayment fees................................................................ 3,500 2,355
Late charge and other servicing fees........................................... 2,356 1,257
Fees and other:
Closing ................................................................... 618 587
Appraisal...................................................................... 947 501
Underwriting................................................................... 453 246
Interest income................................................................ 11,514 11,031
Other ................................................................. 144 160
-------- ---------
Total revenue.................................................................. $ 76,977 $ 77,912
-------- ---------
Expenses:
Compensation and related expenses.............................................. $ 23,794 $ 21,759
Production expenses............................................................ 10,930 5,797
General and administrative expenses............................................ 13,389 8,085
Interest expense............................................................... 12,881 10,098
Provision for loan losses...................................................... 15,210 8,570
-------- ---------
Total expenses..................................................... $ 76,204 $ 54,309
Income (loss) before income taxes.............................................. $ 773 $ 23,603
Provision for income taxes..................................................... 325 10,522
-------- ---------
Net income (loss).............................................................. $ 448 $ 13,081
======== =========
</TABLE>
REVENUE
Total revenue for the three months ended September 30, 1998 was
$77.0 million, down slightly from $77.9 million for the three months ended
September 30, 1997. The decrease in total revenue was due primarily to lower
gain on sale resulting from hedge losses and lower than historical spreads on
the Company's $650 million securitization closed in the quarter ended September
30, 1998. During the first fiscal quarter, the Company, as it had historically,
hedged its fixed rate pipeline by purchasing hedges against U.S. Treasuries. In
the past, changes in Treasury rates were generally reflected in the pass-through
rates of the fixed rate portion of the Company's securitization. During 1998's
first fiscal quarter, unsettled market conditions resulted in a loss on the
Company's hedge position without an equivalent benefit from reductions in the
pass-through rate paid on certificates sold in the fixed rate portion of the
Company's securitization. This decrease in gain on
15
<PAGE> 16
sale was mitigated by significant increases in loan production in the Company's
core retail and broker production channels. See "- General."
Gain on sale, which included $5.20 million of an unrealized gain on
valuation of interest-only strips related to loans sold, for the three months
ended September 30, 1998 was $44.1 million, a 12.9% decrease from $49.8 million
for the corresponding period last year. This decrease reflected the weakened
asset-backed market as a result of widening spreads on asset-backed bonds
relative to U.S. Treasury rates. The increase in the price of U.S. Treasuries
resulted in a hedge loss of $15.3 million (representing a $10.7 million loss
realized in the quarter ended September 30, 1998 and a valuation reserve of $4.6
million on contracts expiring on December 31, 1998) which reduced the reported
gain on sale. The Company securitized $650 million for the period ended
September 30, 1998 compared to $504 million for the period ended September 30,
1997. In light of current market conditions in the securitization markets, the
Company will not effect a securitization in its second quarter. In addition, the
Company may not be able to effect a securitization in the near future unless
market conditions improve dramatically. The Company, therefore, will be
dependent on the whole loan market for its loan disposition strategy. Gains
associated with whole loan sales for cash are generally at levels lower the
those recognized when such loans are securitized. Further, prices currently
being paid by whole loan purchasers are less than the Company's cost of
production. Accordingly, sales of loans in the whole loan market are expected to
result in a loss in the quarter ended December 31, 1998.
Commissions earned on loan originations continue to be an important
component of total revenue, comprising 13.0% and 7.5% of total revenue for the
three months ended September 30, 1998 and 1997, respectively. Commission revenue
was $9.99 million for the three months ended September 30, 1998, a 70% increase
from $5.86 million for the three months ended September 30, 1997. The increase
in commissions for the three months ended September 30, 1998 was the result of
increased production in the Company's core units offset by lower commissions
earned on broker production. Both channels had significant increases in volume,
but competition in the broker market early in the quarter reduced points
collected at origination on this production.
Loan service revenue decreased to $9.23 million in the quarter ended
September 30, 1998, from $9.78 million in the comparable quarter in 1997. 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 reduced by the amortization of the interest-only strips and
OMSRs. The decrease in loan service revenues for the three months ended
September 30, 1998 was due primarily to smaller servicing spreads on the
Company's recent securitizations and increased amortization of the interest-only
strips and OMSRs in the current period.
The Company's loan servicing portfolio at September 30, 1998
increased to $4.44 billion, up 31% from $3.40 billion at September 30, 1997. At
September 30, 1998, 99% of the Company's $4.44 billion servicing portfolio was
serviced in-house, compared to 55% at September 30, 1997. By calendar year-end,
the Company expects to eliminate the use of third party subservicers. See
"-Overview -- Market Conditions." Management believes that the business of loan
servicing provides
16
<PAGE> 17
a more consistent revenue stream and is less cyclical than the business of loan
origination and purchasing. See "- Risk Factors -- Delinquencies and Losses in
Securitization Trusts; Right to Terminate Mortgage Servicing; Negative Impact on
Cash Flow" and "-- Strategic Alternatives."
The Company has historically experienced delinquency rates that are
higher than those prevailing in its industry. With the Company's focus on higher
credit grade loans, delinquencies in the Company's securitized trusts are
expected to decrease in the future. See "- Revenue." Further, by selling loans
in the whole loan market on a servicing released basis, which the Company
intends to do for the near future, the Company will not be adding new loans to
the servicing portfolio. The seasoning of the old portfolio without the addition
of new loans could cause delinquency rates to rise. The delinquency rate for
September 30, 1998 was 15.6% compared to 14.0% at September 30, 1997.
In some cases, the Company has determined that the proceeds from the
disposal of REO and foreclosed properties are maximized by accelerating
disposition of REO properties rather than holding such properties until market
conditions improve. During the three months ended September 30, 1998, losses
increased to $8.63 million from $4.16 million in the prior year period due
primarily to a loss mitigation strategy adopted during the 1997 fiscal year of
minimizing the REO holding period, thereby reducing carrying costs. However, the
Company saw the benefits of this strategy by the decrease in losses compared to
the previous calendar quarter. Losses were $9.81 million in the quarter ended
June 30, 1998. It is the Company's goal to reduce the REO holding period to
maximize the economics of liquidation transactions. Current loss levels have
also increased due to the seasoning of the lower credit grade loans purchased in
bulk and included in the Company's earlier trusts. The Company has reduced
significantly its bulk purchase program and the purchase in bulk of lower credit
grade loans. While the accelerated efforts to sell properties is expected to
have a short-term impact on loss levels, the seasoning of the lower credit grade
bulk portfolio may contribute to an increase in losses over time. The Company
increased its loan loss provision to $15.2 million representing 2.34% of the
securitized pool balances formed during three months ended September 30, 1998
from $8.57 million representing 1.70% of the pool balance for the three months
ended September 30, 1997. See "- Expenses." The following table sets forth
delinquency, foreclosure, loss and reserve information of the Company's
servicing portfolio for the periods indicated:
17
<PAGE> 18
<TABLE>
<CAPTION>
Year Ended Three Months Ended
June 30, September 30,
1998 1997 1996 1998 1997
---- ---- ---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Percentage of dollar amount of delinquent loans
to loans serviced (period end) (1)(2)(3)(4)
One month 3.8% 4.3% 4.9% 3.9% 3.2%
Two months 1.3% 1.9% 1.8% 1.3% 1.3%
Three or more months:
Not foreclosed (4)(5) 9.0% 8.1% 8.0% 8.8% 8.3%
Foreclosed (6) 1.5% 1.0% 1.0% 1.6% 1.2%
----- ----- ----- ----- -----
Total 15.6% 15.3% 15.7% 15.6% 14.0%
===== ===== ===== ===== =====
Percentage of dollar amount of loans foreclosed to
loans serviced (period end)(2)(4) 2.0% 1.5% 1.1% 0.58% 0.58%
Number of loans foreclosed(7) 1,125 560 221 346 241
Principal amount of foreclosed loans(7) $ 84,613 $ 48,029 $ 14,349 $ 25,731 $19,744
Net losses on liquidations(8) $ 26,488 $ 5,470 $ 931 $ 8,627 $ 4,160
One time charge-offs to reserve (9) $ 6,000
Percentage of annualized losses to average
servicing portfolio(4)(10) 0.72% 0.24% 0.09% 0.80% 0.51%
Liquidation loss reserve (11) $ 50,262 $ 43,586 $ 10,300 $ 56,845 $47,948
</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,
and any subservicers as of the end of the periods indicated.
Percentages for fiscal year 1996 have not been restated to include
delinquencies on loans originated by One Stop. The Company believes
any such adjustment would not be material.
(3) At September 30, 1998, the dollar volume of loans delinquent more
than 90 days in the Company's eleven REMIC trusts, four of which
also exceeded certain loss limits, formed in November 1992, June
1993 and during the period from March 1995 to March 1997 exceeded
the permitted limit in the related pooling and servicing agreements.
See "-- Capital Resources" and "- Risk Factors -- Delinquencies and
Losses in Securitization Trusts; Right to Terminate Mortgage
Servicing; Negative Impact on Cash Flow."
(4) The servicing portfolio used in the percentage calculations includes
$35.4 million of loans subserviced for others by the Company on an
interim basis at September 30, 1998.
(5) Represents loans which are in foreclosure but as to which
foreclosure proceedings have not concluded
(6) Represents properties acquired following a foreclosure sale and
still serviced by the Company.
(7) The increase in the number of loans foreclosed and principal amount
of loans foreclosed in the periods presented is due to the larger,
more seasoned servicing portfolio.
(8) Represents losses, net of gains, on foreclosed properties sold
during the period indicated, excluding the one time charge referred
to in footnote (9) below.
(9) Represents a one time reversal of $6.0 million to the loss reserve
recorded in March 1998 resulting from the Company's delay in
recording information transferred from a third party servicer
regarding loan payoffs. The amount was not sufficiently material to
require adjustment of previously reported receivables.
(10) Does not include the one time charge referred to in footnote (9)
above.
(11) Represents period end reserves for future liquidation losses.
Fees and other revenue increased 9.6% to $13.7 million in the three
months ended September 30, 1998 compared to $12.5 million in the three months
ended September 30, 1997. Fees and other revenue consist of fees received by the
Company through its retail loan office network in the form of closing,
appraisal, underwriting and other fees, plus interest income. The dollar amount
of these fees increased in this period due to the larger number of mortgage
loans originated through the Company's retail loan office
18
<PAGE> 19
network. Interest income increased during the period 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, offset by declining
weighted average interest rates on loans held. Fees and other revenues are
expected to decline in future periods as originations decrease as a result of
recent pricing and underwriting changes. Further, interest income will decline
due to the Company's reliance on whole loan sales which decreases the average
number of days loans are held by the Company prior to sale. See "-Overview --
Market Conditions" and "-Business Strategies."
EXPENSES
Compensation and related expenses increased 9.2% to $23.8 million
from $21.8 million for the quarters ended September 30, 1998 and 1997,
respectively. This increase was primarily due to the continued effort to
accommodate increased origination volumes, core origination channel expansion
and increased in-house servicing. However, compensation and related expenses as
a percentage of total loan originations and purchases decreased to 3.3% from
4.2% for the quarters ended September 30, 1998 and 1997, respectively.
Offsetting increased compensation expenses was the waiver by Neil Kornswiet,
President of the Company, of his quarterly bonus due for the quarter ended
September 30, 1998 in the amount of $1.65 million.
Production expenses, primarily advertising, outside appraisal costs,
travel and entertainment, and credit reporting fees, increased 88% to $10.9
million from $5.80 million for the quarters ended September 30, 1998 and 1997,
respectively. The increase in production expenses reflects the Company's retail
and broker network expansion and higher loan production volume. Production costs
as a percentage of total loan originations and purchases were 1.5% and 1.1% for
the three months ended September 30, 1998 and 1997, respectively.
General and administrative expenses increased 66% to $13.4 million
from $8.09 million for the quarters ended September 30, 1998 and 1997,
respectively. The increase was primarily the result of increased occupancy and
communication costs related to the Company's core origination
channel expansion and increased origination volumes.
Interest expense increased to $12.9 million from $10.1 million for
the quarters ended September 30, 1998 and 1997, respectively. The increase was
primarily the result of increased borrowings under various financing
arrangements used to fund the origination and purchase of mortgage loans prior
to their securitization or sale in the secondary market. Interest expense is
expected to increase in future periods due to the Company's continued reliance
on external financing to fund operations.
The provision for loan losses increased to $15.2 million for the
three months ended September 30, 1998 from $8.57 million in the comparable
period in the prior year. The Company recorded provisions for loan losses of
2.34% and 1.70% of the loans securitized during the quarter ended September 30,
1998 and 1997, respectively. This increase reflects the greater amount of higher
credit grade loans with generally higher loan-to-value ratios originated during
this period, as well as the Company's assessment of provision requirements in
conjunction with its review of the adequacy of the reserve for loan losses.
19
<PAGE> 20
INCOME TAXES
The Company's provision for income taxes decreased to $325,000 for
the three months ended September 30, 1998 from $10.5 million for the three
months ended September 30, 1997. The effective tax rate decreased to 42% for the
quarter ended September 30, 1998 from 45% for the quarter ended September 30,
1997. This decrease was due primarily as a result of reduced pre-tax earnings in
the current period and non-deductible compensation expense paid during the
quarter ended September 30, 1997.
FINANCIAL CONDITION
Loans Held for Sale. The Company's portfolio of loans held for sale
increased to $223 million at September 30, 1998, from $198 million at June 30,
1998. This increase is directly related to production volume and the size of the
Company's securitization and sales in the secondary market during the period.
During October 1998, the Company sold $125 million of the $223 million held for
sale at September 30, 1998 in a whole loan sale for cash. See "- Business
Strategies."
Accounts Receivable. Accounts receivable, representing servicing
fees and advances and other receivables, increased to $58.5 million at September
30, 1998, from $51.1 million at June 30, 1998. The level of servicing related
advances, in any given period, are dependent on portfolio delinquencies and the
timing of cash collections.
Interest-Only-Strips. Interest-only-strips increased to $378 million
at September 30, 1998 from $360 million at June 30, 1998 reflecting the non-cash
gain recognized on the Company's securitization in the quarter ended September
30, 1998, net of amortization.
Mortgage Servicing Rights. Mortgage servicing rights increased to
$35.5 million at September 30, 1998 from $32.1 million at June 30, 1998
reflecting the capitalization of mortgage servicing rights on the securitization
in the quarter ended September 30, 1998, net of amortization.
Residual Assets. Residual assets represent the overcollateralization
amounts and reserve accounts required to be maintained in connection with the
Company's securitizations and recorded at the time such amounts are received by
the trust. Residual assets include cash and mortgage loans in excess of the
principal amounts of the senior and subordinated certificates or bonds of the
securitization trusts. Residual assets increased to $211 million at September
30, 1998 from $195 million at June 30, 1998 due to the additional reserves or
overcollaterization required on the Company's securitization in the current
period and increased levels required on existing pools that exceeded certain
delinquency levels during the year. See "- Certain Accounting Considerations"
and "- Risk Factors -- Delinquencies and Losses in Securitization Trusts; Right
to Terminate Mortgage Servicing; Negative Impact on Cash Flow."
Equipment and Improvements, Net. Equipment and improvements, net,
increased slightly to $14.0 million at September 30, 1998 from $13.9 million at
June 30, 1998.
20
<PAGE> 21
Prepaid and Other Assets. Prepaid and other assets decreased to
$15.9 million at September 30, 1998 from $17.0 million at June 30, 1998.
Borrowings. Borrowings increased to $307 million at September 30,
1998 from $287 million at June 30, 1998 due to advances on the Company's
residual financing line completed in September 1998.
Revolving Warehouse Facilities. Amounts outstanding under warehouse
facilities increased to $180 million at September 30, 1998 from $141 million at
June 30, 1998, primarily as a result of the increase in mortgage loans held for
sale and from the negative cash flow from operations during the fiscal quarter
ended September 30, 1998 and the resulting decrease in equity capital. Proceeds
from the Company's whole loan sales and securitizations are used to pay down the
Company's warehouse facilities.
LIQUIDITY
The Company's operations require continued access to short-term and
long-term sources of cash. The Company's primary operating cash requirements
include the funding of: (i) mortgage loan originations and purchases prior to
their securitization and sale, (ii) fees, expenses and hedging costs, if any,
incurred in connection with the securitization and sale of loans, (iii) cash
reserve accounts or overcollateralization requirements in connection with the
securitization and sale of mortgage loans, (iv) tax payments due on recognition
of non-cash gain on sale other than in a debt-for-tax securitization structure,
(v) ongoing administrative and other operating expenses, (vi) interest and
principal payments under the Company's warehouse credit facilities and other
existing indebtedness, (vii) advances in connection with the Company's servicing
portfolio and (viii) costs associated with expanding the Company's core
production units.
Historically, the Company funded its negative operating cash flow
principally through borrowings from financial institutions, sales of equity
securities and sales of senior and subordinated notes, among other sources. The
deterioration of the credit and capital markets has severely restricted the
Company's access to these markets. See "- Overview -- Market Conditions."
Although the Company plans to improve operating and financing cash flow and
reduce the need to access the public equity and debt markets by selling a
portion of its loan production in the whole loan market for cash and, subject to
easing debt covenants restricting the Company's ability to obtain financing
secured by its interest-only strips and residual assets, adding credit
facilities to finance interest-only strips and residual assets, the decreased
profitability of the whole loan market and the limited availability of the
credit markets may impair the execution of this strategy.
Without or with limited access to the securitization, credit and
capital markets and with the decreased profitability of the whole loan market,
the Company's liquidity position is weak. If the Company cannot obtain
additional credit lines secured by its interest-only strips and residual assets
or additional equity capital in the next 30 days, it may have to engage in
extraordinary transactions, such as seeking subservicing arrangements that
include the obligation to make servicing advances
21
<PAGE> 22
or strategic asset sales, to provide the liquidity necessary to operate, albeit
on a much smaller scale. Management believes that any such transaction would
have a material adverse effect on the Company's results of operations. However,
there can be no assurance that any such extraordinary transaction will be
consummated. See "- Recent Events" and "- Risk Factors -- Strategic
Alternatives." Furthermore, the Company's long-term liquidity position depends
on the availability of warehouse lines. While the Company retains access to
warehouse and other credit facilities with borrowing limits aggregating in
excess of $1.0 billion, changes in advance rates recently imposed by some of the
lenders have effectively limited the Company to a single $300 million committed
warehouse line. Its primary line in the amount of $300 million expires on April
8, 1999. Although this line is subject to renewal, the Company believes that
without a change in market conditions or a change in the Company's liquidity
position, it is unlikely that the renewal will be forthcoming. Further,
provisions in this line require the Company to maintain a certain level of
profitability over two consecutive quarters. The reduced profitability of the
first fiscal quarter combined with a potential loss in the second fiscal quarter
may violate these provisions. If the Company is unable to receive the necessary
waivers and is deemed to be in default under the line, the line could be
terminated. See "- Overview -- Market Conditions," "- Business Strategies," "-
Recent Events" and "- Risk Factors -- Dependance on Funding Sources" and "--
Strategic Alternatives." If the Company were unable to secure replacement lines,
it would have to cease loan production operations which would negatively impact
profitability and jeopardize the Company's ability to continue to operate as a
going concern.
Under the terms of the Company's Indenture, dated October 21, 1996
with respect to its 9.125% Senior Notes due 2003, the Company's ability to incur
certain additional indebtedness, including residual financing, is limited to two
times stockholder equity. Warehouse indebtedness is not included in the
indebtedness limitations. Further, until the Company receives investment grade
ratings for the notes issued under the Indenture, the amount of residual
financing the Company may incur on its residuals and interest-only strips
allocable to post-September 1996 securitizations is limited to 75% of the
difference between such post-September 1996 residuals and $225 million. Under
one of the Company's warehouse lines, the Company is currently limited to $50
million of indebtedness secured by its interest-only strips. The Company was
initially unable to ease such restrictions, and due to current market conditions
and the Company's liquidity position, it is unlikely that the Company will be
successful in its further attempts to do so.
Although the Company's loan disposition strategy consists of a
combination of securitizations and whole loan sales, whole loan sales will be
the sole disposition method during the second fiscal quarter. The Company will
continue to monitor market conditions and cash flow and will use the
securitization market when it deems it advisable. During the three months ended
September 30, 1998 and 1997, the Company securitized $650 million and $504
million of loans, respectively. In connection with securitization transactions
completed during these periods, the Company was required to provide credit
enhancements in the form of overcollateralization amounts or reserve accounts.
In addition, during the life of the related securitization trusts, the Company
subordinates a portion of the excess cash flow otherwise due it to the rights of
holders of senior interests as a credit enhancement to support the sale of the
senior interests. The terms of the securitization trusts generally require that
all excess cash flow otherwise payable to the Company during the early months of
the trusts be used to increase the cash reserve accounts or to repay the
22
<PAGE> 23
senior interests in order to increase overcollateralization to specified
maximums. Overcollateralization requirements increase up to approximately twice
the level otherwise required when the delinquency rates exceed the specified
limit. As of September 30, 1998, the Company was required to maintain an
additional $88.7 million in overcollateralization amounts 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 September 30, 1998, $61.2 million remains to be added
to the overcollateralization amounts from future spread income on the loans held
by these trusts. See "- Risk Factors -- Delinquencies and Losses in
Securitization Trusts; Right to Terminate Mortgage Servicing; Negative Impact on
Cash Flow."
In the Company's securitizations structured as a REMIC, the
recognition of non-cash gain on sale 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, hedge costs, and other costs, which in the three months ended September
30, 1998 approximated 2.07% of the principal amount of the securitized mortgage
loans.
CAPITAL RESOURCES
The Company has historically financed its operating cash
requirements primarily through (i) warehouse facilities and working capital
lines of credit, (ii) the securitization and sale of mortgage loans, and (iii)
the issuance of debt and equity securities. Current market conditions have
severely limited the Company's ability to access the credit, securitization and
capital markets. See "- Overview -- Market Conditions."
Warehouse Facilities. At September 30, 1998, the Company had three
warehouse facilities in place. One facility is a warehouse line and working
capital line of credit with a syndicate of ten commercial banks. This facility
provides for a maximum borrowing amount of $400 million ($100 million of which
is an uncommitted bid facility which in the current market conditions is no
longer available to the Company) and is secured by loans originated and
purchased by the Company as well as certain servicing receivables. The warehouse
line bears an interest rate of either 1.05% over the federal funds rate or .80%
over one-month LIBOR and the working capital line bears an interest rate of
either 1.60% over the federal funds rate or 1.35% over the one month LIBOR.
These rates are subject to increase based on the Company's consolidated
leverage, and there can be no assurances that rates will remain stable in the
near future. This line is currently scheduled to expire on April 8, 1999.
Although this line is subject to renewal, the Company believes that without a
change in market conditions or a change in the Company's liquidity position, it
is unlikely that the renewal will be forthcoming. Further, provisions in this
line require the Company to maintain a certain level of profitability over two
consecutive quarters. The reduced profitability of the first
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fiscal quarter combined with a potential loss in the second fiscal quarter may
violate these provisions. See "- Business Strategies." If the Company is unable
to receive the necessary waivers and is deemed to be in default under the line,
the line would be terminated. There is an additional warehouse line of credit
from an investment bank that is secured by loans originated and purchased by the
Company. This line of $300 million bears interest at a rate of .65% over
one-month LIBOR and expires on March 11, 1999. The third line is from a
commercial bank with a maximum borrowing capacity of $300 million at a rate of
.25% over one-month LIBOR, subject to quarterly revisions, which expires on
February 15, 1999. Due to current market conditions, the advance rates on the
latter two lines have been adjusted down to the point where it is no longer
feasible for the Company to use either of them. There can be no assurance that
the Company will be able to obtain warehouse facilities with higher advance
rates or maintain these or similar facilities in the future. The Company will
continue to require short-term warehouse facilities. The levels of short-term
warehouse facilities required is dependent on production volume levels and the
timing of loan sales in the secondary market. If the Company is unable to renew
or replace existing warehouse lines, it would have to cease loan production
operations which would negatively impact profitability and jeopardize the
Company's ability to continue to operate as a going concern.
In September 1998, the Company entered into a revolving line of
credit with a maximum borrowing capacity of $50 million secured by certain of
the Company's interest-only strips. The collateral is subject to mark-to-market
valuation, or may otherwise be deemed unacceptable, in the sole discretion of
the lender. To the extent such provisions result in a shortfall, the line
provides for the term out of the loan or the delivery of additional collateral
to bring the line back to compliance. This line had $20 million outstanding at
September 30, 1998 and expires on September 3, 1999. Additional borrowings under
this line are dependent upon the Company securitizing its loans. See "- Business
Strategies" and "- Risk Factors -- Dependence on Funding Sources."
Additionally, in September 1998, the Company entered into a
repurchase facility secured by multifamily residential and commercial mortgage
loans. The repurchase facility provides for a maximum borrowing amount of $50
million. The repurchase facility bears an interest rate for each transaction
mutually agreed upon by the Company and the financial institution at the time of
the transaction. The repurchase facility had no outstanding balance at September
30, 1998 and expires on September 9, 1999. See "- General."
Loan Sales. The Company's ability to sell loans originated and
purchased by it in the secondary market is necessary to generate cash proceeds
to pay down its warehouse facilities and fund new originations and purchases.
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. Current market conditions have restricted access to the
asset-backed market and adversely impacted the availability of, and pricing in,
the whole loan market. See "- Overview -- Market Conditions," "- Business
Strategies" and "- Risk Factors -- Risk of Adverse Changes in the Secondary
Market for Mortgage Loans."
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Other Capital Resources. The Company has historically funded
negative cash flow primarily from the sale of its equity and debt securities.
However, current market conditions have restricted the Company's ability to
access the public equity and debt markets. In December 1991, July 1993, June
1995, October 1996 and April 1998, the Company effected public offerings of its
common stock with net proceeds to the Company aggregating $217 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. In October 1996, the Company
completed an offering of its 9.125% Senior Notes due 2003 with net proceeds to
the Company of $145 million. Under the agreements relating to these debt
issuances, the Company is required to comply with various operating and
financial covenants including covenants which may restrict the Company's ability
to pay certain distributions, including dividends. At September 30, 1998, the
Company had available $60.0 million for the payment of such distributions under
the most restrictive of such covenants.
On April 27, 1998, the Company issued 2.78 million shares of its
common stock, or 9.9% of the Company's outstanding shares, to private entities
controlled by Ronald Perelman and Gerald Ford, at an aggregate purchase price of
approximately $38 million. The Company also issued warrants to these entities to
purchase an aggregate additional 9.9% of the Company's stock at an exercise
price of $17.2031 (125% of the purchase price of the stock), subject to
customary anti-dilution provisions. The warrants are exercisable only upon a
change in control of the Company and expire in three years.
The Company had cash and cash equivalents of approximately $5.62
million at September 30, 1998. See "- Risk Factors -- Negative Cash Flow and
Capital Needs."
YEAR 2000 COMPLIANCE AND TECHNOLOGICAL ENHANCEMENT
Readers are cautioned that forward-looking statements contained in
this Year 2000 disclosure should be read in conjunction with the Company's
disclosures under the heading, "Special Note on Forward-looking Statements,"
beginning on page 7 above. Readers should understand that the dates on which the
Company believes the Year 2000 project will be completed are based upon
management's best estimates, which were derived utilizing numerous assumptions
of future events, including the availability of certain resources, third-party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved, or that there will not be a delay in, or
increased costs associated with, the implementation of the Company's Year 2000
Compliance Project. A delay in specific factors that might cause differences
between the estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas, the ability of
locating correct all relevant computer code, timely responses to and corrections
by third parties and suppliers, the ability to implement interfaces between the
new systems and the systems not being replaced, and similar uncertainties. Due
to the general uncertainty inherent in the Year 2000 problem, resulting in part
from the uncertainty of the Year 2000 readiness of third parties and the
inter-connection of national and international
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businesses, the Company cannot ensure that its ability to timely and cost
effectively resolve problems associated with the Year 2000 issue that may effect
its operations and business, or expose
it to third party liability.
The Company's year 2000 compliance program consists of four
phases--inventory, risk assessment process, corrective action and testing. The
Company has completed the inventory phase which included the identification of
all computer hardware and software, electronic data exchanges, operating
systems, communications systems and non-information items. As a corollary to the
inventory phase, the Company has made inquiries of its significant vendors as to
their year 2000 readiness.
The Company has also completed the risk assessment process of
assigning risk factors to each system used by the Company to determine the
priority and resource allocation of its year 2000 efforts. The Company expects
to complete the corrective action and testing phases with respect to mission
critical systems by June 1999. The Company will complete any remaining testing
and compliance by the end of 1999.
Costs to Address the Company's Year 2000 Issues. The Company
anticipates that costs relating to year 2000 issues are not expected to be
material since the Company primarily relies on third party software for its
primary information technology systems and does not require significant internal
reprogramming resources to change program codes. The Company is in the process
of converting or is scheduled to convert its major computer systems, including
the loan origination system and the financial system from in-house to
vendor-supported systems. These conversions were planned to upgrade and improve
functionality rather than as a result of year 2000 issues.
Risks of the Company's Year 2000 Issues. The most significant risk
associated with the Company's year 2000 compliance would result from the loss of
the Company's vendor supported servicing system and the inability to maintain
the ongoing loan service operations, including payment processing, collections
and investor remittance processing. The Company's servicing platform uses
software supplied by a subsidiary of Fiserv, Inc. To reduce the risk of
non-compliance, the Company intends to rely on the vendor's representations
regarding year 2000 compliance, the Company's testing efforts, as well as the
testing results of other companies that use the same software. The testing and
other costs relating to the Company's year 2000 compliance program are not
expected to be material.
Another year 2000 risk relates to the Company's vendor supported
loan origination system. In the event of year 2000 issues with respect to the
software used with such system (also supplied by a subsidiary of Fiserv, Inc.),
the Company's ability to originate loans would be diminished and may result in
reduced loan production until the problem is resolved. The Company intends to
rely on the vendor's assurances and Company testing to minimize the risk of
non-compliance of this system.
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Contingency Plans. The Company has no reason to believe that its
most significant systems will not be year 2000 compliant. If testing indicates
any of the systems are not compliant, the Company will develop appropriate
contingency plans.
RISK MANAGEMENT
The Company's earnings may be directly affected by the level of and
fluctuation in interest rates and the level of prepayment in the Company's
securitizations. The Company currently hedges its fixed rate pipeline and some
LIBOR-based tranches in its fixed rate securitizations, and continues to explore
other avenues of risk mitigation, although none have been employed to date. The
current fixed rate hedge products utilized are swap agreements with third
parties that sell United States Treasury securities not yet purchased and the
purchase of Treasury put options. The hedge instrument used on the existing
LIBOR-based tranches secured by fixed rate mortgages is an interest rate
contract with a specified LIBOR rate cap. See "- Certain Accounting
Considerations" and "- Risk Factors -- Prepayment, Credit and Basis Risk." The
amount and timing of hedging transactions are determined by members of the
Company's senior management. During the quarter ending September 30, 1998,
market conditions became extremely unsettled resulting in a break down in the
historical relationship between U.S. Treasury securities and the pass-through
rates on asset-backed securitizations. Historically, the use of an interest rate
hedge against Treasuries has been a more conservative method of limiting
interest rate risk. Changes in Treasury rates were generally reflected in the
pass-through rates of the fixed rate portion of the Company's securitizations.
However, during the quarter ending September 30, 1998, current market conditions
resulted in a loss on the Company's Treasury hedge without receiving an
equivalent benefit from reductions in the pass-through rates paid on the
certificates sold on the fixed rate portion of the Company's first quarter 1998
securitization. This weak asset-backed market resulted in a significantly lower
gain on sale recorded in the period and significantly larger negative cash flow
for the first quarter ending September 30, 1998. The Company is currently
re-evaluating its current hedging policy, and currently has no effective hedge
in place. While the Company monitors the interest rate environment and employs
fixed rate hedging strategies, 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 or prepayment rates.
FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES
Securitizations - Hedging Interest Rate Risk. The most significant
variable in the determination of gain on sale in a securitization is the spread
between the weighted average coupon on the securitized loans and the
pass-through interest rate. In the interim period between loan origination or
purchase and securitization of such loans, the Company is exposed to interest
rate risk. The majority of loans are securitized within 90 days of origination
or purchase. However, a portion of the loans are held for sale or securitization
for as long as 12 months (or longer, in very limited circumstances) prior to
securitization. If interest rates rise during the period that the mortgage loans
are held, the spread between the weighted average interest rate on the loans to
be securitized and the pass-through interest rates on the securities to be sold
(the latter having
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increased as a result of market rate movements) would narrow. Upon
securitization, this would result in a reduction of the Company's related gain
on sale. The Company mitigates this exposure through swap agreements with third
parties that sell United States Treasury securities not yet purchased and the
purchase of Treasury Put Options. During the period, gain on sale included hedge
losses of $15.3 million and $251,000 in the three months ended September 30,
1998 and 1997, respectively. These hedging activities help mitigate the risk of
absolute movements in interest rates but they do not mitigate the risk of a
widening in the spreads between pass-through certificates and U.S. Treasury
securities with comparable maturities.
The Company enters into swap agreements with third parties that sell
United States Treasury Securities not yet purchased. At September 30, 1998 the
Company had outstanding notional balances of such Treasury swap agreements in
the amount of $85 million. This position expires on December 31, 1998 and had a
market value at September 30, 1998 of $80 million. Management believes that due
to current conditions in the securitization market, selling U.S. Treasury
securities not yet purchased does not substantially offset the effects of
pricing in the related securitization. Consequently, the Company recorded the
related hedge loss at September 30, 1998 for the $4.6 million shortfall in the
gain on sale for the current period. The Company had a similar position at June
30, 1998 in the notional amount of $250 million. This position expired on
September 30, 1998 and had a market value at June 30, 1998 of $248 million. Due
to market conditions in the quarter ended September 30, 1998, this position
deteriorated to a loss of $10.7 million which was recorded in gain on sale for
the current quarter. These transactions are subject to Treasury interest rate
fluctuation and require cash settlement at expiration or voluntary termination.
The Company also had LIBOR cap contracts outstanding at September
30, 1998 and 1997 in the notional amount of $7.2 million and $84.6 million,
respectively. These positions were valued at par at both quarter ends as their
contractual cap (strike price) exceeded the LIBOR market rate at September 30,
1998 and 1997. The September 30, 1998 position expires December 23, 1998 and the
September 30, 1997 position had expiration dates from March 30, 1998 to December
23, 1998. These instruments have no negative risk above the original premiums
paid in cash. However, if the LIBOR market rate exceeds the contractual cap, the
Company will receive cash in settlement.
Interest-Only Strips and OMSRs. The Company had interest-only strips
of $378 million and $360 million outstanding at September 30, 1998 and June 30,
1998, respectively. The Company also had OMSRs outstanding at September 30, 1998
and June 30, 1998 in the amount of $35.5 million and $32.1 million,
respectively. Both of these instruments are valued at market at September 30,
1998 and June 30, 1998. The Company values these assets based on the present
value of future revenue streams net of expenses and related loan loss reserves
using various assumptions. The discount rate used to calculate the present value
of the interest-only strips and OMSRs was 10.2% and 10.8% for the Company's
Securitizations of September 30, 1998 and June 30, 1998, respectively. The
weighted average life used for valuation at September 30, 1998 and June 30, 1998
was 2.6 to 3.8 years.
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These assets are subject to risk in accelerated mortgage prepayment
or losses in excess of assumptions used in valuation. Ultimate cash flows
realized from these assets would be reduced should prepayments or losses exceed
assumptions used in the valuation. Conversely, cash flows realized would be
greater should prepayments or losses be below expectations.
RISK FACTORS
Negative Cash Flow and Capital Needs. The Company has historically
operated, and expects to continue to operate, on a negative cash flow basis. The
Company's primary cash requirements include the funding of: (i) mortgage loan
originations and purchases pending their securitization and sale; (ii) fees,
expenses and hedging costs, if any, incurred in connection with the
securitization of loans; (iii) cash reserve accounts or overcollateralization
requirements in connection with the securitization and sale of the loans; (iv)
tax payments due on recognition of non-cash gain on sale, other than in a
debt-for-tax securitization structure; (v) ongoing administrative and other
operating expenses; (vi) interest and principal payments under the Company's
warehouse credit facilities and other existing indebtedness; (vii) advances in
connection with the Company's servicing portfolio; and (viii) costs associated
with expanding the Company's core production units. The more significant of
these cash requirements is a result of the Company's use of securitization as a
loan disposition strategy. In a securitization, the Company recognizes a
non-cash 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 cash flow, which in general is payable over the actual life
of the loans securitized after overcollateralization requirements are met. The
Company incurs significant expense in connection with a securitization and
generally incurs both current and deferred tax liabilities as a result of the
gain on sale. Although the Company will not execute a securitization during the
quarter ended December 31, 1998 and will rely on whole loan sales for cash, the
cash received upon such sales will not be sufficient to eliminate the Company's
negative cash flow and may not be sufficient to sustain the Company as a going
concern. See "- Overview -- Market Conditions." Further, the Company has
implemented, is in the process of implementing or has under discussion various
cash savings plans. However, there can be no assurance that such plans will be
successfully implemented or if successfully implemented will provide liquidity
sufficient to eliminate the Company's negative cash flow. Therefore, the Company
requires continued access to short- and long-term external sources of cash to
fund its operations.
In the past, the Company relied on the public equity and debt
markets to meet its capital needs. However, the uncertainties in those markets
have rendered them inaccessible to the Company at the present time. The
Company's primary sources of liquidity in the near term are expected to be
fundings under warehouse facilities and whole loan sales. The Company currently
has $1.0 billion available to it in warehouse lines. However, in response to
current market conditions, the lenders on two lines aggregating $600 million
have lowered the advance rates on those lines to the point where it is no longer
feasible for the Company to use either of them. The third lender has informed
the Company that a $100 million uncommitted facility is not available to the
Company under current market conditions. Further, provisions in the one
remaining line
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require the Company to maintain a certain level of profitability over two
consecutive quarters. The reduced profitability of the first fiscal quarter
combined with a potential loss in the second fiscal quarter may violate these
provisions. If the Company is unable to receive the necessary waivers and is
deemed to be in default under the line, the line would be terminated. If the
Company were unable to secure replacement lines, it would have to cease loan
production operations which would negatively impact profitability and jeopardize
the Company's ability to continue to operate as a going concern. If not
terminated, this line expires on April 8, 1988. Although this line is subject to
renewal, the Company believes that without a change in market conditions or a
change in the Company's liquidity position, it is unlikely that the renewal will
be forthcoming. Other potential sources of liquidity include access to
additional financing on residuals and additional warehouse lines. See "--
Dependance on Funding Sources." However, the market for these credit lines has
been severely restricted. Further, current market conditions have adversely
affected the premiums received on the whole loan market. See "- Overview --
Market Conditions."
The Company's primary and potential sources of liquidity as
described in the paragraph above (assuming access to residual financing,
availability of the capital markets and implementation of the cash savings plans
which by no means can be assured) are expected to be sufficient to fund the
Company's liquidity requirements through at least the next 12 months if the
Company's future operations are consistent with management's current growth
expectations. See "- Recent Events." If available at all, 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, limitations under debt
covenants and the prevailing conditions in the financial markets. However, due
to the weaknesses in the credit and capital markets, there can be no assurance
that any such sources will be available to the Company at any given time or that
favorable terms will be available or that restrictions currently in place will
be eased. If the Company cannot obtain additional credit lines secured by its
interest-only strips and residual assets or additional equity capital in the
next 30 days, it may have to engage in extraordinary transactions, such as
entering into a subservicing arrangement that includes an obligation to make
servicing advances or strategic asset sales, to provide the liquidity necessary
to operate, albeit on a much smaller scale. Management believes that any such
transaction would have a material adverse effect on the Company's results of
operations. However, no assurance can be given that any such transactions will
be consummated. See "- Recent Events" and "- Risk Factors -- Strategic
Alternatives." As a result of the limitations described above, the Company may
be restricted in the amount of loans that it will be able to produce and dispose
of.
Delinquencies and Losses in Securitization Trusts; Right to
Terminate Mortgage Servicing; Negative Impact on Cash Flow. A substantial
majority of the Company's servicing portfolio consists of loans securitized by
the Company and sold to REMIC or owner trusts in securitization transactions.
Generally, the form of agreement entered into in connection with these
securitizations contains specified limits on delinquencies (i.e., loans past due
90 days or more) and losses that may be incurred in each trust. Losses occur
when the liquidation proceeds from disposal of foreclosed properties, less
liquidation expenses, are less than the principal balances of the loans
previously secured by such properties and related interest and servicing
advances (see below). If, at any measuring date, the delinquencies or losses
with respect to any trust credit-enhanced by monoline
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insurance were to exceed the limits applicable to such trust, provisions of the
agreements permit the monoline insurance company to terminate the Company's
servicing rights to the affected trust.
At September 30, 1998, the dollar volume of loans delinquent more
than 90 days in the Company's 11 securitization trusts formed in November 1992
and June 1993 and during the period from March 1995 to March 1997 exceeded the
permitted limit in the related pooling and servicing agreements. The higher
delinquency rates negatively affect the Company's cash flows by increasing the
required overcollateralization levels, thereby deferring the Company's receipt
of cash and by obligating the Company, as servicer, to advance past due
interest. Higher delinquency levels leading to higher loss levels also adversely
influence the Company's assumptions underlying the gain on sale in a
securitization transaction. Additionally, the higher delinquency rates permit
the monoline insurance company to terminate the Company's servicing rights with
respect to the affected trusts. The Company has implemented various plans to
lower the delinquency rates in its future trusts, including diversifying the
loans it originates and purchases to include higher credit grade loans. The
delinquency rate for September 30, 1998 and June 30, 1998 was 15.6%.
Four of the 11 trusts referred to above plus one additional trust
(representing in the aggregate 11% of the dollar volume of the Company's
servicing portfolio) exceeded one of two loss limits at September 30, 1998. The
limit that has been exceeded provides that losses may not exceed a certain
threshold (which ranges from .50% to .91% of the original pool balances in the
relevant securitization trusts) on a rolling 12 month basis. The other limit,
which was not exceeded, provides that losses may not exceed a certain cumulative
threshold (which ranges from 1.3% to 2.0% of the original pool balances in the
relevant securitization trusts) since the inception of the trust.
Management believes that current loss levels have increased in part
due to a loss mitigation strategy of minimizing the real estate owned ("REO")
holding period, thereby reducing carrying costs, which accelerated the volume of
liquidated properties in the recent period. It is the Company's goal to reduce
the REO holding period to maximize the economics of liquidation transactions.
Current loss levels have also increased due to the seasoning of the lower credit
grade loans purchased in bulk and included in the Company's earlier trusts. The
Company has reduced significantly purchases in bulk of lower credit grade loans.
While the accelerated efforts to sell properties is expected to have a
short-term impact on loss levels, the seasoning of the lower credit grade bulk
portfolio and the current origination of higher credit grade loans may
contribute to an increase in losses over time.
Although the monoline insurance company has the right to terminate
servicing with respect to the trusts referred to above, no servicing rights have
been terminated and the Company believes that the likelihood of such an event is
remote. There can be no assurance, however, that the Company's servicing rights
with respect to the mortgage loans in such trusts, or any other trusts which
exceeds the specified delinquency or loss limits in future periods, will not be
terminated.
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The Company's cash flow is also adversely impacted by high
delinquency rates in its trusts. Generally, provisions in the agreements 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
when the delinquency rates exceed the specified limit up to approximately twice
the level otherwise required when the delinquency rates do not exceed the
specified limit. As of September 30, 1998, the Company was required to maintain
an additional $88.7 million in overcollateralization amounts 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 September 30, 1998, $61.2 million remains to be added
to the overcollateralization amounts from future spread income on the loans held
by these trusts.
Risk of Changes in Interest Rate Environment. A substantial and
sustained increase in long-term interest rates could, among other things: (i)
decrease the demand for consumer credit; (ii) adversely affect the ability of
the Company to originate or purchase loans; and (iii) reduce the average size of
loans underwritten by the Company. A significant decline in long-term 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
reducing the value of the Company's interest-only strips and also reduce the
gains on loan dispositions. A substantial and sustained increase in short-term
interest rates could, among other things, (i) increase the Company's borrowing
cost and (ii) reduce the gains recognized by the Company upon their
securitization and sale of loans.
Year 2000 Compliance and Technology Enhancements. As part of the
Company's overall systems enhancement program, the Company is utilizing both
internal and external resources to identify, correct, reprogram or replace, and
test its systems for year 2000 compliance. It is anticipated that all of the
Company's year 2000 compliance efforts will be completed on time. There can be
no assurance, however, that the systems of other companies on which the
Company's systems rely will be timely reprogrammed for year 2000 compliance.
The Company has recently installed and is testing a year 2000
compliant loan origination system that is expected to add approximately $2.0
million per year to the Company's technology costs over the next three years.
Other technology enhancements are being reviewed but, to date,
the costs for such enhancements have not been determined.
Prepayment Risk. If actual prepayments occur more quickly than was
projected at the time loans were sold, the carrying value of the interest-only
strips may have to be adjusted through a charge to earnings in the period of
adjustment or through increased amortization. Non-cash gain on sale on
securitizations has historically been the most significant component of the
Company's reported revenues. Gain on sale represents the recognition of the
present value of the excess cash flow on securitized loans, which is based on
certain estimates made by management at the time loans are sold, including
estimates regarding prepayment rates. The rate of prepayment of loans may be
affected by a variety of economic and other factors, as discussed above.
Estimates of prepayment rates are made based on management's expectations of
future prepayment rates, which are based, in part, on the historic performance
of the Company's loans and other considerations.
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See "- Certain Accounting Considerations." There can be no assurance of the
accuracy of management's estimates.
Credit Risk. Loans made to borrowers in the lower credit grades have
historically resulted in a higher risk of delinquency and loss than loans made
to borrowers who utilize conventional mortgage sources. While the Company
believes that the underwriting criteria and collection methods it employs enable
it to mitigate the higher risks inherent in loans made to these borrowers, no
assurance can be given that such criteria or methods will afford adequate
protection against such risks. In the event that loans originated and purchased
by the Company experience higher delinquencies, foreclosures or losses than
anticipated, the Company's results of operations or financial condition could be
adversely affected.
Collateral securing the Company's loans may not be sufficient to
cover the principal amount of the loans in the event of liquidation. Losses not
covered by the underlying properties, if in excess of the Company's provision
for such losses, could have a material adverse effect on the Company's results
of operations and financial condition. In addition, historical loss rates affect
the assumptions used by the Company in computing its non-cash gain on sale.
In determining the adjustment for credit risk for a particular
securitization, the Company utilizes assumptions that it believes are reasonable
based on the information on its prior securitizations and the loan-to-value
ratios and credit grades of the loans included in the current securitizations.
At September 30, 1998, the Company had reserves of $56.8 million related to
these credit risks, or 1.40% of the outstanding balance of loans securitized as
of that date. Losses averaged .80% of the average servicing portfolio for the
quarter ended September 30, 1998. Accordingly, the Company believes its
allowance for credit losses is adequate to cover anticipated losses on
previously securitized pools. However, with the Company's recent migration to
higher credit grade loans, the average loan-to-value ratio of its servicing
portfolio has increased. At September 30, 1998, the average initial combined
loan-to-value ratio of the Company's servicing portfolio was 72.8%. Therefore,
the Company's low historical loan loss rates may not be an accurate indication
of anticipated future losses.
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 indexed rate as of the first
adjustment date, credit-impaired borrowers may encounter financial difficulties
as a result of increases in the interest rate over the life of the loan.
Basis Risk. The value of the Company's interest-only strips created
as a result of the securitization of adjustable rate mortgage ("ARM") loans is
subject to so-called basis risk. Basis risk arises when the ARM (including fixed
initial rate mortgage) loans in a securitization trust bear interest based on an
index or adjustment period that is different from the mortgage-backed securities
issued by the trust. Accordingly, in the absence of effective hedging
strategies, in a period of
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increasing interest rates, the value of the interest-only strips would be
adversely affected because the interest rates on the mortgage-backed securities
issued by a securitization trust could adjust faster than the interest rates on
the Company's ARMs in the trust. Moreover, ARMs are typically subject to
periodic and lifetime interest rate caps, which limit the amount an ARM's
interest rate can change during any given period. Hence, in a period of rapidly
increasing interest rates, the value of the interest-only strips could be
adversely affected in the absence of effective hedging strategies because the
interest rates on the mortgage-backed securities issued by a securitization
trust could increase without limitation by caps, while the interest rates on the
Company's ARMs would be so limited.
Dependence on Funding Sources. 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 or sale. At
September 30, 1998, the Company had warehouse facilities with certain financial
institutions and investment banks with aggregate actual borrowing capacity of
$1.0 billion. However, in response to market conditions, two lenders with lines
aggregating $600 million have reduced the advance rates on those lines to a
level that requires the Company to advance more cash than is currently available
and another warehouse lender has informed the Company that a $100 million
uncommitted facility is not available under current market conditions. See "--
Risk of Adverse Changes in the Secondary Market for Mortgage Loans." The
Company's warehouse facilities expire between February 1999 and April 1999. See
"-- Negative Cash Flow and Capital Needs." Although the Company is in
negotiations for additional warehouse lines with higher advance rates, there can
be no assurance that such warehouse lines will be available. In response to
reduced borrowing capacity, the Company has made changes in its underwriting
guidelines and increased pricing which will have the effect of slowing
production. See "- Overview -- Market Conditions." Further, the Company has
entered into a forward commitment for $500 million under which loans will be
sold twice a month. These events should results in a more efficient use of the
$300 million in economical committed warehouse facilities the Company currently
has in place. In September 1998, the Company entered into a $50 million
revolving line of credit secured by its interest-only strips which expires on
September 3, 1999. The Company currently has $20 million outstanding on this
line. Future borrowings under this line, if available at all, are subject to the
Company engaging in securitization transactions. See "- Business Strategies."
Additionally, in September 1998, the Company entered into a $50 million
repurchase facility secured by multifamily residential and commercial mortgage
loans. However, due to market conditions, the Company has currently curtailed
funding commercial loan originations. The Company is currently negotiating with
various financial institutions and investment banks to obtain additional credit
facilities. There can be no assurance that the Company will be able to secure
such financing. Further, 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, arrange new warehouse or other credit
facilities or obtain additional forward commitments, 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 and
jeopardize the Company's ability to continue to operate as a going concern.
34
<PAGE> 35
Risk of Adverse Changes in the Secondary Market for Mortgage Loans.
The Company's ability to sell loans originated and purchased by it in the
secondary market is necessary to generate cash proceeds to pay down its
warehouse facilities and fund new originations and purchases. See "-- Dependence
on Funding Sources." 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. 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 securitize or sell
whole loans for acceptable prices within a reasonable period of time. Adverse
changes in the global markets have severely weakened the asset-backed market.
With the asset-backed market so weakened, many subprime lenders have recently
sought access to the whole loan market for liquidity. This has resulted in an
abundant supply of loans in the whole loan market thereby putting downward
pressure on the price for loans so sold and tightening underwriting guidelines
for loans to be purchased. In response to these conditions, the Company has
increased its prices and modified its underwriting guidelines. There can be no
assurance, however, that these changes will make the whole loan market more
profitable for, or more accessible to, the Company.
The Company has in the past sold a substantial portion of its loans
through securitizations, and if conditions in the asset-backed market improve,
will again securitize a significant portion of its loans. In order to gain
access to the secondary market in securitization transactions, the Company has
utilized 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. Although the Company has used the
senior/subordinated structure, which relies on the internal credit enhancements
of the pool rather than monoline insurance, the Company expects to utilize
monoline insurance companies for at least a portion of its future
securitizations. Any substantial reduction in the size or availability of the
secondary market for the Company's loans, or the unwillingness of the monoline
insurance companies to provide financial 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.
With its strategy of selling a portion of its loans on a whole loan
basis in the secondary market, the Company relies on institutional purchasers,
such as investment banks, financial institutions and other mortgage lenders, to
purchase loans directly from the Company. There can be no assurance that such
purchasers will be willing to purchase loans on terms satisfactory to the
Company or that the market for such loans will continue. To the extent the
Company cannot successfully identify whole loan purchasers or negotiate
favorable terms for loan purchases, the Company's results of operations and
financial condition could be materially adversely affected.
Dependence on Broker Network. The Company depends on independent
mortgage brokers for the origination and purchase of its broker loans, which
constitute a significant portion of the Company's loan production. These
independent mortgage brokers negotiate with multiple lenders for each
prospective borrower. The Company competes with these lenders for the
independent
35
<PAGE> 36
brokers' business on pricing, service, loan fees, costs and other factors. The
Company's competitors also seek to establish relationships with such brokers,
who are not obligated by contract or otherwise to do business with the Company.
The Company's future results of operations and financial condition may be
vulnerable to changes in the volume and cost of its broker loans resulting from,
among other things, competition from other lenders and purchasers of such loans.
Risks Involved in Commercial Mortgage Lending. The Company offers
commercial mortgage loans on a limited basis in amounts ranging from $250,000 to
$2.0 million secured by commercial properties, such as multifamily residences,
retail establishments, office buildings, light industrial/warehouse facilities
and mobile home parks. Due to current market conditions, the Company has
temporarily curtailed the funding of commercial loans. During the quarter ended
September 30, 1998, the Company sold $8.07 million of commercial loans to third
parties, servicing released. The Company bears certain risks during the time it
holds the loans pending their sale. Commercial mortgage lending is generally
viewed as exposing the lender to a greater risk of loss than residential
mortgage lending, in part, because it typically involves larger loans to single
borrowers or groups of related borrowers than residential mortgage loans.
Further, the repayment of commercial mortgages secured by income-producing
properties is typically dependent upon the tenant's ability to meet its
obligations under the lease relating to such property, which in turn depends
upon profitable operations of the related property. In the event of a default on
any commercial mortgage held by the Company, the Company bears the risk of loss
of principal to the extent of any deficiency between the value of the related
mortgage property, plus any payments from an insurer or guarantor, and the
amount owed on the commercial mortgage.
Commercial mortgages generally are non-recourse to the borrower. In
the event of foreclosure on a commercial mortgage, the value of the property and
other collateral securing the commercial mortgage may be less than the principal
amount outstanding on the commercial mortgage and the accrued but unpaid
interest. Also, under the terms of leases with respect to commercial properties,
there may be costs and delays involved in enforcing rights of a property owner
against tenants in default who may seek the protection of the bankruptcy laws
which can result in termination of lease contracts all of which may adversely
affect the timing and amount of payment received by the Company with respect to
such commercial mortgages.
Strategic Alternatives. The Company continues to retain Donaldson,
Lufkin & Jenrette Securities Corporation ("DLJ") as a financial advisor to
develop strategic alternatives for the Company. Since its engagement in June,
1997, DLJ has contacted a number of major financial institutions to explore
potential transactions with the Company. Although a number of these institutions
undertook detailed due diligence, none have made an offer to effect a
transaction. DLJ continues to evaluate opportunities for the Company, including
possible business combinations, equity infusions and asset sales. The Company is
currently in discussions with an entity concerning a substantial equity infusion
that would result in substantial dilution to the Company's stockholders. See "-
Recent Events." No assurance can be given that any such opportunities will be
consummated.
Competition. The Company faces intense competition in the business
of originating, purchasing and selling mortgage loans. Competition among
industry participants can take many forms, including convenience in obtaining a
loan, customer service, marketing and distribution
36
<PAGE> 37
channels, amount and term of the loan, loan origination fees and interest rates.
Many of the Company's competitors are substantially larger and have considerably
greater financial, technical and marketing resources than the Company. The
Company's competitors in the industry include other consumer finance companies,
mortgage banking companies, commercial banks, investment banks, credit unions,
thrift institutions, credit card issuers and insurance companies. In the future,
the Company may also face competition from government-sponsored entities, such
as FNMA and FHLMC. These government-sponsored entities may enter the subprime
mortgage market and target potential customers in the Company's highest credit
grades, who constitute a significant portion of the Company's customer base.
The historical level of gains realized by the Company and its
competitors on the sale of non conforming mortgage loans could attract
additional competitors into this market. Certain large finance companies and
conforming mortgage originators have announced their intention to originate, or
have purchased companies that originate and purchase, non-conforming mortgage
loans, and some of these large mortgage companies, thrifts and commercial banks
have begun offering non-conforming loan products to customers similar to the
borrowers targeted by the Company. In addition, establishing a broker-sourced
loan business requires a substantially smaller commitment of capital and human
resources than a direct-sourced loan business. This relatively low barrier to
entry permits new competitors to enter this market quickly and compete with the
Company's wholesale lending business.
Additional competition may lower the rates the Company can charge
borrowers and increase the cost to purchase loans, thereby potentially lowering
the gain on future loan sales or securitizations. Increased competition may also
reduce the volume of the Company's loan origination and loan sales and increase
the demand for the Company's experienced personnel and the potential that such
personnel will leave the Company for the Company's competitors.
Competitors with lower costs of capital have a competitive advantage
over the Company. During periods of declining rates, competitors may solicit the
Company's customers to refinance their loans. In addition, during periods of
economic slowdown or recession, the Company's borrowers may face financial
difficulties and be more receptive to the offers of the Company's competitors to
refinance their loans.
The Company's correspondent and broker programs depend largely on
independent mortgage bankers and brokers and other financial institutions for
the purchases of new loans. The Company's competitors also seek to establish
relationships with the same sources. The Company's future results may become
more exposed to fluctuations in the volume and cost of the Company's purchases
resulting from competition from other purchasers of such loans, market
conditions and other factors.
Concentration of Operations in California. At September 30, 1998, a
significant portion 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
37
<PAGE> 38
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. 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 the Company's ability to recover losses on properties
affected by such disasters and adversely impact the Company's results of
operations.
Timing of Loan Sales. The Company's loan disposition strategy calls
for substantially all of its production to be sold in the secondary market 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 significant
portion of the Company's loan production beyond a quarter-end would postpone the
recognition of gain on sale related to such loans until their sale and would
likely result in losses for such quarter being reported by the Company.
Economic Conditions. 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 liquidation. 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 these transactions.
See "-- Credit Risk" and "-- Risk of Adverse Changes in the Secondary Market
for Mortgage Loans."
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 on a servicing retained basis.
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 cash flow
distributions in such accounts or application of excess cash flow distributions
to reduce the principal balances of the senior interests
38
<PAGE> 39
issued by the related trust, respectively. Such amounts serve as credit
enhancement for the related 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 cash flow distributions required to be retained or
applied to reduce principal from time-to-time. Such amounts are a condition to
obtaining the requisite rating on the related interests in each trust. In
addition, documents governing the Company's securitization program and whole
loan sales 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 securitization trust, the Company is required to advance interest
payments with respect to such delinquent loans. 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, 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.
The Company currently hedges its fixed rate pipeline and some
LIBOR-based tranches in its fixed rate securitizations, and continues to explore
other avenues of risk mitigation, although none have been employed to date. The
amount and timing of hedging transactions are determined by members of the
Company's senior management. During the first quarter ending September 30, 1998,
market conditions became extremely unsettled resulting in a break down in the
historical relationship between U.S. Treasury securities and the pass-through
rates on asset-backed securitizations. Historically, the use of an interest rate
hedge against Treasuries has been a more conservative method of limiting
interest rate risk. Changes in Treasury rates were generally reflected in the
pass-through rates of the fixed rate portion of the Company's securitizations.
However, during the first quarter ending September 30, 1998, current market
conditions have resulted in a loss on the Company's Treasury hedge without
receiving an equivalent benefit from reductions in the pass- through rates paid
on the certificates sold on the fixed rate portion of the Company's first
quarter 1998 securitization. This weak asset-backed market will result in a
significantly lower gain on sale and significantly larger negative cash flow for
the first quarter ending September 30, 1998. The Company is currently
re-evaluating its current hedging policy. While the Company monitors the
interest rate environment and employs fixed rate hedging strategies, 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 or prepayment rates.
39
<PAGE> 40
Government Regulation. The Company's operations are subject to
extensive regulation, supervision and licensing by federal, state and local
governmental authorities and are subject to various laws and judicial and
administrative decisions imposing requirements and restrictions on part or all
of its operations. The Company's consumer lending activities are subject to the
Federal Truth-in-Lending Act and Regulation Z (including the Home Ownership and
Equity Protection Act of 1994), the Federal Equal Credit Opportunity Act, as
amended, and Regulation B, the Fair Credit Reporting Act of 1970, as amended,
the Federal Real Estate Settlement Procedures Act and Regulation X, the Home
Mortgage Disclosure Act, the Federal Debt Collection Practices Act and the
National Housing Act of 1934, as well as other federal and state statutes and
regulations affecting the Company's activities. The Company is also subject to
the rules and regulations of, and examinations by, state regulatory authorities
with respect to originating, processing, underwriting, selling, securitizing and
servicing loans. These rules and regulations, among other things, impose
licensing obligations on the Company, establish eligibility criteria for
mortgage loans, prohibit discrimination, govern inspections and appraisals of
properties and credit reports on loan applicants, regulate assessment,
collection, foreclosure and claims handling, investment and interest payments on
escrow balances and payment features, mandate certain disclosures and notices to
borrowers and, in some cases, fix maximum interest rates, fees and mortgage loan
amounts. Failure to comply with these requirements can lead to loss of approved
status, certain rights of rescission for mortgage loans, class action lawsuits
and administrative enforcement action.
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.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
40
<PAGE> 41
10.3(c) Amendment No. 1 to the Second Amended and Restated
Employment Agreement between Registrant and Cary H.
Thompson.
10.4(c) Amended and Restated Employment Agreement between
Registrant and Neil B. Kornswiet.
10.22 Residuals Financing Agreement, dated as of September 4,
1998 between Registrant and NationsBank, N.A.
11 Computation of Per Share Earnings
27.1 Financial Disclosure Schedule
(b) Reports on Form 8-K: A current report on Form 8-K dated
August 12, 1998 (reporting earnings, production volume
and cash dividends) was filed during the quarter ended
September 30, 1998.
41
<PAGE> 42
AAMES FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this Report on Form 10-Q to be signed on
its behalf by the undersigned, thereunto duly authorized.
AAMES FINANCIAL CORPORATION
Date: November 16, 1998 By: /s/ David A. Sklar
------------------
David A. Sklar
Executive Vice President-Finance
and Chief Financial and
Accounting Officer
42
<PAGE> 43
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
- ----------- ----------------------
<S> <C>
10.3(c) Amendment No. 1 to the Second Amended and Restated Employment Agreement between
Registrant and Cary H. Thompson.
10.4(c) Amended and Restated Employment Agreement between Registrant and Neil B. Kornswiet.
10.22 Residuals Financing Agreement, dated as of September 4, 1998 between Registrant and
NationsBank, N.A.
11 Computation of Per Share Earnings
27.1 Financial Disclosure Schedule
</TABLE>
<PAGE> 1
EXHIBIT 10.3(c)
AMENDMENT NO. 1 TO
SECOND AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
This Amendment No. 1 to Second Amended and Restated Employment
Agreement (this "Agreement") is made and entered into as of the 26th day of
August, 1998, by and between Aames Financial Corporation, a Delaware corporation
(the "Parent"), and Cary H. Thompson, an individual ("Executive"), with
reference to the following:
RECITALS
WHEREAS, Executive and the Company entered into an Employment
Agreement as of March 11, 1996 as a material inducement to Executive to accept
employment with the Company;
WHEREAS, Executive and the Company entered into an Amended and
Restated Employment Agreement as of June 21, 1996 to clarify the intent of the
parties and a Second Amended and Restated Agreement as of May 8, 1997 to reflect
Executive's new position as Chief Executive Officer of the Company and revised
compensation arrangement (the "Second Amended Agreement"); and
WHEREAS, Executive and the Company desire to amend the Second
Amended Agreement for the purpose of modifying the vesting of Options in the
event of a Change of Control.
AGREEMENT
NOW, THEREFORE, in consideration of the foregoing recitals and
the mutual representations, warranties, covenants and agreements contained in
the Second Amended Agreement, the parties hereto agree as follows:
1. Section 6(c)(ii) is amended in its entirety to read as
follows:
ii) Executive may (but shall not be
obligated to) terminate this Agreement effective 30 days after the giving of
such notice given at any time within two years following a Change in Control. In
the event that Executive elects to terminate this Agreement pursuant to this
Section 6(c)(ii), Executive shall be entitled to receive the Separation Package.
In addition, all Options then held by Executive which are not yet vested shall
vest as of the date of the Change in Control. Further, all Options that have
become exercisable as of the date of such Change in Control (including those
which do so as a result of the provisions of the preceding sentence) shall
remain so for the entire remaining term of the Options. The option provided for
in this Section 6(c)(ii) shall be applicable with respect to
1
<PAGE> 2
each Change in Control notwithstanding Executive's failure to exercise such
option with respect to any prior Change in Control.
2. Capitalized terms used herein have the meanings ascribed to
such terms in the Second Amended Agreement. Except as otherwise amended hereby,
the Second Amended Agreement remains in full force and effect.
IN WITNESS WHEREOF, the parties hereto have duly executed this
Amendment No. 1 to Second Amended and Restated Employment Agreement as of the
day and year first above written.
AAMES FINANCIAL CORPORATION,
a Delaware corporation
/s/ BARBARA S. POLSKY
----------------------------------
By: Barbara S. Polsky
Its: Executive Vice President
EXECUTIVE
/s/ CARY H. THOMPSON
----------------------------------
Cary H. Thompson
2
<PAGE> 1
EXHIBIT 10.4(c)
AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
This Employment Agreement (this "Agreement") is made and entered
into as of the 26th day of August, 1998, by and between Aames Financial
Corporation, a Delaware corporation (the "Parent"), and Neil B. Kornswiet, an
individual ("Executive"), with reference to the following:
RECITALS
A. WHEREAS, the parties entered into an Employment Agreement, dated as
of August 12, 1996 (the "Original Agreement") in connection with an Agreement
and Plan of Reorganization, dated at of August 12, 1996, by and between Aames
Financial Corporation (the "Parent"), One Stop Mortgage, Inc., a Wyoming
Corporation (the "Company"), and Aames Acquisition Corporation, a Delaware
corporation ("Merger Sub") pursuant to which Merger Sub merged with and into the
Company, resulting in the Company becoming a wholly owned subsidiary of Parent;
B. WHEREAS, effective the 1st day of June 1997 the parties entered into
Amendment No. 1 to the Original Agreement (the "Amendment") pursuant to which
Executive was engaged as the President of the Parent and his base salary was
established at $900,000 per annum;
C. WHEREAS, the parties wish to restate the Original Agreement and the
Amendment and amend the performance bonus provisions, change in control
provisions and extend the term.
AGREEMENT
NOW, THEREFORE, in consideration of the foregoing recitals and
the mutual representations, warranties, covenants and agreements contained
herein, the parties hereto agree as follows:
1. EMPLOYMENT AND DUTIES. The Parent hereby employs Executive to
serve as Chief Executive Officer and President and Chairman of the Board of the
Company, and President of the Parent, with the powers and duties customarily
accorded to such positions, including those powers and duties set forth in the
respective Bylaws of the Parent and Company for such office and such other
duties consistent therewith as may be assigned to Executive from time to time by
the Board of Directors of the Parent. Executive shall devote his entire business
time and attention to his duties hereunder and shall endeavor in good faith to
perform his duties in an efficient, faithful and business-like manner. During
the term of his employment, it is intended that Executive also serve as a
Director on the Board of Directors of the Company (the "Company Board") and a
Director on the Board of Directors of Parent (the "Parent Board"), and the
Parent will take action within its powers to include Executive among the slate
of directors proposed to be nominated by the Parent Board at any applicable
stockholders meeting.
2. TERM. The initial term of this Agreement shall begin on the
date hereof and shall expire on the fifth anniversary of the date hereof unless
terminated earlier as set forth in Section 6 hereof or by mutual agreement of
the parties hereto (the "Initial Term"). At the expiration of the
<PAGE> 2
Initial Term and each anniversary thereafter, the term of this Agreement shall
automatically be extended for an additional year (the "Extension Term") unless
either party shall have given written notice to the other party at least ninety
days prior to the end of the Initial Term or the Extension Term, as the case may
be, that it does not desire to extend the term of this Agreement. If Executive's
employment under this Agreement is extended for an Extension Term, it shall
thereafter or during any Extension Term be terminable (other than upon
expiration) only as provided in Section 6 or by mutual agreement of the parties
hereto.
3. COMPENSATION.
(a) Base Salary. During the term of this Agreement,
Executive shall be paid a base salary (the "Base Salary"), payable in accordance
with the Parent's normal payroll practices in the amount of $900,000 per year.
The amount of the Base Salary payable to Executive shall be reviewed at least
annually; provided, however, that Executive's Base Salary shall not be reduced
below $900,000 per annum during the term of this Agreement.
(b) Performance Bonus.
i) In addition to Base Salary to be paid to
Executive hereunder, the Parent shall pay to Executive a quarterly bonus (the
"Performance Bonus") for each fiscal quarter or portion thereof during the term
of Executive's employment hereunder equal to the amount set forth in Exhibit A
to the Agreement which corresponds to the aggregate principal balance ("Volume
Targets") of mortgage loans originated through the retail, retail direct and
wholesale (broker) channels (the "Channels") set forth in Exhibit A; provided,
however, if or whenever the Company acquires the business assets or stock of
another entity that engages in a residential mortgage lending business (the "New
Business") and the New Business (or any part thereof) is merged or otherwise
combined with any of the Channels, the Compensation Committee or the Board of
Directors and Executive will use their reasonable best efforts to mutually agree
to new Volume Targets to account for the New Business for fiscal quarters ending
after such merger or combination; provided, in the event and for so long as no
such mutual agreement is reached, the Volume Targets in effect immediately prior
thereto will remain the Volume Targets.
ii) Within forty-five days following the end of
the first three fiscal quarters during any fiscal year which includes any
portion of the employment term hereunder, the Company shall deliver to Executive
a cash payment in the amount of the Performance Bonus.
iii) Within 90 days following the end of the
fourth quarter of any fiscal year which includes any portion of the employment
term hereunder, the Company shall deliver to Executive a cash payment in the
amount of the Performance Bonus.
(c) Stock Bonus. Executive shall be eligible to receive stock
options under the Parent's stock option plans with annual awards to be
determined by the Compensation Committee of the Parent Board. All options
granted to Executive by the Parent in connection with the Executive's employment
are hereinafter referred to collectively as the "Options."
2
<PAGE> 3
4. OTHER EXECUTIVE BENEFITS. During the term of this Agreement,
the Parent shall provide to Executive benefits commensurate with his position,
including each of the following benefits:
(a) Medical and Dental Coverage. The Parent agrees to provide
coverage to Executive and dependent members of his family under the same medical
and dental plans as may be maintained from time to time in the discretion of the
Parent Board for the benefit of the Chief Executive Officer of Parent (the
"CEO") and the dependent members of his family.
(b) Vacation. Executive shall be entitled to five (5) weeks of
paid vacation each year of employment with the Parent for the term of this
Agreement. In each case, such entitlement shall accrue pro rata over the
contract year and shall be taken at such time or times as shall not unreasonably
interfere with the operations of the Company.
(c) Business Expenses. The Parent will pay or reimburse
Executive for any out-of-pocket expenses incurred by Executive in the course of
providing his services hereunder, which comply with Parent's travel and expense
policies adopted from time to time by the Parent Board for the CEO. Such
reimbursement shall be made by the Parent in the same manner and within the same
time period as applicable to the other executive officers of the Parent.
(d) Automobile. The Parent shall provide Executive with the use
of a luxury automobile that is selected by Executive. On the earlier of
significant damage or destruction or attaining three years of age, the Company
shall replace such automobile with a new automobile selected by Executive. The
Company shall pay all costs of insurance, repair, maintenance and operation of
such automobile.
(e) Benefit Plans. Executive shall be entitled to participate in
any pension, profit-sharing, stock option, stock purchase or other benefit plan
of the Parent and the Company now existing or hereafter adopted for the benefit
of employees generally or the senior executives of the Parent and the Company.
(f) Life Insurance. Provided the following policies may be
obtained at a reasonable cost, the Parent shall provide Executive with a
$1,000,000 standard term life insurance policy and a $1,000,000 standard term
accidental death policy.
(g) Disability. At which time the following policy may be
obtained at a reasonable cost, the Parent shall provide Executive with a
long-term disability policy which provides for an annual disability payment in
an amount equal to 125% of Executive's Base Salary.
5. CONFIDENTIAL INFORMATION
(a) Non-Disclosure. Executive hereby agrees, during the term of
this Agreement, he will not disclose to any person or otherwise use or exploit
any proprietary or confidential information, including, without limitation,
trade secrets, processes, records of research, proposals, reports, methods,
processes, techniques, computer software or programming, or budgets
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or other financial information, regarding the Company, the Parent or any of
their respective subsidiaries or any of their respective businesses, properties,
customers or affairs (collectively, "Confidential Information") obtained by him
at any time during the term, except to the extent required by Executive's
performance of his assigned duties. Notwithstanding anything herein to the
contrary, the term "Confidential Information" shall not include information
which (i) is or becomes generally available to the public other than as a result
of disclosure by Executive in violation of this Agreement, (ii) is or becomes
available to Executive on a non-confidential basis from a source other than the
Company, the Parent or any of their respective subsidiaries, provided that such
source is not known by Executive to be furnishing such information in violation
of a confidentiality agreement with or other obligation of secrecy to the
Company, the Parent or any of their respective subsidiaries, (iii) has been made
available, or is made available, on an unrestricted basis to a third party by
the Company, by an individual authorized to do so or (iv) is known by Executive
prior to its disclosure to Executive. Executive may use and disclose
Confidential Information to the extent necessary to assert any right or defend
against any claim arising under this Agreement or pertaining to Confidential
Information or its use, to the extent necessary to comply with any applicable
statute, constitution, treaty, rule, regulation, ordinance or order, whether of
the United States, any state thereof, or any other jurisdiction applicable to
Executive, or if Executive receives a request to disclose all or any part of the
information contained in the Confidential Information under the terms of a
subpoena, order, civil investigative demand or similar process issued by a court
of competent jurisdiction or by a governmental body or agency, whether of the
United States or any state thereof, or any other jurisdiction applicable to
Executive.
(b) Injunctive Relief. Executive agrees that the remedy at law
for any breach by him of the covenants and agreements set forth in this Section
5 may be inadequate and that in the event of any such breach, the Company, the
Parent or their respective subsidiaries may, in addition to the other remedies
that may be available to it at law, seek injunctive relief prohibiting him
(together with all those persons associated with him) from the breach of such
covenants and agreements.
6. TERMINATION.
(a) Termination by Parent for "Cause" or Voluntarily by
Executive. The Parent may terminate this Agreement for "Cause" effective
immediately upon written notice thereof to Executive. For purposes of this
Agreement, "Cause" shall mean and be limited to the following events: (i) an act
of fraud, embezzlement or similar conduct by Executive involving the Company,
the Parent or any of their respective subsidiaries; (ii) any action by Executive
involving the arrest of Executive for violation of any criminal statute
constituting a felony if the Board reasonably determines that the continuation
of Executive's employment after such event would have an adverse impact on the
operations or reputation of the Company, the Parent or any of their respective
subsidiaries in the financial community; or (iii) a continuing, repeated willful
failure or refusal by Executive to perform his duties; provided, however, that
this Agreement may not be terminated under this subclause (iii) unless Executive
shall have first received written notice from the Board advising Executive of
the specific acts or omissions alleged to constitute a failure or refusal to
perform and such failure or refusal to perform continues after Executive shall
have had a reasonable opportunity to correct the acts or omissions cited in such
notice.
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In the event of termination for "Cause" or voluntarily by
Executive other than as permitted in Sections 6(b)(i) and (ii) and 6(c), (x)
Executive shall be entitled to receive that portion of the Base Salary and all
benefits accrued through the date of termination and (y) all Options that have
become exercisable as of the date of termination shall remain so for a period of
90 days.
(b) Termination by Parent Other Than for "Cause."
i) Death. Provided that notice of termination
has not previously been given under any Section hereof, if Executive shall die
during the term of this Agreement, this Agreement and all of the Parent's
obligations hereunder shall terminate, except that Executive's estate or
designated beneficiaries shall be entitled to receive (A) all earned and unpaid
Base Salary through the date of termination; (B) the Base Salary and Performance
Bonus (as if the Volume Targets for a $1.5 million Performance Bonus had been
satisfied) and all benefits with respect to the then current contract year which
would have been payable or provided to Executive had the term ended two years
following the last day of the month in which Executive's death occurred; and (C)
all other benefits that may be due to Executive or Executive's estate or
beneficiaries under the general provisions of any benefit plan, stock incentive
plan or other plan in which Executive is then a participant, which benefits
shall continue to be provided for a period of two years following the date of
death. In addition, all Options that have become exercisable as of the date of
death shall remain so for a period of twelve (12) months.
ii) Disability. Provided that notice of
termination has not previously been given under any Section hereof, if Executive
becomes ill or is injured or disabled during the term such that Executive fails
to perform all or substantially all of the duties to be rendered hereunder and
such failure continues for a period in excess of 26 consecutive weeks (a
"Disability"), the Parent shall continue to employ Executive under this
Agreement for two years from the date of the Disability (which two year period
shall commence at the beginning of the 26 week period referred to herein) and
shall continue to pay Executive the Base Salary in effect on the date of the
Disability (determined at the beginning of the 26 week period referred to
herein), the Performance Bonus (as if the Volume Targets for a $1.5 million
Performance Bonus had been satisfied) and all benefits then in effect; provided,
that (A) the Parent may relieve Executive of his duties and responsibilities
hereunder to the extent permitted by law and (B) any long-term disability
payments received by Executive under any disability insurance plan made
available to Executive by the Parent if the premiums were paid by the Parent
shall be deducted from the salary and bonus payments otherwise required to be
paid to Executive hereunder. If during the term and subsequent to the Disability
commencement date (which shall be at any time following the end of the 26 week
period referred to herein) Executive shall fully recover, the Parent shall have
the right (exercisable within 60 days after receipt of notice from Executive of
such recovery), but not the obligation, to restore Executive to full-time
service at full compensation. If the Parent elects not to restore Executive to
full-time service, Executive shall be entitled to obtain other employment. If
Executive is not restored to full-time employment with the Parent, all Options
that have become exercisable as of the date of Disability (determined at the end
of the 26 week period referred to herein) shall remain so for a period of 12
months.
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iii) Without Cause. If the Parent elects to
terminate Executive for any reason whatsoever other than as provided in Section
6(a) or if the Parent causes a Defacto Termination of Executive (as defined
below) (each, a "Severance Termination"), Executive shall receive the
"Separation Package." As used herein, the "Separation Package" shall consist of
(x) Base Salary for the Severance Period (at the annual rate in effect at the
date of the Severance Termination), plus (y) an amount equal to $30,000,000
minus the aggregate amount paid to Executive as Performance Bonuses since the
date of this Agreement (the "Performance Severance Payment") and (z) an amount,
if any, necessary to reimburse Executive on a net after tax basis for any
applicable federal excise tax. In addition, all Options which are scheduled to
vest following the date of the Severance Termination shall vest as of such date.
Further, all Options which have become exercisable as of the date of the
Severance Termination (including those which do so as a result of the provisions
of the preceding sentence) shall remain so for a period of 12 months. In the
event of a Severance Termination, Executive will also be provided with
reasonable office space and secretarial support as well as the same mailing
address and telephone number which Executive had during the term for up to six
months, and the Parent shall pay the costs of out placement services with a
provider of its choice at a level appropriate to Executive's title and position
as requested by Executive. For purposes of this paragraph, the "Severance
Period" shall be the longer of (x) three years, and (y) the remaining portion of
the Initial Term of Executive's employment hereunder. For purposes of this
paragraph, a "Defacto Termination" shall include any of the following events:
(i) the Parent shall fail to pay or shall reduce the Base Salary, Performance
Bonus or other benefits provided herein, except as permitted hereunder, or shall
otherwise breach any material provision hereof which breach is not cured within
10 days after receipt of notice thereof from Executive; (ii) the Parent shall
fail to cause Executive to remain President of the Parent and Chief Executive
Officer and President and Chairman of the Board of the Company; (iii) Executive
shall not be continuously afforded the authority, powers, responsibilities and
privileges contemplated in Section 1 above (whether or not accompanied by a
change in title); (iv) the Parent shall require Executive's primary services to
be rendered in an area other than the Company's principal offices in Orange
County and the Parent's principal offices in Los Angeles County; or (v) after a
Change in Control (as defined below), the Parent increases the base salary for
senior executives of the Parent generally without similarly increasing the Base
Salary of Executive. For purposes of clause (iii), Executive shall be deemed not
to have been continuously afforded the authority, powers, responsibilities and
privileges contemplated in Section 1 above if there shall occur any reduction in
the scope, level or nature of Executive's employment hereunder, or any demotion,
any phasing out or assignment to others, of the duties contemplated herein.
(c) Change in Control.
i) Following a Change in Control, the Parent
shall promptly pay to Executive the Performance Severance Payment.
Following a Change in Control and after payment to Executive of the
Performance Severance Payment, in all other respects, this Agreement
shall continue to be binding upon the Company and the Parent, and
Executive shall be entitled to the payments provided for in this Section
6 in the event of termination resulting from death, disability, cause,
or a Separation Termination, all as provided for in Section 6(a) and
6(b), except that Executive shall no longer be entitled to receive the
Performance Bonus under Section 3(b) or under Sections 6(b)(i) or (ii)
or the Performance Severance Payment under Section 6(b)(iii).
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ii) Executive may (but shall not be obligated
to) terminate this Agreement effective 30 days after the giving of such
notice given at any time within two years following a Change in Control.
In the event that Executive elects to terminate this Agreement pursuant
to this Section 6(c)(ii), Executive shall be entitled to the Separation
Package, minus the Performance Severance Payment to the extent the
Performance Severance Payment has been paid pursuant to Section 6(c)(i).
In addition, all Options then held by Executive which are not yet vested
shall vest as of the date of such Change in Control. Further, all
Options that have become exercisable as of the date of such Change in
Control (including those which do so as a result of the provisions of
the preceding sentence) shall remain so for the entire remaining term of
the Options.
(d) Payment of Section 6 Amounts. Executive may elect to
have all amounts to be paid to Executive pursuant to this Section 6 payable (i)
over the remaining term of this Agreement or for such shorter period as
expressly provided for herein , as applicable, or (ii) in a lump sum within 30
days following termination or entitlement, as the case may be; provided,
however, in the case of death or disability, the Performance Bonus shall be
payable at such time as performance-based bonuses are paid to similarly situated
employees of the Parent. In the event Executive elects to be paid pursuant to
clause (i), Executive agrees promptly to notify the Parent in writing of
Executive's acceptance of full-time employment; within 15 days after receipt of
such notice, the Parent shall pay Executive in a lump sum any amounts which
remain otherwise due to Executive hereunder.
(e) Stock and Similar Rights. Except with regard to
the vesting and exercise dates of Options as set forth in this Section 6,
Executive's rights under any other agreement or plan under which stock options,
restricted stock or similar awards are granted shall be determined in accordance
with the terms and provisions of such plans or agreements.
(f) No Mitigation. Payment of any sum under this Section
6 shall not be subject to any claim of mitigation.
(g) Other Insurance Policies. Upon any termination of
Executive's employment, and upon reimbursement of the Company or the Parent of
all amounts paid by the Company or the Parent in connection with such policies,
Executive shall have the right to purchase or otherwise direct the disposition
or assignment of any disability insurance policy on him held by the Company or
the Parent (excluding only group disability insurance policies) upon the payment
of One Dollar ($1.00) as the total consideration for each such policy.
(h) Officer and Director Positions. Executive agrees
that if this Agreement is terminated for any reason, he shall immediately resign
from all officer and director positions he then holds with the Company, the
Parent, or any of their respective subsidiaries.
7. CHANGE IN CONTROL. For purposes of this Agreement, a "Change
in Control" shall mean the occurrence of any of the following events which occur
after the date of the Original Agreement:
(a) The acquisition by any individual, entity or group
(within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange
Act of 1934) (a "Person") of beneficial
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ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act
("Rule 13d-3")) of more than 50% of the combined voting power of the then
outstanding voting securities of the Company or of 20% or more of the combined
voting power of the then outstanding securities of the Parent entitled to vote
generally in the election of directors (the "Outstanding Voting Securities of
Parent"); provided, however, that neither of the following acquisitions shall
constitute a Change in Control; (i) any acquisition by the Company, the Parent
or their respective subsidiaries or (ii) any acquisition by any employee benefit
plan (or related trust) sponsored or maintained by the Company, the Parent or
their respective subsidiaries or any corporation controlled by the Company,
Parent or any of their respective subsidiaries; or
(b) Individuals who, as of the date hereof constitute the
Parent Board (the "Incumbent Board") cease for any reason to constitute at least
a majority of the Board; provided, however, that any individual becoming a
director subsequent to the date of the Original Agreement whose election, or
nomination for election by the stockholders of the Company, shall be approved by
a vote of a least a majority of the directors then compromising the Incumbent
Board shall be considered as though such individual were a member of the
Incumbent Board; or
(c) Approval by the stockholders of the Parent of a
reorganization, merger or consolidation, in each case, unless, following such
reorganization, merger or consolidation: (i) more than 60% of the combined
voting power of the then outstanding voting securities of the corporation
resulting from such reorganization, merger, or consolidation, which may be the
Parent or any of its subsidiaries (the "Resulting Corporation") entitled to vote
generally in the election of directors (the "Resulting Corporation Voting
Securities") shall then be owned beneficially, directly or indirectly, by all or
substantially all of the Persons who were the beneficial owners of Outstanding
Voting Securities immediately prior to such reorganization, merger or
consolidation, in substantially the same proportions as their respective
ownerships of Outstanding Voting Securities immediately prior to such
reorganization, merger, or consolidation; (ii) no Person (excluding the Company,
the Parent or any of their respective subsidiaries or any employee benefit plan
(or related trust) sponsored by any of them, the Resulting Corporation, and any
Person beneficially owning, immediately prior to such reorganization, merger or
consolidation, directly or indirectly, 20% or more of the combined voting power
of Outstanding Voting Securities) shall own beneficially, directly or indirectly
20% or more of the combined voting power of the Resulting Corporation Voting
Securities; and (iii) at least a majority of the members of the Board shall have
been members of the Incumbent Board at the time of the execution of the initial
agreement providing for such reorganization, merger or consolidation; or
(d) Approval by the stockholders of the Parent of (i) a
complete liquidation or dissolution of the Parent or (ii) the sale or other
disposition of all or substantially all of the assets of the Company or Parent,
other than to a corporation (the "Buyer") with respect to which (x) following
such sale or other disposition, more than 60% of the combined voting power of
securities of Buyer entitled to vote generally in the election of directors
("Buyer Voting Securities"), shall be owned beneficially, directly or
indirectly, by Parent, any of its subsidiaries, any employee benefit plan
sponsored by the Company, the Parent or any their respective subsidiaries or by
all or substantially all of the Persons who were the beneficial owners of the
Outstanding Voting Securities immediately prior to such sale or other
disposition, in substantially the same proportion as their
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respective ownership of Outstanding Voting Securities, immediately prior to such
sale or other disposition; (y) no Person (excluding the Company and any employee
benefit plan (or related trust) of the Company or Buyer and any Person that
shall immediately prior to such sale or other disposition own beneficially,
directly or indirectly, 20% or more of the combined voting power of Outstanding
Voting Securities), shall own beneficially, directly or indirectly, 20% or more
of the combined voting power or, Buyer Voting Securities; and (z) at least a
majority of the members of the board of directors of Buyer shall have been
members of the Incumbent Board at the time of the execution of the initial
agreement or action of the Board providing for such sale or other disposition or
assets of the Company.
8. INSURANCE. During the term, the Parent shall maintain, at no
cost to Executive, officers and directors liability insurance that would cover
Executive in an amount of no less than $45,000,000.
9. GENERAL PROVISIONS.
(a) Notices. All notices, requirements, requests,
demands, claims or other communications hereunder shall be in writing. Any
notice, requirement, request, demand, claim or other communication hereunder
shall be deemed duly given (i) if personally delivered, when so delivered, (ii)
if mailed, two (2) business days after having been set by registered or
certified mail, return-receipt requested, postage prepaid and addressed to the
intended recipient as set forth below, (iii) if given by telecopier, once such
notice or other communication is transmitted to the telecopier number specified
below, and the appropriate telephonic confirmation is received, provided that
such notice or other communication is promptly thereafter mailed in accordance
with the provisions of clause (ii) above or (iv) if sent through an overnight
delivery service under circumstances by which such service guarantees next day
delivery, the date following the date so sent:
If to the Company, to:
Aames Financial Corporation
350 S. Grand Avenue
Los Angeles, California 90071
Attention: Barbara S. Polsky, Esq.
Executive Vice President
and General Counsel
If to Executive, to:
Neil B. Kornswiet
16105 Whitecap Lane
Huntington Beach, California 92649
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Any party may change the address to which notices, requests, demands, claims and
other communications hereunder are to be delivered by giving the other party
notice in the manner herein set forth.
(b) Assignment. This Agreement and the benefits hereunder
are personal to the Parent and the Company and are not assignable or
transferable, nor may the services to be performed hereunder be assigned by the
Parent and the Company to any person, firm or corporation; provided however,
that this Agreement and the benefits hereunder may be assigned by the Parent and
the Company to any corporation into which the Parent and the Company may be
merged or consolidated, and this Agreement and the benefits hereunder will
automatically be deemed assigned to any such corporation, subject, however, to
Executive's right to terminate this Agreement to the extent provided in Section
6. In the event of any assignment of this Agreement to any corporation acquiring
all or substantially all of the assets of the Parent or the Company or to any
other corporation into which the Parent or the Company may be merged or
consolidated, the responsibilities and duties assigned to Executive by such
successor corporation shall be the responsibilities and duties of, and
compatible with the status of, a senior executive officer of such successor
corporation. The Parent or the Company may delegate any of its obligations
hereunder to any subsidiary of the Company, provided that such delegation shall
not relieve the Parent or the Company of any of its obligations hereunder.
Executive may not assign his rights hereunder or delegate his duties hereunder
to any Person.
(c) Complete Agreement. This Agreement contains the
entire agreement among the parties hereto with respect to the subject matter
hereof and supersedes and cancels any and all previous written or oral
negotiations, commitments, understandings, agreements and any other writings or
communications in respect of such subject matter.
(d) Amendments. This Agreement may be modified,
amended, superseded or terminated only by a writing duly signed by both parties.
(e) Severability. Any provision of this Agreement which is
invalid, illegal or unenforceable in any jurisdiction shall, as to that
jurisdiction, be ineffective to the extent of such invalidity, illegality or
unenforceability, without affecting in any way the remaining provisions hereof
in such jurisdiction or rendering that or any other provision of this Agreement
invalid, illegal or unenforceable in any other jurisdiction.
(f) No Waiver. Any waiver by either party of a breach
of any provisions of this Agreement shall not operate as or be construed to be a
waiver of any other breach of such provision or of any breach of any other
provision of this Agreement. The failure of either party to insist upon strict
adherence to any term of this Agreement on one or more occasions shall be
considered a waiver or to deprive such party of the right thereafter to insist
upon strict adherence to that term or any other term of this Agreement.
(g) Binding Effect. This Agreement shall be binding on,
and shall inure to the benefit of, the parties hereto and their permitted
assigns, successors and legal representatives.
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(h) Counterparts. This Agreement may be executed by the
parties hereto in separate counterparts, each of which when so executed shall be
deemed to be an original and all of which when taken together shall constitute
one and the same document.
(i) Governing Law. This Agreement has been negotiated and
entered into in the State of California and shall be construed in accordance
with the laws of the State of California.
(j) Arbitration. The parties hereby expressly agree that
any controversy or claim relating to this Agreement, including the construction,
enforcement or application of the terms hereof, shall be submitted to
arbitration in Los Angeles, California by the American Arbitration Association
in accordance with the Commercial Arbitration Rules of such association. The
arbitrator shall be a retired judge of the Los Angeles Superior Court or other
party acceptable to the parties and the rules of evidence shall apply. The costs
of the arbitrator shall be borne equally. Each party shall be responsible for
its own attorneys' fees and costs. However, the arbitrator shall have the right
to award costs and expenses (including actual attorneys' fees) to the prevailing
party as well as equitable relief. The award of the arbitrator shall be final
and binding and shall be enforceable in any court of competent jurisdiction.
Nothing in this paragraph shall preclude the parties from seeking an injunction
or other equitable relief from a court of competent jurisdiction under
appropriate circumstances.
(k) Headings. The headings included in this Agreement are
for the convenience of the parties only and shall not affect the construction or
interpretation of this Agreement.
IN WITNESS WHEREOF, the parties hereto have duly executed this
Agreement as of the day and year first above written.
AAMES FINANCIAL CORPORATION,
a Delaware corporation
/s/ BARBARA POLSKY
--------------------------------
By: Barbara Polsky
Its: General Counsel and EVP
EXECUTIVE
/s/ NEIL B. KORNSWIET
---------------------------------
Neil B. Kornswiet
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EXHIBIT 10.22
RESIDUALS FINANCING AGREEMENT
THIS RESIDUALS FINANCING AGREEMENT (the "Agreement") made and dated as
of the 4th day of September, 1998, by and among AAMES CAPITAL CORPORATION, a
California corporation (the "Company"); AAMES FINANCIAL CORPORATION, a Delaware
corporation and the sole shareholder of the Company (the "Parent"); and
NATIONSBANK, N.A., a national banking association (the "Lender").
RECITALS
A. The Company has requested the Lender to extend credit to the Company in
the form of a convertible revolving line of credit secured by certain assets of
the Company.
B. The Lender has agreed to provide such credit extension on the terms and
subject to the conditions set forth herein, including, without limitation, that
the Parent guaranty all obligations of the Company to the Lender relating
thereto.
NOW, THEREFORE, in consideration of the above Recitals and for other good
and valuable consideration, the receipt and adequacy of which are hereby
acknowledged, the parties hereto hereby agree as follows:
AGREEMENT
1. Convertible Revolving Credit Facility.
1(a) Revolving Credit Limit. On the terms and subject to the
conditions set forth herein, the Lender agrees that it shall from time to time
to but not including the earlier to occur of the Conversion Date and the
Maturity Date (as such terms and capitalized terms not otherwise defined herein
are defined in Paragraph 11 below) make loans (the "Revolving Loans" or a
"Revolving Loan") to the Company in an amount not to exceed, in the aggregate at
any one time outstanding, the lesser of:
(1) The Revolving Credit Limit; and
(2) The Collateral Value of the Residuals Borrowing Base.
1(b) Payment of Revolving Loans. Subject to the conversion option
set forth in Paragraph 1(c) below, the prepayment requirements of Paragraph 3(f)
below and the interest rate conversion and continuation provisions of Paragraph
2(c) below, the Company shall pay the principal amount of each Revolving Loan on
the Maturity Date.
1(c) Conversion Option. In lieu of making a Required Principal
Prepayment pursuant to Paragraph 3(d)(2) below, the Company may, on a one time
basis and subject to the conditions set forth in Paragraph 5(b) below, elect to
convert the revolving credit facility provided pursuant to Paragraph 1(a) above
to a term facility by giving written notice of
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such election to the Lender (the "Term Out Option"). On the Conversion Date: (1)
the Revolving Credit Limit will be reduced to zero and no additional Revolving
Loans will be advanced, and (2) the principal balance of Revolving Loans
outstanding shall be converted into a term loan (the "Term Loan"), which Term
Loan shall payable in nine consecutive equal monthly installments, with the
first such installment payable on the Conversion Date and subsequent
installments due on the first Business Day of each calendar month thereafter.
2. Interest Rate and Yield-Related Provisions.
2(a) Election of Applicable Rate. The outstanding principal
balance of Revolving Loans and, following the Conversion Date, the Term Loan and
portions thereof, shall bear interest from the date disbursed to but not
including the date of payment calculated at a per annum rate equal to, at the
option of and as selected by the Company from time to time (subject to the
provisions of Paragraphs (2(c), 2(d) and 2(e) below), the Applicable Eurodollar
Rate for the applicable Interest Period or the daily average Applicable
Effective Fed Funds Rate during the applicable interest computation period, said
interest to be payable as provided more particularly in Paragraph 2(b) below;
provided, however, that each Revolving Loan and the Term Loan shall initially be
funded as Effective Fed Funds Rate Loans and, thereafter, shall be maintained,
at the election of the Company made from time to time as permitted herein, as
Effective Fed Funds Rate Loans and/or Eurodollar Loans or any combination
thereof.
2(b) Payment of Interest and Fees. The Lender shall deliver to
the Company an interest and fee billing for each month on or before the third
Business Day of the next succeeding month, which billing shall set forth monthly
interest accrued and payable on Loans and fees payable hereunder. On or before
the seventh Business Day following receipt of such billing statement, the
Company shall pay to the Lender the full amount of the interest and fee billing
set forth on such billing statement. In addition, the Company shall pay to the
Lender interest accruing on Eurodollar Loans on the last day of the applicable
Interest Period.
2(c) Conversion and Continuation.
(1) The Company may elect from time to time to convert Eurodollar
Loans to Effective Fed Funds Rate Loans by giving the Lender same day
notice of such election. Any conversion of Eurodollar Loans may only
be made on the last day of the applicable Interest Period. The Company
may elect from time to time to convert Effective Fed Funds Rate Loans
to Eurodollar Loans by giving the Lender at least three Eurodollar
Business Days' prior irrevocable notice of such election. All such
elections shall be evidenced by the delivery by the Company to the
Lender within the required time frame of a duly executed Loan And/Or
Interest Rate Election Request. No Effective Fed Funds Rate Loan shall
be converted into a Eurodollar Loan if an Event of Default or
Potential Default has occurred and is continuing on the date of the
conversion requested by the Company. All or any part of outstanding
Revolving Loans or, following the Conversion Date, the Term Loan may
be converted as provided herein; provided, however, that partial
conversions shall be in a principal amount of $5,000,000.00 or whole
multiples of $1,000,000.00 in excess thereof, and in the case of
conversions into Eurodollar Loans, after giving effect thereto the
aggregate of the then number of Eurodollar Loans of the Lender having
a different Interest Period does not exceed ten.
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(2) Any Eurodollar Loan may be continued as such upon the
expiration of the Interest Period with respect thereto by the Company
giving the Lender at least three Eurodollar Business Days' prior
irrevocable notice of such election as set forth on a duly executed
Loan And/Or Interest Rate Election Request; provided, however, that no
Eurodollar Loan may be continued as such when any Event of Default or
Potential Default has occurred and is continuing, but shall be
automatically converted to an Effective Fed Funds Rate Loan on the
last day of the then current Interest Period applicable thereto, and
the Lender shall notify the Company promptly that such automatic
conversion will occur. If the Company shall fail to give notice as
provided above, the Company shall be deemed to have elected to convert
the affected Eurodollar Loan to an Effective Fed Funds Rate Loan on
the last day of the relevant Interest Period.
2(d) Inability to Determine Rate. In the event that the Lender
shall have determined (which determination shall be conclusive and binding upon
the Company) that by reason of circumstances affecting the London interbank
eurodollar market adequate and reasonable means do not exist for ascertaining
the Eurodollar Rate for any Interest Period, the Lender shall forthwith give
facsimile notice of such determination, confirmed in writing, to the Company. If
such notice is given: (1) any Effective Fed Funds Rate Loan that was to have
been converted to a Eurodollar Loan shall be continued as an Effective Fed Funds
Rate Loan, and (2) any outstanding Eurodollar Loan shall be converted, on the
last day of the then current Interest Period with respect thereto, to an
Effective Fed Funds Rate Loan. Until such notice has been withdrawn by the
Lender, the Company shall not have the right to convert an Effective Fed Funds
Rate Loan to a Eurodollar Loan or to continue a Eurodollar Loan.
2(e) Illegality. Notwithstanding any other provisions herein, if
any law, regulation, treaty or directive, or any change therein or in the
interpretation or application thereof, shall make it unlawful for the Lender to
make or maintain Eurodollar Loans as contemplated by this Agreement: (1) the
commitment of the Lender hereunder to make or to continue Eurodollar Loans or to
convert Effective Fed Funds Rate Loans to Eurodollar Loans shall forthwith be
canceled, and (2) all outstanding Eurodollar Loans, if any, shall be converted
automatically to Effective Fed Funds Rate Loans at the end of their respective
Interest Periods or within such earlier period as is required by law. In the
event of a conversion of any Eurodollar Loan prior to the end of its applicable
Interest Period as provided herein, the Company hereby agrees promptly to pay
the Lender, upon demand, the amounts required pursuant to Paragraph 2(h) below,
it being agreed and understood that such conversion shall constitute a
prepayment for all purposes hereof. The provisions hereof shall survive the
termination of this Agreement and payment of all other Obligations.
2(f) Requirements of Law; Increased Costs. In the event that any
applicable law, order, regulation, treaty or directive issued by any central
bank or other Governmental Authority, or in the governmental or judicial
interpretation or application thereof, or compliance by the Lender with any
request or directive (whether or not having the force of law) issued subsequent
to the date hereof by any central bank or other Governmental Authority:
(1) Does or shall subject the Lender to any tax of any kind
whatsoever with respect to this Agreement or any Loans made hereunder,
or change the basis of taxation of payments to the Lender of
principal, fee, interest or any other amount
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<PAGE> 4
payable hereunder (except for a change in the rate of tax on the
overall net income of the Lender);
(2) Does or shall impose, modify or hold applicable any reserve,
capital requirement, special deposit, compulsory loan or similar
requirements against assets held by, or deposits or other liabilities
in or for the account of, advances or loans by, or other credit
extended by, or any other acquisition of funds by, any office of the
Lender which are not otherwise included in the determination of the
Effective Fed Funds Rate or the Eurodollar Rate; or
(3) Does or shall impose on the Lender any other condition;
and the result of any of the foregoing is to increase the cost to the Lender of
making, renewing or maintaining any Loan or to reduce any amount receivable in
respect thereof or to reduce the rate of return on the capital of the Lender or
any Person controlling the Lender, then, in any such case, the Company shall
promptly pay to the Lender, upon its written demand, any additional amounts
necessary to compensate the Lender for such additional cost or reduced amounts
receivable or rate of return as reasonably determined by the Lender with respect
to this Agreement or Loans made hereunder. If the Lender becomes entitled to
claim any additional amounts pursuant to this Paragraph 2(f), it shall promptly
notify the Company of the event by reason of which it has become so entitled. A
certificate as to any additional amounts payable pursuant to the foregoing
sentence containing the calculation thereof in reasonable detail submitted by
the Lender to the Company shall be conclusive in the absence of manifest error.
The provisions hereof shall survive the termination of this Agreement and
payment of all other Obligations.
2(g) Funding. The Lender shall be entitled to fund all or any
portion of Loans held by it in any manner it may determine in its sole
discretion, including, without limitation, in the Grand Cayman inter-bank
market, the London inter-bank market and within the United States, but all
calculations and transactions hereunder in respect of Eurodollar Loans shall be
conducted as though the Lender actually funds all Eurodollar Loans through the
purchase in London of offshore dollar deposits in the amount of the relevant
Eurodollar Loan in maturities corresponding to the applicable Interest Period.
2(h) Prepayment Premium. In addition to all other payment
obligations hereunder, in the event: (1) any Eurodollar Loan is prepaid prior to
the last day of the applicable Interest Period, whether following a voluntary
prepayment, mandatory prepayment, application of proceeds from the sale of
Collateral or otherwise, or (2) the Company shall fail to continue or to make a
conversion to a Eurodollar Loan after the Company has given notice thereof as
provided in Paragraph 2(c) above, then the Company shall immediately pay to the
Lender an additional premium sum compensating the Lender for losses, costs and
expenses incurred by the Lender in connection with such prepayment. The Company
acknowledges that such losses, costs and expenses are difficult to quantify and
that, in the case of the prepayment of or failure to continue or convert to a
Eurodollar Loan, the following formula represents a fair and reasonable estimate
of such losses, costs and expenses:
4
<PAGE> 5
<TABLE>
<S> <C> <C>
Amount [Applicable Eurodollar Rate ] Days Remaining
Being [Eurodollar Rate for such Incre- ] in Interest
Prepaid or [for Increment ment for Days ] x Period
Being x [Being Prepaid - Remaining in ] -------------
Not Converted [or Not Interest ] 360
or Continued [Converted Period ]
[or Continued (as quoted on the first
Eurodollar Business
Day following Lenders'
receipt of notice thereof)
</TABLE>
For purposes of calculating the current Eurodollar Rate for the days remaining
in the Interest Period for both the increment being prepaid or not converted or
continued, said current Eurodollar Rate shall be an interest rate interpolated
between Eurodollar Rates quoted for standard calendar periods for subsequent
months' maturities in accordance with normal conventions.
2(i) Facility Fee. The Company shall pay to the Lender from the
Initial Funding Date to and including the earlier to occur of the Conversion
Date and the Maturity Date a non-usage fee, monthly, in arrears, and on the
Conversion Date or Maturity Date, as applicable, for such month (or portion
thereof), a non-usage fee in the amount set forth in a fee billing delivered by
the Lender to the Company, which non-usage fee shall equal: (1) the average
daily Revolving Credit Limit in effect during such month (or portion thereof),
minus the daily average outstanding amount of Revolving Loans during such month
(or portion thereof), multiplied by (2) the product of: (i) one fifth of one
percent (0.20%), and (ii) a fraction, the numerator of which is the number of
days in the applicable calculation period and the denominator of which is 360.
2(j) Post-Maturity Interest. Any Obligations not paid when due
(whether at stated maturity, upon acceleration or otherwise) shall bear interest
from the date due until paid in full at a per annum rate equal to three percent
(3%) above the Effective Fed Funds Rate.
2(k) Computations. All computations of interest and fees payable
hereunder shall be based upon a year of 360 days for the actual number of days
elapsed.
3. Miscellaneous Lending Provisions.
3(a) Use of Proceeds. The proceeds of Revolving Loans shall be
utilized by the Company for the purpose of acquiring and/or carrying Eligible
Residual Securities and for other working capital purposes. The proceeds of the
Term Loan shall be utilized by the Company solely for the purpose of repaying
the principal balance of Revolving Loans outstanding on the Conversion Date.
3(b) Request For Revolving Loans; Determination of Availability;
Making of Revolving Loans.
(1) On any Business Day that the Company desires to borrow a
Revolving Loan, it shall deliver a Loan And/Or Interest Rate Election
Request to the
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<PAGE> 6
Lender no later than 9:30 a.m. (Los Angeles time) on such date. Only
one Loan And/Or Interest Rate Election Notice shall be submitted to
the Lender on any date.
(2) Upon receipt of a Loan And/Or Interest Rate Election Request,
the Lender shall make a Determination of Availability with respect to
any requested Revolving Loans. In the event the Lender shall have
determined that the Collateral Value of the Residuals Borrowing Base
is sufficient to support the requested borrowing, the Lender shall
make the amount of the requested Revolving Loan available by wiring
such amount in immediately available same day funds to the Funding
Account no later than 11:30 a.m. (Los Angeles time) on the date of
such request.
(3) Each request for a Revolving Loan shall be in the minimum
amount of $1,000,000.00.
(6) The Company may elect to convert or continue Effective Fed
Funds Rate Loans and/or Eurodollar Loans outstanding on any date
consistent with the timing requirements set forth in Paragraph 2(c)
above.
3(c) Evidence of Indebtedness. The obligation of the Company
to repay the Loans shall be evidenced by notations on the books and records of
the Lender. Such books and records shall be conclusive absent manifest error.
Any failure to record the advance of any Loan, the interest rate applicable
thereto or any other information regarding the Obligations, or any error in
doing so, shall not limit or otherwise affect the obligation of the Company with
respect to any of the Obligations. Upon the request of the Lender, the Company
shall promptly execute a promissory note or promissory notes in favor of the
Lender evidencing the Obligations.
3(d) Borrowing Base Conformity.
(1) In the event the Lender shall determine on any date that the
Collateral Value of the Residuals Borrowing Base is less than the sum
of the aggregate principal amount of Revolving Loans outstanding on
such date, the Lender may, in its sole discretion, elect to deliver to
the Company (which delivery may be by facsimile transmission) a
Collateral Valuation Report so demonstrating. Upon receipt of such a
Collateral Valuation Report, the Company shall, no later than thirty
(30) days thereafter and subject to the right of the Company to
exercise the Term-Out Option as provided in Paragraph 1(c) above, pay
to the Company an amount (a "Required Principal Prepayment") equal to
the amount by which the aggregate principal amount of Revolving Loans
outstanding on the date of payment by the Company exceeds the
Collateral Value of the Residuals Borrowing Base on the date of
payment by the Company.
(2) If, but only if, at such time as the Company shall be
required to prepay Revolving Loans under subparagraph (1) of this
Paragraph 3(d) there shall not have occurred and be continuing an
Event of Default or Potential Default, in lieu of making a Required
Principal Prepayment thereunder or exercising the Term-Out Option, the
Company may deliver to the Lender additional Eligible Residual
Securities with a Established Collateral Value such that the aggregate
principal balance of Revolving Loans outstanding does not exceed the
Collateral Value of the Residuals Borrowing Base, it
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<PAGE> 7
being expressly acknowledged and agreed by the Company that such
additional Eligible Residual Securities must be delivered to the
Lender no later than ten Business Days prior to the date on which the
Required Principal Prepayment is due to permit a timely determination
as to eligibility to be made by the Lender.
(3) The Company may from time to time request the Lender to
release from the Lien in favor of the Lender under the Security
Agreement certain items of collateral, including Residual
Mortgage-Backed Securities, and the Lender shall promptly notify the
Company whether, in its sole and absolute discretion, the Lender will
agree to do so.
3(e) Nature and Place of Payments. All payments made on account
of the Obligations shall be made without setoff or counterclaim in lawful money
of the United States of America in immediately available same day funds, free
and clear of and without deduction for any taxes, fees or other charges of any
nature whatsoever imposed by any taxing authority and must be received by the
Lender at its office at 901 Main Street, Dallas, Texas 75283 by 11:30 a.m. (Los
Angeles time) on the day of payment, it being expressly agreed and understood
that if a payment is received after 11:30 a.m. (Los Angeles time) by the Lender,
such payment will be considered to have been made on the next succeeding
Business Day and interest thereon shall be payable at the then applicable rate
during such extension. If any payment required to be made by the Company
hereunder becomes due and payable on a day other than a Business Day, the due
date thereof shall be extended to the next succeeding Business Day and interest
thereon shall be payable at the then applicable rate during such extension.
3(f) Prepayments.
(1) The Company may prepay Effective Fed Funds Rate Loans in
whole or in part at any time and the Company may prepay Eurodollar
Loans in whole or in part upon three Business Days' notice to the
Lender.
(2) Revolving Loans are subject to mandatory prepayment pursuant
to Paragraph 3(d) above and, in addition, by application of proceeds
of the sale or other disposition of Collateral as provided in the
Security Agreement.
(3) The Term Loan is subject to mandatory prepayment in full no
later than the third day following the date upon which the Lender
delivers to the Company a Collateral Valuation Report demonstrating
that the outstanding principal balance of the Term Loan exceeds eighty
five percent (85%) of the Established Collateral Value of all Eligible
Residual Securities included in the Residuals Borrowing Base.
(4) Prepayments of principal of the Term Loan shall be applied to
installments due on the Term Loan in inverse order of maturity.
(5) The Company shall pay in connection with any prepayment
hereunder all interest accrued but unpaid on Loans to which such
prepayment is applied (including any prepayment premium that may be
due under Paragraph 2(h) above) concurrently with payment to the
Lender of any principal amounts.
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<PAGE> 8
4. Security; Guaranty; Additional Documents.
4(a) Security Agreement. As collateral for the Obligations, on or
before the Initial Funding Date the Company shall execute and deliver to the
Lender: (1) a security agreement in the form of that attached hereto as Exhibit
A (as amended, extended and replaced from time to time, the "Security
Agreement") pursuant to which the Company shall grant to the Lender a first
priority perfected security interest in the Collateral, (2) such UCC-1 financing
statements as the Lender may request, and (3) such releases, consents,
subordination and/or intercreditor agreements as the Lender may require from any
other Person holding an interest, by way of security interest or otherwise, in
any of the Collateral.
4(b) Guaranty. As additional credit support for the Obligations,
on or before the Initial Funding Date the Parent shall execute and deliver to
the Lender a guaranty in the form of that attached hereto as Exhibit B (as
amended, extended and replaced from time to time, the "Guaranty")
4(c) Further Documents. Each of the Company and the Parent agrees
to execute and deliver and to cause to be executed and delivered to the Lender
from time to time such confirmatory or supplementary security agreements,
financing statements and other documents, instruments and agreements as the
Lender may reasonably request, which are in the Lender's judgment necessary or
desirable to obtain and maintain for the Lender the benefit of the Loan
Documents and the Collateral.
5. Conditions to Making of Loans.
5(a) First Revolving Loan. As conditions precedent to the
Lender's obligation to fund the first Revolving Loan hereunder:
(1) The Company and the Parent, as applicable, shall have
delivered or shall have had delivered to the Lender, in form and
substance satisfactory to the Lender and its counsel, each of the
following:
(i) A duly executed copy of this Agreement;
(ii) A duly executed copy of the Security Agreement;
(iii) A duly executed copy of the Guaranty;
(iv) Duly executed copies of all financing statements and
other documents, instruments and agreements, properly executed,
deemed necessary or appropriate by the Lender, in its reasonable
discretion, to create and/or continue in favor of the Lender a
first priority perfected security interest in and lien upon the
Collateral;
(v) Acknowledgment copies of all UCC-1 financing statements
filed with respect to the Collateral, accompanied by a search
report showing such financing statements as duly filed and
evidencing that the security interest of the Lender in the
Collateral is prior to all security interests of record;
8
<PAGE> 9
provided, however, that if the Lender, in its sole discretion,
elects to waive such condition precedent to the initial funding
hereunder, the Company shall cause such acknowledgment copies and
search reports to be delivered no later than the thirtieth day
following the initial funding date and failure of the Lender to
receive the same shall, at Lender's option, constitute an Event
of Default;
(vi) Certified copies of resolutions of the Board of
Directors of each of the Company and the Parent approving the
execution and delivery of the Loan Documents, the performance of
the Obligations and the consummation of the transactions
contemplated thereby;
(vii) A certificate of the Secretary or an Assistant
Secretary of each of the Company and the Parent certifying the
names and true signatures of the officers of the Company and the
Parent, as applicable, authorized to sign the Loan Documents;
(viii) An opinion of counsel for the Company and the Parent,
which counsel shall be satisfactory to the Lender, in
substantially the form of Exhibit C attached hereto and covering
such other matters as the Lender may reasonably request;
(ix) A copy of the Articles of Incorporation of the Company
and the Certificate of Incorporation of the Parent, certified by
the Secretaries of State of the State of California and the State
of Delaware, respectively, as of a recent date;
(x) A copy of the Bylaws of each of the Company and the
Parent, certified by the Secretary or an Assistant Secretary of
the Company and the Parent, as applicable, as of the date of this
Agreement as being accurate and complete;
(xi) Certificates of the Secretary of State of the State of
California and the State of Delaware certifying that each of the
Company and the Parent, respectively, are in good standing as of
a recent date;
(xii) A certificate of an executive officer of each of the
Company and the Parent in the form of that attached hereto as
Exhibit D dated as of the date of this Agreement;
(xiii) A certificate of a Responsible Financial Officer of
each of the Parent and the Company demonstrating in detail
satisfactory to the Lender the Parent's or the Company's
compliance, as applicable, with the financial covenants set forth
in Paragraphs 8(i), 8(j), 8(k) and 8(l) below at and as of July
31, 1998; and
(xiv) Evidence satisfactory to the Lender that the
execution, delivery and performance by the Company and the Parent
of the Loan Documents will not violate any term or provision of
the Warehousing Agreement,
9
<PAGE> 10
which evidence may include an amendment to the Warehousing
Agreement so providing.
(2) All acts and conditions precedent (including, without
limitation, the obtaining of any necessary regulatory approvals and
the making of any required filings, recordings or registrations)
required to be done and performed and to have happened prior to the
execution, delivery and performance of the Loan Documents and to
constitute the same legal, valid and binding obligations, enforceable
in accordance with their respective terms, shall have been done and
performed and shall have happened in due and strict compliance with
all applicable laws.
(3) All documentation, including, without limitation,
documentation for corporate and legal proceedings in connection with
the transactions contemplated by the Loan Documents, shall be
satisfactory in form and substance to the Lender and its counsel.
(4) All fees and expenses of Morrison & Foerster LLP payable by
the Company pursuant to Paragraph 7(g) below for which invoices have
been delivered to the Company prior to or on such date shall have been
paid.
5(b) Ongoing Loans. As conditions precedent to the Lender's
obligation or agreement to make any Revolving Loan hereunder, including the
first Revolving Loan, and to fund the Term Loan, and including the conversion of
any Loan from or into a Eurodollar Loan or the continuation of any Eurodollar
Loan after the end of the applicable Interest Period, at and as of the date of
the funding, conversion or continuation:
(1) There shall have been delivered to the Lender a Loan And/Or
Interest Rate Election Request therefor;
(2) The representations and warranties of the Company and the
Parent contained in the Loan Documents shall be accurate and complete
in all respects as if made on and as of the date of such funding,
conversion or continuance;
(3) There shall not have occurred an Event of Default or
Potential Default;
(4) In the case of the funding of each Revolving Loan, the Lender
shall have determined that upon the funding thereof the Company will
be in compliance with the limitation of Paragraph 1(a) above; and
(4) In the case of the funding of the Term Loan, the Lender shall
have determined that the original principal balance of the Term Loan
will not exceed eighty five percent (85%) of the Established
Collateral Value of all Eligible Residual Securities included in the
Residuals Borrowing Base.
By delivering a Loan And/Or Interest Rate Election Request to the Lender
hereunder, the Company shall be deemed to have represented and warranted the
accuracy and completeness of the statements set forth in subparagraphs (b)(2),
(b)(3) and, as applicable, (b)(3) and (b)(4) above.
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<PAGE> 11
6. Representations and Warranties of the Company and the Parent.
As an inducement to the Lender to enter into this Agreement and to
make Loans as provided herein, each of the Company and the Parent severally
represents and warrants to the Lender that:
6(a) Financial Condition. The financial statements dated the
Statement Date and the Interim Date, copies of which have heretofore been
furnished to the Lender, are complete and correct and present fairly in
accordance with GAAP the financial condition of the Parent and its consolidated
Subsidiaries at such dates and the consolidated and consolidating results of
their operations and changes in financial position for the fiscal periods then
ended.
6(b) No Change. Since the Statement Date there has been no
material adverse change in the business, operations, assets or financial or
other condition of the Company, the Parent or the Parent and its consolidated
Subsidiaries taken as a whole.
6(c) Corporate Existence; Compliance with Law. Each of the
Company and Parent: (1) is duly organized, validly existing and in good standing
as a corporation under the laws of the States of California and Delaware,
respectively, and is qualified to do business in each jurisdiction where its
ownership of property or conduct of business requires such qualification and
where failure to qualify would have a material adverse effect on the Company,
the Parent or their respective property and/or business or on the ability of the
Company to pay or perform the Obligations or the Parent to pay or perform the
Guaranty, (2) has the corporate power and authority and the legal right to own
and operate its property and to conduct business in the manner in which it does
and proposes so to do, and (3) is in compliance with all Requirements of Law and
Contractual Obligations, the failure to comply with which could have a material
adverse effect on the business, operations, assets or financial or other
condition of the Company, the Parent or the Parent and its consolidated
Subsidiaries taken as a whole or on the Collateral.
6(d) Corporate Power; Authorization; Enforceable Obligations.
Each of the Company and the Parent has the corporate power and authority and the
legal right to execute, deliver and perform the Loan Documents to which it is a
party and to obtain extensions of credit hereunder, and has taken all necessary
corporate action to authorize the execution, delivery and performance of the
Loan Documents, and the borrowing and other extensions of credit hereunder. The
Loan Documents have been duly executed and delivered on behalf of the Company
and the Parent, as applicable, and constitute legal, valid and binding
obligations of the Company and the Parent, as applicable, enforceable against
such Person in accordance with their respective terms, subject to the effect of
applicable bankruptcy and other similar laws affecting the rights of creditors
generally and the effect of equitable principles whether applied in an action at
law or a suit in equity.
6(e) No Legal Bar. The execution, delivery and performance of the
Loan Documents, the borrowing and other extensions of credit hereunder and the
use of the proceeds thereof, will not violate any Requirement of Law or any
Contractual Obligation of the Company or the Parent or create or result in the
creation of any Lien (except the Lien created by the Security Agreement) on any
assets of the Company or the Parent.
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<PAGE> 12
6(f) No Material Litigation. Except as disclosed on Exhibit E
hereto, no litigation, investigation or proceeding of or before any arbitrator,
court or Governmental Authority is pending (or, to the knowledge of the Company
or the Parent, threatened) by or against the Parent or any of its Subsidiaries
or against any of such parties' properties or revenues which is likely to be
adversely determined and which, if adversely determined, is likely to have a
material adverse effect on the business, operations, property or financial or
other condition of the Parent or any of its Subsidiaries or on the Collateral or
is likely to have a material adverse effect on the validity or enforceability of
any of the Loan Documents.
6(g) Taxes. The Parent and each of its Subsidiaries have filed or
caused to be filed all tax returns that are required to be filed and have paid
all taxes shown to be due and payable on said returns or on any assessments made
against them or any of their property other than taxes which are being contested
in good faith by appropriate proceedings and as to which the Parent or
applicable Subsidiary has established adequate reserves in conformity with GAAP.
6(h) Investment Company Act. Neither the Company nor the Parent
is an "investment company" or a company "controlled" by an "investment company"
within the meaning of the Investment Company Act of 1940, as amended.
6(i) Subsidiaries. Attached hereto as Exhibit F is an accurate
and complete list of all presently existing Subsidiaries of the Parent, their
respective jurisdictions of incorporation and the percentage of their capital
stock owned by the Parent or other Subsidiaries. All of the issued and
outstanding shares of capital stock of such Subsidiaries have been duly
authorized and issued and are fully paid and non-assessable.
6(j) Federal Reserve Board Regulations. Neither the Parent nor
any of its Subsidiaries is engaged or will engage, principally or as one of its
important activities, in the business of extending credit for the purpose of
"purchasing" or "carrying" any "margin stock" within the respective meanings of
such terms under Regulation U. No part of the proceeds of any Loan made
hereunder nor the Letter of Credit will be used for "purchasing" or "carrying"
"margin stock" as so defined or for any purpose which violates, or which would
be inconsistent with, the provisions of the Regulations of the Board of
Governors of the Federal Reserve System.
6(k) ERISA. The Parent and each of its Subsidiaries are in
compliance in all respects with the requirements of ERISA and no Reportable
Event has occurred under any Plan maintained by the Parent or any of its
Subsidiaries which is likely to result in the termination of such Plan for
purposes of Title IV of ERISA.
6(l) Assets. The Parent and each of its Subsidiaries have good
and marketable title to all property and assets reflected in the financial
statements referred to in Paragraph 6(a) above, except property and assets sold
or otherwise disposed of in the ordinary course of business subsequent to the
respective dates thereof. Except as reflected in the financial statements
referred to in Paragraph 6(a) above or as permitted under Paragraph 8(a) below,
neither the Parent nor any of its Subsidiaries has outstanding Liens on any of
its properties or assets nor are there any security agreements to which the
Parent or any of its Subsidiaries is a party, or title retention agreements,
whether in the form of leases or otherwise, of any personal property.
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<PAGE> 13
6(m) Securities Acts. Neither the Parent nor any of its
Subsidiaries has issued any unregistered securities in violation of the
registration requirements of Section 5 of the Securities Act of 1933, as amended
(the "Act"), or any other law, and is not violating any rule, regulation or
requirement under the Act or the Securities Exchange Act of 1934, as amended.
The Company is not required to qualify an indenture under the Trust Indenture
Act of 1939, as amended, in connection with its execution and delivery of the
Notes.
6(n) Consents, etc. No consent, approval or authorization of, or
registration, declaration or filing with, any Person is required on the part of
the Company or the Parent in connection with the execution and delivery of the
Loan Documents or the borrowing or any other extension of credit hereunder
(other than filings to perfect the Liens granted by the Company pursuant to the
Security Agreement) or the performance of or compliance with the terms,
provisions and conditions hereof or thereof.
7. Affirmative Covenants. Each of the Company and the Parent hereby
covenants and agrees with the Lender that, as long as any Obligations remain
unpaid (or longer as expressly provided in Paragraphs 7(g) and 7(j) below) or
the Lender has any obligation to make Loans hereunder, the Company and the
Parent shall:
7(a) Financial Statements. Furnish or cause to be furnished to
the Lender directly:
(1) Within: (i) ninety (90) days after the last day of each
fiscal year of the Parent, consolidated statements of income and
statements of cash flow of the Parent for such year and a consolidated
balance sheet of the Parent as of the end of such year presented
fairly in accordance with GAAP and accompanied by an unqualified
report of a firm of independent certified public accountants
reasonably acceptable to the Lender, and (ii) ninety (90) days after
the last day of each fiscal year end of the Company, statements of
income and statements of cash flow of the Company for such year and a
balance sheet of the Company as of the end of such year presented
fairly in accordance with GAAP and accompanied by an unqualified
report of a firm of independent certified public accountants
reasonably acceptable to the Lender;
(2) Within forty-five (45) days after the last day of each
calendar quarter, statements of income of the Company for such quarter
and a balance sheet of the Company as of the end of such quarter, and
statements of income and statements of cash flow of the Parent for
such quarter and a balance sheet of the Parent as of the end of such
quarter;
(3) Within thirty (30) days after the last day of each calendar
month, consolidated statements of income for such month and a
consolidated balance sheet as of the end of such month of the Parent
and its Subsidiaries;
(4) Concurrently with each delivery of the financial statements
referred to in subparagraphs (2) and (3) above, a certificate of a
Responsible Financial Officer of the Parent or the Company, as
applicable, in the form of that attached hereto as Exhibit G stating
that such financial statements are presented fairly in accordance with
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<PAGE> 14
GAAP and demonstrating in detail satisfactory to the Lender the
Parent's or Company's, as applicable, compliance with the financial
covenants set forth in Paragraphs 8(i), 8(j), 8(k) and 8(l) below as
of and at the date of such financial statements;
(5) As soon as is available any written report pertaining to
material items in respect of the internal control matters of the
Parent submitted to the Parent by its independent accountants in
connection with each annual or interim special audit of the financial
condition of the Parent made by such independent public accountants;
and
(6) Copies of all proxy statements, financial statements, and
reports which the Parent sends to its stockholders, and copies of all
regular, periodic and special reports, and all registration statements
under the Act which the Parent files with the Securities and Exchange
Commission or any Governmental Authority which may be substituted
therefor, or with any national securities exchange; provided, however,
that there shall not be required to be delivered hereunder such copies
for the Lender of prospectuses relating to future series of offerings
under registration statements filed under Rule 415 of the Act or other
items which the Lender has indicated in writing to the Parent from
time to time need not be delivered to the Lender.
7(b) Certificates; Reports; Other Information. Furnish or cause
to be furnished to the Lender for distribution to the Lender:
(1) Within forty-five (45) days after the last day of each
calendar quarter, management reports providing detailed information
regarding interest only strip and reserve account balances and related
cash receipt information, information relating to prepayment and
credit losses, REO inventory status and loss projections, and
assumptions regarding quarterly securitizations and gains on sales;
(2) At such times as are described on Schedule I attached hereto,
such reports and other information relating to the Collateral,
including, without limitation, Residual Mortgage-Backed Securities as
are described therein; and
(3) Promptly, such additional financial and other information,
including, without limitation, financial statements of the Company,
the Parent, any Subsidiary of the Company or the Parent or any
Approved Investor, and information regarding the Collateral as the
Lender may from time to time reasonably request.
7(c) Payment of Indebtedness. Pay, discharge or otherwise satisfy
at or before maturity or before it becomes delinquent, defaulted or accelerated,
as the case may be, all its Indebtedness (including taxes), except (1)
Indebtedness (other than the Obligations) in an aggregate amount not to exceed
$5,000,000.00, or (2) Indebtedness being contested in good faith and for which
provision is made to the satisfaction of the Lender for the payment thereof in
the event the Company or the Parent, as applicable, is found to be obligated to
pay such Indebtedness and which Indebtedness is thereupon promptly paid by the
Company or the Parent, as applicable.
7(d) Maintenance of Existence and Properties. Maintain its
corporate existence and obtain and maintain all rights, privileges, licenses,
approvals, franchises, properties
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<PAGE> 15
and assets necessary or desirable in the normal conduct of its business and
comply with all Contractual Obligations and Requirements of Law.
7(e) Inspection of Property; Books and Records; Audits.
(1) Keep proper books of record and account in which full, true
and correct entries in conformity with GAAP and all Requirements of
Law shall be made of all dealings and transactions in relation to its
business and activities; and
(2) Permit representatives of the Lender to: (i) visit and
inspect any of its properties and examine and make abstracts from any
of its books and records at any reasonable time and as often as may
reasonably be desired by the Lender, (ii) discuss the business,
operations, properties and financial and other condition of the Parent
and its Subsidiaries with officers and employees of such parties, and
with their independent certified public accountants, and (iii) conduct
periodic operational audits of the Company's business and/or
operations.
7(f) Notices. Promptly give written notice to the Lender directly
of:
(1) The occurrence of any Potential Default or Event of Default;
(2) Any litigation or proceeding affecting the Parent or any of
its Subsidiaries or the Collateral which could have a material adverse
effect on the Collateral or the business, operations, property, or
financial or other condition of the Parent or any of its Subsidiaries,
or could have a material adverse effect on the validity or
enforceability of any of the Loan Documents;
(3) A material adverse change in the business, operations,
property or financial or other condition of the Parent or any of its
Subsidiaries;
(4) Any change in the chief executive officer of the Company;
(5) The incurrence by the Company or the Parent of any obligation
in connection with any derivatives transaction outside of the normal
course of business of the Company or the Parent;
(6) Any event or anticipated event, including, without
limitation, the unavailability of pool insurance or other forms of
credit enhancement, which the Company or the Parent anticipates is
likely to adversely affect the timely planned issuance of any
Mortgage-Backed Security which would have been supported by Mortgage
Loans owned by the Company; and
(7) Receipt by the Company of written notice from any Person that
any pooling and servicing contract under which the Company acts as
servicer has been or may in the future be terminated as a result of
the occurrence of any event of default under such pooling and
servicing contract or otherwise "for cause" pursuant to the terms of
such pooling and servicing contract.
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<PAGE> 16
7(g) Expenses. Pay all reasonable out-of-pocket costs and
expenses (including fees and disbursements of counsel) of the Lender incident to
the preparation, negotiation and administration of the Loan Documents and the
protection of the rights of the Lender under the Loan Documents and incident to
the enforcement of payment of the Obligations, whether by judicial proceedings
or otherwise, including, without limitation, in connection with bankruptcy,
insolvency, liquidation, reorganization, moratorium or other similar proceedings
involving the Company or a "workout" of the Obligations. The obligations of the
Company and the Parent under this Paragraph 7(g) shall be effective and
enforceable whether or not any Loan is advanced by the Lender hereunder and
shall survive payment of all other Obligations.
7(h) Loan Documents. Comply with and observe all terms and
conditions of the Loan Documents.
7(i) Insurance. Obtain and maintain insurance with responsible
companies in such amounts and against such risks as are usually carried by
corporations engaged in similar businesses similarly situated, including,
without limitation, errors and omissions coverage and fidelity coverage, and
furnish the Lender on request full information as to all such insurance.
7(j) Indemnification. Indemnify, defend and hold harmless the
Lender from and against any and all claims, obligations, penalties, actions,
suits, judgments, reasonable costs and disbursements, losses, liabilities and
damages (including, without limitation, reasonable attorneys' fees) of any kind
whatsoever (collectively and severally, "Claims") which may at any time be
imposed on, assessed against or incurred by Lender in any way relating to or
arising out of the Loan Documents or the transactions contemplated thereby or
any action reasonably taken or omitted to be taken by the Lender in connection
with the foregoing; provided, however, that neither the Company nor the Parent
shall be liable for any portion of any Claims arising out of or resulting from
the gross negligence or willful misconduct of the Lender. The Lender agrees that
it will promptly notify the Parent of any claim, action or suit asserted or
commenced against it and that the Parent may assume the defense thereof with
counsel reasonably satisfactory to the Lender at the Parent's sole expense, that
it will cooperate with the Parent on such defense, and that it will not settle
any such claim, action or suit without the consent of the Parent; provided,
however, that in the event the Lender is not reasonably satisfied with such
defense, the Lender may assume such defense with counsel satisfactory to the
Lender at the Parent's sole expense. The indemnification obligations of the
Company and the Parent under this Paragraph 7(j) shall survive termination of
this Agreement and payment in full of the Obligations.
8. Negative Covenants. Each of the Company and the Parent hereby
agrees that, as long as any Obligations remain unpaid or the Lender has any
obligation to make Loans hereunder, neither the Company nor the Parent shall,
nor shall the Company or the Parent permit any Subsidiary of the Company or the
Parent to, at any time, directly or indirectly:
8(a) Liens. Create, incur, assume or suffer to exist, any Lien
upon the Collateral except as contemplated by the Security Agreement or create,
incur, assume or suffer to exist any Lien upon any of its other property and
assets (including servicing rights) except:
(1) Liens or charges for current taxes, assessments or other
governmental charges which are not delinquent or which remain payable
without penalty,
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<PAGE> 17
or the validity of which are contested in good faith by appropriate
proceedings upon stay of execution of the enforcement thereof,
provided the Company or the Parent, as applicable, shall have set
aside on its books and shall maintain adequate reserves for the
payment of same in conformity with GAAP;
(2) Liens, deposits or pledges made to secure statutory
obligations, surety or appeal bonds, or bonds for the release of
attachments or for stay of execution, or to secure the performance of
bids, tenders, contracts (other than for the payment of borrowed
money), leases or for purposes of like general nature in the ordinary
course of the Company's or the Parent's business;
(3) Purchase money security interests for property hereafter
acquired, conditional sale agreements, or other title retention
agreements, with respect to property hereafter acquired; provided,
however, that no such security interest or agreement shall affect any
servicing rights or extend to any property other than the property
acquired; and
(4) Liens securing Permitted Secured Debt.
8(b) Indebtedness. Create, incur, assume or suffer to exist, or
otherwise become or be liable in respect of, any Indebtedness except:
(1) The Obligations;
(2) Indebtedness reflected in the financial statements referred
to in Paragraph 6(a) above;
(3) Trade debt incurred in the ordinary course of business;
(4) Indebtedness secured by Liens permitted under Paragraph 8(a)
above;
(5) Capitalized Lease Obligations in an aggregate amount not to
exceed at any one time outstanding $10,000,000.00;
(6) Unsecured Indebtedness consisting of direct borrowings from
independent third parties incurred in the ordinary course of business,
including Indebtedness incurred pursuant to public debt offerings; and
(7) Permitted Secured Debt and Permitted Guaranties.
8(c) Consolidation and Merger. Liquidate or dissolve, or enter
into any consolidation, merger, partnership, joint venture, syndicate or other
combination unless: (1) the Company and the Parent remain as separate surviving
corporations following any such consolidation, merger, partnership, joint
venture, syndicate or other combination by either the Company or the Parent,
respectively, (2) the fair market value of the total assets of the other Person
party to such consolidation, merger, partnership, joint venture, syndicate or
other combination when combined with the fair market value of the total assets
acquired through any
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<PAGE> 18
other consolidation, merger, partnership, joint venture syndicate or other
combination after the date hereof, does not exceed twenty percent (20%) of the
total assets of the Parent (determined in accordance with GAAP on a consolidated
basis) immediately prior to the proposed effective date of such consolidation,
merger, partnership, joint venture, syndicate or other combination, and (3) no
Potential Default or Event of Default exists immediately prior to, or will occur
as a result of, such consolidation, merger, partnership, joint venture,
syndicate or other combination.
8(d) Acquisitions. Purchase or acquire or incur liability for the
purchase or acquisition of any or all of the assets or business of any Person if
the fair market value of assets being acquired when combined with the fair
market value of all assets similarly acquired after the April 10, 1998, exceeds
twenty percent (20%) of total assets of the Parent (determined in accordance
with GAAP on a consolidated basis) immediately prior to the proposed effective
date of such acquisition.
8(e) Payment of Dividends. Declare or pay any dividends upon any
shares of the Parent's stock now or hereafter outstanding, except dividends
payable in the capital stock of the Parent, or make any distribution of assets
to its stockholders as such, whether in cash, property or securities if upon the
payment thereof there would exist an Event of Default or Potential Default.
8(f) Purchase or Retirement of Stock. In the case of the Parent,
from and after the date of this Agreement, acquire, purchase, redeem or retire
any shares of its capital stock now or hereafter outstanding; provided, however,
that as long as both before and following the consummation of such acquisition,
purchase, redemption or retirement there does not exist an Event of Default or
Potential Default, the Parent may enter into such transactions in an aggregate
fair market dollar amount not to exceed $5,000,000.00.
8(g) Investments; Advances. Make or commit to make any advance,
loan or extension of credit (other than Mortgage Loans and reimbursable
servicing advances made in the ordinary course of the Company's or such
Subsidiary's business) or capital contribution to, or purchase any stock, bonds,
notes, debentures or other securities of, or make any other investment in, any
Person if such investment, advance or commitment to advance, when combined with
all other such investments, advances and commitments to advance, exceeds twenty
percent (20%) of the total equity of the Parent (determined in accordance with
GAAP on a consolidated basis) immediately prior to the proposed effective date
of such investment, advance or commitment to advance.
8(h) Sale of Assets. Sell, lease, assign, transfer or otherwise
dispose of any of its assets (other than obsolete or worn out property), whether
now owned or hereafter acquired, other than in the ordinary course of business
and at fair market value.
8(i) Leverage. Permit at the last day of any calendar month the
Leverage Ratio of the Parent and its consolidated Subsidiaries to exceed
5.00:1.00.
8(j) Minimum Net Worth. Permit at the last day of any calendar
quarter:
(1) The Parent's consolidated net worth, determined in accordance
with GAAP, to be less than the sum of: (i) the greater of (A) ninety
percent (90%) of net
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<PAGE> 19
worth, determined in accordance with GAAP, as of the last day of the
fiscal quarter ended December 31, 1997, or (B) $265,000,000.00, plus
(ii) seventy-five percent (75%) of net income (if positive),
determined in accordance with GAAP, during each calendar quarter after
December 31, 1997, plus (iii) seventy-five percent (75%) of
contributions to equity of the Parent made at any time after December
31, 1997, or
(2) The Company's net worth, determined in accordance with GAAP
to be less than the sum of: (i) the greater of (A) seventy percent
(70%) of net worth, determined in accordance with GAAP, as of the last
day of the fiscal quarter ended December 31, 1997, or (B)
$45,000,000.00, plus (ii) seventy-five percent (75%) of net income (if
positive), determined in accordance with GAAP, during each calendar
quarter after December 31, 1997, plus (iii) seventy-five percent (75%)
of contributions to equity of the Company made at any time after
December 31, 1997.
8(k) Minimum Profitability. Permit at the end of any calendar
quarter the Parent's consolidated net income, determined in accordance with
GAAP, for such calendar quarter and the immediately preceding calendar quarter,
taken together, to be less than $1.00.
8(l) Non-Warehouse Debt. Permit at the end of any calendar
quarter the Non-Warehouse Debt Ratio of the Parent and its consolidated
Subsidiaries to exceed 1.25:1.00.
8(m) Modification of Policies and Procedures. Make any material
change in (1) its underwriting policies and procedures which would, due to
reduced standards of creditworthiness for potential obligors on Mortgage Loans
or reduced standards of approval for real property securing a Mortgage Loan,
result in the expansion of the pool of potential obligors on Mortgage Loans
originated or purchased by the Company or such Subsidiary, or (2) its hedging
policies relating to Mortgage Loans, as such are in effect on the Initial
Funding Date; provided, however, that upon the written request of the Company,
any Subsidiary or the Parent to change such policies and procedures, the
requested change shall automatically be deemed to be approved fifteen (15)
Business Days following the date the Lender receives such request unless during
such fifteen (15) day period the Company is given a written rejection of the
requested change in policies and procedures from the Lender stating the basis of
such rejection.
8(n) Subsidiaries. Create or permit the creation of any
Subsidiary not in existence as of the Initial Funding Date; provided, however,
that upon the written request by the Company or the Parent to create a new
Subsidiary (which request shall include an explanation of the business reason
for creation of such Subsidiary), the request shall automatically be deemed to
be approved fifteen (15) Business Days following the date the Lender receives
such request unless during such fifteen (15) day period the Company is given a
written rejection of the request to create a new Subsidiary from the Lender
stating the basis of such rejection.
8(o) Transactions with Affiliates. Purchase, acquire or lease any
property from, or sell, transfer or lease any property to, lend or advance any
money to, borrow any money from, guarantee any obligation of, acquire any stock,
obligations or securities of, or enter into any management or similar fee
arrangement with, any Affiliate, other than on an arms-length basis upon terms
and conditions comparable to those that could be reached with a third party.
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<PAGE> 20
9. Events of Default. Upon the occurrence of any of the following
events (an "Event of Default"):
9(a) The Company shall fail to pay any Obligation on the date
when due (or, with respect to monthly interest and fees due pursuant to
Paragraph 2(b) above, within two (2) Business Days of the date when due); or
9(b) Any representation or warranty made or deemed made by the
Company or the Parent in any Loan Document or in connection with any Loan
Document shall be inaccurate or incomplete in any respect on or as of the date
made or deemed made; or
9(c) The Company or the Parent shall fail to maintain its
corporate existence or shall default in the observance or performance of any
covenant or agreement contained in Paragraph 8 above or in the Security
Agreement; or
9(d) The Company or the Parent shall fail to observe or perform
any other term or provision contained in the Loan Documents to which it is a
party and such failure shall continue for thirty (30) days; or
9(e) The Parent or any of its Subsidiaries shall default in any
payment of principal of or interest on any Indebtedness (other than the
Obligations and the "Obligations" under, and as that term is defined in the
Warehousing Agreement) in an aggregate amount in excess of $5,000,000.00 or any
other event shall occur, the effect of which other event is to permit such
Indebtedness to be declared or otherwise to become due prior to its stated
maturity or there shall occur an "Event of Default" under (and as that term is
defined in) the Warehousing Agreement; or
9(f) (1) The Parent or any of its Subsidiaries shall commence any
case, proceeding or other action (i) under any existing or future law of any
jurisdiction, domestic or foreign, relating to bankruptcy, insolvency,
reorganization or relief of debtors, seeking to have an order for relief entered
with respect to it, or seeking to adjudicate it a bankrupt or insolvent, or
seeking reorganization, arrangement, adjustment, winding-up, liquidation,
dissolution, composition or other relief with respect to it or its debts, or
(ii) seeking appointment of a receiver, trustee, custodian or other similar
official for it or for all or any substantial part of its assets, or the Parent
or any of its Subsidiaries shall make a general assignment for the benefit of
its creditors; or (2) there shall be commenced against the Parent or any of its
Subsidiaries any case, proceeding or other action of a nature referred to in
clause (1) above which (i) results in the entry of an order for relief or any
such adjudication or appointment, or (ii) remains undismissed, undischarged or
unbonded for a period of sixty (60) days; or (3) there shall be commenced
against the Parent or any of its Subsidiaries any case, proceeding or other
action seeking issuance of a warrant of attachment, execution, distraint or
similar process against all or substantially all of its assets which results in
the entry of an order for any such relief which shall not have been vacated,
discharged, stayed, satisfied or bonded pending appeal within sixty (60) days
from the entry thereof; or (4) the Parent or any of its Subsidiaries shall take
any action in furtherance of, or indicating its consent to, approval of, or
acquiescence in (other than in connection with a final settlement), any of the
acts set forth in clauses (1), (2) or (3) above; or (5) the Parent or any of its
Subsidiaries shall generally
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<PAGE> 21
not, or shall be unable to, or shall admit in writing its inability to, pay its
debts as they become due; or
9(g) (1) Any Person shall engage in any "prohibited transaction"
(as defined in Section 406 of ERISA or Section 4975 of the Code) involving any
Plan, (2) any "accumulated funding deficiency" (as defined in Section 302 of
ERISA), whether or nor waived, shall exist with respect to any Plan, (3) a
Reportable Event shall occur with respect to, or proceedings shall commence to
have a trustee appointed, or a trustee shall be appointed, to administer or to
terminate, any Single Employer Plan, which Reportable Event or institution of
proceedings is, in the reasonable opinion of the Lender, likely to result in the
termination of such Plan for purposes of Title IV of ERISA, and, in the case of
a Reportable Event, the continuance of such Reportable Event unremedied for ten
days after notice of such Reportable Event pursuant to Section 4043(a), (c) or
(d) of ERISA is given or the continuance of such proceedings for ten days after
commencement thereof, as the case may be, (4) any Single Employer Plan shall
terminate for purposes of Title IV of ERISA, (5) any withdrawal liability to a
Multiemployer Plan shall be incurred by the Parent or any of its Subsidiaries or
(6) any other event or condition shall occur or exist; and in each case in
clauses (1) through (6) above, such event or condition, together with all other
such events or conditions, if any, is likely to subject the Parent or any of its
Subsidiaries to any tax, penalty or other liabilities in the aggregate material
in relation to the business, operations, property or financial or other
condition of the Parent or any of its Subsidiaries; or
9(h) One or more judgments or decrees shall be entered against
the Company or any of its Subsidiaries in an aggregate amount in excess of
$2,000,000.00, and all such judgments or decrees shall not have been vacated,
discharged, stayed, satisfied or bonded pending appeal within sixty (60) days
from the entry thereof; or
9(i) The Parent shall fail to observe or perform any covenant or
agreement contained in the Guaranty or shall attempt to rescind or revoke the
Guaranty, with respect to future transactions or otherwise; or
9(j) The Parent shall cease to own one hundred percent (100%) of
the outstanding capital stock of the Company; or
9(k) Any Person shall acquire more than twenty-five percent (25%)
of the voting common stock of the Parent; or the majority of the directors of
the Parent shall consist of directors who were not recommended or elected by the
Parent's Board of Directors;
THEN,
(1) Automatically upon the occurrence of an Event of Default
under Paragraph 9(f) above,
(2) At the option of the Lender upon the occurrence of any other
Event of Default,
the Lender's obligation to make Loans hereunder shall terminate and/or the
principal balance of outstanding Loans and interest accrued but unpaid thereon
and all other Obligations shall become immediately due and payable, without
demand upon or presentment to the Company, which are expressly waived by the
Company.
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10. Miscellaneous Provisions.
10(a) No Assignment. Neither the Company nor the Parent may
assign its rights or obligations under this Agreement or the other Loan
Documents without the prior written consent of the Lender. Any purported
assignment in violation of this Paragraph 10(a) shall automatically be deemed
null and void. Subject to the foregoing, all provisions contained in this
Agreement and the other Loan Documents or any document or agreement referred to
herein or relating hereto shall inure to the benefit of the Lender, its
successors and assigns, and shall be binding upon the Company, the Parent and
their respective successors and assigns.
10(b) Amendment. Neither this Agreement nor any other Loan
Document may be amended or terms or provisions hereof or thereof waived unless
such amendment or waiver is in writing and signed by the Lender, the Company and
the Parent.
10(c) Cumulative Rights; No Waiver. The rights, powers and
remedies of the Lender hereunder and under the other Loan Documents are
cumulative and in addition to all rights, power and remedies provided under any
and all agreements among the Company, the Parent and the Lender relating hereto
and thereto, at law, in equity or otherwise. Any delay or failure by the Lender
to exercise any right, power or remedy shall not constitute a waiver thereof by
the Lender, and no single or partial exercise by the Lender of any right, power
or remedy shall preclude any other or further exercise thereof or any exercise
of any other rights, powers or remedies.
10(d) Entire Agreement. This Agreement and the other Loan
Documents and the documents and agreements referred to herein embody the entire
agreement and understanding between the parties hereto and supersede all prior
agreements and understandings relating to the subject matter hereof and thereof.
10(e) Survival. All representations, warranties, covenants and
agreements contained in this Agreement and the other Loan Documents on the part
of the Company and the Parent shall survive the termination of this Agreement
and shall be effective until the Obligations are paid and performed in full or
longer as expressly provided herein.
10(f) Notices. All notices given by any party to the others to be
given under the Loan Documents shall be in writing (including facsimile
transmission) unless otherwise provided for herein, delivered personally or by
depositing the same in the United States mail, registered, with postage prepaid,
addressed to the party at the address set forth on Schedule II attached hereto.
Any party may change the address to which notices are to be sent by notice of
such change to each other party given as provided herein. Such notices shall be
effective on the date received or, if mailed, on the third Business Day
following the date mailed.
10(g) Governing Law. This Agreement and the other Loan Documents
shall be governed by and construed in accordance with the laws of the State of
California without giving effect to choice of law rules.
10(h) Counterparts. This Agreement and the other Loan Documents
may be executed in any number of counterparts, all of which together shall
constitute one agreement.
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10(i) Waiver of Jury Trial. EACH OF THE PARTIES HERETO WAIVES ITS
RESPECTIVE RIGHTS TO A TRIAL BY JURY OF ANY CLAIM OR CAUSE OF ACTION BASED UPON
OR ARISING OUT OF OR RELATED TO THIS AGREEMENT, THE OTHER LOAN DOCUMENTS OR THE
TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY IN ANY ACTION, PROCEEDING OR OTHER
LITIGATION OF ANY TYPE BROUGHT BY ANY OF THE PARTIES AGAINST ANY OTHER PARTY,
WHETHER WITH RESPECT TO CONTRACT CLAIMS, TORT CLAIMS, OR OTHERWISE. EACH OF THE
PARTIES HERETO AGREES THAT ANY SUCH CLAIM OR CAUSE OF ACTION SHALL BE TRIED BY A
COURT TRIAL WITHOUT A JURY. WITHOUT LIMITING THE FOREGOING, THE PARTIES FURTHER
AGREE THAT THEIR RESPECTIVE RIGHT TO A TRIAL BY JURY IS WAIVED BY OPERATION OF
THIS PARAGRAPH 10(i) AS TO ANY ACTION, COUNTERCLAIM OR OTHER PROCEEDING WHICH
SEEKS, IN WHOLE OR IN PART, TO CHALLENGE THE VALIDITY OR ENFORCEABILITY OF THIS
AGREEMENT OR ANY OTHER LOAN DOCUMENT OR ANY PROVISION HEREOF OR THEREOF. THIS
WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR
MODIFICATIONS TO THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS.
10(j) Limitation on Interest. The Lender, the Company, the Parent
and the other parties to the Loan Documents intend to contract in strict
compliance with applicable usury law from time to time in effect. In furtherance
thereof, such Persons stipulate and agree that none of the terms and provisions
contained in the Loan Documents shall ever be construed to create a contract to
pay, for the use, forbearance or detention of money, interest in excess of the
maximum amount of interest permitted to be charged by applicable law from time
to time.
11. Definitions. For purposes of this Agreement, the terms set forth
below shall have the following meanings:
"Act" shall have the meaning given such term in Paragraph 6(m) above.
"Adjusted Net Worth" shall mean on a consolidated basis for the Parent
at any date an amount equal to: (a) Net Worth (as defined under GAAP), minus (b)
goodwill, plus (c) Subordinated Debt so long as there does not exist an Event of
Default with respect to such Subordinated Debt.
"Affiliate" shall mean, as to any Person, any other Person directly or
indirectly controlling, controlled by or under direct or indirect common control
with, such Person. "Control" as used herein means the power to direct the
management and policies of such Person.
"Agreement" shall mean this Agreement, as the same may be amended,
extended or replaced from time to time.
"Applicable Effective Fed Funds Rate" shall mean on any day the
Effective Fed Funds Rate on such day plus 1.75.
"Applicable Eurodollar Rate" shall mean, with respect to any
Eurodollar Loan for the Interest Period applicable to such Eurodollar Loan, the
rate per annum (rounded upward, if
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<PAGE> 24
necessary, to the next higher 1/32 of one percent) calculated as of the first
day of such Interest Period in accordance with the following formula:
Applicable Eurodollar Rate = ER + 1.75
1-ERP
where
ER = Eurodollar Rate
ERP = Eurodollar Reserve Percentage
"Approved Securities Offering" shall mean an offering of securities by
the Company for which the following statements are true, unless otherwise waived
in writing by the Lender:
(a) The Company has filed and made effective a registration
statement with the Securities and Exchange Commission covering the sale of the
proposed securities, or the sale of the proposed securities is made pursuant to
an effective shelf registration with the Securities and Exchange Commission; and
(b) The Company obtained all permits, exemptions, and licenses
necessary to effect the offering.
"Average Total Liabilities" shall mean for any calendar month the sum
of (a) average consolidated funded Indebtedness of the Parent for such month,
plus (b) all other consolidated liabilities of the Parent, determined in
accordance with GAAP, as of the last day of such month; provided, however, that
for purposes of this definition of "Average Total Liabilities," the terms
"Indebtedness" and "liabilities" shall in no event include any Subordinated Debt
so long as there does not exist a default with respect to such Subordinated
Debt.
"Book-Entry MBS" shall mean a Residual Mortgage-Backed Security (a)
which is not represented by an instrument, and (b) the ownership and transfer of
which is entered upon books maintained for such purpose by a depository."
"Business Day" shall mean any day other than a Saturday, a Sunday or a
day on which banks in Los Angeles, California or Dallas, Texas are authorized or
obligated to close their regular banking business.
"Capitalized Lease Obligations" of any Person shall mean the
obligations of such Person to pay rent or other amounts under any lease of (or
other arrangement conveying the right to use) real or personal property, or a
combination thereof, which obligations are required to be classified and
accounted for as capital leases on a balance sheet of such Person under GAAP
and, for the purposes of this Agreement, the amount of such obligations at any
time shall be the capitalized amount thereof at such time determined in
accordance with GAAP.
"Collateral" shall mean, collectively and severally, the personal
property collateral described as such in the Security Agreement.
24
<PAGE> 25
"Collateral Valuation Report" shall mean a report prepared by the
Lender and delivered to the Company from time to time setting forth the current
Established Collateral Value attributed by the Lender to Eligible Residual
Securities.
"Collateral Value of the Residuals Borrowing Base" shall mean at any
date sixty five percent (65%) of the aggregate Established Collateral Value of
Eligible Residual Securities included in the Residuals Borrowing Base at such
date.
"Commonly Controlled Entity" of a Person shall mean a Person, whether
or not incorporated, which is under common control with such Person within the
meaning of Section 410(c) of the Internal Revenue Code.
"Contractual Obligation" as to any Person shall mean any provision of
any security issued by such Person or of any agreement, instrument or
undertaking to which such Person is a party or by which it or any of its
property is bound.
"Conversion Date" shall mean the date, to be mutually agreed by the
Lender and the Company but not in any event to be later than the thirtieth day
following the receipt by the Company of a notice to make a Required Principal
Prepayment, as of which the Company has exercised the Term-Out Option and the
funding of the Term Loan occurs.
"Determination of Availability" shall mean a determination made by the
Lender upon receipt by the Lender of a request for a Revolving Loan hereunder
that upon the funding of such Revolving Loan the Company will be in compliance
with the requirements of Paragraph 1(a) above.
"Effective Fed Funds Rate" shall mean for any day, the weighted
average of the rates on overnight Federal Funds transactions with members of the
Federal Reserve System arranged by Federal Funds brokers, as published for such
day (or, if such day is not a Business Day, for the next preceding Business Day)
by the Federal Reserve Bank of New York or, if such rate is not so published for
any day that is a Business Day, the average of quotations for such day on such
transactions received by the Lender from three Federal Funds brokers of
recognized standing selected by the Lender.
"Effective Fed Funds Rate Loans" shall mean Revolving Loans and
portions of the Term Loan as such time as they are made or being maintained at a
rate of interest based on the Effective Fed Funds Rate.
"Eligible Residual Security" shall mean a Residual Mortgage-Backed
Security owned by the Company with respect to which the following statements
shall be accurate and complete (and the Company by permitting said Residual
Mortgage-Backed Security to be included in any computation of the Collateral
Value of the Residuals Borrowing Base shall be deemed to so represent and
warrant to the Lender at and as of the date of such computation):
(a) Said Residual Mortgage-Backed Security is a binding and valid
obligation of the obligor thereon, in full force and effect and enforceable in
accordance with its terms;
25
<PAGE> 26
(b) Said Residual Mortgage-Backed Security was issued in
connection with an Approved Securities Offering;
(c) Said Residual Mortgage-Backed Security is free of any default
and from any rescission, cancellation or avoidance, and all right thereof,
whether by operation of law or otherwise;
(d) Said Residual Mortgage-Backed Security has either been
deposited with and is held by the Lender, properly endorsed in blank for
transfer or, if said Residual Mortgage-Backed Security is a Book-Entry MBS, said
Residual Mortgage-Backed Security is the subject of a Perfected Assignment;
(e) At all times said Residual Mortgage-Backed Security will be
free and clear of all liens, encumbrances, charges, rights and interests of any
kind, except in favor of the Lender and the Lender has a first priority,
perfected security interest therein;
(f) The Company has delivered to the Lender no later than ten
Business Days prior to the date said Residual Mortgage-Backed Security is
proposed to be included in the calculation of the Collateral Value of the
Residuals Borrowing Base such information regarding the Residual Mortgage-Backed
Security as the Lender deems necessary or desirable in connection with a
determination of the Established Collateral Value thereof; and
(g) The Lender, in its sole discretion, has not declared said
Residual Mortgage-Backed Security, for whatever reason, to be ineligible for
inclusion in the Residuals Borrowing Base. Without limiting the generality of
this subparagraph (g), it is expressly acknowledged and agreed by the Company
that in the event the Lender agrees to accept the Residual Mortgage-Backed
Security issued to the Company in connection with its 1998B securitization
transaction as an "Eligible Residual Security" hereunder at the time of the
funding of the initial Revolving Loan, such Residual Mortgage-Backed Security
will automatically become ineligible on the thirtieth day following such funding
date, it being anticipated that the Company will pledge to the Lender in
substitution therefor the Residual Mortgage-Backed Security to be issued to the
Company in connection with its securitization transaction to be closed on or
before that date.
"ERISA" shall mean the Employee Retirement Income Security Act of
1974, as the same may from time to time be supplemented or amended.
"Established Collateral Value" shall mean at any date with respect to
any Eligible Residual Security, the borrowing base value of such Eligible
Residual Security as determined by the Lender using such methodologies and
parameters as may be established by the Lender from time to time in its sole
discretion, as such "Established Collateral Value" set forth in the most recent
Collateral Valuation Report delivered by the Lender to the Company.
"Eurodollar Business Day" shall mean a Business Day upon which
commercial banks in London, England are open for domestic and international
business.
26
<PAGE> 27
"Eurodollar Loans" shall mean Revolving Loans and portions of the Term
Loan at such time as they are made and/or being maintained at a rate of interest
based upon the Eurodollar Rate.
"Eurodollar Rate" shall mean, with respect to any Eurodollar Loan for
the Interest Period applicable to such Eurodollar Loan, the arithmetic average
as determined by the Lender of the rates at which deposits in immediately
available U.S. dollars in an amount equal to the amount of such Eurodollar Loan
having a maturity approximately equal to such Interest Period are offered to
four (4) reference banks to be selected by the Lender in the London interbank
market, at approximately 11:00 a.m. (London time) two Eurodollar Business Days
prior to the first day of such Interest Period.
"Eurodollar Reserve Percentage" shall mean with respect to an Interest
Period for a Eurodollar Loan, the maximum aggregate reserve requirement
(including all basic, supplemental, marginal and other reserves and taking into
account any transitional adjustments) which is imposed under Regulation D on
eurocurrency liabilities.
"Event of Default" shall have the meaning given such term in Paragraph
9 above.
"Funding Account" shall mean Account No. 0499-18969 maintained in the
Company's name alone with Sanwa Bank California.
"GAAP" shall mean generally accepted accounting principles in the
United States of America in effect from time to time.
"Governmental Authority" shall mean any nation or government, any
state or other political subdivision thereof, or any entity exercising
executive, legislative, judicial, regulatory or administrative functions of or
pertaining to government.
"Guaranty" shall have the meaning given such term in Paragraph 4(b)
above.
"Indebtedness" of any Person shall mean all items of indebtedness
which, in accordance with GAAP and practices, would be included in determining
liabilities as shown on the liability side of a statement of condition of such
Person as of the date as of which indebtedness is to be determined, including,
without limitation, all obligations for money borrowed and Capitalized Lease
Obligations, and shall also include all indebtedness and liabilities of others
assumed or guaranteed by such Person or in respect of which such Person is
secondarily or contingently liable (other than by endorsement of instruments in
the course of collection) whether by reason of any agreement to acquire such
indebtedness or to supply or advance sums or otherwise.
"Initial Funding Date" shall mean the date on which the initial Loan
or Loans requested by the Company hereunder are funded by the Lender pursuant to
the terms hereof.
"Interest Period" shall mean, with respect to any Eurodollar Loan, the
period commencing on the date advanced and ending two weeks or one, two or three
months thereafter, as designated by the Company in the related Loan And/Or
Interest Rate Election Request; provided, however, that (a) any Interest Period
which would otherwise end on a day which is not a
27
<PAGE> 28
Eurodollar Business Day shall be extended to the next succeeding Eurodollar
Business Day unless by such extension it would fall in another calendar month,
in which case such Interest Period shall end on the immediately preceding
Eurodollar Business Day; (b) any Interest Period applicable to a Eurodollar Loan
which begins on a day for which there is no numerically corresponding day in the
calendar month during which such Interest Period is to end shall, subject to the
provisions of clause (a) above, end on the last day of such calendar month; and
(c) no such Interest Period shall extend beyond the regularly scheduled Maturity
Date.
"Interim Date" shall mean March 31, 1998.
"Leverage Ratio" shall mean at any date the ratio at the last day of
the immediately preceding calendar month of Average Total Liabilities to
Adjusted Net Worth.
"Lien" shall mean any security interest, mortgage, pledge, lien, claim
on property, charge or encumbrance (including any conditional sale or other
title retention agreement), any lease in the nature thereof, and the filing of
or agreement to give any financing statement under the Uniform Commercial Code
of any jurisdiction.
"Loan Documents" shall mean this Agreement, the Security Agreement,
the Notes, the Guaranty and each other document, instrument or agreement
executed by the Company in connection herewith or therewith, as any of the same
may be amended, extended or replaced from time to time.
"Loan And/Or Interest Rate Election Request" shall mean a written
request in the form of Exhibit H attached hereto.
"Loans" shall mean, collectively and severally, the Revolving Loans
and the Term Loan, as applicable.
"Maturity Date" shall mean the earlier of: (a) September 3, 1999, as
such date may be extended from time to time in writing by the Lender, in its
sole discretion, and (b) the date the Lender terminates its obligation to make
further Loans hereunder pursuant to Paragraph 9 above.
"Mortgage-Backed Security" shall mean any security (including, without
limitation, a participation certificate) that represents an interest in a pool
of mortgages, deeds of trusts or other instruments creating a Lien on real
property which is improved by a completed single family dwelling (one-to-four
family units) or a unit in a condominium or planned unit development.
"Mortgage Loan" shall mean a residential real estate secured loan
(including 1-4 family unit, condominium and planned unit development).
"Multiemployer Plan" as to any Person shall mean a Plan of such Person
which is a multiemployer plan as defined in Section 4001(a)(3) of ERISA.
"Non-Warehouse Debt Ratio" shall mean, with respect to the Parent and
its Subsidiaries on a consolidated basis, on any date the ratio at the last day
of the immediately preceding calendar quarter of consolidated funded
Indebtedness (including Subordinated Debt), minus one hundred percent (100%) of
the value, according to the Parent's balance sheet at such
28
<PAGE> 29
date, of all Mortgage Loans held for sale, minus eighty percent (80%) of the
dollar amount of all accounts receivable shown on the Parent's balance sheet at
such date (but excluding all accounts receivable as to which any Affiliate or
any Subsidiary of the Parent is the account party), to consolidated net worth
(as defined under GAAP).
"Obligations" shall mean any and all debts, obligations and
liabilities of the Company to the Lender (whether now existing or hereafter
arising, voluntary or involuntary, whether or not jointly owed with others,
direct or indirect, absolute or contingent, liquidated or unliquidated, and
whether or not from time to time decreased or extinguished and later increased,
created or incurred), arising out of or related to the Loan Documents.
"Parent" shall have the meaning given such term in the introductory
paragraph of this Agreement.
"Perfected Assignment" shall mean, as to any Book-Entry MBS, that the
Residual Mortgage-Backed Security has been transferred to the Lender or any
entity designated by the Lender so that the Lender or such entity may maintain
such Residual Mortgage-Backed Security as depository in one of its book-entry
accounts with a Federal Reserve Bank or the Mortgage Backed Securities Clearing
Corporation Depository System and a pledge to the Lender has been registered
with the Lender or such entity or the Company has taken such other action as the
Lender may request to protect, maintain or perfect the Lender's first priority
perfected security interest in such Book-Entry MBS.
"Permitted Guaranties" shall mean those guaranties executed by the
Company and the Parent covering Indebtedness of Affiliates which Indebtedness is
included in the calculation of Average Total Liabilities for purposes of
computing the Leverage Ratio pursuant to Paragraph 10(i) above.
"Permitted Secured Debt" shall mean that Indebtedness described as
"Permitted Secured Debt" on Exhibit I attached hereto.
"Person" shall mean any corporation, natural person, firm, joint
venture, partnership, limited liability company, trust, unincorporated
organization or Governmental Authority.
"Plan" shall mean, as to any Person, any pension plan that is covered
by Title IV of ERISA and in respect of which such Person or a Commonly
Controlled Entity of such Person is an "employer" as defined in Section 3(5) of
ERISA.
"Potential Default" shall mean an event which but for the lapse of
time or the giving of notice, or both, would constitute an Event of Default.
"Proceeds" shall mean whatever is receivable or received when
Collateral or proceeds are sold, collected, exchanged or otherwise disposed of,
whether such disposition is voluntary or involuntary, and includes, without
limitation, all rights to payment, including return premiums, with respect to
any insurance relating thereto.
"Regulation D" shall mean Regulation D of the Board of Governors of
the Federal Reserve System from time to time in effect and shall include any
successor or other regulation of
29
<PAGE> 30
said Board of Governors relating to reserve requirements applicable to member
banks of the Federal Reserve System.
"Regulation U" shall mean Regulation U of the Board of Governors of
the Federal Reserve System (12 C.F.R. Section 221), as the same may from time to
time be amended, supplemented or superseded.
"Reportable Event" shall mean a reportable event as defined in Title
IV of ERISA, except actions of general applicability by the Secretary of Labor
under Section 110 of ERISA.
"Required Principal Prepayment" shall have the meaning given such term
in Paragraph 3(d)(2) above.
"Requirements of Law" shall mean, as to any Person, the Articles or
Certificate of Incorporation and ByLaws or other organizational or governing
documents of such Person, and any law, treaty, rule or regulation, or a final
and binding determination of an arbitrator or a determination of a court or
other Governmental Authority, in each case applicable to or binding upon such
Person or any of its property or to which such Person or any of its property is
subject.
"Residual Mortgage-Backed Security" shall mean any security which
represents a subordinate or residual interest in a pool of mortgages, deeds of
trust or other instruments creating a lien on one-to-four unit residential
properties improved by a completed single family residence, which security was
issued in an Approved Securities Offering.
"Residuals Borrowing Base" shall mean at any date all Eligible
Residual Securities in which the Lender holds for the benefit of the Lender a
first priority perfected security interest at such date.
"Responsible Financial Officer" shall mean as to any Person the chief
financial officer, senior vice president-finance, vice president-finance or
assistant vice president-finance of such Person, with any Person executing and
delivering any certificate hereunder on behalf of the Company or the Parent
which is required to be executed and delivered by a "Responsible Financial
Officer" being acknowledged by the Company and the Parent as being a Person
actively involved with and knowledgeable with respect to all financial matters
affecting the Company and the Parent, as applicable.
"Revolving Credit Limit" shall mean $50,000,000.00, as such amount may
be increased or decreased by mutual agreement of the Lender and the Company.
"Security Agreement" shall have the meaning given such term in
Paragraph 4(a) above.
"Single Employer Plan" shall mean as to any Person any Plan of such
Person which is not a Multiemployer Plan.
"Statement Date" shall mean December 31, 1997.
"Subordinated Debt" shall mean Indebtedness expressly subordinated to
the Obligations in the manner and to the extent required by the Lender pursuant
to written subordination agreements satisfactory in form and substance to the
Lender.
"Subsidiary" shall mean, with respect to any Person, any corporation
more than fifty percent (50%) of the stock of which having by the terms thereof
ordinary voting power to
30
<PAGE> 31
elect the board of directors, managers or trustees of such corporation shall, at
the time as of which any determination is being made, be owned by such Person,
either directly or through Subsidiaries of such Person (irrespective of whether
or not at such time stock of any other class or classes of such corporation
shall have or might have voting power by reason of the happening of any
contingency); provided, however, that in no event shall the term "Subsidiary" as
it relates to the Company include any special purpose entity formed solely for
the purpose of issuing Mortgage-Backed Securities supported by Mortgage Loans
originated or acquired by the Company and transferred to such special purpose
entity in support of such Mortgage-Backed Securities.
"Term-Out Option" shall have the meaning given such term in Paragraph
1(c) above.
"Warehousing Agreement" shall mean that certain Second Amended and
Restated Mortgage Loan Warehousing Agreement dated as of April 10, 1998 by and
among the Company, the Parent, the lenders party thereto and NationsBank of
Texas, N.A., as Administrative Agent for the lenders, as the same may be
amended, extended and replaced from time to time.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to
be executed as of the day and year first above written.
AAMES CAPITAL CORPORATION,
a California corporation
By /s/ DAVID A. SKLAR
--------------------------------
Name David A. Sklar
Title EVP-Finance & CFO
AAMES FINANCIAL CORPORATION,
a Delaware corporation
By /s/ DAVID A. SKLAR
--------------------------------
Name David A. Sklar
Title EVP-Finance & CFO
NATIONSBANK, N.A., as the Lender
By /s/ CAROLYN WARREN
--------------------------------
Name Carolyn Warren
Title Senior Vice President
31
<PAGE> 1
EXHIBIT 11
AAMES FINANCIAL CORPORATION
Earnings Per Share
For the Three Months September 30, 1998 and September 30, 1997
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-------------
1998 1997
---------- -----------
<S> <C> <C>
BASIC EARNINGS PER COMMON SHARE:
Net Income for calculating basic earnings per
common share $ 448,000 $13,081,000
========== ===========
Average common shares outstanding 30,977,000 27,767,000
---------- -----------
BASIC EARNINGS PER COMMON SHARE $0.01 $0.47
DILUTED EARNINGS PER COMMON SHARE:
Net Income $448,000 $13,081,000
========== ===========
Adjust net income to add back the after-tax amount
of interest recognized in the period associated
with the convertible subordinated notes - 898,000
---------- -----------
Adjusted net income $ 448,000 $13,979,000
========== ===========
Average common shares outstanding 30,977,000 27,767,000
Add exercise of options and warrants 288,000 1,459,000
Convertible subordinated notes - 6,107,000
---------- -----------
Diluted shares outstanding 31,265,000 35,333,000
========== ===========
DILUTED EARNINGS PER COMMON SHARE $0.01 $0.40
========== ===========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 5,625,000
<SECURITIES> 0
<RECEIVABLES> 699,544,000
<ALLOWANCES> 664,000
<INVENTORY> 222,845,000
<CURRENT-ASSETS> 927,350,000
<PP&E> 25,338,000
<DEPRECIATION> 11,304,000
<TOTAL-ASSETS> 941,384,000
<CURRENT-LIABILITIES> 309,331,000
<BONDS> 286,990,000
0
0
<COMMON> 31,000
<OTHER-SE> 345,032,000
<TOTAL-LIABILITY-AND-EQUITY> 941,384,000
<SALES> 76,977,000
<TOTAL-REVENUES> 76,977,000
<CGS> 10,930,000
<TOTAL-COSTS> 10,930,000
<OTHER-EXPENSES> 37,183,000
<LOSS-PROVISION> 15,210,000
<INTEREST-EXPENSE> 12,881,000
<INCOME-PRETAX> 773,000
<INCOME-TAX> 325,000
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 448,000
<EPS-PRIMARY> .01<F1>
<EPS-DILUTED> .01
<FN>
<F1>FOR PURPOSES OF THIS EXHIBIT PRIMARY MEANS BASIC.
</FN>
</TABLE>
