<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 March 31, 1998
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 For the transition
period from _____to _____
COMMISSION FILE NUMBER 0-19604
AAMES FINANCIAL CORPORATION
[Exact name of Registrant as specified in its charter]
DELAWARE 95-4340340
[State or other jurisdiction of [I.R.S. Employer
incorporation or organization] Identification No.]
350 SOUTH GRAND AVENUE, LOS ANGELES, CA 90071-3459
------------------------------------------------------------------------
[Address of Registrant's principal executive offices including zip code]
(213) 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
------- -------
At May 11, 1998, the Registrant had 30,952,552 shares of common stock
outstanding.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
ITEM NO. PAGE NO.
--------
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheets at June 30, 1997 and March 31, 1998 3
Consolidated Statements of Income for the three and nine months ended
March 31, 1997 and 1998 4
Consolidated Statements of Cash Flows for the nine months ended
March 31, 1997 and 1998 5
Notes to Consolidated Financial Statements 6-7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 8-25
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 26
Item 2 - Changes in Securities 26
Item 3 - Defaults Upon Senior Securities 26
Item 4 - Submission of Matters to a Vote of Security Holders 26
Item 5 - Other Information 26
Item 6 - Exhibits and Reports on Form 8-K 26
Signature Page 27
</TABLE>
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AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1997 1998
------------ ------------
(AUDITED) (UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 26,902,000 $ 28,677,000
Loans held for sale, at lower of cost or market 242,987,000 173,565,000
Accounts receivable 59,180,000 25,928,000
Interest-only strips, at fair market value 270,422,000 333,327,000
Mortgage servicing rights 21,641,000 28,619,000
Residual assets 112,827,000 176,201,000
Equipment and improvements, net 12,685,000 14,114,000
Prepaid and other 14,949,000 17,309,000
------------ ------------
Total assets $761,593,000 $797,740,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Borrowings $286,990,000 $286,990,000
Revolving warehouse facilities 137,500,000 126,500,000
Accounts payable and accrued expenses 29,297,000 34,350,000
Income taxes payable 39,452,000 53,484,000
------------ ------------
Total liabilities 493,239,000 501,324,000
------------ ------------
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;
27,758,800, and 28,154,000 shares outstanding 28,000 28,000
Additional paid-in capital 209,358,000 209,628,000
Retained earnings 58,968,000 86,760,000
------------ ------------
Total stockholders' equity 268,354,000 296,416,000
------------ ------------
Total liabilities and stockholders' equity $761,593,000 $797,740,000
============ ============
</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)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------ ------------ ------------ ------------
1997 1998 1997 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Gain on sale of loans $ 53,052,000 $ 33,755,000 $166,212,000 $130,919,000
Net unrealized gain on valuation
of interest-only strips 5,103,000 3,058,000 5,103,000 13,813,000
Commissions 7,586,000 7,515,000 23,173,000 20,531,000
Loan service 8,769,000 11,634,000 18,831,000 31,778,000
Fees and other 9,570,000 12,510,000 26,430,000 36,997,000
------------ ------------ ------------ ------------
Total revenue 84,080,000 68,472,000 239,749,000 234,038,000
------------ ------------ ------------ ------------
Expenses:
Compensation and related expenses 22,250,000 24,348,000 61,283,000 70,668,000
Production expenses 6,566,000 9,292,000 20,800,000 22,630,000
General and administrative expenses 8,082,000 10,258,000 22,799,000 27,923,000
Interest expense 8,364,000 11,703,000 23,551,000 32,620,000
Provision for loan losses 8,509,000 5,700,000 25,441,000 25,163,000
Nonrecurring charges -- -- 28,108,000 --
------------ ------------ ------------ ------------
Total expenses 53,771,000 61,301,000 181,982,000 179,004,000
------------ ------------ ------------ ------------
Income before income taxes 30,309,000 7,171,000 57,767,000 55,034,000
Provision for income taxes 12,734,000 3,051,000 26,542,000 24,490,000
------------ ------------ ------------ ------------
Net income $ 17,575,000 $ 4,120,000 $ 31,225,000 $ 30,544,000
============ ============ ============ ============
Net income per share
Basic $ 0.64 $ 0.15 $ 1.20 $ 1.10
============ ============ ============ ============
Diluted $ 0.51 $ 0.15 $ 0.93 $ 0.95
============ ============ ============ ============
Dividends per share $ 0.03 $ 0.03 $ 0.10 $ 0.10
============ ============ ============ ============
Weighted average number
of shares outstanding
Basic 27,547,000 27,898,000 25,995,000 27,827,000
============ ============ ============ ============
Diluted 36,498,000 34,847,000 36,565,000 35,097,000
============ ============ ============ ============
</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)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
-----------------------------------
1997 1998
--------------- ---------------
<S> <C> <C>
Operating activities:
Net income $ 31,225,000 $ 30,544,000
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Provision for loan losses 25,441,000 25,163,000
Net charge-offs for loans (3,189,000) (22,052,000)
Depreciation and amortization 1,945,000 2,926,000
Deferred income taxes 38,625,000 15,335,000
Gain on sale of loans (214,963,000) (128,330,000)
Net unrealized gain on valuation of interest-only strips (5,103,000) (13,813,000)
Amortization of interest-only strip 44,962,000 76,127,000
Mortgage servicing rights originated (12,452,000) (13,533,000)
Mortgage servicing rights amortization 3,795,000 6,555,000
Changes in assets and liabilities:
Loans originated or purchased (1,745,553,000) (1,709,698,000)
Proceeds from sale of loans 1,824,895,000 1,779,121,000
Decrease (increase) in:
Accounts receivable (28,534,000) 33,252,000
Prepaid and other (8,768,000) (2,360,000)
Residual assets (48,464,000) (63,374,000)
Increase (decrease) in:
Accounts payable and accrued expenses 13,504,000 5,053,000
Income taxes payable (15,276,000) (1,303,000)
--------------- ---------------
Net cash (used in) provided by operating activities (97,910,000) 19,613,000
--------------- ---------------
Investing activities:
Purchases of property and equipment (5,953,000) (4,356,000)
--------------- ---------------
Net cash (used in) investing activities (5,953,000) (4,356,000)
--------------- ---------------
Financing activities:
Proceeds from sale of stock or exercise of options 119,977,000 270,000
Proceeds from borrowing 149,955,000 --
Amounts outstanding under warehouse facilities (37,363,000) (11,000,000)
Dividends paid (2,496,000) (2,752,000)
--------------- ---------------
Net cash provided by (used in) financing activities 230,073,000 (13,482,000)
--------------- ---------------
Net increase in cash and cash equivalents 126,210,000 1,775,000
Cash and cash equivalents at beginning of period 23,941,000 26,902,000
--------------- ---------------
Cash and cash equivalents at end of period $ 150,151,000 $ 28,677,000
=============== ===============
</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 and nine months ended
March 31, 1998 are not necessarily indicative of the results expected for the
full fiscal year.
NOTE 2: RECLASSIFICATIONS
Certain amounts related to fiscal year 1997 have been reclassified
to conform to the fiscal year 1998 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
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.
NOTE 4: NEW ACCOUNTING STANDARDS
The Company adopted Statement of Financial Accounting Standards No.
125 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" ("SFAS 125") effective January 1, 1997. The
adoption of SFAS 125 did not have a material effect on the Company's results of
operations since adoption. As a result of the adoption of SFAS 125, the Company
records amounts previously categorized as "Excess servicing gains" in the
Consolidated Statements of Income as "Gain on sale of loans." Additionally, the
Company now records the right to future interest income that exceeds
contractually specified servicing fees and previously recorded as "Excess
servicing receivable" as an investment security called "Interest-only strips."
The
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Company has classified this asset as a trading security and, for the quarter
ended March 31, 1998, recorded a mark-to-market unrealized gain of $3.1 million
on this security. SFAS 125 requires that this mark-to-market unrealized
adjustment be reported separately from "Gain on sale of loans" and the
adjustment has been labeled "Net unrealized gain on valuation of interest-only
strips" in the Consolidated Statements of Income.
In February 1997, the Financial Accounting Standards Board ("FASB"),
issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("SFAS 128"). SFAS 128 establishes standards for computing and presenting
earnings per share ("EPS") by replacing the presentation of primary EPS with a
presentation of basic EPS. Primary EPS included common stock equivalents while
basic EPS excludes them. This change simplifies the computation of EPS, while
making the United States computation more compatible to the standards of other
countries. It also requires dual presentation of basic and fully diluted EPS on
the face of the income statement for all entities with complex capital
structures. The Company adopted SFAS 128 effective December 31, 1997. The
adoption of SFAS 128 did not have a material impact on the Company's financial
statements.
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 129, "Disclosure of Information about Capital Structure" ("SFAS
129"). SFAS 129 establishes disclosure requirements regarding pertinent rights
and privileges of outstanding securities. Examples of disclosure items regarding
securities include, though are not limited to, items such as dividend and
liquidation preferences, participation rights, call prices and dates, conversion
or exercise prices or rates. The number of shares issued upon conversion,
exercise or satisfaction of required conditions during at least the most recent
annual fiscal period and any subsequent interim period must also be disclosed.
Disclosure of liquidation preferences of preferred stock in the equity section
of the statement of financial condition is also required. SFAS 129 is effective
for fiscal periods beginning after December 15, 1997. The Company will adopt
SFAS 129 effective July 1, 1998.
7
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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.
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 through a broker network. In
late fiscal 1997, the Company began originating a limited amount of small
commercial loans which it currently sells on a whole loan basis servicing
released.
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 residential loans on a
nationwide basis through three primary production channels--retail, broker and
correspondent. The Company underwrites and has each property appraised for every
loan it originates and generally re-underwrites and reviews appraisals on all
loans it purchases.
The Company retains the servicing on a substantial portion of the
loans it originates or purchases and securitizes. During the third quarter of
fiscal 1998, the Company completed the transfer in-house of $688 million of
loans previously subserviced by third parties. Of the Company's $4.0 billion
servicing portfolio (which includes $305 million of loans subserviced by the
Company on an interim basis), only 5.0% was subserviced by a third party at
March 31, 1998. Of the Company's $2.7 billion servicing portfolio at March 31,
1997, 54% was subserviced by a third party at that date. See "Expenses."
The Company's strategic plan calls for continued national expansion
of its retail and broker networks, the Company's core production units, and
decreasing bulk loan purchases resulting in lower production volume in the
correspondent unit. The Company recently established a separate retail
production unit, One Stop Retail Direct, to further penetrate the subprime
market. See "Recent Developments." The Company is also pursuing opportunities on
an international basis, initially in the United Kingdom through its broker
subsidiary One Stop. The Company began lending
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operations in the United Kingdom in April 1998 through a subsidiary of One Stop.
The United Kingdom operation originates residential mortgage loans secured by
properties located primarily in England through a network of mortgage brokers.
The Company intends initially to sell the loans on a whole loan basis. The
Company will continue to evaluate additional international opportunities.
The following table presents the volume of loans originated
and purchased by the Company through each of its three primary production
channels and the portfolio serviced by the Company during the periods presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------ ------------------------
1997 1998 1997 1998
---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Loans originated and purchased:
Broker network ........................... $ 177,587 $ 235,788 $ 508,189 $ 771,378
Retail ................................... 135,532 165,018 351,501 455,856
Correspondent ............................ 297,640 170,090 885,863 482,464
---------- ---------- ---------- ----------
Total .................................... $ 610,759 $ 570,896 $1,745,553 $1,709,698
========== ========== ========== ==========
Servicing portfolio at period end .......... $2,721,900 $ 4,030,900(1)
</TABLE>
(1) Includes $305 million of loans subserviced by the Company on an interim
basis.
Total loan production decreased 6.5% from $611 million for the
quarter ended March 31, 1997 to $571 million for the quarter ended March 31,
1998. The decline was due to the reduction in correspondent bulk loan purchases
as a result of the previously announced pricing changes, which was partially
offset by increased loan production in the retail and broker production units.
The growth in the Company's core retail and broker units reflects continued
geographic expansion through the opening of 16 retail branches and two broker
offices in the third fiscal quarter of 1998.
The Company's retail and broker units increased production 28% on a
quarter over quarter basis from $313 million to $401 million for the quarters
ended March 31, 1997 and 1998, respectively. The Company's retail originations
amounted to $165 million for the quarter ended March 31, 1998, up 21%, compared
to $136 million for the quarter ended March 31, 1997. Origination volume for the
broker network reached $236 million for the quarter ended March 31, 1998, up
33%, compared to $178 million for the quarter ended March 31, 1997.
Correspondent purchases were $170 million for the quarter ended March 31, 1998,
down from $298 million for the quarter ended March 31, 1997. The pricing changes
made in the last fiscal year with respect to bulk purchased loans resulted in
lower production volume in the correspondent unit. The production volume for the
third fiscal quarter of 1998 also reflects the Company's strategic shift up the
credit grade spectrum. Of the total loans originated and purchased by the
Company in the quarter ended March 31, 1998, 93% were A-, A, B and C credit
grade loans and 7% were C- and D credit grade loans, compared to 87% and 13%,
respectively, in last year's comparable quarter.
Although total loan production for the nine months ended March 31,
1997 and March 31, 1998 remained relatively flat, the Company's retail and
broker units increased loan production 40%
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from $860 million to $1.2 billion for the nine months ended March 31, 1997 and
March 31, 1998, respectively. The Company's retail originations increased 30% to
$456 million for the nine months ended March 31, 1998 compared to $352 million
for the nine months ended March 31, 1997. Origination volume for the broker unit
reached $771 million for the nine months ended March 31, 1998, up 52%, compared
to $508 million for the nine months ended March 31, 1997. Correspondent volume
decreased 46% from $886 million at March 31, 1997 to $482 million at March 31,
1998.
At March 31, 1998, the Company operated 91 retail loan offices
serving 32 states compared to 55 offices serving 23 states at March 31, 1997. At
March 31, 1998, One Stop operated 43 branches serving 42 states, compared to 33
branches serving 24 states at March 31, 1997.
Recent Developments
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 a purchase price of $13.7625
per share, or approximately $38 million in the aggregate. The purchase price
represented the average of the closing sales prices of the Company's common
stock on the New York Stock Exchange during the 15-day period preceding the
signing of the agreement (March 19, 1998). As part of the agreement, 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. In addition, the Company appointed Howard Gittis, as nominee for Mr.
Perelman, and Mr. Ford to the Company's Board of Directors.
The Company securitizes on a quarterly basis a significant portion
of its loan production and records non-cash gain on sale in accordance with
generally accepted accounting principles. The Company operates on a negative
cash flow basis related to its securitization program as the significant cash
requirements necessitated by such program exceeds the cash generated by the
Company's operations. In the third fiscal quarter of 1998, the Company adopted a
new business strategy of maximizing opportunities in its loan disposition
transactions. Under this strategy, the Company disposes of its loan production
through a combination of securitizations and whole loan sales, depending on
market conditions, profitability and cash flows. In the quarter ended March 31,
1998, the Company sold on a servicing released, whole loan basis for cash $306
million in principal amount of mortgages and securitized $300 million in
principal amount of mortgages. Because the cash premium received and recorded on
a whole loan sale is generally less than the non-cash gain on sale recorded in a
securitization, the Company recorded a lower gain in the quarter ended March 31,
1998 as compared to last year's comparable quarter.
To implement its strategy of selling a significant portion of its
loans in the whole loan market, the Company previously announced it was
contemplating establishing a real estate investment trust ("REIT") which would
have purchased the Company's loan production. However, the depth of the whole
loan market, among other things, has caused the Company to decide not to form a
REIT in the immediate future.
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In March 1998, One Stop established a separate retail production
unit, One Stop Retail Direct, to enable the Company to further penetrate the
subprime market. Unlike the Company's existing retail office network, which uses
a centralized marketing approach, One Stop Retail Direct uses a decentralized
marketing effort at the branch level. Currently, One Stop Retail Direct is
operating two offices in two states and expects to expand nationwide in the
future.
CERTAIN ACCOUNTING CONSIDERATIONS
The Company sells a significant portion of its loans in
securitization transactions. 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 (net of the unrealized gain or loss on valuation of interest-only strips)
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. The non-cash gain on sale of loans
provides the basis for the calculation of the interest-only strips, which are
recorded as an asset on the Company's consolidated balance sheet. The
interest-only strips represent the present value of the Company's future cash
flows from the securitized pools, adjusted for the reserve for loan losses. 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 the following: (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.
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) and industry data. The rate of prepayment may be affected by a
variety of economic and other factors, including 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. Generally, a declining interest rate environment will
encourage prepayments on higher credit grade loans. There can be no assurance of
the accuracy of management's estimates. 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 written down through a charge to earnings in
the period of adjustment.
In order to determine the present value of the cash flow from the
interest-only strips, the Company discounts the cash flows based upon rates
prevalent in the market.
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 grade of the loans included in the current securitizations. At
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March 31, 1998, the Company had reserves of $46.1 million related to these
credit risks, or 1.3% of the outstanding balance of loans securitized as of that
date. During the nine months ended March 31, 1998, the Company charged $22
million against the reserve. Included in that amount is a one-time charge of
$6.0 million resulting from the Company's delay in the recording of information
transferred from a third party servicer. Cumulative net losses (excluding the
one-time charge of $6.0 million) to date from the Company's securitization
transactions since June 1992 have totaled $22.4 million. The weighted average
loan-to-value ratio of the loans included in the Company's servicing portfolio
was 71% as of March 31, 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. 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. The interest-only strips are marked to market through a charge to
earnings.
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. The Company generally makes loans to credit-impaired borrowers whose
borrowing needs may not be met by traditional financial institutions due to
credit exceptions. In the past, the Company found that credit impaired borrowers
in the lower credit grades, which comprised a significant portion of the
Company's borrower base, were payment sensitive rather than interest rate
sensitive. As the Company has increased the amount of higher credit grade loans
it originates and purchases, it has found that interest rate sensitivity among
its borrower base has increased. See "Risk Factors-Risks of Changes in Interest
Rates." The Company also expects reduced levels of OMSRs associated with whole
loan sale transactions.
RISK FACTORS
Delinquencies and Losses in Securitization Trusts; Right to
Terminate Mortgage Servicing. 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 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.
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At March 31, 1998, the dollar volume of loans delinquent more than
90 days in the Company's nine securitization trusts formed in November 1992 and
during the period from December 1994 to September 1996 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, in certain instances, by obligating the Company, as servicer, to advance
past due interest. See "Liquidity." 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. However, management believes that the disruption of
servicing associated with the recent transfer of servicing in-house from third
parties contributed to the increase in the delinquency rate. The delinquency
rate for March 31, 1998 was 15.4% compared to 13.3% at March 31, 1997.
Seven of the nine trusts referred to above plus one additional trust
(representing 11.0% of the dollar volume of the Company's servicing portfolio)
exceeded one of two loss limits at April 30, 1998. The limit that has been
exceeded provides that losses may not exceed a certain threshold (which ranges
from .38% to .56% 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.
Current loss levels have increased due to a loss mitigation strategy
of minimizing the real estate owned ("REO") holding period, thereby reducing
carrying costs. 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. See
"Expenses."
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.
Risk of Changes in Interest Rate Environment. A substantial and
sustained increase in 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; (iii) reduce the average size of loans underwritten
by the Company; and (iv) reduce the gains recognized by the Company upon their
securitization and sale. A significant decline in interest rates could decrease
the size of the Company's loan servicing portfolio by increasing the level of
loan prepayments, thereby shortening the life and reducing the value of the
Company's interest-only strips. For additional information on the affect of
changes in interest rates on the Company, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Risk
Factors--Economic Conditions" in the Company's Annual Report on Form 10-K for
the fiscal year ended June 30, 1997.
13
<PAGE> 14
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 committed to purchase a year 2000
compliant loan origination system that is expected to add approximately $2
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.
Forward-Looking Statements. This Report contains forward looking
statements relating to such matters as anticipated financial performance,
business prospects and similar matters. The Private Securities Litigation Reform
Act of 1995 provides a safe harbor for forward-looking statements. In order to
comply with the terms of the safe harbor, the Company notes that a variety of
factors could cause the Company's actual results and experience to differ
materially from the anticipated results or other expectations expressed in the
Company's forward-looking statements. The risks and uncertainties that may
affect the operations, performance and results of the Company's business include
the following: negative cash flows and capital needs; delinquencies, negative
impact on cash flow, right to terminate mortgage servicing; prepayment, basis
and credit risk; losses in securitization trusts, right to terminate mortgage
servicing; risks of contracted servicing; risk of adverse changes in the
secondary market for mortgage loans; dependence on funding sources; capitalized
interest-only strips, mortgage servicing rights; recent acquisition of One Stop;
dependence on broker network; impact of increases in correspondent pricing;
risks associated with high loan-to-value loan products; risks involved in
commercial mortgage lending; competition; concentration of operations in
California; timing of loan sales; economic conditions; contingent risks; and
government regulation. For a more complete discussion of these risks and
uncertainties, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations-Risk Factors" in the Company's Form 10-K for the
fiscal year ended June 30, 1997 and Form 10-Q's for the quarters ended September
30, 1997 and December 31, 1997.
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<PAGE> 15
RESULTS OF OPERATIONS-THREE AND NINE MONTHS ENDED MARCH 31, 1997 AND 1998
The following table sets forth information regarding the
components of the Company's revenue and expenses for the three and nine months
ended March 31, 1997 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------- --------------------
1997 1998 1997 1998
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenue:
Gain on sale of loans ............... $ 53,052 $ 33,755 $166,212 $130,919
Net unrealized gain on valuation
of interest-only strips ........... 5,103 3,058 5,103 13,813
Commissions ......................... 7,586 7,515 23,173 20,531
Loan service:
Servicing spread .................... 5,898 6,830 12,445 18,251
Prepayment fees ..................... 1,678 2,629 3,898 8,247
Late charges and other servicing fees 1,193 2,175 2,488 5,280
Fees and other:
Closing ............................. 613 697 2,149 1,954
Appraisal ........................... 477 704 1,406 1,839
Underwriting ........................ 211 282 1,159 822
Interest income ..................... 8,105 10,761 21,149 31,870
Other ............................... 164 66 567 512
-------- -------- -------- --------
Total revenue ....................... $ 84,080 $ 68,472 $239,749 $234,038
-------- -------- -------- --------
Expenses:
Compensation and related expenses ... $ 22,250 $ 24,348 $ 61,283 $ 70,668
Production expenses ................. 6,566 9,292 20,800 22,630
General and administrative expenses . 8,082 10,258 22,799 27,923
Interest expense .................... 8,364 11,703 23,551 32,620
Provision for loan losses ........... 8,509 5,700 25,441 25,163
Nonrecurring charges ................ -- -- 28,108 --
-------- -------- -------- --------
Total expenses ...................... $ 53,771 $ 61,301 $181,982 $179,004
-------- -------- -------- --------
Income before income taxes .......... $ 30,309 $ 7,171 $ 57,767 $ 55,034
Provision for income taxes .......... 12,734 3,051 26,542 24,490
-------- -------- -------- --------
Net income .......................... $ 17,575 $ 4,120 $ 31,225 $ 30,544
======== ======== ======== ========
</TABLE>
REVENUE
Total revenue for the three and nine months ended March 31, 1998 was
$68.5 million and $234 million, a 19% and 2.5% decrease from $84.1 million and
$240 million for the three and nine months ended March 31, 1997, respectively.
The decrease in total revenue was primarily due to lower gain on sale resulting
from the sale of a significant portion of the quarter's production on a whole
loan basis. The cash premium received and recorded on a whole loan sale is
generally less than the non-cash gain on sale recorded in a securitization.
Gain on sale of loans for the three and nine months ended March 31,
1998, which included $3.1 million and $13.8 million of an unrealized gain on
valuation of interest-only strips related to loans sold, was $36.8 million and
$145 million, respectively, a 37% and 15% decrease from $58.2
15
<PAGE> 16
million and $171 million for the corresponding periods last year. The decreases
for the three and nine month periods were primarily the result of the lower gain
on sale due to the execution of whole loan sales in the amount of $306 million
and the smaller mortgage loan pool securitized and sold by the Company in the
third quarter of fiscal 1998. The whole loan sale gain recognized in the quarter
ended March 31, 1998 includes a $2.5 million reserve for potential repurchase
obligations with respect to approximately $50 million of principal amount of
loans sold. The lower gain on sale also reflects the increased prepayment rate
assumption implemented during the quarter ended June 30, 1997 used to record the
gain on sale on the Company's securitized ARM product, thereby reducing the
total amount of gain recorded compared to prior periods. During the nine months
ended March 31, 1998, the impact of this change was offset by the lower premiums
paid on the quarter's correspondent production. Premiums paid for loans
purchased are netted against the gains recorded on the securitization or sale of
loans. The Company securitized $300 million and $1.4 billion of loans for the
three and nine months ended March 31, 1998, respectively, compared to $633
million and $1.8 billion of loans for the corresponding periods in the prior
year. The carryover of loans held for sale at March 31, 1998 decreased to $174
million from $216 million at December 31, 1997.
Commissions earned on loan originations continue to be an important
component of total revenue, comprising 11% and 8.8% of total revenue for the
three and nine months ended March 31, 1998, compared to 9.0% and 9.7% for the
same periods last year. Commission revenue for the three and nine months ended
March 31, 1998 was $7.5 million and $20.5 million, down 1.3% and 12%,
respectively, when compared to $7.6 million and $23.2 million for the
corresponding periods in the prior year. The decrease in commissions for the
three and nine months ended March 31, 1998 was the result of a decline in
weighted average commission rates for both the retail and broker network
production units. The lower weighted average commission rate in fiscal year 1998
reflects competitive factors, and the increase of higher credit grade loans
originated which generally carry lower commission rates, offset by continued
growth in retail originations.
Loan service revenue for the three and nine months ended March 31,
1998 increased to $11.6 million and $31.8 million, an increase of 32% and 69%,
respectively, from $8.8 million and $18.8 million for the corresponding periods
in the prior year. 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 increase in loan service revenue for the
three and nine months ended March 31, 1998 was due primarily to the greater size
of the portfolio of loans serviced in this period offset by increased
amortization of the interest-only strips and OMSRs.
The Company's loan servicing portfolio at March 31, 1998 increased
to $4.0 billion (which includes $305 million subserviced by the Company on an
interim basis), up 48% from $2.7 billion at March 31, 1997. Consistent with the
Company's strategic plan, the Company's in-house serviced portfolio increased by
both the transfer in-house of loans which had been subserviced by third parties,
and the direct servicing of the majority of the new production securitized
during the period. In-house servicing grew to $3.8 billion, up 217% from $1.2
billion one year ago. Additional personnel were added in the third fiscal
quarter to allow the Company to service directly substantially all of its
servicing portfolio by the end of that quarter. See "Expenses." Management
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<PAGE> 17
believes the business of loan servicing provides a more consistent revenue
stream and is less cyclical than the business of loan origination and
purchasing.
DELINQUENCIES AND FORECLOSURES
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. However, management believes that the
disruption of servicing associated with the recent transfer of servicing
in-house from third parties contributed to the increase in the delinquency rate.
See "Revenues." The delinquency rate for March 31, 1998 was 15.4% compared to
13.3% at March 31, 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 nine months ended March 31, 1998, losses
increased over the prior year period due to a loss mitigation strategy of
minimizing the REO holding period, thereby reducing carrying costs. 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 has increased its
loan loss provision from an average of 1.44% of the pool balances for the nine
months ended March 31, 1997 to an average of 1.79% of the pool balances for the
nine months ended March 31, 1998. 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 Nine Months Ended
June 30, March 31,
1995 1996 1997 1997 1998
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Percentage of dollar amount of delinquent loans
to loans serviced (period end)(1)(2)(3)(11)
One month .......................................... 3.9% 4.9% 4.3% 2.8% 4.0%
Two months ......................................... 1.6 1.8 1.9 1.5 1.2
Three or more months:
Not foreclosed(4) .................................. 5.0 8.0 8.1 8.1 8.7
Foreclosed(5) ...................................... 1.5 1.0 1.0 .9 1.5
---------- ---------- ---------- ---------- ----------
Total .............................................. 12.0% 15.7% 15.3% 13.3% 15.4%
Percentage of dollar amount of loans foreclosed to
loans serviced (period end)(2)(11) ............. 1.2% 1.1% 1.5% 1.1% 1.6%
Number of loans foreclosed(6) ...................... 159 221 560 356 826
Principal amount of foreclosed loans ............... $ 6,675 $ 14,349 $ 48,029 $ 30,817 $ 63,892
Net losses on foreclosed loans included in pools(7). $ 127 $ 931 $ 5,470 $ 3,229 $ 15,944
One-time charge against loan loss reserve(8) ....... -- -- -- -- $ 6,000
Percentage of annualized losses to average
servicing portfolio(9)(11) ......................... .03% .09% .24% .21% .59%
Liquidation loss reserve(10) ....................... $ 3,371 $ 10,300 $ 43,586 $ 32,827 $ 46,072
Servicing portfolio (period end) ................... $ 608,700 $1,370,000 $3,174,000 $2,721,900 $4,030,900(11)
</TABLE>
(1) Delinquent loans are loans for which more than one payment is
past 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, including $305 million of loans subserviced by the
Company on an interim basis, and any subservicer as of the end of
the periods indicated. Percentages for fiscal year 1996 have not
been restated to include delinquencies of loans originated by One
Stop. The Company believes any such adjustment would not be
material.
(3) At April 30, 1998, the dollar volume of loans delinquent more
than 90 days in the Company's nine REMIC trusts formed in
November 1992 and during the period from December 1994 to
September 1996 exceeded the permitted limit in the related
pooling and servicing agreements. Seven of those trusts plus one
additional trust exceeded certain loss limits. See "Risk Factors-
Delinquencies and Losses in Securitization Trusts; Right to
Terminate Mortgage Servicing."
(4) Represents loans which are in foreclosure but as to which
foreclosure proceedings have not concluded.
(5) Represents properties acquired following a foreclosure sale and
still serviced by the Company.
(6) The increase in the number of loans foreclosed and principal
amount of loans foreclosed in fiscal year 1997 and nine months
ended March 31, 1998 relative to fiscal year 1996 and nine months
ended March 31, 1997 is due to the larger, more seasoned
servicing portfolio.
(7) Represents losses, net of gains, on foreclosed properties in
pools sold during the period indicated excluding the one-time
charge referred to in footnote (8) below.
(8) Represents a one-time charge to the loss reserve resulting from
the Company's delay in recording information transferred from a
third party servicer.
(9) Does not include the one-time charge referred to in footnote (8)
above.
(10) Represents period end reserves for future liquidation losses.
(11) Includes $305 million of loans subserviced by the Company on an
interim basis.
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<PAGE> 19
Fees and other revenue for the three and nine months ended March 31,
1998 increased 30% and 40% from $9.6 million and $26.4 million, for the three
and nine months ended March 31, 1997, to $12.5 million and $37.0 million for the
three and nine months ended March 31, 1998. Included in other revenue is
interest income earned on loans in the Company's portfolio held for sale.
Interest income increased for the three and nine months ended March 31, 1998 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 the decline in the weighted average coupon from 10.2% for the
three months ended March 31, 1997 to 10.0% for the three months ended March 31,
1998. Fees and other revenue also includes fees received by the Company through
its retail loan office network in the form of appraisal, underwriting and other
fees.
EXPENSES
Compensation and related expenses for the three and nine months
ended March 31, 1998 increased 9.0% and 15% from $22.3 million and $61.3 million
for the three and nine months ended March 31, 1997, to $24.3 million and $70.7
million for the three and nine months ended March 31, 1998. This increase was
primarily due to the continued effort to enhance the loan servicing
infrastructure for the final third party portfolio transfer completed in March
1998 and start up costs due to the expansion of the Company's core production
units. The record expansion in the branch system resulted in the opening of 16
new retail offices and two broker offices during the quarter. Generally, new
offices become profitable within three to four months of opening. Compensation
and related expenses as a percentage of total loan originations and purchases
were 4.3% and 4.1% for the three and nine months ended March 31, 1998 compared
to 3.6% and 3.5% for the corresponding periods last year.
Production expenses, primarily advertising, outside appraisal costs,
travel and entertainment, and credit reporting fees for the three and nine
months ended March 31, 1998 increased 41% and 8.7% from $6.6 million and $20.8
million for the three and nine months ended March 31, 1997, to $9.3 million and
$22.6 million for the three and nine months ended March 31, 1998. The increase
in production expenses reflects the Company's retail and broker network
expansion and higher loan production volume. The Company continually monitors
the sources of its loan applications to determine the most effective methods of
advertising. Production costs as a percentage of total loan originations and
purchases were 1.6% and 1.3% for the three and nine months ended March 31, 1998
compared to 1.1% and 1.2% for the corresponding periods last year.
General and administrative expenses for the three and nine months
ended March 31, 1998 increased 27% and 22% from $8.1 million and $22.8 million
for the three and nine months ended March 31, 1997, to $10.3 million and $27.9
million for the three and nine months ended March 31, 1998. The increase was
primarily the result of increased occupancy and communication costs related to
the Company's retail expansion and increased loan service infrastructure in
connection with the in-house transfer of servicing.
19
<PAGE> 20
Interest expense for the three and nine months ended March 31, 1998
increased 39% and 38% from $8.4 million and $23.6 million for the three and nine
months ended March 31, 1997, to $11.7 million and $32.6 million for the three
and nine months ended March 31, 1998. The increase is primarily due to increased
warehouse line usage and the 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
relative to production volume is expected to decrease in future periods due to
reduced reliance on external sources resulting from the benefit of cash flow
related to whole loan sales.
The provision for loan losses for the three and nine months ended
March 31, 1998 decreased 33% and .8% from $8.5 million and $25.4 million for the
three and nine months ended March 31, 1997, respectively, to $5.7 million and
$25.2 million for the three and nine months ended March 31, 1998, respectively.
The decrease in the quarter ended March 31, 1998 was attributable to the sale of
a significant portion of loans in a whole loan, servicing released transaction,
offset by the increased provision on the securitized product. Management
analyzes the provision for loan losses on a quarterly basis to determine the
appropriate provision to maintain the adequacy of the loss reserve. At March 31,
1998, the loss reserve represented 289% of net losses on foreclosed loans during
the nine months ended March 31, 1998. Based on this percentage, and after taking
account of the one-time charge referred to in "Certain Accounting
Considerations," management believes the loss reserve at March 31, 1998 was
adequate.
In the nine months ended March 31, 1997, the Company incurred $28.1
million of nonrecurring charges. Approximately $25.0 million was directly
related to the acquisition of One Stop. The remaining amount related primarily
to a reserve for vacating corporate headquarters.
INCOME TAXES
The Company's provision for income taxes decreased from $26.5
million for the nine months ended March 31, 1997 to $24.5 million for the nine
months ended March 31, 1998. The decrease in the provision for income taxes was
due to lower taxable earnings offset by an increase in the Company's effective
tax rate from 42% for the quarter ended June 30, 1997 to 44% for the nine months
ended March 31, 1998. This increase in effective tax rate was due to
non-deductible compensation expense during the nine month period ended March 31,
1998.
FINANCIAL CONDITION
Loans held for sale. The Company's portfolio of loans held for sale
decreased from $243 million at June 30, 1997, to $174 million at March 31, 1998.
This decline from the June 30, 1997 quarter carryover, resulted from the
Company's sale of mortgages exceeding production levels in the first three
fiscal quarters of 1998. However, the Company continues to carryover
significantly more loans than in previous years. Management believes the
increase in the carryover amount will provide the Company with additional cash
flows, efficiencies and flexibility in the future. There can be no assurance
that the Company can maintain this level of carryover in future periods.
Accounts receivable. Accounts receivable, representing servicing
fees and advances and other receivables, decreased from $59.2 million at June
30, 1997, to $25.9 million at March 31, 1998. This decrease was primarily the
result of more timely recovery of amounts previously
20
<PAGE> 21
advanced in pool related receivables due to the transfer of servicing in-house
and the immediate access to related cash collections.
Interest-only strips. Interest-only strips increased from $270
million at June 30, 1997 to $333 million at March 31, 1998 reflecting the
Company's non-cash gain on sale from the securitizations in the nine months
ended March 31, 1998, net of amortization and provision for loan losses.
Mortgage servicing rights. Mortgage servicing rights increased from
$21.6 million at June 30, 1997 to $28.6 million at March 31, 1998 reflecting the
Company's non-cash gain on sale relating to OMSRs from the securitizations in
the nine months ended March 31, 1998, net of amortization.
Residual assets. Residual assets represent the reserve accounts and
overcollateralization amounts required to be maintained in connection with the
securitization of loans. Residual assets include cash and mortgage loans in
excess of the principal amounts of the senior and subordinated certificates or
bonds of the securitization trust. Residual assets increased from $113 million
at June 30, 1997, to $176 million at March 31, 1998.
Equipment and improvements, net. Primarily as a result of the
expansion of the Company's retail loan office network and the associated
investment in technology, equipment and improvements, net, increased from $12.7
million at June 30, 1997 to $14.1 million at March 31, 1998.
Prepaid and other assets. Prepaid and other assets increased from
$14.9 million at June 30, 1997 to $17.3 million at March 31, 1998.
Borrowings. Borrowings remained unchanged at $287 million for both
June 30, 1997 and March 31, 1998.
Revolving warehouse facilities. Amounts outstanding under warehouse
facilities decreased from $138 million at June 30, 1997, to $127 million at
March 31, 1998, primarily as a result of the reduction in mortgage loan
carryover, offset by negative cash flow for the nine months ended March 31,
1998. Proceeds from the Company's loan sales are used to pay down the Company's
warehouse facilities.
LIQUIDITY
The Company's primary objective is to increase cash flows with the
ultimate goal of becoming cash flow positive. To accomplish these goals, the
Company has adopted a strategy of maximizing opportunities in loan disposition
transactions through a combination of securitizations and whole loan sales.
Depending on transaction economics and the amount of loans securitized versus
sold on a whole loan basis for cash, the Company may continue to operate on a
negative cash flow basis.
In the quarter ended March 31, 1998, the Company sold on a servicing
released, whole loan basis for cash $306 million in principal amount of
mortgages and securitized $300 million in
21
<PAGE> 22
principal amount of mortgages. The Company's loan sale strategy in the third
quarter resulted in a decrease in the gain on sale recorded in the period as
compared to the comparable period in fiscal 1997. The whole loan gain recognized
in the current quarter includes a $2.5 million reserve for potential repurchase
obligations with respect to approximately $50 million of principal amount of
loans sold on a whole loan basis.
In addition, the Company's cash flow position will continue to be
impacted by the Company's level of future and historical securitizations. The
securitizations completed by the Company over the past six years will continue
to have cash requirements in the form of reserve accounts or
overcollateralization requirements and servicing and interest advances.
Both on an historical and continuing basis, the Company's operating
cash requirements include the funding of: (i) mortgage loan originations and
purchases prior to their securitization or sale, (ii) fees and expenses 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 retail and
broker networks.
The Company's historical operations have required continued access
to short-term and long-term sources of cash. 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 Company expects to improve cash flow and reduce
the need to access the capital markets by selling a significant portion of its
loan production in the whole loan market for cash. In addition, the completion
of the $38 million capital infusion in April 1998 provides the Company with a
significant source of cash for expanding operations and additional flexibility
in loan disposition strategies. See "Recent Developments" and "Capital
Resources." During the short term, its negative operating cash flows, subject to
limitations under the Company's existing credit facilities, will be funded
principally from borrowings from financial institutions. There can be no
assurance that the Company will have access to the capital markets in the future
or that financing will be available to satisfy the Company's operating and debt
service requirements or to fund its future growth. The Company anticipates that
its sources of liquidity will be sufficient to fund the Company's liquidity
requirements for at least the next 12 months. There can be no assurance that the
Company will be successful in executing whole loan sale transactions in the
future on terms the Company would consider to be favorable. Further, principally
as a result of the events described under "Item 1, Business--Recent Events," in
the Company's Annual Report on Form 10-K for the fiscal year ended June 30,
1997, certain rating agencies had placed certain issues of the Company's debt
under credit watch. At March 31, 1998, only one rating agency maintains such
debt on credit watch. Agency ratings may affect the ability of the Company to
secure credit facilities on favorable terms.
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,
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<PAGE> 23
including residual financing, is limited to approximately two times
stockholders' equity. 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 interest-only strips
and $225 million. Warehouse indebtedness is not included in the indebtedness
limitations.
The Company securitized or sold in the secondary market $606 million
and $1.8 billion of loans for the three and nine months ended March 31, 1998,
compared to $633 million and $1.8 billion during the corresponding periods in
the prior year. 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 senior
interests in order to increase overcollateralization to specified minimums. The
accumulated amounts of such over- collateralization and cash reserve accounts
are reflected on the Company's balance sheet as "residual assets." At March 31,
1998, the balance was $176 million compared to $93 million at March 31, 1997.
In addition, the use of securitization transactions as a funding
source by the Company has resulted in a significant amount of non-cash gain on
sale of loans recognized by the Company. During the three and nine months ended
March 31, 1998, the Company recognized non-cash gain on sale of loans in the
amounts of $25.2 million and $112 million, respectively, compared to $53.1
million and $166 million during the same periods of the prior year. In addition,
the Company recognized $3.1 million and $13.8 million for the three and nine
months ended March 31, 1998 in net unrealized gain on valuation of interest-only
strips in accordance with SFAS 125 implemented in the quarter ended March 31,
1997. 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.
Combining whole loan sales and securitizations will reduce the amount of gain
the Company can defer for tax purposes.
The Company also incurs certain expenses in connection with
securitizations, including underwriting fees, credit enhancement fees, trustee
fees, hedging and other costs which, for the pools sold during the nine months
ended March 31, 1998, approximated .64% of the principal amount of the
securitized mortgage loans sold.
CAPITAL RESOURCES
The Company has historically financed its operational cash
requirements primarily through (i) warehouse facilities and working capital
lines of credit, (ii) the securitization or sale of
23
<PAGE> 24
mortgage loans, and (iii) the issuance of debt and equity securities. The
Company's new loan disposition strategy is expected to reduce reliance on
external financing sources.
Warehouse Facilities. At March 31, 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 10 commercial banks. This facility
provides for a maximum borrowing amount of $400 million, 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. This line is currently scheduled to expire on April 8, 1999
and is subject to renewal. There are two additional financing facilities from
investment banks that are secured by loans originated and purchased by the
Company. One is a warehouse line of credit in the amount of $250 million which
bears interest at a rate of 0.70% over one-month LIBOR and expires on June 30,
1998. The second is a repurchase agreement in the amount of $300 million which
bears interest at a rate of .65% over one month LIBOR and expires on September
11, 1998. Management expects, although there can be no assurance, that the
Company will be able to maintain these or similar facilities in the future.
Although external financing dependence is expected to ease with the future
implementation of the Company's diversified loan sale strategy, 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.
Loan Sales. The Company's most important capital resource has been
its ability to sell loans originated and purchased by it in the secondary market
in order to generate cash proceeds to pay down its warehouse facilities and fund
new originations and purchases. The 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.
Other Capital Resources. The Company has historically funded
negative cash flow primarily from the sale of its equity and debt securities. In
December 1991, July 1993, June 1995, October 1996 and April 1998, the Company
effected 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 March 31, 1998, the Company had cash and cash equivalents of
approximately $28.7 million.
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 a purchase price of $13.7625
per share, or approximately $38 million. The purchase price represented the
average of the closing sales prices of the Company's common stock on the New
York Stock Exchange during the 15-day period preceding the signing of the
agreement (March 19,
24
<PAGE> 25
1998). As part of the agreement, 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. In addition, the
Company appointed Howard Gittis, as nominee for Mr. Perelman, and Mr. Ford to
the Company's Board of Directors.
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 any
LIBOR-based tranche 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 swap
with a specified LIBOR rate cap. The amount and timing of hedging transactions
are determined by members of the Company's senior management. 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.
25
<PAGE> 26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - Not applicable.
Item 2. Changes in Securities - Not applicable.
Item 3. Defaults upon Senior Securities - Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders - Not
applicable.
Item 5. Other Information - Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11 Computation of Per Share Earnings
27.1 Financial Data Schedule
99 Press Release issued on April 28, 1998
(b) Reports on Form 8-K: Current reports on Form 8-K dated
December 23, 1997 (reporting a Board change), January 28,
1998 (reporting earnings, cash dividends and intended whole
loan sales) and March 10, 1998 (reporting a proposed capital
infusion, a new financing facility and a Board and officer
change) were filed during the quarter ended March 31, 1998.
26
<PAGE> 27
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
Dated: May 14, 1998 By:/s/ David A. Sklar
----------------------------------
David A. Sklar
Executive Vice President--Finance
and Chief Financial and Accounting
Officer
27
<PAGE> 28
EXHIBIT INDEX
Exhibit No. Description of Exhibit
11 Computation of Per Share Earnings
27.1 Financial Data Schedule
99 Press Release issued on April 28, 1998
<PAGE> 1
EXHIBIT 11
AAMES FINANCIAL CORPORATION
Earnings Per Share
For the three and nine months ended March 31, 1997 and 1998
<TABLE>
<CAPTION>
Three months ended Nine months ended
March 31, March 31,
----------------------- ------------------------
1997 1998 1997 1998
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
BASIC EARNINGS PER COMMON SHARE:
Net Income for calculating basic earnings per
common share $17,575,000 $4,120,000 $31,225,000 $30,544,000
=========== ========== =========== ===========
Average common shares outstanding 27,547,000 27,898,000 25,995,000 27,827,000
----------- ---------- ----------- -----------
BASIC EARNINGS PER COMMON SHARE $ 0.64 $ 0.15 $ 1.20 $ 1.10
=========== ========== =========== ===========
DILUTED EARNINGS PER COMMON SHARE:
Net Income $17,575,000 $4,120,000 $31,225,000 $30,544,000
=========== ========== =========== ===========
Adjust net income to add back the after-tax amount
of interest recognized in the period associated
with the convertible subordinated notes 926,000 967,000 2,801,000 2,726,000
----------- ---------- ----------- -----------
Adjusted net income $18,501,000 $5,087,000 $34,026,000 $33,270,000
=========== ========== =========== ===========
Average common shares outstanding 27,547,000 27,898,000 25,995,000 27,827,000
Add exercise of options and warrants 2,799,000 842,000 4,412,000 1,164,000
Convertible subordinated notes 6,152,000 6,107,000 6,158,000 6,106,000
----------- ---------- ----------- -----------
Diluted shares outstanding 36,498,000 34,847,000 36,565,000 35,097,000
=========== ========== =========== ===========
DILUTED EARNINGS PER COMMON SHARE $ 0.51 $ 0.15 $ 0.93 $ 0.95
=========== ========== =========== ===========
</TABLE>
<PAGE> 1
EXHIBIT 99
FOR IMMEDIATE RELEASE
- ---------------------
CONTACT:
David Sklar Jeffrey Lloyd/Steve Hawkins
Aames Financial Corporation Sitrick And Company
(213) 210-5311 (310) 788-2850
AAMES FINANCIAL CORPORATION COMPLETES
$38 MILLION EQUITY INVESTMENT
REPORTS THIRD QUARTER RESULTS
AND DECLARES REGULAR QUARTERLY DIVIDEND
LOS ANGELES, CALIFORNIA, APRIL 28, 1998 -- AAMES FINANCIAL CORPORATION
(NYSE: AAM), a leader in subprime home equity lending, today announced that the
Company has completed its equity placement with private entities controlled by
Ronald O. Perelman of New York and Gerald J. Ford of Dallas, and that they have
purchased a total of 2.78 million newly issued shares of Aames common stock at a
purchase price of $13.7625 per share, totaling approximately $38 million, or 9.9
percent of Aames' outstanding shares. Under the terms of the purchase
agreements, the Perelman and Ford entities also received warrants to purchase an
aggregate additional 9.9 percent of Aames' outstanding shares exercisable only
upon a change of control of Aames. The exercise price of the warrants is 125
percent of the original stock purchase price, subject to anti-dilution
provisions, and expire in three years. Mr. Ford and Howard Gittis, as nominee
for Mr. Perelman, have been appointed to the Company's Board of Directors.
Financial Results for Three and Nine Months Ended March 31, 1998
The Company also announced revenue for the third quarter of fiscal
1998 was $68.5 million, compared to $84.1 million earned in last year's third
quarter. Net income for the quarter was $4.1 million, versus $17.6 million for
the same period a year ago. On a basic and diluted per share basis, net income
per share for the quarter was $0.15, compared with $0.64 and $0.51 in the prior
year period.
Cary H. Thompson, Aames' chief executive officer, said, "Revenues and
net income for the third quarter reflect the Company's new business strategy to
reduce its reliance on non-cash securitization gains, and sell a significant
percentage of its production on a whole loan basis for cash. When we announced
our new strategy we acknowledged that it would have a negative impact on
earnings, while improving the quality of those earnings. We believe that we are
already beginning to see the positive benefits of this new strategy as our
quarterly negative cash flow was reduced materially. The quarter's revenues and
net income also reflect increased expenses related to our expedited retail
expansion, the 105 percent increase in our in-house servicing portfolio since
September 1997, new One Stop Retail Direct and our new One Stop
1
<PAGE> 2
U.K. operation. We expect to reap the benefits of these expenses during the next
year."
The current quarter's gain on sale revenue reflects the lower cash
gains attributable to the $305 million of whole loans sold and the non-cash
gains attributable to $300 million of loans sold in securitization. The whole
loan gains include a $2.5 million reserve established should the Company elect
to repurchase approximately $50.0 million of loans sold. In addition, the
securitization gains reflect the ongoing application of the changes in
prepayment assumptions which were announced in the fourth quarter of fiscal
1997. At that time the Company increased the prepayment rate assumptions, which
resulted in the recognition of lower securitization gain on sale. This reduction
was offset by the positive impact of reduced reliance on high premium
correspondent bulk purchases. The provision for loan losses decreased by $2.8
million for the three months ended March 31, 1998 when compared to the same
period last year. This reduction is attributable to the sale of a significant
portion of loans in a whole loan sale, servicing released transaction, offset by
the increased provision on the securitized product. The carryover of loans held
for sale at March 31, 1998 decreased to $174 million from $216 million at
December 31, 1997.
Neil B. Kornswiet, Aames' co-chairman and president, said, "The Aames
retail production unit continued on its record-breaking path. Total retail loan
originations for the quarter were $165 million, up 21 percent from $136 million
a year ago. Originations for the One Stop broker network totaled $236 million
for the quarter, up 33 percent from $178 million a year ago. Total loan
production for the quarter was $571 million, down 7 percent from $611 million a
year ago, due to a 43 percent reduction in less profitable correspondent loan
production as a result of the previously announced pricing changes."
Kornswiet added, "This quarter's results also reflect the Company's
focus on fostering further growth in the Aames retail production unit.
Implementation of the Company's previously announced aggressive growth strategy
resulted in the opening of a record 16 new retail offices during the quarter. In
March 1998, One Stop established a separate retail production unit, One Stop
Retail Direct, to enable us to further penetrate the subprime market. Unlike the
Aames retail office network, which utilizes a centralized marketing approach,
One Stop Retail Direct uses a decentralized marketing effort at the branch
level. Currently One Stop Retail Direct is operating two offices in two states
and anticipates opening seven additional branches during the current quarter.
Eventually, we expect One Stop Retail Direct to operate on a nationwide basis.
We believe the long-term benefits of that expansion will offset the increased
compensation and production-related expenses to be incurred. In addition, during
this quarter One Stop commenced business in the United Kingdom through its
subsidiary One Stop Mortgage Limited."
Revenue for the first nine months of fiscal 1998 totaled $234 million,
down from $240 million reported a year ago. For the first nine months of fiscal
1998, net income was $30.5 million, compared to $31.2 million for last year's
period. Excluding nonrecurring charges of $18.6 million (net of taxes) in the
prior year's first nine months, net income amounted to $49.8 million for that
period. On a basic and diluted per share basis, net income for the first nine
months totaled $1.10 and $0.95, compared to $1.20 and $0.93 (including
nonrecurring charges and adjusted for the three-for-two stock split in the form
of a stock dividend effected in February 1997) in last year's comparable period.
2
<PAGE> 3
Thompson added, "At March 31, 1998, Aames' loan servicing portfolio
increased to $4.0 billion, up 48 percent from $2.7 billion at March 31, 1997.
During March, the Company transferred in-house $688 million of loans which had
been previously subserviced by third parties. By continuing to reduce our use of
third party subservicers, the Company not only expects to generate greater cash
flows and revenues, but also to reduce the potential for problems associated
with using third party servicers. During the last quarter, the Company charged
$6.0 million against its loan loss reserve as a result of a delay in the
recording of information transferred from a third party servicer."
Aames' Board Declares Regular Cash Dividend
The Company also announced that its board of directors has declared a
regular quarterly cash dividend of $0.033 per share, payable on May 22, 1998, to
stockholders of record as of May 7, 1998.
Aames Financial Corporation is a leading home equity lender, and
currently operates 94 Aames Home Loan offices serving 32 states throughout the
United States. Its wholly owned subsidiary, One Stop Mortgage, Inc. currently
operates 45 broker offices serving 42 states and 2 retail direct offices serving
2 states.
From time to time the Company may publish forward-looking statements relating to
such matters as anticipated financial performance, business prospects and
similar matters. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor for forward-looking statements. In order to comply with the terms of
the safe harbor, the Company notes that a variety of factors could cause the
Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's
forward-looking statements. The risks and uncertainties that may affect the
operations, performance and results of the Company's business include the
following: negative cash flows and capital needs; delinquencies, negative impact
on cash flow, right to terminate mortgage servicing; prepayment, basis and
credit risk; losses in securitization trusts, right to terminate mortgage
servicing; risks of contracted servicing; risk of adverse changes in the
secondary market for mortgage loans; dependence on funding sources; capitalized
interest-only strips, mortgage servicing rights; recent acquisition of One Stop;
dependence on broker network; impact of increases in correspondent pricing;
risks associated with high loan-to-value loan products; risks involved in
commercial mortgage lending; competition; concentration of operations in
California; timing of loan sales; year 2000 compliance; economic conditions;
contingent risks; and government regulation. For a more complete discussion of
these risks and uncertainties, see "Item 7". "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk Factors" in
the Company's form 10-K for the fiscal year ended June 30, 1997 and form 10-Q
for the quarters ended September 30, 1997 and December 31, 1997.
# # #
[Financial Tables Follow]
3
<PAGE> 4
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
1997 1998 1997 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Gain on sale of loans $ 53,052,000 $ 33,755,000 $166,212,000 $130,919,000
Net unrealized gain on valuation
of interest-only strips 5,103,000 3,058,000 5,103,000 13,813,000
Commissions 7,586,000 7,515,000 23,173,000 20,531,000
Loan service 8,769,000 11,634,000 18,831,000 31,778,000
Fees and other 9,570,000 12,510,000 26,430,000 36,997,000
------------ ------------ ------------ ------------
Total revenue 84,080,000 68,472,000 239,749,000 234,038,000
------------ ------------ ------------ ------------
Expenses:
Compensation and related expenses 22,250,000 24,348,000 61,283,000 70,668,000
Production expenses 6,566,000 9,292,000 20,800,000 22,630,000
General and administrative expenses 8,082,000 10,258,000 22,799,000 27,923,000
Interest expense 8,364,000 11,703,000 23,551,000 32,620,000
Provision for loan losses 8,509,000 5,700,000 25,441,000 25,163,000
Nonrecurring charges -- -- 28,108,000 --
------------ ------------ ------------ ------------
Total expenses 53,771,000 61,301,000 181,982,000 179,004,000
------------ ------------ ------------ ------------
Income before income taxes 30,309,000 7,171,000 57,767,000 55,034,000
Provision for income taxes 12,734,000 3,051,000 26,542,000 24,490,000
============ ============ ============ ============
Net income $ 17,575,000 $ 4,120,000 $ 31,225,000 $ 30,544,000
============ ============ ============ ============
Net income per share
Basic $ 0.64 $ 0.15 $ 1.20 $ 1.10
============ ============ ============ ============
Diluted $ 0.51 $ 0.15 $ 0.93 $ 0.95
============ ============ ============ ============
Dividends per share $ 0.03 $ 0.03 $ 0.10 $ 0.10
============ ============ ============ ============
Weighted average number
of shares outstanding
Basic 27,547,000 27,898,000 25,995,000 27,827,000
============ ============ ============ ============
Diluted 36,498,000 34,847,000 36,565,000 35,097,000
============ ============ ============ ============
</TABLE>
5
<PAGE> 5
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
1997 1998
------------ ------------
(AUDITED) (UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 26,902,000 $ 28,677,000
Loans held for sale, at lower of cost or market 242,987,000 173,565,000
Accounts receivable 59,180,000 25,928,000
Interest-only strips, estimated at fair market value 270,422,000 333,327,000
Mortgage servicing rights 21,641,000 28,619,000
Residual assets 112,827,000 176,201,000
Equipment and improvements, net 12,685,000 14,114,000
Prepaid and other 14,949,000 17,309,000
------------ ------------
Total assets $761,593,000 $797,740,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Borrowings $286,990,000 $286,990,000
Revolving warehouse facilities 137,500,000 126,500,000
Accounts payable and accrued expenses 29,297,000 34,350,000
Income taxes payable 39,452,000 53,484,000
------------ ------------
Total liabilities 493,239,000 501,324,000
------------ ------------
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;
27,758,800, and 28,154,000 shares outstanding 28,000 28,000
Additional paid-in capital 209,358,000 209,628,000
Retained earnings 58,968,000 86,760,000
------------ ------------
Total stockholders' equity 268,354,000 296,416,000
------------ ------------
Total liabilities and stockholders' equity $761,593,000 $797,740,000
============ ============
</TABLE>
6
<PAGE> 6
AAMES FINANCIAL CORPORATION
QUARTERLY FINANCIAL STATISTICS
<TABLE>
<CAPTION>
--------------------------------- ---------------------------------
QUARTER ENDED NINE MONTHS ENDED
Mar-97 Mar-98 Mar-97 Mar-98
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
ORIGINATION VOLUME:
BROKER NETWORK $ 177,587,000 $ 235,788,000 $ 508,189,000 $ 771,378,000
RETAIL* 135,532,000 165,018,000 351,501,000 455,856,000
CORRESPONDENT 297,640,000 170,090,000 885,863,000 482,464,000
----------------------------------------------------------------------
TOTAL $ 610,759,000 $ 570,896,000 $ 1,745,553,000 $ 1,709,698,000
----------------------------------------------------------------------
RETAIL WTD AVG COMM RATE 4.46% 4.16% 5.02% 4.35%
SERVICING PORTFOLIO: 2,721,900,000 4,030,900,000
LOAN SALES:
WHOLE LOANS SOLD $ -- $304,755,000 $ 7,532,000 $ 344,790,000
SECURITIZATIONS 633,146,000 299,985,000 1,762,675,000 1,409,263,000
SERVICING SPREAD ON SECURITIZATIONS 3.91% 3.91% 4.23% 3.98%
COMPONENTS OF REVENUE:
GAIN ON SALE OF LOANS $ 53,052,000 $ 33,755,000 $ 166,212,000 $ 130,919,000
NET UNREALIZED GAIN ON VALUATION
OF INTEREST-ONLY STRIPS 5,103,000 3,058,000 5,103,000 13,813,000
COMMISSIONS:
RETAIL 5,760,000 6,903,000 16,419,000 18,364,000
BROKER NETWORK 1,145,000 (15,000) 4,387,000 743,000
OTHER 681,000 627,000 2,367,000 1,424,000
LOAN SERVICE:
SERVICING SPREAD 5,898,000 6,830,000 12,445,000 18,251,000
PREPAYMENT FEES 1,678,000 2,629,000 3,898,000 8,247,000
LATE CHGS & OTHER SERV FEES 1,193,000 2,175,000 2,488,000 5,280,000
FEES & OTHER:
CLOSING 613,000 697,000 2,149,000 1,954,000
APPRAISAL 477,000 704,000 1,406,000 1,839,000
UNDERWRITING 211,000 282,000 1,159,000 822,000
INTEREST INCOME 8,105,000 10,761,000 21,149,000 31,870,000
OTHER 164,000 66,000 567,000 512,000
----------------------------------------------------------------------
TOTAL REVENUE $ 84,080,000 $ 68,472,000 $ 239,749,000 $ 234,038,000
----------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
* Includes 125 product, private investor repurchases and broker loans
at March 1997.
[End Tables]
7
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 28,677,000
<SECURITIES> 0
<RECEIVABLES> 582,048,000
<ALLOWANCES> 664,000
<INVENTORY> 173,565,000
<CURRENT-ASSETS> 783,626,000
<PP&E> 23,211,000
<DEPRECIATION> 9,097,000
<TOTAL-ASSETS> 797,740,000
<CURRENT-LIABILITIES> 214,334,000
<BONDS> 286,990,000
0
0
<COMMON> 28,000
<OTHER-SE> 296,388,000
<TOTAL-LIABILITY-AND-EQUITY> 797,740,000
<SALES> 234,038,000
<TOTAL-REVENUES> 234,038,000
<CGS> 22,630,000
<TOTAL-COSTS> 22,630,000
<OTHER-EXPENSES> 98,591,000
<LOSS-PROVISION> 25,163,000
<INTEREST-EXPENSE> 32,620,000
<INCOME-PRETAX> 55,034,000
<INCOME-TAX> 24,490,000
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 30,544,000
<EPS-PRIMARY> 1.10
<EPS-DILUTED> 0.95
</TABLE>
