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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
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<C> <S>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1999
OR
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<C> <S>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 0-19604
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AAMES FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 95-4340340
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
</TABLE>
350 SOUTH GRAND AVENUE, LOS ANGELES, CA 90071-3459
(Address of Registrant's principal executive offices including zip code)
(323) 210-5000
(Registrant's telephone number,
including area code)
NO CHANGES
(Former name, former address and former fiscal year,
if changed since last report)
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
AT FEBRUARY 11, 2000, REGISTRANT HAD 31,056,570 SHARES OF COMMON STOCK
OUTSTANDING.
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TABLE OF CONTENTS
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ITEM NO. PAGE NO.
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PART I--FINANCIAL INFORMATION
Item 1-- Financial Statements
Condensed Consolidated Balance Sheets at
December 31, 1999 and June 30, 1999............ 3
Condensed Consolidated Statements of Operations
for the three and six months ended December 31,
1999 and 1998.................................. 4
Condensed Consolidated Statements of Cash Flows
for the six months ended December 31, 1999 and
1998........................................... 5
Notes to Condensed Consolidated Financial
Statements..................................... 6
Item 2-- Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 8
PART II--OTHER INFORMATION
Item 1-- Legal Proceedings............................. 37
Item 2-- Changes in Securities......................... 37
Item 3-- Defaults Upon Senior Securities............... 37
Item 4-- Submission of Matters to a Vote of Security
Holders..................................................... 37
Item 5-- Other Information............................. 37
Item 6-- Exhibits and Reports on Form 8-K.............. 37
Signature Page.............................................. 38
</TABLE>
2
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AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 1999
------------ ---------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 16,018,000 $ 20,764,000
Loans held for sale, at lower of cost or market............. 371,728,000 559,869,000
Accounts receivable......................................... 58,853,000 56,964,000
Residual interests, at estimated fair market value.......... 342,595,000 332,327,000
Mortgage servicing rights, net.............................. 16,643,000 20,928,000
Equipment and improvements, net............................. 11,141,000 13,495,000
Prepaid and other........................................... 11,039,000 15,013,000
Income tax refund receivable................................ -- 1,737,000
------------ ---------------
Total assets............................................ $828,017,000 $1,021,097,0000
============ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Borrowings.................................................. $281,220,000 $ 281,220,000
Revolving warehouse and repurchase facilities............... 366,171,000 535,997,000
Accounts payable and accrued expenses....................... 51,927,000 50,505,000
Income taxes payable........................................ 8,571,000 7,819,000
------------ ---------------
Total liabilities....................................... 707,889,000 875,541,000
------------ ---------------
Commitments and contingencies............................... -- --
Stockholders' equity:
Series A Preferred Stock, par value $.001 per share;
500,000 shares authorized; none outstanding............. -- --
Series B Convertible Preferred Stock, par value $0.001 per
share; 29,704,000 and 100,000,000 shares authorized;
26,704,000 and 26,704,000 shares outstanding............ 27,000 27,000
Series C Convertible Preferred Stock, par value $0.001 per
share; 107,105,700 and 100,000,000 shares authorized;
101,106,000 and 75,046,000 shares outstanding........... 101,000 75,000
Common Stock, par value $.001 per share 400,000,000 and
50,000,000 shares authorized; 31,044,870 and 30,016,964
shares outstanding...................................... 31,000 31,000
Additional paid-in capital................................ 367,231,000 342,193,000
Retained deficit.......................................... (247,262,000) (196,770,000)
------------ ---------------
Total stockholders' equity.............................. 120,128,000 145,556,000
------------ ---------------
Total liabilities and stockholders' equity.............. $828,017,000 $ 1,021,097,000
============ ===============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------- ----------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1999 1998 1999 1998
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Revenue:
Gain on sale of loans.............. $ 9,553,000 $ 8,752,000 $ 31,350,000 $ 28,429,000
Write-down of residual interests
and mortgage servicing rights.... (35,190,000) (191,646,000) (35,190,000) (186,451,000)
Origination fees................... 10,371,000 9,633,000 21,758,000 21,784,000
Loan servicing..................... 4,420,000 6,847,000 8,175,000 13,116,000
Interest........................... 23,762,000 11,991,000 47,760,000 26,460,000
------------ ------------- ------------ -------------
Total revenue, including
write-down of residual
interests and mortgage
servicing rights............... 12,916,000 (154,423,000) 73,853,000 (96,662,000)
------------ ------------- ------------ -------------
Expenses:
Compensation....................... 22,370,000 19,907,000 45,482,000 43,701,000
Production......................... 6,974,000 10,559,000 15,615,000 21,489,000
General and administrative......... 17,031,000 13,784,000 31,302,000 27,172,000
Interest........................... 12,886,000 9,403,000 26,434,000 22,285,000
------------ ------------- ------------ -------------
Total expenses................... 59,261,000 53,653,000 118,833,000 114,647,000
------------ ------------- ------------ -------------
Loss before income taxes............. (46,345,000) (208,076,000) (44,980,000) (211,309,000)
Provision (benefit) for income
taxes.............................. 1,350,000 (12,331,000) 1,925,000 (13,408,000)
------------ ------------- ------------ -------------
Net loss............................. $(47,695,000) $(195,745,000) $(46,905,000) $(197,901,000)
============ ============= ============ =============
Net loss per share:
Basic.............................. $ (1.60) $ (6.31) $ (1.63) $ (6.39)
============ ============= ============ =============
Diluted............................ $ (1.60) $ (6.31) $ (1.63) $ (6.39)
============ ============= ============ =============
Dividends per share................ $ -- $ -- $ -- $ 0.03
============ ============= ============ =============
Weighted average number shares
outstanding:
Basic.............................. 31,027,000 31,007,000 31,018,000 30,992,000
============ ============= ============ =============
Diluted............................ 31,027,000 31,007,000 31,018,000 30,992,000
============ ============= ============ =============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
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AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
---------------------------------
DECEMBER 31, DECEMBER 31,
1999 1998
--------------- ---------------
<S> <C> <C>
Operating activities:
Net loss.................................................. $ (46,905,000) $ (197,901,000)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization........................... 2,926,000 2,469,000
Gain on sale of loans................................... (34,596,000) (35,716,000)
Valuation of residual interests and mortgage servicing
rights................................................ 35,190,000 186,451,000
Accretion of residual interests......................... (25,752,000) (8,243,000)
Mortgage servicing rights originated.................... (5,175,000) (6,194,000)
Mortgage servicing rights amortized..................... 4,460,000 5,955,000
Changes in assets and liabilities:
Loans held for sale originated or purchased........... (1,104,376,000) (1,275,276,000)
Proceeds from sale of loans held for sale............. 1,292,517,000 1,202,154,000
Decrease (increase) in:
Accounts receivable................................... (1,889,000) 2,228,000
Residual interests.................................... 19,890,000 22,629,000
Prepaid and other..................................... 3,974,000 (190,000)
Income tax refund receivable.......................... 1,737,000 --
Increase (decrease) in:
Accounts payable and accrued expenses................. 1,422,000 (4,961,000)
Income taxes payable.................................. 752,000 (18,378,000)
6.5% accrued preferred stock dividend................... (3,580,000) --
--------------- ---------------
Net cash provided by (used in) operating activities......... 140,595,000 (124,973,000)
--------------- ---------------
Investing activities:
Purchases of equipment and improvements................... (572,000) (3,260,000)
--------------- ---------------
Net cash used in investing activities....................... (572,000) (3,260,000)
--------------- ---------------
Financing activities:
Net proceeds from convertible preferred stock issuance.... 25,060,000 --
Proceeds from exercise of common stock options............ 2,000 235,000
Proceeds from borrowings.................................. -- 20,000,000
Proceeds from (reductions in) revolving warehouse and
repurchase facilities................................... (169,826,000) 108,488,000
Dividends paid............................................ -- (1,022,000)
Other..................................................... (5,000) --
--------------- ---------------
Net cash provided by (used in) financing activities......... (144,769,000) 127,701,000
--------------- ---------------
Net decrease in cash and cash equivalents................... (4,746,000) (532,000)
Cash and cash equivalents at beginning of period............ 20,764,000 12,322,000
--------------- ---------------
Cash and cash equivalents at end of period.................. $ 16,018,000 $ 11,790,000
=============== ===============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
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AAMES FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The condensed 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 condensed 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 and six months ended
December 31, 1999 are not necessarily indicative of the results expected for the
full fiscal year.
NOTE 2: SUBSIDIARY GUARANTORS
In October 1996, the Company completed an offering of its 9.125% Senior
Notes due 2003 which were guaranteed by all of the Company's operating
subsidiaries, all of which are wholly-owned. The guarantees are joint and
several, full, complete and unconditional. There are no restrictions on the
ability of such subsidiaries to transfer funds to the Company in the form of
cash dividends, loans or advances. The Company is a holding company with limited
assets or operations other than its investments in its subsidiaries. Separate
financial statements of the guarantors are not presented because the aggregate
total assets, net earnings and net equity of such subsidiaries are substantially
equivalent to the total assets, net earnings and net equity of the Company on a
consolidated basis.
NOTE 3: STOCKHOLDERS' EQUITY
On August 3, 1999, the Company received $25.0 million of additional capital
(the "Additional Investment") from a partnership controlled by Capital Z
Financial Services Fund, II, L.P., a Bermuda limited partnership ("Capital Z")
at which time the Company issued 25,000 additional shares of Series C
Convertible Preferred Stock, par value $0.001, for $1,000 per share. Net
proceeds to the Company from the Additional Investment, after issuance expenses,
were $24.8 million.
On September 24, 1999, the Company effected a 1,000-for-1 stock split to the
then outstanding shares of its Series B Convertible Preferred Stock and
Series C Convertible Preferred Stock. All authorized and outstanding Series B
and Series C Convertible Preferred Stock share amounts in the accompanying
condensed consolidated financial statements have been retroactively restated to
reflect the stock split.
On October 7, 1999, the Company received $4.2 million of capital from
existing holders of the Company's Common Stock in connection with its rights
offering of up to 31.0 million shares of Series C Convertible Preferred Stock to
stockholders (the "Rights Offering"). On October 27, 1999, the Company received
$20.8 million of capital from Capital Z in connection with Capital Z's standby
commitment to purchase up to $25.0 million unsubscribed shares in the Rights
Offering (the "Standby Commitment"). The Company issued an aggregate of
25.0 million shares of Series C Convertible Preferred Stock in the Rights
Offering and pursuant to the Standby Commitment of which net proceeds, after
issuance expenses, were approximately $24.0 million.
On October 1, 1999, the Company received $1.1 million of capital from
certain members of the Company's management team in the form of cash and
promissory notes and issued 1.1 million shares of Series C Convertible Preferred
Stock. The following table sets forth information regarding net loss per
6
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common share for the three and six months ended December 31, 1999 and 1998
(unaudited) (Dollars and weighted average number of shares in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1999 1998 1999 1998
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Basic net loss per common share:
Net loss......................................... $(47,695) $(195,745) $(46,905) $(197,901)
Plus: Accrued dividends on Series B and C
Convertible Preferred Stock.................... (2,039) ( --) (3,580) ( --)
-------- --------- -------- ---------
Net loss to common stockholders.................. $(49,734) $(195,745) $(50,485) $(197,901)
Weighted average number of common shares
outstanding.................................... 31,027 31,007 31,018 30,992
-------- --------- -------- ---------
Basic net loss per common share.................... $ (1.60) $ (6.31) $ (1.63) $ (6.39)
======== ========= ======== =========
Diluted net loss per common share:
Net loss to common stockholders.................. $(49,734) $(195,745) $(50,485) $(197,901)
Weighted average number of common shares
outstanding.................................... 31,027 31,007 31,018 30,992
======== ========= ======== =========
Diluted net loss per common share.................. $ (1.60) $ (6.31) $ (1.63) $ (6.39)
======== ========= ======== =========
</TABLE>
NOTE 4: RECLASSIFICATIONS
Certain amounts related to fiscal year 1999 have been reclassified to
conform to the fiscal year 2000 presentation.
NOTE 5: SUBSEQUENT EVENT
On February 11, 2000, the Company entered into a $200.0 million revolving
repurchase facility with an investment bank whose prior $90.0 million revolving
warehouse facility had recently expired (the "Facility"). The Facility has a
364-day term and is renewable upon maturity and at the sole discretion of the
lender for an additional 364-day term. Included in the Facility is a
$35.0 million working capital subline. The working capital subline is secured by
substantially all of the Company's previously unencumbered and pledgeable
residual interests, is subject to scheduled amortization payments, has an
initial 364 day term and is renewable for an additional 364 day term; and
thereafter, renewable on a month-to-month basis for an additional six month
period contingent upon, in all cases, that certain repayment, financial and
performance conditions are met. As part of the transaction, Capital Z, the
Company's largest shareholder, agreed to provide certain credit enhancements to
the lender for a portion of the working capital subline. In connection
therewith, the Company has agreed to pay Capital Z a $1 million fee.
In an effort to augment its core retail and broker production, the Company
hired a majority of the retail and broker loan production employees, and
acquired certain assets including loans in process, of another sub-prime
mortgage lender in January and February 2000.
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
Condensed Consolidated Financial Statements included in Item 1 of this
Form 10-Q.
SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION
This Report contains statements that constitute "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934 and
Section 27A of the Securities Act of 1933. The words "expect," "estimate,"
"anticipate," "predict," "believe," and similar expressions and variations
thereof are intended to identify forward-looking statements. Such statements
appear in a number of places in this filing and include statements regarding the
intent, belief or current expectations of the Company, its directors or officers
with respect to, among other things (a) market conditions in the securitization,
capital, credit and whole loan markets and their future impact on the Company's
operations, (b) trends affecting the Company's liquidity position, including,
but not limited to, its access to warehouse, working capital and other credit
facilities and its ability to effect securitizations and whole loan sales,
(c) the impact of the various cash savings plans and other restructuring
strategies being considered by the Company, (d) the Company's on-going efforts
in improving its equity position, (e) trends affecting the Company's financial
condition and results of operations, (f) the Company's plans regarding Year 2000
compliance and (g) the Company's business and liquidity strategies. The
stockholders of the Company are cautioned not to put undue reliance on such
forward-looking statements. Such forward-looking statements are not guarantees
of future performance and involve risks and uncertainties. Actual results may
differ materially from those projected in this Report, for the reasons, among
others, discussed under the captions "--Recent Developments" and "--Risk
Factors" and the other portions of Management's Discussion and Analysis of
Financial Condition and Results of Operations. The Company undertakes no
obligation to publicly revise these forward-looking statements to reflect events
or circumstances that arise after the date hereof. Readers should carefully
review the factors referred to above and the other documents the Company files
from time to time with the Securities and Exchange Commission, including the
Company's Annual Report on Form 10-K and Form 10-K/A for the fiscal year ended
June 30, 1999, the quarterly reports on Form 10-Q filed by the Company during
the remainder of fiscal 2000, and any current reports on Form 8-K filed by the
Company.
RECENT DEVELOPMENTS
The results for the quarter ended December 31, 1999 reflect the effects of
continuation of difficult market conditions on the Company's operations. The
Company lost $47.7 million for the quarter. The $47.7 million loss includes a
$35.2 write-down of the Company's residual interests and mortgage servicing
rights ("MSRs") during the quarter resulting from the Company's regular
quarterly evaluation of the carrying values. The write-down was taken due to
increased losses on loans included in the Company's securitization trusts, and
estimated increased costs of servicing loans in its portfolio. Exclusive of the
write-down, the Company had a net operating loss of approximately
$12.5 million.
On February 11, 2000, the Company secured $35.0 million in working capital
secured by certain of its residual interests and certain other collateral
through the renewal of a $90.0 million committed warehouse line which expired on
February 9, 2000. The committed warehouse line was increased to $200.0 million
and included a $35 million non-revolving working capital subline, which the
Company drew down on February 11, 2000. In light of the innovative and complex
aspects of this financing transaction, costs and commitments for future services
were higher than previously experienced by the Company for warehouse facilities.
These higher costs will be amortized to expense over the next twelve to
twenty-four months. Additionally, as part of the transaction, Capital Z, the
Company's largest shareholder, agreed to provide certain credit enhancements to
the lender for a portion of the working capital subline. In connection
therewith, the Company has agreed to pay Capital Z a $1 million fee.
8
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The Company increased its loan production to $580.9 million for the
December 1999 quarter from $523.5 million for the quarter-ended September 30,
1999. Loan production for the December quarter was also up $30.6 million from
the December 1998 quarter. Although loan production for the six months ended
December 31, 1999 of $1.1 billion has not yet recovered to the production levels
of $1.3 billion for the comparable six month period in the prior year, core
retail and broker production increased $12.9 million, offset by a
$183.8 million decrease in correspondent production resulting from the Company's
previously announced plans to focus on its core retail and broker production.
In an effort to augment its core retail and broker production, the Company
hired a majority of the retail and broker loan production employees, and
acquired certain assets including loans in process, of another sub-prime
mortgage lender in January and February 2000.
The Company sold $588.1 million and $1.3 billion of loans during the three
and six months ended December 31, 1999, respectively, compared to
$501.4 million and $1.2 billion of loans sold during the comparable periods for
1998. The Company's loan dispositions during the December 1999 quarter included
a $403.5 million securitization, and whole loan sales totaling $184.6 million,
reflecting the Company's strategy of disposition of loans through a combination
of securitizations and whole loan sales. The Company's loan dispositions during
the quarter ended December 31, 1998 consisted entirely of whole loan sales
totaling $501.4 million.
By completing the securitization of servicing retained mortgage loans during
the most recent quarter, the Company also increased its servicing portfolio, net
of run-off, by $52.0 million from the prior quarter to $3.9 billion, the second
consecutive quarterly increase. However, the servicing portfolio has not yet
recovered to the level at the quarter ended December 31, 1998, when the
portfolio stood at $4.4 billion.
The Company has current borrowing capacity under committed revolving
warehouse and repurchase facilities of $840.0 million (excluding the
$35.0 million working capital subline discussed above). The Company added an
additional $250.0 million revolving repurchase facility in October 1999, and
increased one of its committed warehouse facilities by $110.0 million to
$200.0 million (excluding the $35.0 million working capital subline) from
$90.0 million in February 2000, partially offsetting the expiration of a
$125.0 million repurchase facility at the end of February 2000, increasing its
committed warehouse capacity from $590.0 million at September 30, 1999. However,
as a result of the difficult market conditions which began in the quarter ended
December 31, 1998 and continuing through December 31, 1999, and the Company's
recent financial performance, including the prices the Company has received in
recent whole loan sales, certain of the Company's warehouse and repurchase
lenders advance less than 100% of the principal balance of the mortgage loans,
requiring the Company to use working capital to fund the remaining portion of
the principal balance of the mortgage loans.
The Company currently funds the majority of its mortgage loans at closing
through a warehouse facility which expires on February 29, 2000 (the "Concurrent
Funding Facility"). The Company is not permitted to use its other revolving
warehouse and repurchase facilities to fund mortgage loans at closing; instead,
the Company must use funds either from the Concurrent Funding Facility, or
working capital, to close the mortgage loans. After the mortgage loans are
closed, the Company can pledge them under one of its other revolving warehouse
or repurchase facilities to repay the Concurrent Funding Facility or replenish
working capital. The Company does not expect to renew the Concurrent Funding
Facility. The Company is seeking new revolving warehouse and repurchase
facilities which the Company can use to fund mortgage loans and meet its
expected funding needs; however, the Company does not expect to have access to a
new revolving warehouse or repurchase facility, prior to the expiration of the
Concurrent Funding facility on February 29, 2000. Moreover, commencing on
February 29, 2000, and until the Company is able to negotiate new warehouse or
repurchase facilities, the Company will be required to fund mortgage loans, and
until such mortgage loans can be transferred to another facility or sold,
exclusively out of working capital. This could restrict the ability of the
Company to continue to fund its mortgage loan production at current levels. See
"Liquidity and Capital Resources--Warehouse and Repurchase Facilities."
9
<PAGE>
As previously reported, the Company completed the final phase of its
recapitalization in October, 1999 through the successful completion of the
Rights Offering to its stockholders for $4.2 million and the Standby Commitment
from Capital Z for $20.8 million.
As previously reported, the Board of Directors appointed A. Jay Meyerson as
the Company's Chief Executive Officer, effective October 25, 1999, replacing
Mani A. Sadeghi, a director of the Company, who was serving as the Company's
Chief Executive Officer on an interim basis. Mr. Meyerson was also appointed to
the Board of Directors, effective November 1, 1999, to replace George W. Coombe
who resigned. The Board of Directors also appointed David H. Elliot to the Board
effective December 2, 1999 to replace Neil B. Kornswiet who resigned. Also as
previously reported, Mr. Kornswiet no longer serves as an officer of the
Company.
The Company continues to focus on its core business strategy, which consists
of: (i) continuing to focus on its core loan production units; (ii) increasing
its servicing portfolio and servicing capabilities; and (iii) diversifying its
funding sources to become self-financing (i.e., the ability to obtain sufficient
lines of credit to provide financing for assets created by the Company and the
reduction of reliance on the public equity and debt markets). In particular, the
Company intends to employ the following strategies:
FOCUS ON CORE LOAN PRODUCTION. The Company intends to evaluate expansion
opportunities in its retail and broker operations by improving market
penetration in existing locations and evaluating other potential locations and
by building new relationships with independent mortgage brokers, with the goal
of increasing market share in these areas. The Company regularly reviews its
loan offerings and introduces new loan products to further meet the needs of its
customers and increase its core loan production volume. However, no assurance as
to the Company's ability to accomplish this goal can be given.
INCREASE SERVICING PORTFOLIO AND INCREASE MARGINS. The Company plans to
continue to build the size of its servicing portfolio to provide a stable and
significant source of recurring revenue. The Company expects to increase slowly
the size of its loan servicing portfolio by continuing to increase loan
originations and selling a portion of its loan production through new
securitizations. However, no assurance as to the Company's ability to accomplish
this goal can be given.
CONTINUE TO DIVERSIFY FUNDING SOURCES AND BECOME SELF-FINANCING. The
Company intends to continue to expand and diversify its funding sources by
adding additional warehouse or repurchase facilities, disposing of a portion of
its loan production for cash in the whole loan market, and developing new
sources for working capital. However, no assurance as to the Company's ability
to accomplish this goal can be given.
The strategies discussed above contain forward-looking statements. Such
statements are based on current expectations and are subject to risks,
uncertainties and assumptions, including those discussed under "Risk Factors."
Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those anticipated, estimated or projected. Thus, no assurance can be given that
the Company will be able to accomplish the above strategies.
GENERAL
The Company is a consumer finance company primarily engaged, through its
subsidiaries, in the business of originating, purchasing, selling, and servicing
home equity mortgage loans secured by single family residences. Upon its
formation in 1991, the Company acquired Aames Home Loan, a home equity lender
founded in 1954. In August 1996, the Company acquired One Stop Mortgage, Inc.
("One Stop") which originates mortgage loans primarily through a broker network.
In 1999, the Company consolidated its loan production channels into one company
and the retail and broker production channels (including the former One Stop)
now operate under the name "Aames Home Loan."
10
<PAGE>
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, and to a lesser extent, to
purchase homes.
LOAN ORIGINATION. The Company originates and purchases loans nationally
through three production channels-retail, broker and correspondent. In recent
quarters, the Company has emphasized its core retail and broker loan production
channels and decreased its reliance on correspondent purchases. The Company
underwrites and appraises every loan it originates and generally reviews
appraisals and re-underwrites all loans it purchases.
The following table presents the volume of loans originated and purchased by
the Company during the periods presented:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- -----------------------
1999 1998 1999 1998
-------- ----------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Loans originated and purchased:
Broker Network.............................. $365,992 $289,492 $ 697,538 $ 640,293(1)
Retail...................................... 202,574 197,937 381,790 426,114
Correspondent............................... 12,286 62,789 25,047 208,868
-------- -------- ---------- ----------
Total......................................... $580,852 $550,218 $1,104,375 $1,275,275
======== ======== ========== ==========
</TABLE>
- ------------------------
(1) Includes $14.4 million of commercial loans.
Total loan production for the three months ended December 31, 1999 was
$580.9 million, up $57.4 million, or 11.0% from the $523.5 million reported for
the quarter ended September 30, 1999 and up $30.6 million, or 5.6%, from the
$550.2 million in origination reported for the quarter ended December 31, 1998.
Loan origination from the Company's broker channels increased to $366.0 million
during the December 1999 quarter, up $34.5 million, or 10.4%, from the
$331.5 million reported for the three months ended September 30, 1999 and up
$76.5 million, or 26.4%, from the $289.5 million reported for the three months
ended December 31, 1998. The Company's retail production increased
$23.4 million during the quarter ended December 31, 1999 from the September 30,
1999 quarter and $4.7 million from the December 30, 1998 quarter. Although this
reflects the second consecutive quarterly increase in retail production, the
Company's retail production has not yet recovered to the production levels
achieved in the quarter ended September 30, 1998. Moreover, the increase in the
Company's retail production in the December 1999 quarter from that in the
comparable 1998 quarter is attributable, in part, to the fact that the Company's
retail production during the December 1998 quarter was constrained by limited
warehouse capacity during the December 1998 quarter. Correspondent production
during the three months ended December 31, 1999 declined $500,000 to
$12.3 million from $12.8 million during the quarter ended September 30, 1999,
but declined $50.5 million from $62.8 million in the comparable quarter a year
ago. The decline in correspondent production during the December 1999 quarter
reflects the Company's previously reported decision to decrease its reliance on
this channel for loan production.
Total loan production for the six months ended December 31, 1999 was
$1.1 billion, a decrease of $170.9 million, or 13.4%, from the $1.3 billion
reported in the comparable six month period a year ago. Correspondent production
decreased $183.8 million during the six months ended December 31, 1999 to
$25.0 million from $208.9 million in the comparable six month period a year ago
reflecting the Company's decreased reliance on this production channel. While
the Company's broker loan production was up
11
<PAGE>
$57.2 million during the six months ended December 31, 1999 from levels during
the comparable 1998 period, retail production declined $44.3 million for the
period and continues to be negatively affected by a rising interest rate
environment, increased pricing in response thereto and other underwriting
changes to respond to adverse conditions in the mortgage refinance market. The
Company expects current market conditions to continue which could adversely
impact the Company's future loan production levels.
In the later part of the quarter ended December 31, 1999, the Company
commenced originating loans through the internet, through an affiliation with
certain internet lending sites. Included in the retail production volumes for
the three and six months ended December 31, 1999 is $6.1 million of loans
originated through this production channel.
The following table sets forth the number of retail branch and broker
offices operated by the Company at December 31, 1999 and 1998:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1999 1998
-------- --------
<S> <C> <C>
Retail branch offices....................................... 105 110
Broker offices.............................................. 21 48
</TABLE>
The decline between December 31, 1998 and 1999 in the number of retail
branches reflects the Company's efforts in closing smaller, less productive
centralized retail channel branch offices. The decline between December 31, 1998
and 1999 in the number of broker offices reflects the Company's decision, as
part of cost reduction efforts, to close unprofitable branches and to
regionalize its back office operations including the underwriting, loan
processing and appraisal review functions while maintaining its national network
of loan officers dealing with individual loan brokers within its markets across
the country.
LOAN SECURITIZATIONS AND SALES. As a fundamental part of its business and
financing strategy, the Company sells its loans to third party investors in the
secondary market as market conditions allow. The Company maximizes opportunities
in its loan disposition transactions by disposing of its loan production through
a combination of securitizations and whole loan sales, depending on market
conditions, profitability and cash flows. The Company generally realizes higher
gain on sale on securitization than it does on whole loan sales for cash. The
higher gain on sale in securitizations transactions is attributable to the
excess servicing spread and mortgage servicing rights associated with retaining
a residual interest and the servicing on the mortgage loans in the
securitization, respectively, net of transactional costs. In a monoline-insured
securitization, the underlying securities are over-collateralized by the Company
depositing a combination of mortgage loans with a principal balance exceeding
the principal balance of the securities, and cash into the securitization, which
requires a cash outflow. In whole loan sales with servicing released, the gain
on sale is generally lower than gains realized in securitizations, but the
Company receives the gain in the form of cash. The following table sets forth
certain information regarding the Company's securitizations and whole loan sales
during the three and six months ended December 31, 1999 and 1998 (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------- -----------------------
1999 1998 1999 1998
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Loans pooled and sold in
securitizations................ $403,492 $ -- $ 803,557 $ 649,999
Whole loan sales................. 184,617 501,358 477,218 547,124
-------- -------- ---------- ----------
Total loans securitized and
sold......................... $588,109 $501,358 $1,280,775 $1,197,123
======== ======== ========== ==========
</TABLE>
The Company's loan dispositions during the three and six months ended
December 31, 1999 reflected the Company's current business strategy of a
combination of securitizations and whole loan sales.
12
<PAGE>
However, the Company's loan dispositions during the six months ended
December 31, 1998 reflect the dramatic shift in market conditions that occurred
in early fiscal 1999. During the three months ended September 30, 1998, the
Company primarily relied upon securitizations for its loan dispositions. During
the quarter ended December 31, 1998, the asset-backed market remained weak, and
inaccessible to, or impracticable for, the Company, and therefore, the Company
relied solely upon whole loan sales for cash during that quarter.
LOAN SERVICING. The Company retains the servicing on the loans it
originates or purchases and securitizes. The following table sets forth certain
information regarding the Company's servicing portfolio at December 31, 1999 and
1998 (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
-------------------------- ----------
1999 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Servicing portfolio............... $3,922,000(1) $4,429,000(2) $3,841,000(3)
Serviced in-house................. 3,586,000(1) 4,429,000(2) 3,428,000(3)
</TABLE>
- ------------------------
(1) Includes $136.4 million of loans subserviced for others by the Company on an
interim basis.
(2) Includes $248.0 million of loans subserviced for others by the Company on an
interim basis.
(3) Includes $84.0 million of loans subserviced for others by the Company on an
interim basis.
The Company's loan servicing portfolio at December 31, 1999 increased to
$3.9 billion from $3.8 billion reported at June 30, 1999, reflecting the
Company's $803.6 million of securitizations during the six months ended
December 31, 1999, net of loan servicing portfolio run-off during the period.
The Company's loan servicing portfolio at December 31, 1999 declined to
$3.9 billion from $4.4 billion at December 31, 1998 reflecting the Company's
reliance on whole loan sales with servicing released from October 1998 until
consummation of $803.6 million of securitizations during the six month period
ended December 31, 1999.
At December 31, 1999, of the Company's $3.9 billion servicing portfolio,
91.4% was serviced in-house compared to 100% of the Company's $4.4 billion
servicing portfolio serviced in-house at December 31, 1998. During the quarter
ended June 30, 1999, the Company entered into two arrangements in order to
reduce its servicing advance obligations. In the first arrangement, a loan
servicing company purchased certain cumulative advances and agreed to make
future servicing advances with respect to an aggregate of $388.0 million
($335.7 million at December 31, 1999) in principal amount of loans. In the
second arrangement, an investment bank purchased certain cumulative advances and
undertook the obligation to make a substantial portion of the Company's advance
obligations on its pre-1999 securitization trusts.
The growth of the Company's servicing portfolio will be impacted by the
Company's sales of whole loans on a servicing released basis which will result
in lower growth than historical periods when the Company predominately sold its
loan production in securitizations. Should prepayments be faster in future
periods, such portfolio run off could lead to a smaller servicing portfolio in
spite of a return to securitization. Nevertheless, the Company believes that the
business of loan servicing provides a more consistent revenue stream and is less
cyclical than the business of loan origination and disposition. See "Risk
Factors."
CERTAIN ACCOUNTING CONSIDERATIONS
ACCOUNTING FOR SECURITIZATIONS. The Company's loan disposition strategy
relies on a combination of securitization transactions and whole loan sales. See
"General--Loan Securitization and Sales." The following discusses certain
accounting considerations which arise only in the context of 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
13
<PAGE>
represented by the non-cash gain on sale of loans. The cash proceeds are raised
through an offering of the pass-through certificates or bonds evidencing the
right to receive principal payments on the securitized loans and the interest
rate on the certificate balance or on the bonds. The non-cash gain on sale of
loans represents the difference between the proceeds (including premiums) from
the sale, net of related transaction costs, and the allocated carrying amount of
the loans sold. The allocated carrying amount is determined by allocating the
original cost basis amount of loans (including premiums paid on loans purchased)
between the portion sold and any retained interests (residual interests), based
on their relative fair values at the date of transfer. The residual interests
represent, over the estimated life of the loans, the present value of the
estimated future cash flows. These cash flows are determined by 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%),
a monoline insurance fee, if any, and an estimate for loan losses. In quarters
where the Company engaged in a securitization transaction, net gains or losses
in valuation of residual interests and mortgage servicing rights include the
recognition of a gain or loss which represents the initial difference between
the allocated carrying amount and the fair market value of the residual
interests at the date of sale. Each agreement that the Company has entered into
in connection with its securitizations requires either the overcollateralization
of the trust or the establishment of a reserve account that may initially be
funded by cash deposited by the Company.
The Company determines the present value of the cash flows at the time each
securitization transaction closes using certain estimates made by management at
the time the loans are sold. These estimates include: (i) future rate of
prepayment; (ii) discount rate used to calculate present value; and
(iii) credit losses on loans sold. The future cash flows represent management's
best estimate. Management monitors the performance of the loans, and any changes
in the estimates are reflected in earnings. There can be no assurance of the
accuracy of management's estimates.
RATE OF PREPAYMENT. The estimated life of the securitized loans depends
on the assumed annual prepayment rate which is a function of estimated
voluntary (full and partial) and involuntary (liquidations) prepayments. The
prepayment rate represents management's expectations of future prepayment
rates based on prior and expected loan performance, the type of loans in the
relevant pool (fixed or adjustable rate), the production channel which
produced the loan, prevailing interest rates, the presence of prepayment
penalties, the loan-to-value ratios and the credit grades of the loans
included in the securitization and other industry data. The rate of
prepayment may be affected by a variety of economic and other factors. For
the quarters up to and including September 30, 1998, prepayment rates used
by the Company were held constant, i.e. flat, over the life of the pool. The
estimates used by the Company for the quarters up to and including
September 30, 1998 were flat prepayment rates ranging from 26% for fixed to
30.5% for adjustable and hybrid loan products. These rates represented a
weighted average loan life of approximately 2.6 to 3.8 years. During the
quarter ended December 31, 1998, the Company changed its estimate of
prepayment rates from a flat constant prepayment rate to a vectored rate,
which more closely approximates the performance of the securitized loans.
The new vectored prepayment rates peak at approximately 29% for fixed and
approximately 42% to 57% for adjustable rate loans. These revised prepayment
rates resulted in a weighted average life of approximately 2.9 years.
During the three months ended December 31, 1999, the Company evaluated
actual prepayment trends of mortgage loans in its securitized pools. That
evaluation indicated that the Company's previously used assumed annual
prepayment rates required modification. Accordingly, during the quarter
ended December 31, 1999, the Company changed its estimate of prepayment
rates to peak at approximately 27% for fixed rate mortgage loans and
approximately 41% for adjustable rate mortgage loans. These revised
prepayment rates result in a weighted average life of approximately 3.0
years.
The impact of the change in prepayment speeds amounted to a favorable
adjustment of approximately $21.1 million to the Company's residual assets
during the three months ended December 31, 1999.
14
<PAGE>
DISCOUNT RATE. In order to determine the fair value of the cash flow
from the residual interests, the Company discounts the cash flows based upon
rates prevalent in the market. For the quarters up to and including
September 30, 1998, the Company used the weighted average interest rates of
the loans included in the pool as the best estimate available as an
appropriate discount rate to determine fair value. As the market
deteriorated in the quarter ended December 31, 1998, it became apparent that
a change in discount rate would be required in order for the estimate of
fair value to be consistent with market conditions. For quarters commencing
with the quarter ended December 31, 1998, the Company used a discount rate
of 15% to reflect current market conditions and the appropriate rate of
return given the inherent risk of the related asset.
CREDIT LOSSES. In determining the estimate for credit losses on loans
securitized, the Company uses assumptions that it believes are reasonable
based on information from its prior securitizations, the loan-to-value
ratios, credit grades of the loans included in the current securitizations
and other industry data. For the quarters up to and including September 30,
1998, the Company used a prospective cumulative loan loss estimate of
approximately 1.4% of the balance of the loans in the securitization pools
as an appropriate estimate to determine fair value. As market conditions
deteriorated in the quarter ended December 31, 1998, the Company refined its
estimate of credit losses by expanding the factors it considers in
developing its credit loss estimates to include loss and delinquency
information by channel, credit grade and product, and information available
from other market participants such as investment bankers, credit providers
and credit agencies. Accordingly, the Company increased its prospective
cumulative loan loss estimate at December 31, 1998. The Company entered the
December 31, 1999 quarter with a prospective cumulative loss estimate of
2.4% of the remaining balance of the loans in its securitized pools. At
December 31, 1999, the Company adjusted its prospective cumulative loss
estimate to 3.6% of the remaining balance of the loans in its securitized
pools in light of higher than expected credit losses. The Company previously
disclosed that if actual losses exceeded management's assumptions, the
Company would be required to take a charge to earnings. The change in the
credit loss estimate resulted in a $51.3 million unfavorable adjustment to
the Company's residual interest assets during the quarter ended
December 31, 1999. The increase in the prospective cumulative loss estimate
was primarily related to current credit loss experience related to loans
purchased in bulk transactions from correspondents during fiscal years 1996
and 1997, and loans acquired through certain brokers during the same period.
As previously reported, the Company has eliminated its bulk purchase
program; however, the seasoning of the lower credit grade bulk portfolio may
continue to contribute to an increase in losses over time.
The Company incurred losses on liquidations of $41.9 million for the six
months ended December 31, 1999 compared to losses of $20.5 million for the
six months ended December 31, 1998. The recent increase in losses on
liquidations principally reflects losses in the portfolio of lower credit
grade correspondent loans purchased in bulk sales, together with the
Company's efforts to improve its liquidity by accelerating delinquent loan
loss resolution through early disposition of REO and acceptance of less than
full principal payoffs in certain cases. As previously disclosed, the
Company has also incurred losses on mortgage loans having lower than average
balances and secured by properties having low appraised values. Although
such loans were originated by correspondents and brokers with whom the
Company has since ceased doing business, the Company may incur continued
losses on these loans. While the Company has eliminated its bulk purchase
program, the seasoning of the lower grade bulk portfolio may continue to
contribute to increased losses over time. The Company believes that its
practice of early disposition of REO and accepting short principal payoffs
in certain cases is more cost effective than incurring longer-term, and
generally higher costs (including interest advances in the securitizations)
associated with extended REO holding periods or with migration of delinquent
loans through the foreclosure process.
The Company believes its efforts in early problem credit intervention
result in higher loss trends in the near term, but do not necessarily
increase the absolute level of losses. However, the Company
15
<PAGE>
closely monitors its residual interests and should higher loss levels
continue, it will incorporate this factor into its normal quarterly
valuation of its residual interests.
The residual interests are recorded at estimated fair value and are marked
to market through a charge (or credit) to earnings. On a quarterly basis, the
Company reviews the fair value of the residual interests by analyzing its
prepayment, discount rate and loss assumptions in relation to its actual
experience and current rates of prepayment and loss prevalent in the industry
and may adjust or take a charge to earnings through an adjustment to net gain or
loss on valuation of residual interests. In its regular quarterly review of its
residual interests, the Company considered the historical performance of its
securitized loan pools, the recent prepayment experience of those pools, the
credit performance of previously securitized loans and other industry data.
During the three months ended December 31, 1999, the Company adjusted its
residual interests downward by $30.2 million through a charge to income. This
write-down resulted from the Company's regular review during the quarter of the
recent credit loss performance and prepayment trends of loans in its securitized
pools. See "Credit Losses" above.
Additionally, upon sale or securitization of servicing retained mortgages,
the Company capitalizes the fair value of MSRs 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 Company uses an interest rate
of 15% to discount these cash flows. The capitalized cost basis 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 rights. This review is performed on a disaggregated basis for the
predominant risk characteristics of the underlying loans which are loan type and
origination date. During the three months ended December 31, 1999, the Company
adjusted its MSRs downward by $5.0 million reflecting management's estimate of
the effects of increased costs associated with the Company's increased early
intervention efforts in servicing delinquencies in the portfolio.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." In July 1999, the FASB issued SFAS 137
which deferred the effective date of SFAS 133 to fiscal years beginning after
June 15, 2000. SFAS No. 133 requires companies to record derivatives on the
balance sheet as assets and liabilities, measured at fair value. Gains and
losses resulting from changes in the values of those derivatives would be
accounted for in earnings. Depending on the use of the derivative and the
satisfaction of other requirements, special hedge accounting may apply. The
Company has not determined the impact that adoption of this standard will have
on its future consolidated financial statements.
16
<PAGE>
RESULTS OF OPERATIONS--THREE AND SIX MONTHS ENDED DECEMBER 31, 1999 AND 1998
The following table sets forth information regarding the components of the
Company's revenue and expenses for the three and six months ended December 31,
1999 and 1998 (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1999 1998 1999 1998
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Revenue:
Gain on sale of loans............................ $ 9,553 $ 8,752 $ 31,350 $ 28,429
Write-down of residual interests and mortgage
servicing rights............................... (35,190) (191,646) (35,190) (186,451)
Origination fees................................. 10,371 9,633 21,758 21,784
Loan service..................................... 4,420 6,847 8,175 13,116
Interest income.................................. 23,762 11,991 47,760 26,460
-------- --------- -------- ---------
Total revenue, including write-down................ 12,916 (154,423) 73,853 (96,662)
-------- --------- -------- ---------
Expenses:
Compensation..................................... 22,370 19,907 45,482 43,701
Production....................................... 6,974 10,559 15,615 21,489
General and administrative....................... 17,031 13,784 31,302 27,172
Interest......................................... 12,886 9,403 26,434 22,285
-------- --------- -------- ---------
Total expenses..................................... 59,261 53,653 118,833 114,647
-------- --------- -------- ---------
Loss before income taxes........................... (46,345) (208,076) (44,980) (211,309)
Provision (benefit) for income taxes............... 1,350 (12,331) 1,925 (13,408)
-------- --------- -------- ---------
Net loss........................................... $(47,695) $(195,745) $(46,905) $(197,901)
======== ========= ======== =========
</TABLE>
REVENUE
Total revenue for the three and six months ended December 31, 1999 was
$12.9 million and $73.9 million, respectively, as compared to $(154.4) million
and $(96.7) million for the three and six months ended December 31, 1998,
respectively. The 1999 period revenues include a $35.2 million write-down of the
Company's residual interests and MSRs taken during the quarter ended
December 31, 1999 resulting from the Company's regular quarterly evaluation of
the carrying values of such residual interests and MSRs which indicated that a
valuation adjustment was warranted due to the credit loss experience of loans in
its securitized trusts and estimated increased costs of servicing loans in its
servicing portfolio. See "Certain Accounting Considerations--Accounting for
Securitizations--Credit Losses." Total revenues in the 1998 periods include a
$191.6 million write-down of the Company's residual interests charged against
income during the three months ended December 31, 1998. As previously reported,
the valuation adjustment in 1998 reflects the impact that adverse existing
market conditions at the time had on the prepayment, loss and discount rate
assumptions applied by the Company in estimating the fair value of its residual
interests. Excluding the aforementioned valuation adjustments, revenues for the
three and six months ended December 31, 1999 were $48.1 million and
$109.0 million, respectively, compared to $37.2 million and $89.8 million,
respectively, for the comparable periods in 1998.
Gain on sale for the three months ended December 31, 1999 was $9.6 million,
an $801,000 increase from the $8.8 million gain on sale reported during the
comparable three month period a year ago. Gain on sale for the six months ended
December 31, 1999 was $31.4 million, a $2.9 million increase from the
$28.4 million gain on sale reported in the comparable six month period in 1998.
Gain on sale for the three and six months ended December 31, 1999 reflects the
Company's current loan disposition strategy of a combination of securitizations
and whole loan sales. During the quarter ended December 31, 1999, the
17
<PAGE>
Company securitized $403.5 million of loans and sold $184.6 million in loans in
whole loan sales. During 1998's comparable quarter, however, the Company
determined the asset-backed market that existed during the quarter made it
impracticable for the Company to complete a securitization, and therefore the
Company relied solely on the whole loan market for loan dispositions and sold
$501.4 million of mortgage loans during that quarter. Also negatively impacting
gain on sale during the three months ended December 31, 1998 was the Company's
need to sell loans on an expedited basis to free up limited warehouse capacity
that existed during the quarter ended December 31, 1998. During the six months
ended December 31, 1999, the Company's securitized and sold in the whole loan
market $803.6 million and $477.2 million, respectively, as compared to
$650.0 million and $547.1 million, respectively, in the comparable six month
period in 1998. The gains associated with the Company's securitizations and
whole loan sales during the six months ended December 31, 1999 were lower than
the gains associated with the securitizations and whole loan sale transactions
during the six months ended December 31, 1998. The gain on sale for the
securitizations in the three and six months ended December 31, 1999 were lower
than historical gains due to, among other things, market conditions at the time
of the securitizations and the Company's adoption of revised gain related
assumptions implemented during the three months ended December 31, 1998. As
previously reported, gain on sale for the six months ended December 31, 1998 was
adversely affected by a $13.5 million hedge loss recorded in the period. As of
and during the six months ended December 31, 1999, the Company had no hedge
positions in place.
Origination fee revenue is primarily comprised of points charged on mortgage
loans originated by the Company and, to a lesser extent, other fees charged in
the loan origination process. Origination fee revenue in the form of points is
primarily a function of the volume of mortgage loans originated by the Company
through its retail channel, the credit grade of the loans originated and the
weighted average points charged on such loans. Deferred origination fee revenue
recognized during the period is attributable to the mix in the composition of
loans being either securitized or sold in whole loan sales in excess of the
loans originated during the same periods. The recognition of deferred
origination fee revenue during a period coincides with the recognition of
deferred compensation expense during the same period. See "Expenses.".
Origination fee revenue during the three months ended December 31, 1999 was
$10.4 million, up $700,000, or 7.7% from $9.6 million during the three months
ended December 31, 1998. Origination fee revenue for the three months ended
December 31, 1999 includes $508,000 of recognized deferred origination fee
revenue relating to prior periods' loan production. Origination fee revenue for
the three months ended December 31, 1998 is net of $2.1 million of origination
fee revenue deferred to future periods. Net of the effects of the recognition or
deferral of deferred origination fee revenue, during the three months ended
December 31, 1999 origination fee revenue decreased $1.8 million to
$9.9 million from $11.7 million during the comparable period a year ago despite
the $4.6 million increase in the Company's loan production volumes in its retail
units.
Origination fee revenue during the six months was $21.8 million during both
the six months ended December 31, 1999 and 1998. Origination fee revenue for the
six months ended December 31, 1999 includes $2.0 million of deferred origination
fee revenue recognized during the period relating to prior periods' loan
production. Origination fee revenue for the six months ended December 31, 1998
is net of $1.8 million of origination fees related loan production deferred to
future periods. Net of the effects of recognition or deferral of deferred
origination fee revenue, during the six months ended December 31, 1999
origination fee revenue decreased $3.8 million to $19.8 million from
$23.6 million during the comparable period a year ago reflecting the decrease in
the Company's loan production volumes in its retail units.
Origination fee revenue earned in future periods could be reduced by recent
changes in the Company's pricing strategies that place a higher emphasis on
coupon rates rather than points at origination.
Loan service revenue decreased to $4.4 million in the three months ended
December 31, 1999 from $6.8 million during the three months ended December 31,
1998. Loan service revenue decreased to
18
<PAGE>
$8.2 million during the six months ended December 31, 1999 from $13.1 million
during the comparable six month period in 1998. Loan service revenue consists of
prepayment fees, late charges and other fees retained by the Company; and,
servicing fees earned on securitized pools, reduced by the subservicing costs
and amortization of the Company's MSRs. The decrease in loan service revenue
during the three and six months ended December 31, 1999 from the comparable
periods in 1998 was due primarily to expenses incurred in the periods for
subservicing arrangements and monthly servicing advances being handled by third
parties that were not in place a year ago. To a lesser extent, the decrease is
due to the decline in the balance of loans serviced by the Company during the
current periods when compared to the 1998 periods. See "General--Loan
Servicing."
The delinquency rate at December 31, 1999 declined to 14.5% from 16.3% at
December 31, 1998 and 15.7% at June 30, 1999. The decline in delinquencies is
due primarily to the Company's strategy of increasing early collection
intervention efforts on one payment delinquencies within applicable grace
payment periods. The Company has historically experienced delinquency rates that
are higher than those prevailing in this industry due to its origination of
lower credit grade loans. At the close of fiscal year 1997, the Company started
to focus more on higher credit grade loans which the Company believes will cause
delinquencies in the Company's servicing portfolio to decrease in the future.
The Company's sale of a portion of its loan production in the whole loan market
on a servicing released basis will diminish growth of the servicing portfolio.
The seasoning of older loans in a slow growing or declining portfolio could
cause delinquency rates to rise.
During the six months ended December 31, 1999, REO losses increased to
$41.9 million from $20.6 million in the comparable prior year period primarily
due to the seasoning of the lower credit grade loans purchased in bulk and
included in the Company's earlier trusts. See "Certain Accounting
Considerations--Accounting for Securitizations--Credit Losses." Further, the
adverse market conditions that have existed since the fall of 1998 have resulted
in the tightening in underwriting guidelines by purchasers of whole loans and
the insolvency of several large subprime home equity lenders. These factors have
had the effect of decreasing the availability of credit to delinquent lower
credit grade borrowers who in the past had avoided default by refinancing.
During the three months ended December 31, 1999, the Company's evaluation of the
trend in credit losses included in its normal quarterly valuation of its
residual interests resulted in a $30.2 million charge to income. See "Certain
Accounting Considerations--Accounting for Securitizations--Credit Losses."
19
<PAGE>
The following table sets forth delinquency, foreclosure, and loss
information of the Company's servicing portfolio for the periods indicated:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED JUNE 30, DECEMBER 31,
------------------------------------------ --------------------------
1999 1998 1997 1999 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)(4)
One month..................... 2.4% 3.8% 4.3% 2.1% 4.0%
Two months.................... 1.0% 1.3% 1.9% 0.9% 1.2%
Three or more months:
Not foreclosed(4)(5).......... 10.3% 9.0% 8.1% 9.4% 9.4%
Foreclosed(6)................. 2.0% 1.5% 1.0% 2.1% 1.7%
---------- ---------- ---------- ---------- ----------
Total....................... 15.7% 15.6% 15.3% 14.5% 16.3%
========== ========== ========== ========== ==========
Percentage of dollar amount of
loans foreclosed during the
period to servicing
portfolio(4)(8)............. 2.9% 2.0% 1.5% 1.9% 1.3%
Number of loans foreclosed
during the period(6)........ 1,680 1,125 560 1,004 785
Principal amount of foreclosed
loans during the period..... $ 122,445 $ 84,613 $ 48,029 $ 73,831 $ 57,814
Net losses on liquidations
during the period(7)........ $ 51,730 $ 26,488 $ 5,470 $ 41,925 $ 20,575
Percentage of annualized
losses to servicing
portfolio(4)(8)............. 1.2% 0.7% 0.2% 2.2% 1.0%
Servicing portfolio at period
end......................... $3,841,300 $4,147,000 $3,174,000 $3,922,000 $4,429,000
</TABLE>
- ------------------------
(1) Delinquent loans are loans for which more than one payment is due.
(2) The delinquency and foreclosure percentages are calculated on the basis of
the total dollar amount of mortgage loans serviced by the Company, and any
subservicers as of the end of the periods indicated.
(3) At December 31, 1999, the dollar volume of loans delinquent more than
90 days in 10 of the Company's REMIC trusts, exceeded the permitted limit in
the related pooling and servicing agreements. Three of those REMIC trusts,
plus one additional REMIC trust, have also exceeded certain loss limits. See
"--Certain Accounting Considerations" and "--Risk Factors".
(4) The servicing portfolio used in the percentage calculations includes loans
subserviced for others by the Company on an interim basis of $84.0 million,
$82.0 million, $-0-, $136.3 million, and $248.0 million for the periods
ended June 30, 1999, June 30, 1998, June 30, 1997, December 31, 1999, and,
December 31, 1998, respectively.
(5) Represents loans which are in foreclosure but as to which foreclosure
proceedings have not concluded
(6) Represents properties acquired following a foreclosure sale and still
serviced by the Company.
(7) Represents losses, net of gains, on foreclosed properties sold during the
period indicated.
20
<PAGE>
(8) The percentages for periods subsequent to June 30, 1998 were calculated to
reflect the dollar volume of loans foreclosed or annualized losses, as the
case may be, to the average dollar amount of mortgage loans serviced by the
Company and any subservicers during the related periods indicated.
Interest income includes interest on loans held for sale, interest on
short-term overnight investments and accretion income associated with the
Company's residual interests. Interest income during the three months ended
December 31, 1999 increased $11.8 million to $23.8 million from $12.0 million
during the three months ended December 31, 1998. During the six months ended
December 31, 1999, interest income was $47.8 million, up $21.3 million, from
$26.5 million reported during the comparable period a year ago. Interest income
increased during the three and six months ended December 31, 1999 over the
comparable 1998 periods due primarily to higher accretion on Company's residual
interests due to a higher level of residuals recorded as a consequence of
securitization activity in the 1999 periods that was absent a year ago, and use
of a higher discount rate during the six months ended December 31, 1999 over the
comparable period in 1998. To a lesser extent, the increase in interest income
is attributable to weighted average interest rates on higher balances of loans
held for sale during the three and six months ended December 31, 1999 when
compared to such rates and balances during the comparable periods in 1998.
EXPENSES
Total expenses increased $5.6 million to $59.3 million during the three
months ended December 31, 1999 from $53.7 million during the comparable period
in 1998 and increased $4.2 million to $118.8 million for the six months ended
December 31, 1999 from $114.6 million during the six months ended December 31,
1998. The overall increases in total expenses during the three and six months
ended December 31, 1999 from amounts reported in the comparable 1998 periods are
attributable to increases in compensation, general and administrative and
interest expense, partially offset by a decline between periods in production
costs.
Compensation expense during the three months ended December 31, 1999
increased $2.5 million, or 12.4%, to $22.4 million from $19.9 million during the
three months ended December 31, 1998. Compensation expense for the three months
ended December 31, 1999 includes $743,000 of deferred direct compensation costs
associated with loans originated in prior periods that were disposed of in
either whole loan sales or in the securitization consummated during the quarter.
Compensation expense for the three months ended December 31, 1998, however, is
net of $1.2 million of direct compensation costs associated with loans
originations which were deferred to future periods pending disposition of the
loans in either whole loans sales or securitizations. Net of the effects of the
recognition or the deferral of direct compensatory costs, compensation expense
during the quarter ended December 31, 1999 declined $500,000 to $21.6 million
from $22.1 million during the comparable period a year ago despite a $30.6
million increase in loan production during the quarter from loan production
levels in the same period a year ago, primarily reflecting cost reduction
efforts taken by the Company to reduce compensatory costs.
Compensation expense during the six months ended December 31, 1999 increased
$1.8 million, or 4.1%, to $45.5 million from $43.7 million during the six months
ended December 31, 1998. Compensation expense for the six months ended
December 31, 1999 includes $3.1 million of deferred direct compensation costs
associated with loans originated in prior periods that were disposed of in
either whole loan sales or in the securitization consummated during the period,
and also includes $1.0 million of nonrecurring severance costs incurred during
the quarter ended September 30, 1999. Compensation expense for the six months
ended December 31, 1998 is net of $1.5 million of direct compensation costs
associated with loans originations which were deferred to future periods pending
disposition of the loans in either whole loans sales or securitizations. Net of
the effects of the recognition or the deferral of direct compensatory costs,
compensation expense for the six months ended December 31, 1999 declined
$2.8 million to $42.4 million from $45.2 million during the comparable period
from a year ago which reflects costs reduction efforts undertaken by the
Company.
21
<PAGE>
Production expense, primarily advertising, outside appraisal costs, travel
and entertainment, and credit reporting fees is generally related to the
Company's loan origination volume. Production expense during the three months
ended December 31, 1999 decreased $3.6 million, or 34%, to $7.0 million from
$10.6 million during the three months ended December 31, 1998. During the six
months ended December 31, 1999 production expense decreased $5.9 million, or
27%, from $21.5 million during the comparable six months in 1998. The decreases
in production expense during the three and six months ended December 31, 1999
from the comparable periods in 1998 is due primarily to the Company closing
smaller, less productive centralized retail channel branch offices and
transferring other branches to its decentralized retail channel which has lower
advertising costs. As part of its cost reduction efforts, the Company has
focused on reducing its advertising expenses by improving the efficiency and
penetration of its advertising strategies. Additionally, in December 1999, in an
effort to further reduce production costs, the Company commenced the practice of
having prospective borrowers pay for appraisal costs prior to incurrence of the
appraisal expense during the loan origination process. Prior thereto, the
Company did not charge customers for appraisals unless and until their loans
closed, and absorbed as a production expense appraisal costs incurred for loan
applications where the prospective applicants' loans were not closed and funded.
Production expense expressed as a percentage of total loan origination volume
for the three months ended December 31, 1999 was 1.2% compared to 1.9% during
the comparable three month period in 1998. The decrease in the percentage
reflects the decline in production expense during the December 1999 quarter from
the 1998 quarter despite a $30.6 million increase in total loan production
between the two periods. Production expense expressed as a percentage of total
loan origination volume for the six months ended December 31, 1999 was 1.4%
compared to 1.7% during the comparable six month period in 1998. The decrease in
the percentage of production expense to total loan origination volume for the
six months ended December 31, 1999 from the similar percentage in the comparable
1998 period is due primarily to the decline between periods in the level of
production costs and, to a lesser extent, the decline in total loan origination
volume in the six months ended December 31, 1999 from the same period a year
ago.
General and administrative expenses increased $3.2 million and $4.1 million
to $17.0 million and $31.3 million during the three and six months ended
December 31, 1999 from $13.8 million and $27.2 million during the comparable
three and six month periods in 1998. The increases were primarily attributable
to the Company's decision to utilize outside professional advisors on specific
operational projects, primarily to support the two servicing advance facilities
the Company put in place to reduce its servicing advance obligations, Y2K
compliance related issues, and miscellaneous operational charges taken by the
Company, partially offset by declines in the Company's communication and
miscellaneous expenses. The Company reviewed its accounts receivable consisting
of servicing advances made by the Company in connection with its securitized
pools and valued such receivables to reflect their fair market value at
December 31, 1999. This valuation resulted in a write-down in the amount of
$2.0 million and was recorded in the quarter ended December 31, 1999. As part of
the Company's on-going costs savings program, it ceased activities in certain
retail and broker branches that were deemed unprofitable by management or as
part of the regionalization of branches in the broker network. The office space
for some of the closed branches remains subject to operating leases that
management is attempting to sublease or terminate. The Company is also
attempting to sublet significant space at its headquarter office located at 350
South Grand Avenue in downtown Los Angeles. If such office space is subleased at
lease rates less than existing base lease terms or if the lease commitments are
bought out as a consequence of a negotiated lease termination, the Company could
incur a significant one-time charge.
22
<PAGE>
Interest expense increased $3.5 million and $4.2 million to $12.9 million
and $26.4 million for the three and six months ended December 31, 1999,
respectively, from $9.4 million and $22.3 million for the comparable three and
six month periods in 1998, respectively. The increase in interest expense in the
three and six months ended December 31, 1999 from levels reported in the
comparable 1998 periods resulted primarily from increased borrowings at higher
interest rates under various revolving warehouse and repurchase facilities to
fund the origination and purchase of mortgage loans prior to their
securitization or sale in the secondary market. Interest expense is expected to
increase in future periods due to the Company's continued reliance on external
financing arrangements to fund its operations.
INCOME TAXES
During the three and six months ended December 31, 1999, the Company
recorded an income tax provision of $1,350,000 and $1,925,000, respectively, and
such provisions relate exclusively to the Company's estimate for taxes on excess
inclusion income on its REMIC trusts. During the three and six months ended
December 31, 1998, the Company recorded estimated tax benefits of $12.3 million
and $13.4 million, respectively, which were net of tax valuation adjustments
recorded to account for estimated non-realizable deferred tax assets. The
investment in the Company by Capital Z resulted in a change in control for
income tax purposes thereby limiting future net operating loss and certain other
future deductions.
FINANCIAL CONDITION
LOANS HELD FOR SALE. The Company's portfolio of loans held for sale
decreased to $371.7 million at December 31, 1999 from $559.9 million at
June 30, 1999. The decline is due to the Company's $803.6 million of
securitizations and $477.2 million of whole loan sales in the secondary markets
during the six months ended December 31, 1999, partially offset by the Company's
loan production during the period.
ACCOUNTS RECEIVABLE. Accounts receivable, representing servicing fees and
advances and other receivables, increased to $58.9 million at December 31, 1999
from $57.0 million at June 30, 1999. Included in accounts receivable at
June 30, 1999 was $25.0 million of estimated proceeds from the Additional
Investment which were subsequently received by the Company in August 1999. The
level of servicing related advances, in any given period, is dependent upon
portfolio delinquencies, the levels of REO and loans in the process of
foreclosure and the timing of cash collections. The increase in the Company's
accounts receivable since June 30, 1999 is primarily attributable to advances on
delinquent loans in the two securitizations closed during the six month period
and continued advances on seriously deliquent loans. Loans in such
securitizations are not eligible for funding under arrangements the Company made
with an investment bank in the quarter ended June 30, 1999 to make a portion of
the Company's servicing advances on pre-1999 securitization.
RESIDUAL INTERESTS. Residual interests increased to $342.6 million at
December 31, 1999 from $332.3 million at June 30, 1999 reflecting residual
interests recognized in the Company's securitizations in the six months ended
December 31, 1999, plus accretion during the same period, net of the
$30.2 million write-down during the three months ended December 31, 1999.
MORTGAGE SERVICING RIGHTS, NET. Mortgage servicing rights, net, decreased
to $16.6 million at December 31, 1999 from $20.9 million at June 30, 1999
reflecting the capitalization of mortgage servicing rights on the
securitizations during the six months ended December 31, 1999, net of
amortization during the period and the $5.0 million write-down during the three
months ended December 31, 1999.
EQUIPMENT AND IMPROVEMENTS, NET. Equipment and improvements, net, decreased
to $11.1 million at December 31, 1999 from $13.5 million at June 30, 1999 due to
depreciation and amortization outpacing current period equipment and improvement
acquisitions during the six months ended December 31, 1999.
23
<PAGE>
PREPAID AND OTHER ASSETS. Prepaid and other assets declined to
$11.0 million at December 31, 1999 from $15.0 million at June 30, 1999. The
$1.7 million of income tax refunds receivable at June 30, 1999 were realized in
cash during the six months ended December 31, 1999.
BORROWINGS. Amounts outstanding under borrowings at December 31, 1999
remained unchanged from the $281.2 million outstanding at June 30, 1999. In
January 2000, the Company reduced borrowings by $5.8 million by making a
regularly scheduled sinking fund payment on its 10.5% Senior Notes.
REVOLVING WAREHOUSE FACILITIES. Amounts outstanding under revolving
warehouse and repurchase facilities decreased to $366.2 million at December 31,
1999 from $536.0 million at June 30, 1999, primarily as the result of the
decrease in loans held for sale due to whole loan sales and the securitizations
during the six months ended December 31, 1999, partially offset by the Company's
loan production during the period. Proceeds from whole loan sales and
securitizations are used to reduce balances outstanding under the Company's
revolving warehouse and repurchase facilities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations require continued access to short-term and
long-term sources of cash. The Company's primary operating cash requirements
include: (i) the funding of mortgage loan originations and purchases prior to
their securitization and sale, (ii) fees, expenses and hedging costs, if any,
incurred in connection with the securitization and sale of loans, (iii)
overcollateralization or reserve requirements in connection with the
securitization, (iv) ongoing administrative, operating, and tax expenses,
(v) interest and principal payments under the Company's warehouse and repurchase
credit facilities and other existing indebtedness, (vi) advances in connection
with the Company's servicing portfolio and (vii) costs associated with
realigning the Company's core production units.
The Company has historically financed its operating cash requirements
primarily through: (i) warehouse and repurchase facilities, (ii) working capital
financing facilities, (iii) the securitization and sale of mortgage loans, and
(iv) the issuance of debt and equity securities.
WAREHOUSE AND REPURCHASE FACILITIES. The Company generally relies on
warehouse and repurchase facilities to originate and purchase mortgage loans and
hold them prior to securitization and sale. Prior to the global economic crises
that existed in early fiscal 1999, the Company retained access to warehouse and
other credit facilities with borrowing limits aggregating in excess of
$1.0 billion. However, during the December 1998 quarter, changes in advance
rates imposed by lenders effectively limited the Company to a single
$300.0 million committed warehouse line until the initial investment by Capital
Z on February 10, 1999. As previously reported, with the Capital Z investment,
the Company was able to obtain other committed and uncommitted revolving
warehouse and repurchase facilities. The Company had committed revolving
warehouse and repurchase facilities in the amount of $790.0 million during the
quarter ended December 31, 1999 and an uncommitted warehouse line of
$100.0 million. Of the $790.0 million of committed facilities available at
December 31, 1999, $90.0 million expired on February 9, 2000, $150.0 million
(which is to be reduced to $125.0 million on February 15, 2000) expires on
February 29, 2000, $300.0 million expires on March 31, 2000 and the remaining
$250.0 million expires on October 29, 2000. On February 11, 2000, the Company
renewed the $90.0 million facility which expired and increased the borrowing
limit under the facility by $110.0 million to $200.0 million (less any amount
outstanding under its working capital subline described below).
The Company currently uses the Concurrent Funding Facility which expires on
February 29, 2000 to fund the majority of its mortgage loans at closing. The
Company is not permitted to use its other revolving warehouse and repurchase
facilities to fund mortgage loans at closing; instead, the Company must use
funds either from the Concurrent Funding Facility, or working capital, to close
the mortgage loans. After the mortgage loans are closed, the Company can pledge
them under one of its other revolving warehouse or repurchase facilities to
repay the Concurrent Funding Facility or replenish working capital. The
24
<PAGE>
Company does not expect to renew the Concurrent Funding Facility. The Company is
seeking new revolving warehouse and repurchase facilities which the Company can
use to fund mortgage loans and meet its expected funding needs; however, the
Company does not expect to have access to a new revolving warehouse or
repurchase facility, prior to the expiration of the Concurrent Funding Facility
on February 29, 2000. Moreover, commencing on February 29, 2000, and until the
Company is able to negotiate new warehouse or repurchase facilities, the Company
will be required to fund mortgage loans, and until such mortgage loans can be
transferred to another facility or sold, exclusively out of working capital.
This could restrict the ability of the Company to continue to fund its mortgage
loan production at current levels. A reduction in mortgage loan production will
negatively impact the profitability of the Company. If loan fundings are reduced
due to a lack of funding or capital alternatives, ongoing operations may be
jeopardized, which would negatively impact profitability and jeopardize the
Company's ability to continue to operate as a going concern.
All of the Company's revolving warehouse and repurchase facilities contain
provisions requiring the Company to meet certain periodic financial covenants,
including among other things, minimum liquidity, stockholders' equity and net
earning income levels. Due to, among other things, the $47.7 million loss for
the quarter, including the $35.2 write-down of its residual interests and
mortgage servicing rights, the Company needed to seek and obtained amendments to
all of its revolving warehouse and repurchase facilities to amend their
respective financial covenants, as it would have been otherwise unable to meet
those covenants. If the Company is unable to meet these financial covenants
going forward, or for any other reason is unable to maintain existing warehouse
or repurchase lines or renew them when they expire, it would have to cease loan
production operations which would negatively impact profitability and jeopardize
the Company's ability to continue to operate as a going concern.
WORKING CAPITAL FINANCING FACILITIES. The Company has historically relied
on working capital lines to help it fund its servicing advance obligations. In
April 1999, the Company reduced its servicing advance obligations by engaging a
loan servicing company to subservice two of the Company's securitization trusts,
pursuant to which, the loan service company assumed the obligations to make all
future advances on those two trusts. The Company also sold to the loan servicing
company the outstanding servicing advances on those two trusts for approximately
$13.0 million. In June 1999, in order to further reduce its servicing advance
obligations, the Company entered into an arrangement with an investment bank
pursuant to which the bank purchased certain cumulative advances and undertook
the obligation to make a substantial portion of the Company's advance
obligations on its pre-1999 securitization trusts.
The Company also requires working capital to originate mortgage loans.
Historically, the Company has had access to warehouse and repurchase facilities
which advanced up to 100% of the principal balance of the mortgage loans to the
Company. However, as a result of the difficult current market conditions which
began in the quarter ended December 31, 1998, and the Company's recent financial
performance, including the prices the Company has received in recent whole loan
sales, certain of the Company's warehouse and repurchase lenders advance less
than 100% of the principal balance of the mortgage loans, requiring the Company
to use working capital to fund the remaining portion of the principal balance of
the mortgage loans. The Company also requires working capital to fund mortgage
loans at closing. See "Liquidity and Capital Resources--Warehouse and Repurchase
Facilities."
On February 11, 2000, the Company secured $35.0 million in working capital
secured by certain of its residual interests and certain other collateral
through the renewal of a $90.0 million committed warehouse line which expired on
February 9, 2000. The committed warehouse line was increased to $200.0 million
and included a $35 million non-revolving working capital subline, which the
Company drew down on February 11, 2000. As part of the transaction, Capital Z,
the Company's largest shareholder, agreed to provide certain credit enhancements
to the lender for a portion of the working capital subline. In connection
therewith, the Company has agreed to pay Capital Z a $1 million fee.
25
<PAGE>
Under the terms of the Company's Indenture dated October 21, 1996 with
respect to its 9.125% Senior Notes due 2003, the Company's ability to incur
certain additional indebtedness, including residual financing, is limited to two
times stockholders' equity. Warehouse indebtedness is generally not included in
the indebtedness limitations. As a result of the loss for the quarter ended
December 31, 1999, the Company is restricted from incurring additional
indebtedness as defined in the Indenture. The Company's repurchase and warehouse
facilities also contain limits on the Company's ability to incur additional
indebtedness. Further, until the Company receives investment grade ratings for
the notes issued under the Indenture, the amount of assets allocable to
post-September 1996 securitizations which the Company may pledge to secure debt
is limited by the Indenture to 75% of the difference between such
post-September 1996 residuals and servicing advances and $225.0 million. The
Company pledged certain residuals to secure the working capital subline. Under
the terms of the working capital subline, the Company is required to pledge
additional residual interests in an amount equal to $10.0 million in order to
maintain the scheduled amortization and maturity of the subline. The Company
does not anticipate having available additional residual interests to finance in
the near term. This could restrict the Company's ability to borrow to provide
working capital as needed in the future.
THE SECURITIZATION AND SALE OF MORTGAGE LOANS. The Company's ability to
sell loans originated and purchased by it in the secondary market through
securitizations and whole loan sales is necessary to generate cash proceeds to
pay down its warehouse and repurchase 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. See "--Risk Factors--A Prolonged
Interruption or Reduction in the Secondary Market Would Hurt Our Financial
Performance."
The Company securitized $403.5 million and $803.6 million of loans held for
sale during the three and six months ended December 31, 1999, respectively. The
Company did not securitize loans held for sale during the three months ended
December 31, 1998, but did complete a $650.0 million securitization during the
quarter ended September 30, 1998. The gain on sale recognized on securitizations
during the three and six months ended December 31, 1999 was lower than
historical gains due, among other things, to market conditions at the time of
the securitizations, and the Company's adoption of the revised assumptions
during the quarter ended December 31, 1998. See "--Certain Accounting
Considerations--Accounting for Securitizations." In connection with
securitization transactions, the Company is generally 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 maximums.
Overcollateralization requirements for certain pools increase up to
approximately twice the level otherwise required when the delinquency rates or
realized losses for those pools exceed the specified limit. As of December 31,
1999, the Company was required to maintain an additional $56.6 million in
overcollateralization amounts as a result of the level of its delinquency rates
and realized losses above that which would have been required to be maintained
if the applicable delinquency rates and realized losses had been below the
specified limit. Of this amount, at December 31, 1999, $24.3 million remains to
be added to the overcollateralization amounts from future spread income on the
loans held by these trusts.
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 cash flows are received and
applicable reserve or overcollateralization requirements are met.
26
<PAGE>
During the three and six months ended December 31, 1999, the Company sold
loans for cash in whole loan sales with servicing released of $184.6 million and
$477.2 million, respectively, compared to $501.4 million and $547.1 million
during the three and six months ended December 31, 1998, respectively. The
Company currently has in place two forward commitments for whole loan sales. One
of the commitments, entered into in May 1999, expires in May, 2000 and has a
minimum and maximum commitment amount of $500.0 million and $1.5 billion,
respectively, of which approximately $189.6 million of loans had been sold at
December 31, 1999. The other commitment was secured in November 1999, expires in
November 2000 and has a minimum and maximum commitment amount of $300.0 and
$600.0 million, respectively, of which approximately $112.1 million of loans had
been sold at December 31, 1999.
THE ISSUANCE OF DEBT AND EQUITY SECURITIES. The Company has historically
funded negative cash flow primarily from the sale of its equity and debt
securities. However, current market conditions have restricted the Company's
ability to access its traditional equity and debt sources. In December 1991,
July 1993, June 1995 and October 1996, the Company effected public offerings and
in April 1998 effected a private placement of its common stock with net proceeds
to the Company aggregating $217.0 million. In the private placement, the Company
also issued warrants to purchase an aggregate additional 6.3 million shares (as
adjusted) of the Company's common stock at an exercise price of $7.67 (as
adjusted), subject to customary anti-dilution provisions. The warrants are
exercisable only upon a change in control of the Company and expire in
April 2001. 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
$112.0 million. In October 1996, the Company completed an offering of its 9.125%
Senior Notes due 2003 with net proceeds to the Company of $145.0 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 December 31, 1999, under the most restrictive of such covenants,
the Company had no money available for the payment of such distributions and
does not expect to have the ability to pay dividends for the foreseeable future.
The Company has raised $127.9 million through the sale of preferred stock in
several phases to Capital Z and its designees, certain members of the Company's
management and holders of the Company's common stock. The Company raised
$76.8 million in February 1999, $25.0 million in August 1999 and $25.0 million
($4.2 million in the Rights Offering and $20.8 million pursuant to the Standby
Commitment) in October 1999 which was accrued at September 30, 1999. In
October 1999, the Company also issued $1.1 million of preferred stock to certain
management investors. In connection with the sale of stock to Capital Z, the
Company also issued warrants to affiliates and employees of an affiliate of
Capital Z to purchase an aggregate of 2.5 million shares of the Company's common
stock for $1.00 per share.
The Company's primary sources of liquidity are expected to be fundings under
revolving warehouse and repurchase facilities and whole loan sales and the
monetization of the Company's servicing advances. See "Liquidity and Capital
Resources." If the Company's access to warehouse lines, working capital or the
securitization or whole loan markets is restricted, or cash savings are not
realized through the implementation of the Company's cost reduction efforts, the
Company may have to seek additional equity. Further, if available at all, the
type, timing and terms of financing selected by the Company will be dependent
upon the Company's cash needs, the availability of other financing sources,
limitations under debt covenants and the prevailing conditions in the financial
markets. There can be no assurance that any such sources will be available to
the Company at any given time or that favorable terms will be available. As a
result of the limitations described above, the Company may be restricted in the
amount of loans that it will be able to produce and sell. This would negatively
impact profitability and jeopardize the Company's ability to continue to operate
as a going concern.
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YEAR 2000 COMPLIANCE AND TECHNOLOGICAL ENHANCEMENT
RISKS OF THE COMPANY'S YEAR 2000 ISSUES. The most significant risk
associated with the Company's Year 2000 compliance would result from the loss of
the Company's vendor supported servicing system and the inability to maintain
the ongoing loan service operations, including payment processing, collections
and investor remittance processing. Another Year 2000 risk relates to the
Company's two vendor supported loan origination systems for its different
production channels. In the event of Year 2000 issues with respect to the
software used with either such system, the Company's ability to originate loans
would be diminished and may result in reduced loan production until the problem
is resolved.
The Company completed the Year 2000 compliance program including the testing
efforts by December 31, 1999. The Company did not incur any disruptions to the
normal operations as a result of any Year 2000 issues encountered during the
rollover to January 1, 2000. The Company will continue to monitor key dates in
the current year. The Company has no reason to believe that any Year 2000 issues
will occur later in the current year.
RISK MANAGEMENT
The Company is currently re-evaluating its current hedging policy, and at
December 31, 1999 had no hedge transactions in place. While the Company monitors
the interest rate environment and has employed fixed rate hedging strategies in
the past, there can be no assurance that the earnings of the Company would not
be adversely affected during any period of unexpected changes in interest rates
or prepayment rates.
FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES
SALE OF LOANS--SECURITIZATIONS AND WHOLE LOAN SALES--INTEREST RATE
RISK. The most significant variable in the determination of gain on sale in a
securitization is the spread between the weighted average coupon on the
securitized loans and the pass-through interest rate. In the interim period
between loan origination or purchase and securitization or sale of such loans,
the Company is exposed to interest rate risk. The majority of loans are
securitized or sold within 90 days of origination or purchase. However, a
portion of the loans are held for sale or securitization for as long as
12 months (or longer in very limited circumstances) prior to securitization or
sale. If interest rates rise during the period that the mortgage loans are held,
for securitized loans the spread between the weighted average interest rate on
the loans to be securitized and the pass-through interest rates on the
securities to be sold (the latter having increased as a result of market rate
movements) would narrow, and reduce the Company's related gain on sale upon
securitization. For loans sold in whole loan sales, if interest rates rise while
the loans are held, the gain on sale recognized by the Company may be reduced.
In the past, the Company mitigated exposure to rising interest rates through
swap agreements with third parties that sell United States Treasury securities
not yet purchased and the purchase of Treasury Put Options. Hedge gains or
losses are initially deferred and subsequently included in gain on sale upon
completion of the securitization or whole loan sale. These hedging activities
help mitigate the risk of absolute movements in interest rates but they do not
mitigate the risk of a widening in the spreads between pass-through certificates
and U.S. Treasury securities with comparable maturities. At December 31, 1999
and during the three and six months then ended, the Company did not have any
hedge transactions in place. Accordingly, during the three and six months ended
December 31, 1999, there were no hedge losses in gain on sale. At September 30,
1998, the Company had outstanding notional balances of Treasury swap agreements
in the amount of $85 million. This position, which was terminated by the Company
on December 31, 1998, had a market value at September 30, 1998 of $80 million.
The Company recorded the related hedge loss at September 30, 1998 for the
$4.6 million shortfall in the gain on sale for that period. The Company had a
similar swap agreement in the notional amount of $250.0 million which expired on
September 30, 1998 and had a market value at June 30, 1998 of $248 million. Due
to market conditions in the quarter ended September 30, 1998, this position
deteriorated to a loss of $10.7 million which was
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recorded in gain on sale during the three months ended September 30, 1998. The
Company also had LIBOR cap contracts outstanding at September 30, 1998 in the
notional amount of $7.2 million. These positions were valued at par at
September 30, 1998 as their contractual cap (strike price) exceeded the LIBOR
market rate at September 30, 1998. The September 30, 1998 position expired
December 23, 1998. These instruments had no negative risk above the original
premiums paid in cash.
RESIDUAL INTERESTS AND MSRS. The Company had residual interests of
$342.6 million and $332.3 million outstanding at December 31, 1999 and June 30,
1999, respectively. The Company also had MSRs outstanding at December 31, 1999
and June 30, 1999 in the amount of $16.6 million and $20.9 million,
respectively. Both of these instruments are recorded at amounts that approximate
estimated fair value at December 31, 1999 and June 30, 1999. Residual interests
and MSRs increased during the six months ended December 31, 1999, reflecting the
residual interests and MSR's recognized on the Company's securitizations during
the period, plus accretion during the quarter, partially offset by the
$35.2 million write-down. See "Certain Accounting Considerations--Accounting for
Securitizations". The Company values these assets based on the present value of
future revenue streams net of expenses using various assumptions. The discount
rate used to calculate the present value of the residual interests and MSRs was
15.0% both at December 31, 1999 and June 30, 1999. The weighted average life
used for valuations at December 31, 1999 and June 30, 1999 was 2.9 years.
These assets are subject to risk in accelerated mortgage prepayment or
losses in excess of assumptions used in valuation. Ultimate cash flows realized
from these assets would be reduced should prepayments or losses exceed
assumptions used in the valuation. Conversely, cash flows realized would be
greater should prepayments or losses be below expectations.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The Company's financial instruments
recorded at contractual amounts that approximate market or fair value primarily
consist of loans held for sale, accounts receivables and revolving warehouse and
repurchase facilities which are short term in nature and/or generally bear
market rates of interest, thus, the carrying amounts of these instruments are
reasonable estimates of their fair values. The carrying amount of the Company's
borrowings approximate fair value when valued using available quoted market
prices.
CREDIT RISK. The Company is exposed to on-balance sheet credit risk related
to its loans held for sale and residual interests. The Company is exposed to
off-balance sheet credit risk related to loans which the Company has committed
to originate or purchase.
The Company is a party to financial instruments with off-balance sheet
credit risk in the normal course of business, including commitments to extend
credit to borrowers. The Company has a first or second lien position on all of
its loans, and the combined loan-to-value ratio ("CLTV") permitted by the
Company's mortgage underwriting guidelines generally may not exceed 90%. In some
cases, the Company originates loans up to 97% CLTV that are insured down to
approximately 67% with mortgage insurance. The CLTV represents the combined
first and second mortgage balances as a percentage of the appraised value of the
mortgaged property at the time of origination, with the appraised value
determined by an appraiser with appropriate professional designations. A title
insurance policy is required for all loans.
WAREHOUSING EXPOSURE. The Company utilizes warehouse and repurchase
financing facilities to facilitate the holding of mortgage loans prior to
securitization or sale. At December 31, 1999, the Company had total committed
revolving warehouse and repurchase facilities available in the amount of
$790.0 million and the total outstanding related to these facilities was
$366.2 million. At June 30, 1999, the Company had total committed revolving
warehouse and repurchase facilities available of $590.0 million and the
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total outstanding related to those facilities was $536.0 million. Warehouse and
repurchase facilities are typically for a term of one year or less and are
designated to fund mortgages originated within specified underwriting
guidelines. The majority of the assets remain in the facilities for a period of
up to 90 days at which point they are either securitized or sold to
institutional investors. As these amounts are short term in nature and/or
generally bear market rates of interest, the contractual amounts of these
instruments are reasonable estimates of their fair values.
RISK FACTORS
IF OUTSIDE SOURCES OF CASH ARE NOT SUFFICIENT, OUR ABILITY TO MAKE AND
SERVICE LOANS WILL BE IMPAIRED AND OUR REVENUES WILL SUFFER.
We operate on a negative cash flow basis, which means our cash expenditures
exceed our cash earnings. Therefore, we need continued access to short- and
long-term external sources of cash to fund our operations.
Our primary uses of cash include:
- mortgage loan originations and purchases before their securitization or
sale in the secondary market;
- fees, expenses and hedging costs, if any, incurred for the securitization
of loans;
- cash reserve accounts or overcollateralization required in the
securitization of loans;
- tax payments generally due on recognition of non-cash gain on sale
recorded in the securitizations;
- ongoing administrative and other operating expenses;
- interest and principal payments under our credit facilities and other
existing indebtedness;
- cash advances made on delinquent loans included in our loan servicing
portfolio; and
- costs of expanding our loan production units.
Our primary sources of cash are expected to be warehouse and repurchase
facilities, transactions by which we monetize our servicing advance receivables,
securitizations and whole loan sales.
Our primary and potential sources of cash as described in the paragraph
above should be sufficient to fund our cash requirements through at least the
next 12 months, assuming the Company successfully closes a new warehouse
facility which provides for concurrent funding or receives additional equity
capital. If available at all, the type, timing and terms of financing selected
by us will be dependent upon our cash needs, the availability of other financing
sources, limitations under debt covenants and the prevailing conditions in the
financial markets. However, we are not sure that these sources of cash will be
available when needed. Even if the sources of cash are available, the providers
of cash may impose terms that are not favorable to us. As a result of the
limitations described above, we may be restricted in the amount of loans that we
will be able to produce and sell.
IF WE ARE UNABLE TO MAINTAIN ADEQUATE FINANCING SOURCES, OUR ABILITY TO MAKE
MORTGAGE LOANS WILL BE IMPAIRED AND OUR REVENUES WILL SUFFER.
We use cash draws under credit facilities, referred to as revolving
warehouse and repurchase facilities, to fund new originations and purchases of
mortgage loans before securitization or sale. We currently have four committed
lines with aggregate borrowing capacity of $840.0 million (excluding a
$35.0 million working capital subline). The facility which the Company uses to
fund the majority of its mortgage loans at closing expires on February 29, 2000,
and it is unlikely the Company will renew that facility. The remaining existing
facilities expire between March 2000 and October 2000 and no assurances can be
given that we will be able to extend or replace these facilities at the times
they mature. We recently entered into a transaction
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pursuant to which we sold certain accounts receivable representing servicing
advances we had previously made and engaged an investment bank to make a
substantial portion of future servicing advances on substantially all of the
loans in our servicing portfolio. As servicer of the loans we securitize, we are
required to advance, or loan, to the trusts delinquent interest. In addition, as
servicer, we advance to the trusts foreclosure related expenses, and certain tax
and insurance remittances relating to loans serviced. To the extent that we are
unable to maintain existing credit facilities, arrange new warehouse, repurchase
or other credit facilities or obtain additional commitments to sell whole loans
for cash, we may have to curtail making loans. This would have a material
adverse effect on our financial position and results of operations and
jeopardize our ability to continue to operate as a going concern.
OUR RIGHT TO SERVICE LOANS MAY BE TERMINATED BECAUSE OF THE HIGH
DELINQUENCIES AND LOSSES ON THE LOANS IN OUR SERVICING PORTFOLIO.
If, at any measuring date, the delinquencies or losses with respect to any
of our securitization trusts credit-enhanced by monoline insurance were to
exceed the delinquency or loss limits applicable to that trust, our rights to
service the loans in the affected trust may be terminated.
A substantial majority of our servicing portfolio consists of loans
securitized by us and sold to real estate mortgage investment conduits or owner
trusts in securitization transactions. Generally, the agreement entered into in
connection with these securitizations contains specified limits on
delinquencies, which means loans past due 90, or in some cases past due 60, days
or more, and losses that may be incurred in each trust. Losses occur when the
cash we receive from the sale of foreclosed properties, less sales expenses, is
less than the principal balances of the loans previously secured by those
properties and related interest and servicing advances. See below.
A majority of our securitization transactions were credit-enhanced by an
insurance policy issued by a monoline insurance company. That insurance policy
protects the securitization investor against certain losses. The monoline
insurance company can terminate us as servicer if delinquencies or losses are
over a specified limit. Additionally, the agreements entered into in connection
with our 1999 securitizations provide that our rights and obligations to service
the loans will periodically cease unless renewed by the monoline insurance
carrier for successive periods.
At December 31, 1999, the dollar volume of loans delinquent more than
90 days in 10 of our securitization trusts formed during the period from
March 1995 to March 1997 and during December 1997, exceeded the permitted limit
in the related securitization agreements.
We have implemented various plans to lower the delinquency rates in our
future trusts, including diversifying the loans we originate and purchase to
include higher credit grade loans. The delinquency rate at December 31, 1999 was
14.5% and at June 30, 1999 was 15.7%.
Three of the ten trusts referred to above, plus one additional trust, which
represent in the aggregate 12.9% of the dollar volume of our servicing
portfolio, exceeded loss limits at December 31, 1999. The limit that has been
exceeded provides that losses may not exceed a certain threshold, which ranges
from 0.47% to 0.83% of the original pool balances in the relevant securitization
trusts, on a rolling 12 month basis.
Although the monoline insurance company has the right to terminate servicing
with respect to the 1999 securitization trusts and the trusts that exceed the
delinquency and loss limits, no servicing rights have been terminated and we
believe that it is unlikely that we will be terminated as servicer. We cannot be
sure, however, that our servicing rights with respect to the mortgage loans in
such trusts, or any other trusts which exceed the specified delinquency or loss
limits in future periods, will not be terminated.
HIGH DELINQUENCIES ON THE LOANS IN OUR SERVICING PORTFOLIO MAY HURT OUR CASH
FLOWS.
As servicer of the loans we securitize, we are required to advance, or loan,
to the trusts delinquent interest. In addition, as servicer, we advance to the
trusts foreclosure related expenses, and certain tax and insurance remittances
relating to loans serviced. We recently entered into a transaction pursuant to
which
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we sold certain accounts receivable representing servicing advances we had
previously made and engaged an investment bank to make a substantial portion of
future servicing advances on substantially all of the loans in our servicing
portfolio.
High delinquency rates hurt our cash flows. When delinquency rates exceed
the limit specified in the securitization agreement, our right to receive cash
from the trust is delayed. When delinquency rates exceed the specified amount,
we are required to use the cash flows from the trust to make accelerated
payments of principal on the certificates or bonds issued by the trust. These
accelerated payments increase the overcollateralization levels. The
overcollateralization level represents the amount that the principal balance of
the loans in the trust exceeds the principal balance of the certificates or
bonds issued by the trust. We do not receive distributions from the trust until
after the required overcollateralization levels are met. Generally, provisions
in the securitization agreements have the effect of requiring the
overcollateralization amount to be increased up to approximately twice the level
otherwise required when the delinquency rates do not exceed the specified limit.
As of December 31, 1999, we were required to maintain an additional
$56.6 million in overcollateralization amounts as a result of the level of the
delinquency rates above that which would have been required to be maintained if
the applicable delinquency rates had been below the specified limit. Of this
amount, at December 31, 1999, $24.3 million remains to be added to the
overcollateralization amounts from future spread income on the loans held by
these trusts.
High delinquency rates also negatively affect our cash flows because we act
as servicer of the loans in the trust. As the servicer, we are required to use
our cash to advance to the trust past due interest.
HIGH DELINQUENCIES AND LOSSES MAY HURT OUR EARNINGS.
Higher delinquency and loss levels may also affect our reported earnings. We
apply certain assumptions with respect to expected losses on loans in a
securitization trust to determine the amount of non-cash gain on sale that we
record at the closing of a securitization transaction. If actual losses exceed
those assumptions, we may be required to take a charge to earnings. The charge
to earnings would result in an adjustment to the carrying value of the residual
interests strips recorded on our balance sheet.
OUR LOANS ARE SUBJECT TO HIGHER RISKS OF DELINQUENCY AND LOSS THAN THOSE
MADE BY CONVENTIONAL MORTGAGE SOURCES.
Loans made to borrowers in the lower credit grades have historically
resulted in a higher risk of delinquency and loss than loans made to borrowers
who use conventional mortgage sources. We believe that the underwriting criteria
and collection methods we use permit us to mitigate the higher risks inherent in
loans made to these borrowers. However, we cannot be sure that those criteria or
methods will protect us against those risks.
All of our loans are collateralized by residential property. The value of
the property collateralizing our loans may not be sufficient to cover the
principal amount of the loans in the event of liquidation. Losses not covered by
the underlying properties could have a material adverse effect on our results of
operations and financial condition. In addition, historical loss rates affect
the assumptions used by us in computing our non-cash gain on sale. If actual
losses exceed those assumptions, we may be required to take a charge to
earnings.
Adjustable rate loans account for a substantial portion of the mortgage
loans that we originate or purchase. Credit-impaired borrowers may encounter
financial difficulties as a result of increases in the interest rate over the
life of the loan. Substantially all of the adjustable rate mortgages include a
teaser rate, i.e., an initial interest rate significantly below the fully
indexed interest rate at origination. Loans with an initial adjustment date six
months after funding are underwritten at the indexed rate as of the first
adjustment date, and loans with an initial adjustment date two or three years
after funding are underwritten at the teaser rate. As a result, borrowers will
face interest rate increases on their adjustable rate loan, even in a stable
interest rate environment.
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FASTER THAN EXPECTED PREPAYMENT RATES ON OUR LOANS WILL HURT EARNINGS.
If actual prepayments occur more quickly than was projected at the time
loans were sold, the carrying value of the residual interests may have to be
adjusted through a charge to earnings in the period of adjustment. The rate of
prepayment of loans may be affected by a variety of economic and other factors.
We estimate prepayment rates based on our expectations of future prepayment
rates, which are based, in part, on the historic performance of our loans and
other considerations.
OUR OPERATIONS MAY BE HURT BY A SUBSTANTIAL AND SUSTAINED INCREASE OR
DECREASE IN INTEREST RATES.
A substantial and sustained increase in long-term interest rates could,
among other things:
- decrease the demand for consumer credit;
- adversely affect our ability to make loans; and
- reduce the average size of loans we underwrite.
A substantial and sustained increase in short-term interest rates could,
among other things,
- increase our borrowing costs, most of which are tied to those rates; and
- reduce the gains recorded by us upon the securitization and sale of loans.
A significant decline in long-term or short-term interest rates could
increase the level of loan prepayments. An increase in prepayments would
decrease the size of, and servicing income from, our servicing portfolio. Our
expectations as to prepayment are used to determine the amount of non-cash gain
on sale recorded at the closing of a securitization transaction. An increase in
prepayment rates could result in a charge to earnings if the rate is faster than
originally expected.
IN AN INCREASING INTEREST RATE ENVIRONMENT, OUR EARNINGS COULD SUFFER
BECAUSE OF ADJUSTABLE RATE LOANS THAT WE SECURITIZED.
The value of our residual interests created as a result of the
securitization of adjustable rate mortgage loans is subject to so-called basis
risk. Basis risk arises when the adjustable rate mortgage loans in a
securitization trust, including those with a fixed initial rate, bear interest
based on an index or adjustment period that is different from the certificates
or bonds issued by the trust. In the absence of effective hedging or loss
mitigation strategies, in a period of increasing interest rates, the value of
the residual interests could be adversely affected because the interest rates on
the certificates or bonds issued by a securitization trust could adjust faster
than the interest rates on our adjustable rate mortgage loans in the trust.
Adjustable rate mortgage loans are typically subject to periodic and lifetime
interest rate caps, which limit the amount an adjustable rate mortgage loan's
interest rate can change during any given period. In a period of rapidly
increasing interest rates, the value of the residual interests could be
adversely affected in the absence of effective hedging strategies because the
interest rates on the certificates or bonds issued by a securitization trust
could increase without limitation by caps, while the interest rates on our
adjustable rate mortgage loans would be so limited.
A PROLONGED INTERRUPTION OR REDUCTION IN THE SECONDARY MARKET WOULD HURT OUR
FINANCIAL PERFORMANCE.
We must be able to sell loans we make in the securitization and whole loan
market to generate cash proceeds to pay down our warehouse and repurchase
facilities and fund new loans. Our ability to sell loans in the securitization
and whole loan markets on acceptable terms is essential for the continuation of
our loan origination and purchase operations. The value of and market for our
loans are dependent upon a number of factors, including general economic
conditions, interest rates and governmental regulations. Adverse changes in
these factors may affect our ability to securitize or sell whole loans for
acceptable prices within a reasonable period of time.
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To facilitate the sale of certificates or bonds issued by the securitization
trust, we must obtain investment grade ratings for the certificates or bonds. To
obtain those credit ratings, we credit-enhance the securitization trust. The
overcollateralization amount is one form of credit enhancement. Additionally, we
either obtain an insurance policy to protect holders of the certificates or
bonds against certain losses, or sell subordinated interests in the
securitization program.
Our financial position and results of operations would be materially
affected if investors were unwilling to purchase interests in our securitization
trusts or monoline insurance companies were unwilling to provide financial
guarantee insurance for the certificates or bonds sold. Other accounting, tax or
regulatory changes could also adversely affect our securitization program.
We rely on institutional purchasers, such as investment banks, financial
institutions and other mortgage lenders, to purchase our loans in the whole loan
market. We cannot be sure that the purchasers will be willing to purchase loans
on satisfactory terms or that the market for such loans will continue. Our
results of operations and financial condition could be materially adversely
affected if we could not successfully identify whole loan purchasers or
negotiate favorable terms for loan purchases.
IF WE ARE UNABLE TO SELL A SIGNIFICANT PORTION OF OUR LOANS ON AT LEAST A
QUARTERLY BASIS, OUR EARNINGS WOULD BE SIGNIFICANTLY AFFECTED.
Any delay in the sale of a significant portion of our loan production beyond
a quarter-end would postpone the recognition of gain on sale related to such
loans until their sale and would likely result in losses for the quarter. Our
loan disposition strategy calls for substantially all of our production to be
sold in the secondary market within 90 days of origination. However, market and
other considerations, including the conformity of loan pools to monoline
insurance company and rating agency requirements, could affect the timing of the
sale transactions.
CHANGES IN THE VOLUME AND COST OF OUR BROKER LOANS MAY DECREASE OUR LOAN
PRODUCTION.
We depend on independent mortgage brokers for the origination and purchase
of our broker loans, which constitute a significant portion of our loan
production. Our future results of operations and financial condition may be
vulnerable to changes in the volume and cost of our broker loans resulting from,
among other things, competition from other lenders and purchasers of such loans.
These independent mortgage brokers negotiate with multiple lenders for each
prospective borrower. We compete with these lenders for the independent brokers'
business on pricing, service, loan fees, costs and other factors. Our
competitors also seek to establish relationships with such brokers, who are not
obligated by contract or otherwise to do business with us.
OUR COMPETITORS IN THE MORTGAGE BANKING MARKET ARE OFTEN LARGER AND HAVE
GREATER FINANCIAL RESOURCES THAN WE DO, WHICH WILL MAKE IT DIFFICULT FOR US TO
SUCCESSFULLY COMPETE.
We face intense competition in the business of originating, purchasing and
selling mortgage loans. Competition among industry participants can take many
forms, including convenience in obtaining a loan, customer service, marketing
and distribution channels, amount and term of the loan, loan origination fees
and interest rates. Many of our competitors are substantially larger and have
considerably greater financial, technical and marketing resources than we do.
Our competitors in the industry include other consumer finance companies,
mortgage banking companies, commercial banks, investment banks, credit unions,
thrift institutions, credit card issuers and insurance companies. In the future,
we may also face competition from government-sponsored entities, such as FNMA
and FHLMC. These government-sponsored entities may enter the subprime mortgage
market and target potential customers in our highest credit grades, who
constitute a significant portion of our customer base.
The historical level of gains realized on the sale of subprime mortgage
loans could attract additional competitors into this market. Certain large
finance companies and conforming mortgage originators have announced their
intention to originate, or have purchased companies that originate and purchase,
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subprime mortgage loans, and some of these large mortgage companies, thrifts and
commercial banks have begun offering subprime loan products to customers similar
to our targeted borrowers. In addition, establishing a broker-sourced loan
business requires a substantially smaller commitment of capital and human
resources than a direct-sourced loan business. This relatively low barrier to
entry permits new competitors to enter this market quickly and compete with our
broker lending business.
Additional competition may lower the rates we can charge borrowers and
increase the cost to purchase loans, which could potentially lower the gain on
future loan sales or securitizations. Increased competition may also reduce the
volume of our loan origination and loan sales and increase the demand for our
experienced personnel and the potential that such personnel will leave for
competitors.
Competitors with lower costs of capital have a competitive advantage over
us. During periods of declining rates, competitors may solicit our customers to
refinance their loans. In addition, during periods of economic slowdown or
recession, our borrowers may face financial difficulties and be more receptive
to the offers of our competitors to refinance their loans.
Our correspondent and broker programs depend largely on independent mortgage
bankers and brokers and other financial institutions for the purchases of new
loans. Our competitors also seek to establish relationships with the same
sources.
BECAUSE A SIGNIFICANT AMOUNT OF THE LOANS WE SERVICE ARE IN CALIFORNIA AND
FLORIDA, OUR OPERATIONS COULD BE HURT BY ECONOMIC DOWNTURNS OR NATURAL DISASTERS
IN THOSE STATES.
At December 31, 1999, 20.8% and 11.5% of the loans we serviced were
collateralized by residential properties located in California and Florida,
respectively. Because of these concentrations, our financial position and
results of operations have been and are expected to continue to be influenced by
general trends in the California and Florida economies and their residential
real estate markets. Residential real estate market declines may adversely
affect the values of the properties collateralizing loans. If the principal
balances of our loans, together with any primary financing on the mortgaged
properties, equal or exceed the value of the mortgaged properties, we could
incur higher losses on sales of properties collateralizing foreclosed loans.
California historically has been vulnerable to certain natural disaster risks,
such as earthquakes and erosion-caused mudslides. Florida historically has been
vulnerable to certain other natural disasters, such as tropical storms and
hurricanes. Such natural disasters are not typically covered by the standard
hazard insurance policies maintained by borrowers. Uninsured disasters may
adversely impact our ability to recover losses on properties affected by such
disasters and adversely impact our results of operations.
THE RISKS ASSOCIATED WITH OUR BUSINESS BECOME MORE ACUTE IN ANY ECONOMIC
SLOWDOWN OR RECESSION.
Periods of economic slowdown or recession may be accompanied by decreased
demand for consumer credit and declining real estate values. Any material
decline in real estate values reduces the ability of borrowers to use home
equity to support borrowings. Material declines in real estate values also
weakens collateral coverage and increases the possibility of a loss in the event
of liquidation. Further, delinquencies, foreclosures and losses generally
increase during economic slowdowns or recessions. Because of our focus on
credit-impaired borrowers, the actual rates of delinquencies, foreclosures and
losses on such loans could be higher than those generally experienced in the
mortgage lending industry. In addition, in an economic slowdown or recession,
our servicing costs may increase. Any sustained period of increased
delinquencies, foreclosure, losses or increased costs could adversely affect our
ability to securitize or sell loans in the secondary market and could increase
the cost of these transactions.
EVEN AFTER WE SELL OUR LOANS, WE REMAIN SUBJECT TO RISKS FROM DELINQUENCIES
AND LOSSES ON THE LOANS WE SERVICE.
Although we sell substantially all the mortgage loans which we originate or
purchase, we retain some degree of credit risk on substantially all loans sold
where we continue to service those loans. During the period of time that loans
are held before sale, we are subject to the various business risks associated
with
35
<PAGE>
the lending business including the risk of borrower default, the risk of
foreclosure and the risk that a rapid increase in interest rates would result in
a decline in the value of loans to potential purchasers. Cash flows from the
securitization trust are represented by the interest rate earned on the loans in
the trust over the amount of interest paid by the trust to the holders of the
certificates or bonds issued by the trust, plus certain monoline and servicing
fees. The agreements governing our securitization program require us to
credit-enhance the securitization trust by either establishing deposit accounts
or building overcollateralization levels. Deposit accounts are established by
maintaining a portion of the excess cash flows in a trust deposit account.
Overcollateralization levels are built up by applying these excess cash flows to
reduce the principal balances of the certificates or bonds issued by the trust.
Those amounts are available to fund losses realized on loans held by such trust.
We continue to be subject to the risks of default and foreclosure following
securitization and the sale of loans to the extent excess cash flows are
required to be maintained in the deposit account or applied to build up
overcollateralization, as opposed to being distributed to us.
When borrowers are delinquent in making monthly payments on loans included
in a securitization trust, as servicer of the loans in the trust, we are
required to advance interest payments with respect to such delinquent loans.
These advances require funding from our capital resources, but have priority of
repayment from collections or recoveries on the loans in the related pool in the
succeeding month. In connection with our whole loan sales, we may be obligated
in certain instances to buy back mortgage loans if the borrower defaults on the
first payment of principal and interest due.
WE MAY BE REQUIRED TO REPURCHASE LOANS OR INDEMNIFY INVESTORS IF WE BREACH
REPRESENTATIONS AND WARRANTIES.
In the ordinary course of our business, we are subject to claims made
against us by borrowers arising from, among other things, losses that are
claimed to have been incurred as a result of alleged breaches of fiduciary
obligations, misrepresentations, errors and omissions of our employees and
officers, incomplete documentation and failures to comply with various laws and
regulations applicable to our business. In addition, agreements governing our
securitization program and whole loan sales require us to commit to repurchase
or replace loans which do not conform to our representations and warranties at
the time of sale. We believe that liability with respect to any currently
asserted claims or legal actions is not likely to be material to our financial
position or results of operations. However, any claims asserted in the future
may result in expenses or liabilities which could have a material adverse effect
on our financial position and results of operations.
IF WE ARE UNABLE TO COMPLY WITH MORTGAGE BANKING RULES AND REGULATIONS, OUR
ABILITY TO MAKE MORTGAGE LOANS MAY BE RESTRICTED.
Our operations are subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and are subject
to various laws, regulations and judicial and administrative decisions imposing
requirements and restrictions on part or all of our operations. Failure to
comply with these requirements can lead to loss of approved status, certain
rights of rescission for mortgage loans, class action lawsuits and
administrative enforcement action. Our consumer lending activities are subject
to various federal laws and regulations. We are also subject to the rules and
regulations of, and examinations by, state regulatory authorities with respect
to originating, processing, underwriting, selling, securitizing and servicing
loans. These rules and regulations, among other things, impose licensing
obligations on us, establish eligibility criteria for mortgage loans, prohibit
discrimination, govern inspections and appraisals of properties and credit
reports on loan applicants, regulate collection, foreclosure and claims
handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, fees and mortgage loan amounts. Because our
business is highly regulated, the laws, rules and regulations applicable to us
are subject to regular modification and change. There are currently proposed
various laws, rules and regulations which, if adopted, could negatively impact
us.
36
<PAGE>
CHANGES IN THE MORTGAGE INTEREST DEDUCTION COULD HURT OUR FINANCIAL
PERFORMANCE.
Members of Congress and government officials have from time-to-time
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of our loans are made to borrowers for the
purpose of consolidating consumer debt or financing other consumer needs, the
competitive advantages of tax deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for loans of the
kind offered by us.
OUR BUSINESS OPERATIONS MAY BE INTERRUPTED IF WE EXPERIENCE UNEXPECTED YEAR
2000 PROBLEMS.
Many existing computer systems and software products do not properly
recognize dates after December 31, 1999. This Year 2000 problem could result in
data corruption, system failures or disruptions of operations. We are subject to
potential Year 2000 problem affecting our products and services, our internal
systems and the systems of third parties on whom we rely. If third parties on
whom we rely are not Year 2000 compliant, our business could be adversely
affected later this year.
WE WILL BE UNABLE TO PAY DIVIDENDS ON OUR CAPITAL STOCK FOR THE FORESEEABLE
FUTURE.
The indentures governing certain of our outstanding indebtedness as well as
our other credit agreements limit our ability to pay cash dividends on our
capital stock. Under the most restrictive of these limitations, we will be
prevented from paying cash dividends on our capital stock for the foreseeable
future.
THE CONCENTRATED OWNERSHIP OF OUR VOTING STOCK BY OUR CONTROLLING
STOCKHOLDER MAY HAVE AN ADVERSE EFFECT ON YOUR ABILITY TO INFLUENCE THE
DIRECTION WE WILL TAKE.
At January 15, 2000, Capital Z beneficially owned senior preferred stock
representing 46.2% of our combined voting power in the election of directors and
76.1% of the combined voting in all matters other than the election of
directors. Representatives or nominees of Capital Z have five seats on our nine
person Board of Directors, and as current members' terms expire Capital Z has
the continuing right to appoint and elect four directors and nominate one
additional director. As a result of its beneficial ownership and Board
representation, Capital Z has, and will continue to have, sufficient power to
determine our direction and policies.
37
<PAGE>
PART II--OTHER INFORMATION
Item 1. Legal Proceedings--None
Item 2. Changes in Securities--None
Item 3. Defaults upon Senior Securities--None
Item 4. Submission of Matters to a Vote of Security Holders--None
Item 5. Other Information--None
Item 6. Exhibits and Reports on Form 8-K
(c) Exhibits: See Exhibit Index
(d) During the quarter ended December 31, 1999, the Company filed (i) a Current
Report on Form 8-K on October 5, 1999 (earliest event reported
September 27, 1999), reporting information under Item 5 regarding the
extension of the Company's rights offering and the status of the listing
application for a class of preferred stock; (ii) a Current Report on Form
8-K on October 20, 1999 (earliest event reported October 13, 1999),
reporting information under Item 5 regarding personnel matters; (iii) a
Current Report on Form 8-K on October 20, 1999 (earliest event reported
October 8, 1999), reporting information under Item 5 regarding the results
of the Company's rights offering; (iv) a Current Report on Form 8-K on
November 2, 1999 (earliest event reported October 25, 1999), reporting
information under Item 5 regarding the appointment of the Company's Chief
Executive Officer; (v) a Current Report on Form 8-K on November 3 (earliest
even reported October 29, 1999) reporting information under Item 5 regarding
the Company's financial results for the first fiscal quarter; (vi) a Current
Report on Form 8-K on November 10, 1999 (earliest event reported
November 2, 1999) reporting information under Item 5 regarding a business
relationship with an on-line company; (vii) a Current Report on Form 8-K on
November 30, 1999 (earliest event reported November 15, 1999) regarding
information under Item 7 regarding the Company's securitization; (viii) a
Current Report on Form 8-K on December 6, 1999 (earliest event reported
December 2, 1999) regarding information under Item 5 regarding the
appointment of a director of the Company.
38
<PAGE>
AAMES FINANCIAL CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this Report on Form 10-Q to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
AAMES FINANCIAL CORPORATION
By: /s/ DAVID A. SKLAR
-----------------------------------------
David A. Sklar
EXECUTIVE VICE PRESIDENT--FINANCE AND
Date: February 14, 2000 CHIEF FINANCIAL ACCOUNTING OFFICER
</TABLE>
39
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
<C> <S>
10.26(f) Fourth Amendment to Amended and Restated Master Repurchase
Agreement Governing Purchases and Sales of Mortgage Loans,
dated as of December 30, 1999, between Aames Capital
Corporation and Lehman Commercial Paper Inc.
10.27(g) Amendment No. 3 to Guaranty, dated as of December 1, 1999,
between Aames Financial Corporation and Greenwich Capital
Financial Products, Inc.(1)
10.27(h) Amendment No. 4 to Guaranty, dated as of December 30, 1999,
between Aames Financial Corporation and Greenwich Capital
Financial Products, Inc.
10.28(e) Third Amendment to Master Repurchase Agreement and Guaranty,
dated as of December 29, 1999, between Aames Capital
Corporation, Aames Financial Corporation and Bank of
America, N.A.(1)
10.28(f) Fourth Amendment to Master Repurchase Agreement and
Guaranty, dated as of February 2, 2000, between Aames
Capital Corporation, Aames Financial Corporation and Bank of
America, N.A.
10.37(a) Master Loan and Security Agreement, dated as of October 29,
1999, between Aames Capital Corporation and Morgan Stanley
Mortgage Capital, Inc.(1)
10.37(b) First Amendment to Master Loan and Security Agreement, dated
as of December 30, 1999, between Aames Capital Corporation
and Mortgage Stanley Mortgage Capital, Inc.
11 Computation of Per Share Earnings
27.1 Financial Disclosure Schedule
</TABLE>
- ------------------------
(1) Incorporated by reference from Registrant's Current Report on Form 8-K filed
on January 14, 2000.
40
<PAGE>
Exhibit 10.26(f)
FOURTH AMENDMENT TO AMENDED AND RESTATED MASTER
REPURCHASE AGREEMENT GOVERNING
PURCHASES AND SALES OF MORTGAGE LOANS
This Fourth Amendment, dated as of December 30, 1999 (the "FOURTH
AMENDMENT") to the Amended and Restated Master Repurchase Agreement Governing
Purchases and Sales of Mortgage Loans dated as of February 10, 1999, is made by
and between LEHMAN COMMERCIAL PAPER INC. ("BUYER") and AAMES CAPITAL CORPORATION
("SELLER" and, together with they Buyer, the "Parties").
R E C I T A L S
WHEREAS, the Seller and the Buyer are parties to an Amended and Restated
Master Repurchase Agreement Governing Purchases and Sales of Mortgage Loans,
dated as of February 10, 1999 (as amended, the "AGREEMENT"), pursuant to which
Buyer has agreed, subject to the terms and conditions set forth in the
Agreement, to purchase certain mortgage loans owned by the Seller, including,
without limitation, all rights of Seller to service and administer such mortgage
loans. Terms used but not defined herein shall have the respective meanings
ascribed to such terms in the Agreement, as amended hereby.
WHEREAS, the Parties wish to amend the Agreement to modify certain of the
terms and conditions governing the purchase and sale of the mortgage loans.
NOW, THEREFORE, for good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the Parties hereto agree as
follows, effective as of the date hereof:
SECTION 1. AMENDMENTS.
1.1 Paragraph (a) of the definition of "Trigger Event" in Section 2 is
deleted in its entirety and replaced with the following language:
"Net Worth shall be less than $105,000,000 at any time from December
31, 1999 to March 31, 2000."
1.2 Paragraph (b) of the definition "Trigger Event" in Section 2 is deleted
in its entirety and replaced with the following language:
"Tangible Net Worth shall be less than $105,000,000 at any time from
December 31, 1999 to March 31, 2000."
<PAGE>
1.3 Paragraph (c) of the definition of "Trigger Event in Section 2 is
deleted in its entirety and replaced with the following language:
"The Leverage Ration shall exceed 6.5 to 1.0".
1.4 Section 13(xiii) is deleted in its entirety and replaced with the
following language:
"Net Worth shall be less than $100,000,000 at any time from December
31, 1999 to March 31, 2000."
1.5 Section 13(xiv) is deleted in its entirety and replaced with the
following language:
"Tangible Net Worth shall be less than $100,000,000 at any time from
December 31, 1999 to March 31, 2000."
1.6 Section 13(xv) is deleted in its entirety and replaced with the
following language:
"at any time, the Leverage Ratio shall exceed 6.5 to 1.0;"
1.7 Section 13(xvi) is deleted in its entirety and replaced with the
following language:
"the Adjusted Leverage Ratio shall exceed (a) 3.0 to 1.0 on the last
Business Day of any calendar month or (b) 3.5 to 1.0 on any other day;"
1.8 Section 13(xvii) is deleted in its entirety and replaced with the
following language:
"At quarter end on or after March 31, 2000, the Interest Coverage Ratio
shall be less than 1.0 to 1.0;"
SECTION 2. COVENANTS, REPRESENTATIONS AND WARRANTIES OF THE PARTIES.
2.1 Except as expressly amended by Section 1 hereof, the Agreement remains
unaltered and in full force and effect. Each Party hereby reaffirms all terms
and covenants made in the Agreement as amended hereby.
2.2 Each of the Parties hereby represents and warrants to the other parties
that (a) this Second Amendment constitutes the legal, valid and binding
obligation of such Party, enforceable against such Party in accordance with its
terms, and (b) the execution and delivery by such Party of this Fourth Amendment
has been duly authorized by all requisite corporate action on the party of such
Party and will not violate any provision of the organizational documents of such
Party.
<PAGE>
SECTION 3. EXPENSES.
Seller shall pay all out-of-pocket costs and expenses (including legal fees
and disbursements) reasonably incurred by Buyer in connection with the
preparation and execution of this Fourth Amendment.
SECTION 4. EFFECT UPON THE AGREEMENT.
4.1 Except as specifically set forth herein, the Agreement shall remain in
full force and effect and is hereby ratified and confirmed. All references to
this "Agreement" in the Amended and Restated Master Repurchase Agreement
Governing Purchases and Sales of Mortgage Loans shall mean and refer to the
Amended and Restated Master Repurchase Agreement Governing Purchases and Sales
of Mortgage Loans as modified and amended hereby.
4.2 The execution, delivery and effectiveness of this Fourth Amendment
shall not operate as a waiver of any right, power or remedy of any Party under
the Agreement, or any other document, instrument or agreement executed and/or
delivered in connection therewith.
SECTION 5. GOVERNING LAW.
THIS FOURTH AMENDMENT SHALL BE CONSTRUED, INTERPRETED AND GOVERNED BY THE
LAW OF THE STATE OF NEW YORK, WITHOUT GIVING EFFECT TO THE CONFLICT OF LAWS
PRINCIPLES THEREOF.
SECTION 6. COUNTERPARTS.
This Fourth Amendment may be executed in any number of counterparts, and
all such counterparts shall together constitute the same agreement.
SECTION 7. OTHER.
This Fourth Amendment is subject to the successful consummation and funding
of the Greenwich working capital transaction in the approximate amount of
$35,000,000 by on or about February 11, 2000.
[SIGNATURE PAGE FOLLOWS]
<PAGE>
IN WITNESS WHEREOF, the Parties hereto have caused this Fourth Amendment to
be executed as of the day and year first above written.
SELLER:
AAMES CAPITAL CORPORATION, as Seller
By: /s/ David A. Sklar
----------------------------------------
Name: David A. Sklar
Title: Executive Vice President and CFO
BUYER:
LEHMAN COMMERCIAL PAPER INC., as Buyer
By: /s/ Francis X. Gilhool
----------------------------------------
Name: Francis X. Gilhool
Title: SVP
<PAGE>
Exhibit 10.27(h)
AMENDMENT NO. 4
TO
GUARANTY
This Amendment No. 4 (this "Amendment") dated December 30, 1999 amends the
Guaranty dated as of February 10, 1999 (the "Guaranty"), made by Aames Financial
Corporation (the "Guarantor") in favor of Greenwich Capital Financial Products,
Inc. (the "Lender"). Capitalized terms used herein and not otherwise defined
herein shall have the meanings set forth in the Guaranty or, if not so defined
therein, the Loan Agreement (as defined in the Guaranty). The Guarantor and the
Lender, for good and valuable consideration, the receipt and sufficiency of
which are hereby acknowledged, enter into this Agreement and agree as follows:
I. AMENDMENTS
Effective as of December 30, 1999 Sections 3(b)(i), (iv) and (vi) of the
Guaranty are hereby amended and restated in their entirety as follows:
(i) MAINTENANCE OF TANGIBLE NET WORTH. The Tangible Net Worth of the
Guarantor, on a consolidated basis and on any given day, shall be
not less than $105,000,000.
(iv) MAINTENANCE OF RATIO OF EARNINGS TO TOTAL INTEREST EXPENSE. The
Guarantor shall not permit the ratio of earnings before interest and
taxes to total expense, on a consolidated basis, to be less than
1:00:1.00 commencing with the quarter ending March 31, 2000.
(v) PROFITABILITY. The Guarantor shall have a GAAP after tax net income
of at least $1.00 as measured at the end of March 31, 2000.
Effective as of January 31, 2000 Sections 3(b)(iii) of the Guaranty is hereby
amended and restated in its entirety as follows:
(iii) LIQUIDITY. The aggregate amount of the Guarantor's cash, Cash
Equivalents and available borrowing capacity on unencumbered assets
that could be drawn against (taking into account required haircuts)
under committed warehouse or working capital facilities, on a
consolidated basis and on any given day, shall be prior to and on
February 11, 2000, $5,000,000.
2. REPRESENTATIONS
In order to induce Lender to execute and deliver this Amendment, the Guarantor
hereby represents to the Lender that as of the date hereof, after giving effect
to this Amendment, (a) the representations and warranties set forth in Section 3
of the Guaranty are and shall
<PAGE>
be and remain true and correct and (b) the Guarantor is in full compliance
with all of the terms and conditions of the Guaranty.
3. MISCELLANEOUS
Except as specifically amended herein, the Guaranty shall continue in full force
and effect in accordance with its original terms. Reference to this specific
Amendment need not be made in the Guaranty or any other instrument or documents
executed in connection therewith, or in any certificate, letter or communication
on issued or made pursuant to or with respect to the Guaranty, any reference in
any of such items to the Guaranty being sufficient to refer to the Guaranty as
amended hereby.
IN WITNESS WHEREOF, the Guarantor and the Lender have caused this Amendment No.
4 to be duly executed and delivered as of the date first above written.
AAMES FINANCIAL CORPORATION
By: /s/ David A. Sklar
----------------------------------------
Name: David A. Sklar
Title: Executive Vice President and CFO
GREENWICH CAPITAL FINANCIAL
PRODUCTS, INC.
By: /s/ John C. Anderson
----------------------------------------
Name: John C. Anderson
Title: Senior Vice President
<PAGE>
Exhibit 10.28(f)
FOURTH AMENDMENT
TO MASTER REPURCHASE AGREEMENT AND GUARANTY
THIS FOURTH AMENDMENT TO MASTER REPURCHASE AGREEMENT AND GUARANTY (this
"Fourth Amendment") is made and dated as of the 2nd day of February, 2000, by
and among AAMES CAPITAL CORPORATION, a California corporation (the "Seller"),
AAMES FINANCIAL CORPORATION, a Delaware corporation (the "Guarantor"), and BANK
OF AMERICA, N.A., a national banking association (the "Buyer").
RECITALS
A. Pursuant to that certain Master Repurchase Agreement dated as of April
8, 1999 by and between the Buyer and the Seller (as amended from time to time,
the "Repo Agreement"), the Buyer and the Seller agreed to enter into
Transactions on the terms and subject to the conditions set forth therein. All
capitalized terms not otherwise defined herein shall have the meanings given to
such terms in the Repo Agreement.
B. Pursuant to that certain Guaranty dated as of April 8, 1999 by the
Guarantor in favor of the Buyer (as amended from time to time, the "Guaranty"),
the Guarantor agreed to guarantee the Seller's obligations under the Repo
Agreement on the terms and subject to the conditions set forth therein.
C. The Seller wishes to enter into a transaction (the "Proposed
Transaction") with Greenwich Capital Financial Products, Inc. ("Greenwich") in
which the Seller will (i) sell to Greenwich on or about February 11, 2000
certain of the Seller's receivables tied to its advances in its securitization
trusts, with expected proceeds of approximately $15,000,000 which the Seller
will use to repurchase Purchased Repo Assets under the Repo Agreement, and (ii)
enter into a working capital facility secured by certain assets of the Seller,
all as described more particularly in that certain letter dated January 27, 2000
by the Guarantor to the Seller.
D. The Seller and the Guarantor have also requested certain amendment and
waivers to the Repo Agreement and the Guaranty, all as set forth more
particularly below.
NOW, THEREFORE, in consideration of the foregoing Recitals and for other
valuable consideration, the receipt and adequacy of which are hereby
acknowledged, the parties hereto hereby agree as follows:
AGREEMENT
1. SPECIAL REPRESENTATIONS AND WARRANTIES OF THE SELLER AND THE GUARANTOR.
Each of the Seller and the Guarantor hereby represents and warrants to the Buyer
that (a) the financial and other information provided to the Buyer by the Seller
and the Guarantor in connection with their request for the amendments and
waivers set forth in this Fourth Amendment, copies of which information are
attached hereto as EXHIBIT A, is and shall continue to be true, accurate,
complete and not misleading during the period covered thereby, and (b) the
Seller intends to and expects to be able to repurchase all Purchased Repo Assets
and to pay all outstanding Repurchase Price on or before February 29, 2000, the
termination date of the Repo Agreement and all Transactions thereunder. The
Buyer has agreed to accommodate the request of the Seller and the Guarantor
1
<PAGE>
for the amendments and waivers set forth in this Fourth Amendment in reliance
of such continued representations and warranties. Each of the Seller and the
Guarantor hereby acknowledges and agrees that any breach of such
representations and warranties shall constitute an immediate Event of Default
under the Repo Agreement.
2. PROPOSED TRANSACTION. In connection with the Proposed Transaction,
effective as of the Fourth Amendment Effective Date (as defined in Paragraph 8
below), the Buyer hereby waives compliance by the Seller with the negative
covenant on sale of assets set forth in Paragraph 12(h) of the Repo Agreement
and by the Guarantor with the negative covenant on sale of assets set forth in
Paragraph 4(h) of the Guaranty, in each case solely with respect to the Proposed
Transaction, which shall occur no later than February 15, 2000.
3. REDUCTION OF AGGREGATE PURCHASE PRICE LIMIT. To reflect the agreement of
the parties hereto to reduce the Aggregate Purchase Price Limit on February 4,
2000 and on February 15, 2000, effective as of the Fourth Amendment Effective
Date, the definition of the term "Aggregate Purchase Price Limit" set forth in
Paragraph 2 of the Repo Agreement is hereby amended to read in its entirety as
follows:
"'AGGREGATE PURCHASE PRICE LIMIT' shall mean on any date an amount
equal to: (a) (i) at any time prior to February 4, 2000, $150,000,000, (ii)
at any time on and after February 4, 2000 but prior to February 15, 2000,
$140,000,000, (iii) at any time on and after February 15, 2000,
$125,000,000, in each case minus (b) the Buyer's commitment to extend
credit to Aames Funding Corp. in the aggregate amount of $1,000,000."
4. MINIMUM TANGIBLE NET WORTH. To reflect the agreement of the parties
hereto to amend the negative covenant regarding the Guarantor's and the Seller's
respective minimum Tangible Net Worth, effective as of the Fourth Amendment
Effective Date:
(a) Subparagraphs 12(j)(1) and 12(j)(2) of the Repo Agreement are
hereby amended to read in their entirety as follows:
"(1) Guarantor's Tangible Net Worth to be less than $105,000,000
during the period from December 31, 1999 through February 29, 2000, or
(2) Seller's Tangible Net Worth to be less than $390,000,000 during
the period from December 31, 1999 through February 29, 2000."
(b) Subparagraphs 4(j)(1) and 4(j)(2) of the Guaranty are hereby
amended to read in their entirety as follows:
"(1) Guarantor's Tangible Net Worth to be less than $105,000,000
during the period from December 31, 1999 through February 29, 2000, or
(2) Seller's Tangible Net Worth to be less than $390,000,000 during
the period from December 31, 1999 through February 29, 2000."
5. MINIMUM PROFITABILITY. The Buyer hereby waives, effective as of the
Fourth Amendment Effective Date: (a) compliance by the Seller with the negative
covenant on
2
<PAGE>
minimum profitability set forth in Paragraph 12(k) of the Repo Agreement for
the calendar quarter ended December 31, 1999, and (b) compliance by the
Guarantor with the negative covenant on minimum profitability set forth in
Paragraph 4(k) of the Repo Agreement for the calendar quarter ended December
31, 1999.
6. NON-WAREHOUSE DEBT. To reflect the agreement of the parties hereto to
amend the negative covenant regarding the Non-Warehouse Debt Ratio, effective as
of the Fourth Amendment Effective Date:
(a) Paragraph 12(l) of the Repo Agreement is hereby amended to read in
its entirety as follows:
"(l) NON-WAREHOUSE DEBT. Permit the Non-Warehouse Debt Ratio of
Guarantor and its consolidated Subsidiaries to exceed 2.50:1.00 for the
calendar quarter ending December 31, 1999."
(b) Paragraph 4(l) of the Guaranty is hereby amended to read in its
entirety as follows:
"(l) NON-WAREHOUSE DEBT. Permit the Non-Warehouse Debt Ratio of
Guarantor and its consolidated Subsidiaries to exceed 2.50:1.00 for the
calendar quarter ending December 31, 1999."
7. MAINTENANCE OF LIQUIDITY. To reflect the agreement of the parties hereto
to amend the negative covenant regarding the maintenance of liquidity, effective
as of the Fourth Amendment Effective Date:
(a) Subparagraph 12(m)(1) of the Repo Agreement is hereby amended to
read in its entirety as follows:
"(1) The aggregate amount of the Guarantor's cash, Cash
Equivalents and available borrowing capacity on unencumbered assets
that could be drawn against (taking into account required haircuts)
under committed warehouse or working capital facilities, on a
consolidated basis and on any given day, to be less than $5,000,000;
PROVIDED, HOWEVER, that the liquidity of the Guarantor, on a
consolidated basis and on any given day, may fall below the foregoing
threshold one time in any given calendar month and such noncompliance
shall not last for more than three Business Days, but may in no event
fall below $1,000,000 at any time; or"
(b) Subparagraph 4(m)(1) of the Guaranty is hereby amended to read in
its entirety as follows:
"(1) The aggregate amount of the Guarantor's cash, Cash
Equivalents and available borrowing capacity on unencumbered assets
that could be drawn against (taking into account required haircuts)
under committed warehouse or working capital facilities, on a
consolidated basis and on any given day, to be less than $5,000,000;
PROVIDED, HOWEVER, that the liquidity of the Guarantor, on a
consolidated basis and on any given day, may fall below the foregoing
threshold one time in any given calendar month and
3
<PAGE>
such noncompliance shall not last for more than three Business
Days, but may in no event fall below $1,000,000 at any time; or"
8. FOURTH AMENDMENT EFFECTIVE DATE. This Fourth Amendment shall become
effective as of December 30, 1999 (the "Fourth Amendment Effective Date") upon
the earliest date on which the Buyer has received a copy of this Fourth
Amendment, duly executed by all parties hereto.
9. REAFFIRMATION OF OBLIGATIONS. Each of Seller and Guarantor hereby
reaffirms all of its obligations under the Repo Agreement and Guaranty
respectively and under all other documents, instruments and agreements executed
in connection therewith and acknowledges and agrees that such obligations are
not altered, modified or affected in any manner or to any extent except as
expressly provided herein.
10. COUNTERPARTS. This Fourth Amendment may be executed in any number of
counterparts, each of which when so executed shall be deemed to be an original
and all of which when taken together shall constitute one and the same
agreement.
11. REPRESENTATIONS AND WARRANTIES. Each of Seller and Guarantor hereby
represents and warrants to Buyer as follows:
(a) Each of Seller and Guarantor has the corporate power and authority
and the legal right to execute, deliver and perform this Fourth Amendment and
has taken all necessary corporate action to authorize the execution, delivery
and performance of this Fourth Amendment. This Fourth Amendment has been duly
executed and delivered on behalf of Seller and Guarantor and constitutes the
legal, valid and binding obligations of each, enforceable against each in
accordance with its terms.
(b) At and as of the date of execution hereof and at and as of the
Fourth Amendment Effective Date and both prior to and after giving effect
hereto: (i) the representations and warranties of Seller and Guarantor contained
in the Repo Agreement and the Guaranty are accurate and complete in all
respects, and (ii) there has not occurred an Event of Default or Potential
Default.
12. NO OTHER AMENDMENT OR WAIVER. Except as expressly amended hereby, the
Repo Agreement and the Guaranty shall remain in full force and effect as written
and amended to date. Each of the Seller and the Guarantor hereby acknowledges
and agrees that nothing contained herein shall constitute any agreement by the
Buyer to waive any covenant in the Repo Agreement or in the Guaranty other than
those expressly waived pursuant to Paragraph 2 and Paragraph 5 above.
------------------------------------------------------------------------------
[signature page to follow]
4
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Fourth
Amendment to be executed as of the day and year first above written.
AAMES CAPITAL CORPORATION
By: /s/ David A. Sklar
-------------------------------------
Name: David A. Sklar
----------------------------------
Title: Executive Vice President and CFO
----------------------------------
AAMES FINANCIAL CORPORATION
By: /s/ David A. Sklar
-------------------------------------
Name: David A. Sklar
----------------------------------
Title: Executive Vice President and CFO
----------------------------------
BANK OF AMERICA, N.A.
By: /s/ Kurt Y. Kodama
-------------------------------------
Name: Kurt Y. Kodama
----------------------------------
Title: Vice President
----------------------------------
5
<PAGE>
Exhibit 10.37(b)
FIRST AMENDMENT
TO
MASTER LOAN AND SECURITY AGREEMENT
THIS FIRST AMENDMENT TO MASTER LOAN and SECURITY AGREEMENT (the "First
Amendment") is made and dated as of the 30th day of December, 1999, by and among
AAMES CAPITAL CORPORATION, a California corporation (the "Borrower"), and MORGAN
STANLEY MORTGAGE CAPITAL, INC., a New York corporation (the "Lender"), and
together with the Borrower (the "Parties").
RECITALS
A. Pursuant to that certain Master Loan and Security Agreement dated as
of October 29, 1999 by and between the Borrower and the Lender (the
"Loan Agreement"), the Borrower and Lender agreed to enter into
transactions on the terms and subject to the conditions set forth
therein. All capitalized terms not otherwise defined herein shall have
the meanings given to such terms in the Loan Agreement.
B. The Parties hereto wish to amend certain provisions in the Loan
Agreement as set forth more particularly below.
NOW, THEREFORE, in consideration of the foregoing Recitals and for other
valuable consideration, the receipt and adequacy of which are hereby
acknowledged, the Parties hereto agree as follows:
AGREEMENT
1. MAINTENANCE OF PROFITABILITY. To reflect the agreement of the Parties
hereto to amend the negative covenant regarding the Borrower's Maintenance of
Profitability, effective as of the First Amendment Effective Date; Section 7.16
of the Loan Agreement is hereby amended to delete the reference to "December 31,
1999" and to replace it with "June 30, 2000".
2. FIRST AMENDMENT EFFECTIVE DATE. This First Amendment shall become
effective on the 30th day of December, 1999 (the "First Amendment Effective
Date").
3. REAFFIRMATION OF OBLIGATIONS. The Borrower hereby reaffirms all of its
obligations under the Loan Agreement and under all other documents, instruments
and agreements executed in connection therewith and acknowledges and agrees that
such obligations are not altered, modified or affected in any manner or to any
extent except as expressly provided herein.
<PAGE>
4. COUNTERPARTS. This First Amendment may be executed in any number of
counterparts, each of which when so executed shall be deemed to be an original
and all of which when taken together shall constitute one and the same
agreement.
5. REPRESENTATIONS AND WARRANTIES. The Borrower hereby represents and
warrants to Lender as follows:
(a) The Borrower has the corporate power and authority and the leagal
right to execute, deliver and perform this First Amendment and
has taken all necessary corporate action to authorize the
execution, delivery and performance of this First Amendment. This
First Amendment has been duly executed and delivered on behalf of
the Borrower and constitutes the legal, valid and binding
obligations enforceable in accordance with its terms.
(b) At and as of the date of execution hereof and as of the First
Amendment Effective Date and both prior to and after giving
effect hereto: (a) the representations and warranties of Borrower
contained in the Loan Agreement are accurate and complete in all
respects, and (ii) there has not occurred and Event of Default.
6. NO OTHER AMENDMENT. Except as expressly amended hereby, the Loan
Agreement shall remain in full force and effect as written and amended to date.
[SIGNATURE PAGE FOLLOWS]
<PAGE>
IN WITNESS WHEREOF, the Parties hereto have caused this First Amendment to
be executed as of the day and year first above written.
AAMES CAPITAL CORPORATION
By: /s/ David A. Sklar
-------------------------------------
Name: David A. Sklar
Title: Executive Vice President and CFO
MORGAN STANLEY MORTGAGE
CAPITAL INC.
By: /s/ Andrew Neuberger
-------------------------------------
Name: Andres Neuberger
Title: Vice President
<PAGE>
AAMES FINANCIAL CORPORATION
LOSS PER SHARE
FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
BASIC LOSS PER COMMON SHARE:
Net loss $ (47,695,000) (195,745,000) $ (46,805,000) (197,901,000)
Plus: Accrued preferred dividends (2,039,000) - (3,580,000) -
------------- ------------- ------------- -------------
Net loss available to common stockholders $ (49,734,000) (195,745,000) $ (50,485) (197,901,000)
Average common shares outstanding 31,027,000 31,007,000 31,108,000 30,992,000
------------- ------------- ------------- -------------
Basic loss per common share $ (1.60) (6.31) $ (1.63) (6.39)
============= ============= ============= =============
DILUTED LOSS PER COMMON SHARE:
Net loss for calculating diluted $ (49,734,000) (195,745,000) $ (50,485) (197,901,000)
loss per common share
Adjust net loss to add back the after-tax amount
of interest recognized in the period associated
with the convertible subordinated notes - - - -
------------- ------------- ------------- -------------
Adjusted diluted net loss $ (49,734,000) (195,745,000) $ (50,485) (197,901,000)
------------- ------------- ------------- -------------
Average common shares outstanding 31,027,000 31,007,000 31,108,000 30,992,000
Add exercise of options and warrants - - - -
Convertible subordinated notes - - - -
------------- ------------- ------------- -------------
Diluted shares outstanding 31,027,000 31,007,000 31,108,000 30,992,000
------------- ------------- ------------- -------------
Diluted loss per common share $ (1.60) (6.31) (1.63) (6.39)
============= ============= ============= =============
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 16,018,000
<SECURITIES> 0
<RECEIVABLES> 430,330,000
<ALLOWANCES> 1,200,000
<INVENTORY> 371,728,000
<CURRENT-ASSETS> 816,876,000
<PP&E> 29,354,000
<DEPRECIATION> 18,213,000
<TOTAL-ASSETS> 828,017,000
<CURRENT-LIABILITIES> 426,669,000
<BONDS> 281,220,000
0
118,000
<COMMON> 31,000
<OTHER-SE> 119,979,000
<TOTAL-LIABILITY-AND-EQUITY> 828,017,000
<SALES> 73,853,000
<TOTAL-REVENUES> 73,853,000
<CGS> 15,615,000
<TOTAL-COSTS> 15,615,000
<OTHER-EXPENSES> 76,784,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 26,434,000
<INCOME-PRETAX> (44,980,000)
<INCOME-TAX> 1,925,000
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (46,905,000)
<EPS-BASIC> (1.63)
<EPS-DILUTED> (1.63)
</TABLE>
