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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-K
(MARK ONE)
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<C> <S>
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE FISCAL YEAR ENDED JUNE 30, 2000
OR
<TABLE>
<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
--------------------------
AAMES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 95-4340340
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation)
350 S. GRAND AVENUE, LOS
ANGELES, CALIFORNIA 90071
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (323) 210-5000
--------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
<S> <C>
COMMON STOCK, PAR VALUE $0.001 NEW YORK STOCK EXCHANGE
PREFERRED STOCK PURCHASE RIGHTS NEW YORK STOCK EXCHANGE
10.50% SENIOR NOTES DUE 2002 NEW YORK STOCK EXCHANGE
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
--------------------------
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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
At September 27, 2000, there were outstanding 6,235,226 shares of the Common
Stock of Registrant, and the aggregate market value of the shares held on that
date by non-affiliates of the Registrant, based on the closing price ($1.5625
per share) of the Registrant's Common Stock on the New York Stock Exchange was
$9,183,973.00. For purposes of this computation, it has been assumed that the
shares beneficially held by directors and executive officers of Registrant were
"held by affiliates"; this assumption is not to be deemed to be an admission by
such persons that they are affiliates of Registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement relating to its 2000 Annual Meeting
of Stockholders or an amendment to this Form 10-K are incorporated by reference
in Items 10, 11, 12 and 13 of Part III of this Annual Report.
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PART I
ITEM 1. BUSINESS
GENERAL
Aames Financial Corporation (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 making loans in California since it was founded in
1954. In 1995, the Company expanded its retail presence outside of California
and began purchasing loans from correspondents. In August 1996, the Company
acquired its broker production channel through the acquisition of One Stop
Mortgage, Inc. 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."
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.
The Company originates loans nationally through its core retail and broker
production channels. The Company also purchases loans through correspondents,
which it has materially decreased since fiscal 1998. During the years ended
June 30, 2000, 1999 and 1998, the Company originated $2.0 billion, $2.0 billion
and $1.7 billion, respectively, of mortgage loans and purchased $32.7 million,
$241.5 million and $646.3 million of mortgage loans from correspondents. The
Company underwrites and appraises every loan it originates and generally reviews
appraisals and re-underwrites all loans it purchases. See--"Mortgage Loan
Production."
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. During the years ended June 30, 2000, 1999 and
1998, the Company sold $2.2 billion, $1.9 billion and $2.5 billion,
respectively, of loans. See "--Loan Disposition."
The Company generally retains the servicing on the loans it securitizes. At
June 30, 2000, 1999 and 1998, the Company's servicing portfolio was
$3.6 billion, $3.8 billion and $4.1 billion, respectively. Loans serviced
in-house at June 30, 2000, 1999 and 1998 were $3.3 billion, $3.4 billion and
$3.9 billion, respectively, or 92.6%, 89.2% and $95.0%, respectively.
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, including internet, and broker operations by
improving market penetration in existing locations and evaluating other
potential locations and by building new relationships with independent mortgage
2
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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.
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.
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.
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 "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--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.
RECENT EVENTS
The Company lost $122.4 million during the fiscal year ended June 30, 2000.
The $122.4 million loss resulted from the Company's $82.5 million write down to
its residual interests and mortgage servicing rights and a $39.9 million net
operating loss. Of the $82.5 million write down, $77.5 million related to the
reduction to the fair value of the Company's residual interests reflecting the
Company's assessment of recent credit loss experience in its securitized pools
and the impact of recent interest rate increases which reduced excess spread in
such pools . The Company also wrote down the carrying value of its mortgage
servicing rights by $5.0 million during fiscal 2000 to reflect increased costs
incurred by the Company due in part to subservicing arrangements. The
$39.9 million net operating loss during the fiscal year is attributable
primarily to the Company's reliance on the whole loan sale market as its sole
loan disposition strategy during the March and June quarters, and the delay in
realizing the benefits of the Company's recently implemented expense management
efforts.
In June and July 2000, the Company completed an investment of $50.0 million
from Specialty Finance Partners ("SFP"), the Company's largest stockholder which
is controlled by Capital Z Financial Services Fund, II, L.P., a Bermuda
partnership (together with SFP, "Capital Z"), issuing 58.8 million shares of
Series D Preferred Stock for a price per share equal to $0.85 per share, and
warrants to purchase an additional 5.0 million shares of Series D Preferred
Stock at $0.85 per share.
On August 31, 2000, the Company entered into a Residual Forward Sale
Facility (the "Residual Facility") with Capital Z Investments, L.P., a Bermuda
partnership ("CZI"), an affiliate of Capital Z, pursuant to which the Company
may sell, on a forward flow basis, up to $75.0 million of residual interests
created in future securitizations through the earliest of (i) September 30,
2002, (ii) the full utilization of the $75.0 million amount of the Residual
Facility, or (iii) a termination event, as defined in the Residual Facility. The
Company believes that the Residual Facility will assist the Company by
strengthening its ability to include securitizations in its loan disposition
strategy through reducing the negative cash flow aspects of securitizations and
by providing another source of cash to the Company through periodically
converting residual interests into cash.
On August 31, 2000, the Company renewed a $250.0 million committed warehouse
facility and increased the borrowing limit thereunder by $50.0 million to
$300.0 million. As previously reported, on
3
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April 28, 2000, the Company renewed a $300.0 million committed repurchase
facility, decreasing the borrowing limit thereunder by $100.0 million to
$200.0 million. With these recent renewals, the Company has current borrowing
capacity under committed revolving warehouse and repurchase facilities of
$665.0 million (excluding a $35.0 million non-revolving subline). All of the
Company's revolving warehouse and repurchase facilities contain provisions
requiring the Company to meet certain periodic financial covenants. In addition,
under the Company's 1999 securitization trusts, the monoline insurance company
providing credit enhancement requires the Company to maintain a specified net
worth and level of cash liquidity in order to continue to service the loans in
the trust. The Company met all of its financial covenants under its revolving
warehouse and repurchase facilities and its securitization trusts at June 30,
2000.
On September 21, 2000, the Company completed a securitization of
$460.0 million of mortgage loans and sold its residual interest through the
Residual Facility for cash. Although the Company generally retains the servicing
on the loans it securities, the Company sold its servicing rights and the rights
to prepayment penalties under the securitization because the gain realized on
sale was higher than what the Company would have realized had the mortgage
servicing rights and the rights to prepayment fees been retained, and the gain
was for cash.
As previously reported, the Company's existing revolving warehouse and
repurchase facilities do not provide for the funding of mortgage loans at
closing; instead, the Company uses working capital to close mortgage loans.
After the mortgage loans are closed, the Company pledges them under one of its
revolving warehouse or repurchase facilities to replenish working capital. The
Company is currently seeking a new revolving warehouse or repurchase facility to
fund mortgage loans at closing. As a result of the recent $50.0 million
investment, and the $460.0 million securitization, the residual sale under the
Residual Facility and the sale of servicing rights and the rights to prepayment
penalties completed September 21, 2000, the Company believes it has sufficient
cash to fund at closing its current loan production.
As a result of the recent investment by Capital Z, the Company intends to
make a distribution to the holders of the Company's Common Stock, and Series C
Convertible Preferred Stock, in the form of a dividend of nontransferable
subscription rights to purchase shares of Series D Preferred Stock for $0.85 per
share (the "Rights Offering"). Capital Z has agreed that neither they nor any of
their affiliates (including SFP) will participate in the Rights Offering.
Consequently, the number of shares offered in the Rights Offering to
stockholders not affiliated with Capital Z (the "Nonaffiliated Stockholders")
will be approximately 19.8 million shares of Series D Preferred Stock. The
Company expects to complete the Rights Offering during the quarter ending
December 31, 2000.
The Company was notified in writing by the New York Stock Exchange (the
"NYSE") on September 12, 2000 (the "NYSE Notice") that the average closing price
per share of the Company's Common Stock was below the NYSE's minimum stock price
requirement of $1.00 per share as of the thirty trading-day period ended
July 19, 2000. Pursuant to the NYSE Notice, the Company has until December 29,
2000 to raise the thirty day average closing price of the Common Stock above
$1.00 per share or the NYSE will suspend the Company's listing and apply to the
Securities and Exchange Commission ("SEC") for delisting. The closing price of
the Common Stock on September 27, 2000 was $1.5625 per share and the average
closing price for the thirty trading-day period ended September 27, 2000 was
$1.45 per share. There can be no assurance that the thirty day average closing
price of the Common Stock will remain above $1.00 per share or that the Common
Stock will not be delisted by the NYSE. If the Common Stock were delisted by the
NYSE, it would seriously impair the ability of Common stockholders to trade
their shares.
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MORTGAGE LOAN PRODUCTION
The Company's principal loan product is a non-conforming home equity loan
with a fixed principal amount and term to maturity which is typically secured by
a first or second mortgage on the borrower's residence with either a fixed or
adjustable interest rate. Non-conforming home equity loans are loans made to
homeowners whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions or other factors and generally cannot be
directly marketed to agencies such as Fannie Mae and Freddie Mac. During the
year ended June 30, 2000, the Company originated its residential loans through
its primary retail and broker channels, and to a lesser extent, purchased closed
loans.
The following table presents certain information about the Company's loan
production at or during the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------------
2000 1999 1998
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Retail loans(1):
Total dollar amount................................ $ 783,700 $ 770,000 $ 636,100
Number of loans.................................... 11,226 12,214 11,531
Average loan amount................................ 70 63 55
Average initial combined loan to value............. 73% 72% 70%
Weighted average interest rate(3).................. 10.0% 9.5% 10.3%
Number of retail loan offices at period end........ 100 101 103
Broker loans(2):
Total dollar amount................................ $1,262,900 $1,182,100(3) $1,101,200(3)
Number of loans.................................... 13,838 14,006 12,763
Average loan amount................................ 91 84 86
Average initial combined loan to value............. 78% 76% 75%
Weighted average interest rate(3).................. 10.3% 9.9% 9.8%
Number of broker loan offices at period end........ 7 35 52
Correspondent program:
Total dollar amount................................ $ 32,700 $ 241,500 $ 646,300
Number of loans.................................... 289 2,219 6,252
Average loan amount................................ 113 109 103
Average initial combined loan to value............. 81% 80% 79%
Weighted average interest rate(3).................. 10.2% 10.0% 10.2%
Total loans:
Total dollar amount................................ $2,079,300 $2,193,600 $2,383,600
Number of loans.................................... 25,353 28,439 30,546
Average loan amount................................ 82 77 78
Average initial combined loan to value............. 76% 75% 75%
Weighted average interest rate(3).................. 10.2% 9.8% 10.1%
</TABLE>
------------------------------
(1) During the quarter ended December 31, 1999, the Company commenced
originating loans through the internet, through an affiliation with certain
internet lending sites. The numbers for fiscal year 2000 includes 82 loans
with a total dollar amount of $5.9 million in loans originated through the
internet.
(2) During the quarter ended June 30, 2000, the Company's broker channel
commenced originating loans through telemarketing and the internet, through
an affiliation with certain internet lending sites. The numbers for fiscal
year 2000 includes 241 loans with a total dollar amount of $24.9 million in
loans originated through these sources.
(3) Calculated with respect to the interest rate at the time the loan was
originated or purchased by the Company.
(4) Includes commercial loans. In late fiscal 1997, the Company began
originating small commercial loans on a limited basis. In January 1999, the
Company discontinued its commercial loan operation.
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Total loan production during the fiscal year ended June 30, 2000 of
$2.1 billion was down from the $2.2 billion reported for the fiscal year ended
June 30, 1999 and the $2.4 billion reported for the fiscal year ended June 30,
1998; however, core retail and broker production was $2.0 billion for fiscal
2000, and $2.0 billion for fiscal 1999 and $1.7 billion for fiscal 1998. Loan
origination volume from the Company's broker channel increased to $1.3 billion
during fiscal 2000 from $1.2 billion in production reported during fiscal 1999
and $1.1 billion reported for fiscal 1998. During fiscal 2000, the Company's
retail channel production increased to $783.7 million from $770.0 million during
fiscal 1999 and $636.1 million during fiscal 1998. Correspondent production
during fiscal 2000 declined to $32.7 million from $241.5 million during fiscal
1999 and $646.3 million during fiscal 1998, reflecting the Company's previously
reported decision to decrease its reliance on this channel.
RETAIL LOAN CHANNEL. The Company originates home equity mortgage loans
through its network of retail loan offices and through the internet. At
June 30, 2000, the Company had 100 offices serving borrowers nationally. During
the coming year, the Company intends to evaluate opportunities for further
retail office expansion. The Company selects areas in which to introduce or
expand its retail presence on the basis of selected demographic statistics,
marketing analyses and other criteria developed by the Company.
The Company generates applications for loans through its retail loan office
network principally through a direct response marketing program, which relies
primarily on the use of direct mailings to homeowners, telemarketing and
yellow-page listings. In the past, the Company has also used television and
radio advertising. The Company generates customer leads for the retail network
in two ways: produced by the Company based upon Company derived models and
commercially developed customer lists, the ("centralized marketing approach")
and generated by the local branch by the loan officers who are familiar with the
local area (the "decentralized marketing approach"). Prior to fiscal year 1999,
the Company relied exclusively on the centralized marketing approach and added
the decentralized marketing approach in fiscal year 1999 in order to increase
its retail loan production and further penetrate the non-conforming home equity
market. The Company believes that its marketing efforts campaigns establish name
recognition and serve to distinguish the Company from its competitors. The
Company continually monitors the sources of its applications to determine the
most effective methods and manner of marketing.
The Company's direct mail invites prospective borrowers to call the Company
to apply for a loan. Direct mail is often followed up by telephone calls to
potential customers. All contact with the customer is handled through the local
branch. On the basis of an initial screening conducted at the time of the call,
the Company's loan officer at the local retail loan office makes a preliminary
determination of whether the customer and the property meet the Company's
lending criteria. If so, the loan officer assists the applicant in completing
the loan application, arranges for an appraisal, orders a credit report from an
independent, nationally recognized credit reporting agency and performs various
other tasks in connection with the completion of the loan package. The loan
officer may complete the application over the telephone, or schedule an
appointment in the retail loan office most conveniently located to the customer
or in the customer's home, depending on the customer's needs. The loan package
is then underwritten for loan approval. If the loan package is approved, the
loan is funded by the Company. The Company's loan officers are trained to
structure loans that meet the applicant's needs while satisfying the Company's
lending guidelines.
In November of 1999, the Company sought to increase its retail loan
production and further penetrate the non-conforming home equity market through
loan originations through the internet. The Company obtains leads through
several commercially available internet sites as well as through its own
internet web site "Aames.net". Retail internet loan originations totaled
$5.9 million, or 0.8% of retail production for fiscal year 2000. The Company
expects retail internet production to generate an increasing dollar amount and
percentage of retail loan production in the coming quarters.
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INDEPENDENT MORTGAGE BROKER CHANNEL. At June 30, 2000, the Company operated
7 regional offices and had approximately 8,100 approved mortgage brokers. During
fiscal 2000, the Company originated loans through approximately 4,700 brokers,
no one of which accounted for more than 3% of total broker originations. All
broker loans originated by the Company are underwritten in accordance with the
Company's underwriting guidelines. Once approved, the loan is funded by the
Company directly.
The broker's role is to identify the applicant, assist in completing the
loan application form, gather necessary information and documents and serve as
the Company's liaison with the borrower through the lending process. The Company
reviews and underwrites the applications submitted by the broker, approves or
denies the application, sets the interest rate and other terms of the loan and,
upon acceptance by the borrower and satisfaction of all conditions imposed by
the Company, funds the loan. Because brokers conduct their own marketing and
employ their own personnel to complete loan applications and maintain contact
with borrowers, originating loans through its broker network allows the Company
to increase its loan volume without incurring the higher marketing and employee
costs associated with increased retail originations.
Because mortgage brokers generally submit loan files to several prospective
lenders simultaneously, consistent underwriting, quick response times and
personal service are critical to successfully producing loans through
independent mortgage brokers. To meet these requirements, the Company strives to
provide quick response time to the loan application (generally within
24 hours). In addition, loan consultants and loan processors, including
underwriters, are available in the Company's regional offices to answer
questions, assist in the loan application process and facilitate ultimate
funding of the loan.
In the fourth quarter of fiscal year 2000, the Company sought to use
telemarketing and the internet to increase its broker loan production and
further penetrate the non-conforming home equity broker market through its
"Broker Direct" program. Through Broker Direct, the Company makes out bound
telemarketing calls to brokers who are not currently doing business with the
Company or are outside the geographic areas served by the loan officers. Through
"Broker Direct", the Company obtains leads through a commercially available
internet site as well as through its own internet web site "Aamesdirect.com".
"Broker Direct" loan origination totaled $24.0 million for telemarketing
generated leads, and $875,000 for internet generated leads for fiscal year ended
June 30, 2000. The Company expects "Broker Direct" to generate an increasing
dollar amount and percentage of broker loan production in the coming quarters.
CORRESPONDENT CHANNEL. The Company purchases a limited amount of closed
loans from mortgage bankers and other financial institutions on a continuous or
"flow" basis. The Company believes that its flow correspondent program enables
the Company to supplement its core loan production on a cost effective basis.
Prior to fiscal 1999, the Company purchased a significant dollar amount of
correspondent loans in bulk purchases, but eliminated bulk purchases and
decreased its reliance on correspondent production in fiscal 1999, shifting its
focus on core retail and broker production.
UNDERWRITING. The Company underwrites every residential loan it originates
and generally re-underwrites each loan it purchases. The Company's underwriting
guidelines are designed to assess the borrower's creditworthiness and the
adequacy of the real property as collateral for the loan. The borrower's
creditworthiness is assessed by examination of a number of factors, including
calculation of debt-to-income ratios, which is the sum of the borrower's monthly
debt payments divided by the borrowers's monthly income before taxes and other
payroll deductions, an examination of the borrower's credit history and credit
score through standard credit reporting bureaus, and by evaluating the
borrower's payment history with respect to existing mortgages, if any, on the
property.
An assessment of the adequacy of the real property as collateral for the
loan is primarily based upon an appraisal of the property and a calculation of
the ratios of the loan applied for (the "LTV") and of all mortgages existing on
the property (including the loan applied for) (the "combined loan-to-value
ratio") or "CLTV" to the appraised value of the property at the time of
origination. As a
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lender that specializes in loans made to credit impaired borrowers, the Company
makes home equity mortgage loans to borrowers with credit histories or other
factors that would typically disqualify them from consideration for a loan from
traditional financial institutions. Consequently, the Company's underwriting
guidelines for such credit-impaired borrowers generally require lower combined
loan-to-value ratios than would typically be the case if the borrower could
qualify for a loan from a traditional financial institution.
Appraisers determine a property's value by reference to the sales prices of
comparable properties recently sold, adjusted to reflect the condition of the
property as determined through inspection. Appraisals on loans purchased as part
of the Company's correspondent program are reviewed by Company appraisers or
Company-qualified contract appraisers to assure that they meet the Company's
standards.
The underwriting of a mortgage loan to be originated or purchased by the
Company includes a review of the completed loan package, which includes the loan
application, a current appraisal, a preliminary title report and a credit
report. All loan applications and all closed loans offered to the Company for
purchase must be approved by the Company in accordance with its underwriting
criteria. The Company regularly reviews its underwriting guidelines and makes
changes when appropriate to respond to market conditions, the performance of
loans representing a particular loan product or changes in laws or regulations.
The Company requires title insurance coverage issued on an American Land
Title Association (or similar) form of title insurance on all residential
properties securing mortgage loans it originates or purchases. The loan
originator and its assignees are generally named as the insured. Title insurance
policies indicate the lien position of the mortgage loan and protect the Company
against loss if the title or lien position is not as indicated. The applicant is
also required to maintain hazard and, in certain instances, flood insurance, in
an amount sufficient to cover the new loan and any senior mortgage, subject to
the maximum amount available under the National Flood Insurance Program.
The Company has two general underwriting programs through which it
implements the above:
- the "traditional" underwriting program, under which the borrower's
mortgage credit and consumer credit are each scored and weighted to
determine the overall credit grade of the borrower with the borrower then
being assigned an "A" through "D" credit grade, and
- a credit score/LTV based underwriting program (referred to as the "SNAP
program"), under which the borrower's credit score as reported by various
reporting agencies and the LTV of the loan are used to determine whether
the borrower qualifies for the loan requested and the appropriate pricing
for that loan. Loans under this program are converted to "traditional"
underwriting credit scores for reporting purposes.
"TRADITIONAL" UNDERWRITING PROGRAM. The Company assigns a credit grade (A,
A-, B, C, C- and D) to each loan it originates or purchases depending on the
risk profile of the loan, with the higher credit grades exhibiting a lower risk
profile and the lower credit grades exhibiting increasingly higher risk
profiles. Generally, the higher credit grade loans have higher loan-to-value
ratios and carry a lower
8
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interest rate. The following chart generally outlines certain parameters of the
credit grades of the Company's traditional underwriting program at
September 15, 2000:
<TABLE>
<CAPTION>
"A" CREDIT "A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE GRADE
-------------- -------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
GENERAL REPAYMENT Has good Has good Generally good Marginal Marginal Designed to
credit. credit but mortgage pay credit history credit history provide a
might have history but which is not offset by borrower with
some minor may have offset by other positive poor credit
delinquency. marginal other positive attributes. history an
consumer attributes. opportunity to
credit correct past
history. credit
problems.
EXISTING MORTGAGE No lates in No more than No more than Can have No more than Greater than
LOANS past 12 59 days late 89 days late multiple 149 days 150 days
months. at closing and at closing and 30-day lates delinquent in delinquent in
a maximum of a maximum of and two 60-day the past 12 the past 12
two 30-day four 30-day lates or one months. Can months.
lates in the lates in the 90-day late in have multiple
past 12 past 12 months the past 12 90-day lates
months. or one 60-day months; or one 120 day
late and two currently not late in the
30-day lates. more than 119 past 12
days late at months.
closing.
CONSUMER CREDIT Consumer Consumer Consumer Consumer Consumer Consumer
credit is good credit is good credit must be credit is fair credit is poor credit is poor
in the last 12 in the last 12 satisfactory in the last 12 in the last 12 in the last 12
months. Less months. Less in the last 12 months. The months with months. The
than 25% of than 35% of months. Less majority of currently majority of
credit report credit report than 40% of the credit is delinquent the credit is
items items credit report not currently accounts. Less derogatory
derogatory derogatory items delinquent. than 60% of (more than
with no 60-day with no 90-day derogatory. Less than 50% credit report 60%).
or more lates. or more lates. Generally, of credit items Percentage of
Generally, Generally, requires a report items derogatory. derogatory
requires a requires a minimum credit derogatory. Generally, items not a
minimum credit minimum credit score of 560. Generally, requires a factor.
score of 600. score of 580. requires a minimum credit Generally,
minimum credit score of 500. requires a
score of 530. minimum credit
score of 500.
BANKRUPTCY 2 years since 2 years since 1 year since Bankruptcy Bankruptcy Current
discharge or discharge or discharge with filing 12 filed within bankruptcy
dismissal with dismissal with reestablished months old, last 12 months must be paid
reestablished reestablished "B" credit or discharged or and discharged through loan.
"A" credit. "A-" credit. 18 months dismissed or dismissed
since prior to prior to
discharge application. application.
without
reestablished
credit.
DEBT SERVICE- Generally not Generally not Generally not Generally not Generally not Generally not
TO-INCOME RATIO to exceed 45%. to exceed 45%. to exceed 50%. to exceed 55%. to exceed 60%. to exceed 60%.
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
"A" CREDIT "A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE GRADE
-------------- -------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
MAXIMUM LOAN-TO-
VALUE RATIO:
OWNER OCCUPIED Generally 90% Generally 90% Generally 80% Generally 75% Generally 70% Generally 65%
for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4
family family family family family family
dwelling. dwelling. dwelling. dwelling. dwelling. dwelling.
NON-OWNER OCCUPIED Generally 80% Generally 70% Generally 65% Generally 65% Generally 65% Generally 60%
for a 1 to 4 for a 1 to 4 for a 1 to 2 for a 1 to 4 for a 1 to 4 for a 1 to 4
family family family family family family
dwelling. dwelling. dwelling. dwelling. dwelling. dwelling.
</TABLE>
"SNAP" UNDERWRITING PROGRAM. The SNAP program was developed by the Company
to enhance its ability to risk-base price its loan products, to increase
uniformity of creditworthiness within each credit "band" and to reduce
subjectivity and simplify the underwriting process in order to improve
efficiency and service levels to its customers.
The SNAP program uses the credit score (as defined below) of the primary
borrower (i.e., the borrower with the majority of total income) to determine
program eligibility and then to determine the maximum LTV and interest rate for
which the borrower may qualify. Generally, the minimum acceptable credit score
under the SNAP program is 500.
In most cases, the payment history of the borrower under the existing
mortgage loan is also taken into consideration. Borrowers with lower credit
scores generally qualify for lower maximum LTVs and are charged higher interest
rates than borrowers with higher credit scores. "Credit Scores" are discussed
below.
Under the SNAP program, a verification of the borrower's mortgage payment
history under his existing mortgage loan over the most recent 12 months is
required in all cases where the primary borrower's credit score is less than 600
(or less than 640 if the loan amount is less than $100,000). The maximum LTV
allowed and the interest rate for the loan indicated by the SNAP program may be
adjusted based on the borrower's past mortgage payment history. Under the SNAP
program, a poor mortgage payment history will result in a lower maximum LTV and
a higher interest rate (comparable to the maximum LTV and interest rate for a
borrower with a lower credit score) in order to reflect the increased risk of
default indicated by the mortgage payment history. The LTV and credit score
adjustments are set forth in the chart below.
<TABLE>
<CAPTION>
ADJUSTED CREDIT SCORE AND MAXIMUM LTV
BASED UPON MORTGAGE LATES IN PREVIOUS MONTHS
----------------------------------------------------------------------------------------
ACTUAL CREDIT 4X30 AND 0X60; 12X30 AND 2X60;
SCORE 2X30 2X30 AND 1X60 12X30 AND 1X90 12X60 AND 1X120 1X150
----- -------- ----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C>
700+................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
680.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
660.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
640.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
620.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
600.................. 600 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
580.................. 580 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
560.................. 560 560; 80%max LTV 550; 75%max LTV 520; 70%max LTV 500; 65%max LTV
540.................. 540 540 540 520; 70%max LTV 500; 65%max LTV
520.................. 520 520 520 520; 70%max LTV 500; 65%max LTV
500.................. 500 500 500 500 500
</TABLE>
For example, under the SNAP program, in the case of a borrower with a credit
score of 640 who has had not more than one 30-day late payment on his existing
mortgage loan during the previous
10
<PAGE>
12 months (i.e., 1x30) and who otherwise qualifies for a maximum LTV of 90%, the
borrower's actual credit score of 640 would be used for purposes of qualifying
for the loan and determining the applicable interest rate and the 90% maximum
LTV allowed would not be adjusted downward. However, under the SNAP program, if
the borrower with the 640 credit score had two 30-day late payments in the
previous 12 months (i.e., 2x30), the credit score used for purposes of
qualifying and determining pricing, would fall to 600--and the maximum LTV
allowed would be 80%. In addition, the interest rate for that loan would be
determined as if the borrower's credit score were 600 (instead of the actual
credit score of 640). If that same borrower had a mortgage delinquency of 2x30
and 1x60 or 4x30 and 0x60 during the previous 12 months, then the maximum LTV
allowed would be 80% and the loan would be priced as if the credit score was
560. If that borrower had a mortgage delinquency of 12x30 and 2x60 or 12x30 and
1x60 and 1x90 for the previous 12 months, then the maximum LTV falls to 75% and
the loan would be priced as if the credit score was 550. If that borrower had a
mortgage delinquency of 12x90, or 12x60 and 1x90 and 1x120 for the previous
12 months, then the maximum LTV decreases to 70% and the credit score used for
pricing falls to 520. If that borrower had a mortgage delinquency of 1x150 or
more for the previous 12 months, then the maximum LTV falls to 65% and the loan
would be priced as if the credit score were 500.
CREDIT SCORES. "Credit scores" are obtained by many lenders in connection
with mortgage loan applications to help assess a borrower's creditworthiness.
Credit scores are obtained from credit reports provided by various credit
reporting organizations, each of which may employ differing computer models and
methodologies. The credit score is designed to assess a borrower's credit
history at a single point, using objective information currently on file for the
borrower at a particular credit reporting organization. Information utilized to
create a credit score may include, among other things, payment history,
delinquencies on accounts, level of outstanding indebtedness, length of credit
history, types of credit, and bankruptcy experience. Credit scores range from
approximately 400 to approximately 800, with higher scores indicating an
individual with a more favorable credit history compared to an individual with a
lower score. However, a credit score purports only to be a measurement of the
relative degree of risk a borrower represents to a lender, that is, a borrower
with a higher score is statistically expected to be less likely to default in
payment than a borrower with a lower score. In addition, it should be noted that
credit scores were developed to indicate a level of default probability over a
two-year period, which does not correspond to the life of a mortgage loan.
Furthermore, credit scores were not developed specifically for use in connection
with mortgage loans, but for consumer loans in general, and assess only the
borrower's past credit history. Therefore, a credit score does not take into
consideration the differences between mortgage loans and consumer loans
generally or the specific characteristics of the related mortgage loan
including, for example, the LTV or CLTV, the collateral for the mortgage loan,
or the debt to income ratio. There can be no assurance that the credit scores of
the mortgagors will be an accurate predictor of the likelihood of repayment of
the related mortgage loans.
The tables on the following page present certain information about the
Company's loan production through its retail, broker and correspondent channels
during the years ended June 30, 2000, 1999 and 1998:
11
<PAGE>
LOAN ORIGINATIONS AND PURCHASES DURING THE YEAR ENDED JUNE 30, 2000
TRADITIONAL UNDERWRITING PROGRAM AND "SNAP" UNDERWRITING PROGRAM
<TABLE>
<CAPTION>
WEIGHTED
DOLLAR AMOUNT % OF COMBINED WEIGHTED AVERAGE
CREDIT GRADE(2) OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE(1)
--------------- -------------- -------- ------------- ----------------
<S> <C> <C> <C> <C>
A......................... $ 772,412,000 37% 79% 9.6%
A-........................ 499,408,000 24 77 9.8
B......................... 508,467,000 24 76 10.4
C......................... 197,119,000 9 63 11.5
C-........................ 43,310,000 2 68 12.6
D......................... 58,562,000 3 61 13.8
-------------- --- --- ----
Total..................... $2,079,278,000 100% 76% 10.2 %
============== === === ====
</TABLE>
LOAN ORIGINATIONS AND PURCHASES DURING THE YEAR ENDED JUNE 30, 1999
TRADITIONAL UNDERWRITING PROGRAM ONLY
<TABLE>
<CAPTION>
WEIGHTED
DOLLAR AMOUNT % OF COMBINED WEIGHTED AVERAGE
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE(1)
------------ -------------- -------- ------------- ----------------
<S> <C> <C> <C> <C>
A........................... $ 707,644,000 32% 79% 9.1%
A-.......................... 729,237,000 33 77 9.4
B........................... 475,370,000 22 75 10.1
C........................... 119,730,000 5 68 11.1
C-.......................... 37,990,000 2 65 12.3
D........................... 123,665,000 6 62 12.9
-------------- --- -- ----
Total....................... $2,193,636,000 100% 75% 9.8%
============== === == ====
</TABLE>
LOAN ORIGINATIONS AND PURCHASES DURING THE YEAR ENDED JUNE 30, 1998
TRADITIONAL UNDERWRITING PROGRAM ONLY
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
DOLLAR AMOUNT % OF COMBINED WEIGHTED AVERAGE
CREDIT GRADE OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE(1)
------------ -------------- -------- ------------- ----------------
<S> <C> <C> <C> <C>
A........................... $ 651,303,000 27% 77% 9.3%
A-.......................... 835,834,000 35 78 9.7
B........................... 560,710,000 24 74 10.2
C........................... 159,652,000 7 67 11.2
C-.......................... 45,378,000 2 65 12.2
D........................... 130,761,000 5 61 13.2
-------------- --- -- ----
Total....................... $2,383,638,000 100% 75% 10.1%
============== === == ====
</TABLE>
------------------------
(1) Calculated with respect to the interest rate at the time the loan is
originated or purchased by the Company, as applicable.
(2) Loans underwritten under the "SNAP" underwriting program are assigned a
credit grade that the Company believes correlates to the credit grades in
the "Traditional" underwriting program.
12
<PAGE>
QUALITY CONTROL. The Company's quality control program is intended to
(i) monitor and improve the overall quality of loan production generated by the
Company's retail loan channel, independent mortgage broker channel and
correspondent channel and (ii) identify and communicate to management existing
or potential underwriting and loan packaging problems or areas of concern. The
quality control file review examines compliance with the Company's underwriting
guidelines and federal and state regulations. This is accomplished by focusing
on: (i) the accuracy of all credit and legal information; (ii) a collateral
analysis which may include a desk or field re-appraisal of the property and
review of the original appraisal; (iii) employment and/or income verification;
and (iv) legal document review to ensure that the necessary documents are in
place.
LOAN DISPOSITION
As a fundamental part of its business and financing strategy, the Company
sells loans to third party investors in the secondary markets as market
conditions allow. The Company maximizes opportunities in its loan disposition
transactions by selling 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. However, the
upfront overcollateralization and servicing advance obligations required on
retaining the servicing in securitizations are cash flow negative to the Company
in the early years of the securitization. These negative cash flow
considerations along with conditions in the securitization market precluded the
Company from securitizing mortgage loans in the second half of the year ended
June 30, 2000. The Company believes that the Residual Facility will assist the
Company by strengthening its ability to include securitizations in its loan
disposition strategy through reducing the negative cash flow aspects of
securitization and by providing another source of cash to the Company through
periodically converting residual interests into 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. Generally, in a
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 Company generally seeks to dispose of substantially all of its
production within 90 days. The Company applies the net proceeds of the loan
dispositions, whether through securitizations or whole loan sales, to pay down
its warehouse and repurchase facilities in order to make these facilities
available for future funding of mortgage loans.
The following table sets forth certain information regarding the Company's
securitizations and whole loan sales during the periods presented (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------
2000 1999 1998
---------- ---------- ----------
<S> <C> <C> <C>
Loans pooled and sold in
securitizations........................ $ 803,557 $ 649,999 $2,034,300
Whole loan sales......................... 1,419,199 1,236,050 416,390
---------- ---------- ----------
Total loans securitized and sold....... $2,222,756 $1,886,049 $2,450,690
========== ========== ==========
</TABLE>
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. If losses exceed the amount of the
overcollateralization or the reserve account, as applicable, the
credit-enhancement aspects of the trust are triggered. In a securitization
credit-enhanced by a monoline insurance policy, any further losses experienced
by holders
13
<PAGE>
of the senior interests in the related trust will be paid under such policy. To
date, there have been no claims on any monoline insurance policy obtained in any
of the Company's securitizations. In a senior/ subordinated structure, losses in
excess of the overcollateralization amount generally are allocated first to the
holders of the subordinated interests and then to the holders of the senior
interests of the trust. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources--The Securitization and Sale of Mortgage Loans."
LOAN SERVICING
Servicing includes collecting and remitting loan payments, accounting for
principal and interest, contacting delinquent borrowers, managing borrower
defaults and liquidating foreclosed properties. It is the Company's strategy to
build and retain its core servicing portfolio. 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. The Company
generally retains the servicing rights to the residential loans it securitizes.
However, in the securitization completed by the Company on September 21, 2000,
the Company sold its servicing rights, together with the rights to prepayment
penalties because the gain realized on sale was higher than what the Company
would have realized had the mortgage servicing rights and the rights to
prepayment fees been retained, and the gain was for cash. Moreover, the Company
does not generally retain servicing on loans it sells in whole loan sales for
cash. The Company's servicing portfolio is subject to reduction by normal
monthly principal amortization, by voluntary prepayment and by foreclosure. The
following table sets forth certain information regarding the Company's servicing
portfolio for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------------
2000 1999 1998
---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Servicing portfolio (period end)....... $3,560,000(1) $3,841,000(2) $4,147,000(3)
Serviced in-house...................... 3,296,000 3,428,000 3,941,000
Loan service revenue................... 15,654 23,329 10,634
</TABLE>
------------------------
(1) Includes $280.2 million of loans subserviced for others on an interim basis
and approximately 265.4 million of loans subserviced by others.
(2) Includes $84.0 million of loans subserviced for others on an interim basis
and approximately $413.0 million of loans subserviced by others.
(3) Includes $82.0 million of loans subserviced for others on an interim basis.
14
<PAGE>
The following table illustrates the mix of credit grades in the Company's
servicing portfolio as of June 30, 2000 (dollars in thousands):
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
COMBINED WEIGHTED AVERAGE
DOLLAR AMOUNT % OF INITIAL ORIGINAL
CREDIT GRADE(1) OF LOAN TOTAL LOAN-TO-VALUE INTEREST RATE
--------------- ------------- -------- ------------- ----------------
<S> <C> <C> <C> <C>
A............................. $ 808,000 23% 78% 9.6%
A-............................ 1,268,000 35 76 10.2
B............................. 840,000 23 74 10.9
C............................. 309,000 9 69 11.8
C-............................ 97,000 3 65 12.8
D............................. 234,000 7 62 13.7
Other (2)..................... 4,000 0 53 11.3
---------- --- --- ----
Total......................... $3,560,000 100% 74% 10.7%
========== === === ====
</TABLE>
------------------------
(1) Loans underwritten under the "SNAP" Underwriting Program are assigned, for
loan servicing purposes, a credit grade that the Company believes correlates
to the credit grades in the "Traditional" underwriting program.
(2) Consists of older loans that were not assigned a credit grade at
origination.
At June 30, 2000, of the Company's $3.6 billion servicing portfolio, 92.6%
was serviced in-house compared to 89.2% of the Company's $3.8 billion servicing
portfolio serviced in-house at June 30, 1999 and 95.0% of the Company's
$4.1 billion servicing portfolio at June 30, 1998. During the year ended
June 30, 1999, in order to reduce its servicing advance obligations, the Company
entered into an arrangement with a loan servicing company whereby the servicing
company purchased certain cumulative advances and agreed to make future
servicing advances with respect to an aggregate of $388.0 million
($265.4 million at June 30, 2000) in principal amount of loans.
The agreements between the Company and the real estate mortgage investment
conduit ("REMIC") or owner trusts established in connection with securitizations
typically require the Company, in its role as servicer, to advance interest (but
not principal) on delinquent loans to the holders of the senior interests in the
related trusts. The agreements also require the Company to make certain
servicing advances (e.g., for property taxes or hazard insurance) unless the
Company determines that such advances would not be recoverable. Realized losses
on the loans are paid out of the related loss reserves established by the
Company at the time of securitization or paid out of principal and interest
payments or overcollateralized amounts as applicable, and if necessary, from the
related monoline insurance policy or the subordinated interests.
In the case of securitizations credit-enhanced by monoline insurance, the
agreements also typically provide that the Company may be terminated as servicer
by the monoline insurance company (or by the trustee with the consent of the
monoline insurance company) upon certain events of default, including the
Company's failure to perform its obligations under the servicing agreement, the
rate of over 90-day delinquency (including properties acquired by foreclosure
and not sold) exceeding specified limits, losses on liquidation of collateral
exceeding certain limits, any payment being made by the monoline insurance
company under its policy, and certain events of bankruptcy or insolvency. At
June 30, 2000, ten trusts representing approximately 18.0% (by dollar volume) of
the Company's servicing portfolio exceeded the specified delinquency rate. Nine
of the ten trusts representing approximately 17.6% (by dollar volume) of the
Company's servicing portfolio exceeded specified loss limits at June 30, 2000.
In addition, under the Company's 1999 Securitization Trusts, the Company is
appointed as a servicer on a term-to-term basis, and the monoline insurer has
the right not to renew
15
<PAGE>
the term at any time. None of the servicing rights of the Company have been
terminated. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Risk Factors--Our Right to Service Loans
May be Terminated Because of the High Delinquencies and Losses on the Loans in
Our Servicing Portfolio." In the case of the Company's senior/subordinated
securitization transactions, holders of 51% of the certificates may terminate
the servicer upon certain events of default generally relating to certain levels
of loss experience, but not delinquency rates. No such events of default have
occurred to date in the Company's senior/subordinated securitizations.
The Company receives a servicing fee based on a percentage of the declining
principal balance of each loan serviced. Servicing fees are collected by the
Company out of the borrower's monthly payments. In addition, the Company, as
servicer, generally receives all late fees and assumption charges paid by the
borrower on loans serviced directly by the Company, as well as other
miscellaneous fees for performing various loan servicing functions. The Company
also generally receives any prepayment fees paid by borrowers. Under
arrangements entered into in fiscal 2000 and 1999 with an investment bank to
reduce the Company's servicing advances, the Company's right to receive fees,
charges and prepayment fees collected on loans in its securitization trusts has
been subordinated to the right of the investment bank to such fees to repay
advances previously made to those trusts. Under the Company's December 1999
Securitization Trusts, the Company's right to receive any prepayment penalties
collected on loans in the trust has been subordinated to the right to such
prepayment penalties as payment to trust as additional over collateralization.
The Company believes that continued technology and processing enhancements
will provide it with improved margins on its servicing. In general, revenue from
the Company's loan servicing portfolio may be adversely affected by competitive
market conditions that result in lower mortgage interest rates or accelerated
prepayment activity, subject to the receipt by the Company of prepayment fee
income. In some states in which the Company currently operates, prepayment fees
may be limited or prohibited by applicable law.
COLLECTIONS, DELINQUENCIES AND FORECLOSURES
The Company sends borrowers a monthly billing statement approximately ten
days prior to the monthly payment due date. Although borrowers generally make
loan payments within ten to fifteen days after the due date (the "grace
period"), if a borrower fails to pay the monthly payment within the grace
period, the Company commences collection efforts by notifying the borrower of
the delinquency. In the case of borrowers in the "B," "C," "C-" and "D" credit
grades, collection efforts begin immediately after the due date. The Company
continues contact with the borrower to determine the cause of the delinquency
and to obtain a commitment to cure the delinquency at the earliest possible
time.
As a general matter, if efforts to obtain payment have not been successful,
a pre-foreclosure notice will be sent to the borrower immediately after the due
date of the next subsequently scheduled installment (five days after the initial
due date for C- and D credit grades), providing 30 days' notice of impending
foreclosure action. During the 30-day notice period, collection efforts continue
and the Company evaluates various legal options and remedies to protect the
value of the loan, including arranging for extended prepayment terms, accepting
a deed-in-lieu of foreclosure, entering into a short sale (a sale for less than
the outstanding principal amount) or commencing foreclosure proceedings. If no
substantial progress has been made in collecting delinquent payments from the
borrower, foreclosure proceedings will begin. Generally, the Company will have
commenced foreclosure proceedings when a loan is 45 to 100 days delinquent,
depending upon credit grade, other credit considerations or borrower bankruptcy
status.
Servicing and collection practices change over time in accordance with,
among other things, the Company's business judgment, changes in portfolio
performance and applicable laws and regulations.
16
<PAGE>
Loans originated or purchased by the Company are secured by mortgages, deeds
of trust, security deeds or deeds to secure debt, depending upon the prevailing
practice in the state in which the property securing the loan is located.
Depending on local law, foreclosure is effected by judicial action or
nonjudicial sale, and is subject to various notice and filing requirements. In
general, the borrower, or any person having a junior encumbrance on the real
estate, may cure a monetary default by paying the entire amount in arrears plus
other designated costs and expenses incurred in enforcing the obligation during
a statutorily prescribed reinstatement period. Generally, state law controls the
amount of foreclosure expenses and costs, including attorneys' fees, which may
be recovered by a lender, the minimum time required to foreclose and the
reinstatement or redemption rights of the borrower.
Although foreclosure sales are typically public sales, frequently no
third-party purchaser bids in excess of the lender's lien because of the
difficulty of determining the exact status of title to the property, the
possible deterioration of the property during the foreclosure proceedings and a
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus, the Company often purchases the property from the trustee or
referee through a credit bid in an amount up to the principal amount outstanding
under the loan, accrued and unpaid interest, servicing advances and the expenses
of foreclosure. Depending upon market conditions, the ultimate proceeds of the
sale may not equal the Company's investment in the property.
The Company has historically experienced delinquency rates that are higher
than those prevailing in its industry due to its origination of lower credit
grade loans. During the year ended June 30, 1997, the Company started to focus
more on higher credit grade loans which should cause delinquencies in the
Company's servicing portfolio to decrease in the future. If the Company were to
sell 100% of its loans in the whole loan market on a servicing released basis,
the Company would not be adding new loans to the servicing portfolio. The
seasoning of the old portfolio without the addition of new loans might cause
delinquency rates to rise. The delinquency rate at June 30, 2000 was 13.6%
compared to 15.7% at June 30, 1999.
During the fiscal year ended June 30, 2000, losses on loan liquidations
increased to $96.1 million from $51.7 million in the prior year primarily due to
seasoning of the loans purchased in bulk and included in the Company's earlier
trusts. The Company has eliminated its bulk purchase program. Credit losses
incurred by the Company on liquidation were disproportionately higher for
correspondent loans purchased in bulk than experienced upon liquidations of
loans originated in the Company's core production channels. During the year
ended June 30, 2000, approximately 57.0% of losses on liquidation were from
losses on disposition of real estate collateral for bulk purchased correspondent
loans. In turn, bulk purchased correspondent loans comprised approximately 34.0%
of the Company's servicing portfolios when measured at July 1, 1999. The
seasoning of the bulk purchased portfolio may continue this trend in losses
during the current fiscal year. Further, the adverse market conditions that
existed during 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. Management believes that continuance of
these factors will contribute to the Company's losses during the current fiscal
year.
Because foreclosures and losses typically occur months or years after a loan
is originated, data relating to delinquencies, foreclosures and losses as a
percentage of the current portfolio can understate the risk of future
delinquencies, losses or foreclosures.
17
<PAGE>
The following table sets forth delinquency, foreclosure and loss information
relating to the Company's servicing portfolio as of or for the periods
indicated:
<TABLE>
<CAPTION>
AT OR DURING THE YEAR ENDED JUNE 30,
------------------------------------------
2000 1999 1998
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Percentage of dollar amount of delinquent
loans to loans serviced (period
end)(1)(2)(3)(4)
One Month............................... 1.9% 2.4% 3.8%
Two Months.............................. 0.8 1.0 1.3
Three or More Months
Not foreclosed(5)..................... 9.0 10.3 9.0
Foreclosed(6)......................... 1.9 2.0 1.5
---------- ---------- ----------
Total............................... 13.6% 15.7% 15.6%
========== ========== ==========
Percentage of dollar amount of loans
foreclosed during the period to loans
serviced(4)(8).......................... 3.6% 2.9% 2.0%
Number of loans foreclosed during the
period.................................. 1,854 1,680 1,125
Principal amount of foreclosed loans
during the period....................... $ 135,629 $ 122,445 $ 84,613
Number of loans liquidated during the
period.................................. 2,749 1,518 812
Net losses on liquidations during the
period(7)............................... $ 96,119 $ 51,730 $ 26,488
Percentage of annualized losses to average
servicing portfolio(4)(8)............... 2.6% 1.2% .7%
Servicing portfolio at period end......... $3,560,000 $3,841,000 $4,147,000
</TABLE>
------------------------------
(1) Delinquent loans are loans for which more than one payment is past due.
(2) The delinquency and foreclosure percentages are calculated on the basis of
the total dollar amount of mortgage loans serviced by the Company and any
subservicers as of the end of the periods indicated.
(3) At June 30, 2000, the dollar volume of loans delinquent more than 90 days in
the Company's ten REMIC trusts exceeded the permitted limit in the related
pooling and servicing agreements. Nine of those trusts exceeded certain loss
limits. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Certain Accounting Considerations;" and
"--Risk Factors--Our Right to Service Loans May Be Terminated Because of the
High Delinquencies and Losses on the Loans in Our Servicing Portfolio".
(4) The servicing portfolio used in percentage calculations includes loans
subserviced for others by the Company on an interim basis of
$280.2 million, $84.0 million and $82.0 million at June 30, 2000, 1999, and
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 at period end.
(7) Represents losses, net of gains, on properties sold through foreclosure or
other default management activities during the periods indicated.
(8) The percentage 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 subservicer's during the related periods indicated.
18
<PAGE>
COMPETITION
The Company faces intense competition in the business of originating,
purchasing and selling mortgage loans. The Company's competitors in the industry
include consumer finance companies, mortgage banking companies, investment
banks, commercial banks, credit unions, thrift institutions, credit card issuers
and insurance companies. Many of these competitors are substantially larger and
have considerably greater financial, technical and marketing resources than the
Company. In addition, the current level of gains realized by the Company and its
competitors on the sale of non-conforming loans could attract additional
competitors into this market. 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. Additional competition may lower the rates
the Company can charge borrowers and increase the price paid for purchased
loans, thereby potentially lowering gain on future loan sales and
securitizations. To the extent any of these competitors significantly expand
their activities in the Company's market, the Company could be materially
adversely affected. Fluctuations in interest rates and general economic
conditions may also affect competition. During periods of rising rates,
competitors that have locked in lower rates to potential borrowers may have a
competitive advantage. During periods of declining rates, competitors may
solicit the Company's customers to refinance their loans.
The Company believes its competitive strengths include: (i) emphasizing
customer service to attract borrowers; (ii) providing a high level of service to
brokers and their customers; (iii) offering competitive loan programs for
borrowers whose needs are not met by conventional mortgage lenders;
(iv) providing convenience to the customer through the Company's nationwide
network of retail and broker offices and the internet; and (v) emphasizing
customer service in its loan servicing division.
REGULATION
The Company's operations are subject to extensive regulation, supervision
and licensing by federal, state and local governmental authorities and are
subject to various laws and judicial and administrative decisions imposing
requirements and restrictions on part or all of its operations. The Company's
consumer lending activities are subject to the Federal Truth-in-Lending Act and
Regulation Z (including the Home Ownership and Equity Protection Act of 1994),
the Federal Equal Credit Opportunity Act, as amended, and Regulation B, the Fair
Credit Reporting Act of 1970, as amended, the Federal Real Estate Settlement
Procedures Act and Regulation X, the Home Mortgage Disclosure Act, the Federal
Debt Collection Practices Act and the National Housing Act of 1934, as well as
other federal and state statutes and regulations affecting the Company's
activities. The Company is also subject to the rules and regulations of, and
examinations by, state regulatory authorities with respect to originating,
processing, underwriting, selling, securitizing and servicing loans. These rules
and regulations, among other things, impose licensing obligations on the
Company, establish eligibility criteria for mortgage loans, prohibit
discrimination, govern inspections and appraisals of properties and credit
reports on loan applicants, regulate assessment, collection, foreclosure and
claims handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, fees and mortgage loan amounts. A significant
portion of the Company's mortgage loans are so-called "high cost mortgage loans"
where the borrower is charged points and fees or interest rates above certain
levels. Such high cost mortgage loans are subject to special disclosure
requirements and certain substantive prohibitions under the Home Ownership and
Equity Protection Act of 1994 and regulations thereunder, and certain state
laws. The federal regulations governing high cost mortgage loans establish
guidelines for determination of whether an individual loan is a high cost
mortgage loan. Such guidelines may be interpreted differently by different
lenders. Federal regulations on high cost mortgage loans make assignees of such
mortgage loans liable for violations of the regulations. As a result of the
increased regulation and scrutiny of high cost mortgage loans, certain lenders,
including certain purchasers of the
19
<PAGE>
Company's loans, will not purchase high cost mortgage loans. In addition, there
has been recent class action litigation and regulatory actions by certain state
agencies against lenders for violations of high cost mortgage regulations. The
Company has not to date been subject to any material class action litigation or
regulatory action.
Failure to comply with these requirements can lead to loss of approved
status, certain rights of rescission for mortgage loans, individual and class
action lawsuits and administrative enforcement action. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations--Risk
Factors--If We are Unable to Comply with Mortgage Banking Rules and Regulations,
Our Ability to Make Mortgage Loans May be Restricted."
In the course of its business, the Company may acquire properties as a
result of foreclosure. There is a risk that hazardous or toxic waste could be
found on such properties. In such event, the Company could be held responsible
for the cost of cleaning up or removing such waste, and such cost could exceed
the value of the underlying properties.
The Company is also subject to various other federal and state laws
regulating the issuance and sale of securities, relationships with entities
regulated by the Employee Retirement Income Security Act of 1974, as amended,
and other aspects of its business.
EMPLOYEES
At June 30, 2000, the Company employed 1,476 persons. The Company has
satisfactory relations with its employees.
ITEM 2. PROPERTIES
The executive and administrative offices of the Company are located at 350
S. Grand Avenue, Los Angeles, California, and consist of approximately 178,000
square feet. The Company is attempting to sublet a significant amount of these
premises. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations--Fiscal Years 2000,
1999 and 1998--Expenses." The lease on these premises extends through
February 2012. The Company also leases approximately 39,000 square feet of
office space at its former headquarters location at 3731 Wilshire Boulevard, Los
Angeles, California, which it uses for its telemarketing operations and its
internet production related operations. This lease expires in December 2008. The
administrative offices of the Company's Irvine office are located at 3347
Michaelson Drive, Irvine, California, and consist of approximately 47,000 square
feet. The lease on these premises extends through July 31, 2003.
The Company also leases space for its retail branch and broker regional
offices. These facilities aggregate approximately 264,000 square feet and are
leased under terms which vary as to duration. In general, the leases expire
between 2000 and 2005, and provide for rent escalations tied to either increases
in the lessor's operating expenses or fluctuations in the consumer price index
in the relevant geographical area.
20
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in litigation arising in the normal course of
business. The Company believes that any liability with respect to such legal
actions, individually or in the aggregate, is not likely to be material to the
Company's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of fiscal 2000 to a vote
of the security holders of the Company.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In November 1995, the Company's common stock began trading under the symbol
AAM on the NYSE. The Company was notified in writing by the NYSE on
September 12, 2000 that the average closing price per share of the Company's
Common Stock was below the NYSE's minimum stock price requirement of $1.00 per
share as of the thirty trading-day period ended July 19, 2000. Pursuant to the
NYSE Notice, the Company has until December 29, 2000 to raise the thirty day
average closing price of the Common Stock above $1.00 per share or the NYSE will
suspend the Company's listing and apply to the Securities and Exchange
Commission ("SEC") for delisting. This was an extension of time from the NYSE
for the Company to meet the minimum stock price requirement. As previously
reported, the Company was originally notified in writing by the NYSE on
December 2, 1999 that the average price of the Company's Common Stock was below
the NYSE's minimum stock price requirement as of October 29, 1999. As previously
reported, on April 14, 2000, the Company effected a one for five reverse stock
split of the issued and outstanding shares of Common Stock and Series C
Preferred Stock, among other reasons, to increase the market price of each share
of Common Stock. The closing price of the Common Stock on September 27, 2000 was
$1.5625 per share and the average closing price for the thirty trading-day
period ended September 27, 2000 was $1.45 per share. There can be no assurance
that the thirty day average closing price of the Common Stock will remain above
$1.00 per share or that the Common Stock will not be delisted by the NYSE. If
the Common Stock were delisted by the NYSE, it would seriously impair the
ability of Common stockholders to trade their shares. The following table sets
forth the range of high and low sale prices and per share cash dividends
declared for the periods indicated.
<TABLE>
<CAPTION>
CASH
HIGH LOW DIVIDEND
-------- -------- --------
<S> <C> <C> <C>
Fiscal 2000*
First Quarter.................................. $ 9.063 $ 3.750 --
Second Quarter................................. 7.500 3.080 --
Third Quarter.................................. 4.688 2.500 --
Fourth Quarter................................. 3.125 0.813 --
Fiscal 1999*
First Quarter.................................. $66.875 $30.315 $0.17
Second Quarter................................. 24.065 6.250 --
Third Quarter.................................. 17.190 6.875 --
First Quarter.................................. 10.000 6.565 --
</TABLE>
------------------------
* As reported by Bloomberg
As of September 27, 2000, the Company had 318 stockholders of record. No
common share dividends were accrued or paid in the year ended June 30, 2000. The
Company accrued and
21
<PAGE>
subsequently paid an aggregate of $0.17 per common share in dividends for the
fiscal year ended June 30, 1999. The Company declared and subsequently paid an
aggregate of $0.66 per common share in dividends for the fiscal year ended
June 30, 1998, representing approximately 13.7% of its net income for the
period. The Board of Directors of the Company reviews the Company's dividend
policy at least annually in light of the earnings, cash position and capital
needs of the Company, general business conditions and other relevant factors. In
November 1998, the Board of Directors decided to suspend cash dividends on the
common stock until the Company's earnings and cash flows improved. Credit
agreements generally limit the Company's ability to pay dividends if such
payment would result in an event of default under the agreements or would
otherwise cause a breach of a net worth or liquidity covenants. The Company's
Indenture relating to its 9.125% Senior Notes due 2003 prohibits the payment of
dividends if the aggregate amount of such dividends since October 26, 1996
exceeds the sum of (a) 25% of the Company's net income during that period (minus
100% of any deficit); (b) net cash proceeds from any securities issuances; and
(c) proceeds from the sale of certain investments. The Company's Indenture of
Trust relating to its 10.50% Senior Notes due 2002 restricts the payment of
dividends to an amount which does not exceed (i) $2.0 million, plus (ii) 50% of
the Company's aggregate net income for each fiscal year after the year ended
June 30, 1994 (minus 100% of net losses for any fiscal year), plus (iii) 100% of
the net proceeds received by the Company on offerings of its equity securities
after December 31, 1994. Under the most restrictive of these limitations, the
Company will be prohibited from paying cash dividends on its capital stock for
the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below with respect to the
Company for the five years ended June 30, 2000 have been derived from the
audited consolidated financial statements. The selected consolidated financial
data should be read in conjunction with the consolidated financial
22
<PAGE>
statements and notes thereto and other financial information included herein.
The selected consolidated financial data gives effect to the acquisition of One
Stop in August 1996.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue:
Gain on sale of loans............................... $ 48,098 $ 44,855 $ 120,828 $ 135,421 $ 71,255
Valuation (write-down) of residual interests and
mortgage servicing rights......................... (82,490) (194,551) 19,495 (18,950) --
Origination fees.................................... 37,951 39,689 34,282 35,616 27,505
Loan servicing...................................... 15,654 23,329 10,634 14,096 9,863
Interest income..................................... 94,569 70,525 81,250 48,348 19,805
---------- ---------- ---------- ---------- ----------
Total revenue, including valuation (write-down) of
residual interests and mortgage servicing
rights.......................................... 113,782 (16,153) 266,489 214,531 128,428
Total expenses...................................... 232,785 261,996 213,683 205,071 89,541
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes................... (119,003) (278,149) 52,806 9,460 38,887
Provision (benefit) for income taxes................ 3,369 (30,182) 25,243 7,982 17,814
---------- ---------- ---------- ---------- ----------
Net income (loss)................................... $ (122,372) $ (247,967) $ 27,563 $ 1,478 $ 21,073
---------- ---------- ---------- ---------- ----------
Net income (loss) per common share (diluted)........ $ (21.02) $ (40.31) $ 4.36 $ 0.26 $ 4.08
========== ========== ========== ========== ==========
Weighted average number of common shares outstanding
(in thousands) (diluted).......................... 6,209 6,200 7,150 5,674 5,450
========== ========== ========== ========== ==========
Cash dividends paid per common share................ $ -- $ 0.17 $ 0.66 $ 0.65 $ 0.66
========== ========== ========== ========== ==========
CASH FLOW DATA:
Cash provided by (used in) operating activities....... $ 99,391 $ (466,966) $ (49,661) $ (280,073) $ (241,073)
Cash used in investing activities..................... (2,664) (5,229) (5,163) (8,864) (5,885)
Cash provided by (used in) financing activities....... (107,312) 480,637 40,244 291,898 250,540
Net increase (decrease) in cash and cash
equivalents......................................... (10,585) 8,442 (14,580) 2,961 3,582
OTHER DATA:
Loans originated or purchased:
Broker network...................................... $1,262,900 $1,182,100 $1,101,200 $ 741,000 $ 319,800
Retail loans........................................ 783,700 770,000 636,100 436,900 220,900
Correspondent loans................................. 32,700 241,500 646,300 1,170,000 628,200
---------- ---------- ---------- ---------- ----------
Total............................................. $2,079,300 2,193,600 2,383,600 2,347,900 1,168,900
========== ========== ========== ========== ==========
Whole loans sold...................................... $1,419,199 $1,236,050 $ 416,390 $ 7,500 $ 202,200
Loans pooled and sold in securitizations.............. 803,557 649,999 2,034,300 2,262,700 791,300
Loans serviced at period end.......................... 3,560,000 3,841,000 4,147,000 3,174,000 1,370,000
Weighted average points on retail loan
originations(1)..................................... 4.7% 4.8% 4.3% 4.9% 7.7%
Weighted average interest rate(1)..................... 10.2 9.8 10.1 10.6 11.3
Weighted average initial combined loan-to-value
ratio(1)(2):
Retail loans........................................ 73 72 70 67 60
Broker network...................................... 78 76 75 71 68
Correspondent loans................................. 81 80 79 71 66
At period end:
Number of retail branch offices..................... 100 101 103 56 48
Number of broker offices............................ 7 35 52 37 25
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
AT JUNE 30,
------------------------------------------------------
2000 1999 1998 1997 1996
-------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents...................... $ 10,179 $ 20,764 $ 12,322 $ 26,902 $ 23,941
Residual interests and mortgage servicing
rights....................................... 303,302 353,255 522,632 360,892 167,740
Total assets................................... 790,364 1,021,097 815,187 717,595 401,524
-------- ---------- -------- -------- --------
10.5% Senior Notes due 2002.................... 11,500 17,250 23,000 23,000 23,000
9.125% Senior Notes due 2003................... 150,000 150,000 150,000 150,000 --
5.5% Convertible Subordinated Debentures due
2006......................................... 113,970 113,970 113,990 113,990 115,000
Other long-term debt........................... -- -- -- -- 45
-------- ---------- -------- -------- --------
Total long-term debt......................... 275,470 281,220 286,990 286,990 138,045
Stockholders' equity........................... 74,478 145,556 304,051 239,755 120,461
</TABLE>
------------------------
(1) Computed on loans originated or purchased during the fiscal year presented.
(2) The weighted average initial combined loan-to-value ratio is determined by
dividing the sum of all loans secured by the junior or senior mortgages on
the property by the appraised value at origination.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion should be read in conjunction with Item 6. Selected
Financial Data and Item 8. Financial Statements and Supplementary Data.
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, and (f) 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 "Item 1.
Business and Risk Factors." The Company undertakes no obligation to publicly
revise these forward-looking statements to reflect events or circumstances that
arise after the date hereof. Readers should carefully review the factors
referred to above and the other documents the Company files from time to time
with the Securities and Exchange Commission, including the quarterly reports on
Form 10-Q filed by the Company during fiscal 2001 and any current reports on
Form 8-K filed by the Company.
24
<PAGE>
CERTAIN ACCOUNTING CONSIDERATIONS
ACCOUNTING FOR SECURITIZATIONS. The Company's loan disposition strategy
relies on a combination of securitization transactions and whole loan 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) in exchange for cash proceeds
and a residual interest in the trust. The cash proceeds are raised through an
offering of the pass-through certificates or bonds evidencing the right to
receive principal payments and interest 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 of the 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 represents, over the estimated life
of the loans, the present value of the estimated 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, a monoline insurance fee, if any, and an estimate for loan
losses. 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) credit losses; and (iii) discount rate used to calculate
present value. 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.
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, credit loss and discount rate assumptions in relation to its actual
experience and current rates of prepayment and credit loss prevalent in the
industry. The Company may adjust the value of the residual interests or take a
charge to earnings related to the residual interests, as appropriate, to reflect
a valuation or write-down of its residual interests based upon the actual
performance of the Company's residual interests as compared to the Company's key
assumptions and estimates used to determine fair value. Although management
believes that the assumptions to estimate the fair values of its residual
interests are reasonable, there can be no assurance as to the accuracy of the
assumptions or 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.
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 and
credit grades of the loans included in the securitizations, loss and delinquency
information by origination channel, and information available from other market
participants such as investment bankers, credit providers and credit agencies.
On a quarterly basis, the Company re-evaluates its credit loss estimates.
25
<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.
The actual performance of the Company's residual interests as compared to
the key assumptions and estimates used to evaluate their carrying value resulted
in valuation adjustments to the residual interests of $77.5 million and
$188.6 million during the years ended June 30, 2000 and 1999, respectively.
The $77.5 million valuation adjustment recorded during the year ended
June 30, 2000 was comprised of unfavorable adjustments of $86.3 million taken in
light of higher than expected credit loss experience and $12.3 million due to
the effects of rising interest rates on excess spreads which were offset by a
favorable $21.1 million adjustment due to actual prepayment rate trends compared
to prepayment rate assumptions.
The $188.6 million valuation adjustment recorded during the year ended
June 30, 1999 was comprised of unfavorable adjustments of $62.1 million,
$67.2 million and $64.5 million made to the rate of prepayment, credit loss and
discount rate assumptions, respectively, offset by a positive valuation
adjustment of $5.2 million.
Certain historical data and key assumptions and estimates used by the
Company in its June 30, 2000 review of the residual interests were the
following:
<TABLE>
<S> <C>
Prepayments:
Actual weighted average annual prepayment rate, as a
percentage of outstanding principal balance of
securitized loans, during the year ended June 30, 2000... 30.9%
Estimated peak annual prepayment rates, as a percentage
of outstanding principal balance of securitized loans:
Fixed rate loans....................................... 22.3% to 29.5%
Adjustable rate loans.................................. 36.7% to 46.3%
Estimated weighted average life of securitized loans..... 3.1 years
Credit losses:
Actual credit losses to date, as a percentage of original
principal balances of securitized loans................ 2.6%
Future estimated prospective credit losses, as a
percentage of original principal balances of
securitized loans...................................... 2.0%
Total actual and estimated prospective credit losses, as
a percentage of original principal balance of
securitized loans...................................... 4.6%
Total actual credit losses to date and estimated
prospective credit losses (dollars in thousands)....... $323,634
Discount rate.............................................. 15.0%
</TABLE>
Additionally, upon sale or securitization of servicing retained mortgages,
the Company capitalizes the fair value of mortgage servicing rights ("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 cost allocated to the servicing rights is amortized over the period of
estimated net future servicing fee income. The Company periodically reviews the
valuation of its MSR's. This review is performed on a desegregated basis for the
predominant risk characteristics of the underlying loans which are loan type and
origination date.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standard
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." ("SFAS 133") 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. At
June 30, 2000, the Company had no freestanding derivative instruments in place
and had no material amounts of embedded derivative instruments. The Company
adopted SFAS 133 on July 1, 2000. Based upon the Company's application of SFAS
No. 133, its adoption had no materially adverse effect on the Company's
consolidated financial statements.
26
<PAGE>
RESULTS OF OPERATIONS--FISCAL YEARS 2000, 1999 AND 1998
The following table sets forth information regarding the components of the
Company's revenue and expenses in fiscal 2000, 1999 and 1998:
<TABLE>
<CAPTION>
2000 1999 1998
-------------------- -------------------- -------------------
$ % $ % $ %
--------- -------- --------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Gain on sale of loans......... $ 48,098 42.3 % $ 44,855 (277.7)% $120,828 45.3%
Valuation (write-down) of
residual interests and
mortgage servicing rights... (82,490) (72.5) (194,551) 1,204.4 19,495 7.3
Origination fees.............. 37,951 33.4 39,689 (245.7) 34,282 12.9
Loan servicing................ 15,654 13.8 23,329 (144.4) 10,634 4.0
Interest income............... 94,569 83.1 70,525 (436.6) 81,250 30.5
--------- ------ --------- -------- -------- -----
Total revenue, including
valuation (write-down) of
residual interests and
mortgage servicing
rights.................... 113,782 100.0 % (16,153) 100.0 % 266,489 100.0%
--------- ------ --------- -------- -------- -----
Expenses:
Compensation.................. 93,239 81.9 % 80,167 (496.3)% 94,820 35.6%
Production.................... 26,718 23.5 40,061 (248.0) 34,195 12.8
General and administrative.... 60,489 53.2 60,635 (375.4) 40,686 15.3
Interest...................... 52,339 46.0 44,089 (272.9) 43,982 16.5
Nonrecurring charges.......... -- -- 37,044 (229.3) -- --
--------- ------ --------- -------- -------- -----
Total expenses.............. 232,785 204.6 % 261,996 (1,622.0)% 213,683 80.2%
--------- ------ --------- -------- -------- -----
Income (loss) before income
taxes......................... (119,003) (104.6) (278,149) 1,722.0 52,806 19.8
Provision (benefit) for income
taxes......................... 3,369 3.0 (30,182) 186.8 25,243 9.5
--------- ------ --------- -------- -------- -----
Net income (loss)........... $(122,372) (107.6)% $(247,967) 1,535.2 % $ 27,563 10.3%
========= ====== ========= ======== ======== =====
</TABLE>
REVENUE
GENERAL. Total revenue during the year ended June 30, 2000 was
$113.8 million, compared to $(16.2) million during the year ended June 30, 1999
and $266.5 million during the year ended June 30, 1998. Included in total
revenue during the years ended June 30, 2000 and 1999 were write-downs of
$82.5 million and $194.6 million, respectively, to the Company's residual
interests and mortgage servicing rights. Included in total revenue during the
year ended June 30, 1998 was a positive valuation adjustment to the Company's
residual interests of $19.5 million.
Excluding the write-downs of residual interests and mortgage servicing
rights, total revenue during the year ended June 30, 2000 increased $17.9
million to $196.3 million compared to $178.4 million, for the year ended
June 30, 1999. The $17.9 million increase in total revenue is attributable
primarily to an increase in gain on sale of loans and interest income, partially
offset by declines in origination fees and loan servicing revenue.
Excluding the $194.6 million write-down of residual interests and mortgage
servicing rights during the year ended June 30, 1999, total revenue of
$178.4 million declined $88.1 million from the $266.5 million reported during
the year ended June 30, 1998. The decline in total revenue during the year ended
June 30, 1999 from a year earlier was comprised of decreases in gain on sale of
loans and interest income, partially offset by increases in origination fees and
loan servicing revenues.
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GAIN ON SALE OF LOANS. Gain on sale of loans during the year ended
June 30, 2000 was $48.1 million, an increase of $3.2 million, or 7.2%, from the
$44.9 million reported during the year ended June 30, 1999. The increase in gain
on sale of loans during the year end June 30, 2000 over the year ended June 30,
1999 was due to increases in the volume of loans sold in whole loan sales and
securitizations, and higher gains on whole loan sales in fiscal 2000 compared to
fiscal 1999, partially offset by lower gains recorded on securitizations during
the year ended June 30, 2000. During the year ended June 30, 2000, the Company
disposed of $1.4 billion and $803.6 million of loans in whole loan sales and
securitizations, respectively, compared to $1.2 billion of loans in whole loan
sales for cash and $650.0 million of loan dispositions in the form of
securitizations for the year ended June 30, 1999. Gain on sale of loans in
securitizations during the year ended June 30, 2000 were lower than historical
gains due to, among other things, market conditions at the time of the
securitizations, higher margins paid by the Company on the certificates issued
by the securitization trusts and the Company's adoption of revised gain rate
assumptions during the second half of the year ended June 30, 1999. However, the
gain on sale recognized on whole loan sales during the year ended June 30, 2000
were generally higher than the gains recognized during the year ended June 30,
1999 due primarily to improved market conditions during fiscal 2000, changes in
loan product mix and loan pricing and, to a lesser extent, to the volume of
whole loans sold during the year ended June 30, 2000 over that during fiscal
1999. Additionally, gain on sale of loans during the year ended June 30, 1999
was negatively impacted by conditions imposed by whole loan buyers due to the
onset of adverse market conditions in October 1998 and the Company's limited
warehouse capacity which necessitated the expedited sale of loans. As previously
reported, gain on sale during the year ended June 30, 1999 was adversely
effected by a $13.5 million hedge loss.
Gain on sale declined $76.0 million to $44.9 million during the year ended
June 30, 1999 from $120.8 million during the year ended June 30, 1998. The
decrease in gain on sale was due to the $564.6 million decline in loan
dispositions which totaled $1.9 billion in fiscal year 1999, and the higher
volume and percentage of whole loan sales for cash in fiscal 1999, and lower
volume and percentage of securitizations compared to the year ended June 30,
1998. Gains associated with whole loan sales for cash during the year ended
June 30, 1999 were substantially less than the gains associated with the
securitizations during the year ended June 30, 1998. As previously mentioned,
gain on sale during June 30, 1999 was also adversely effected by a
$13.5 million hedge loss.
Subsequent to June 30, 2000, the Company sold approximately $460.0 million
of loans held for sale in a securitization, and sold the residual interest
created in this securitization to an affiliate through the Residual Facility for
cash.
ORIGINATION FEES. 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 loan office network, the credit
grade of the loans originated and the weighted average commission rate charged
on such loans. Origination fee revenue during the year ended June 30, 2000 was
$38.0 million, compared to $39.7 million during the year ended June 30, 1999 and
$34.3 million reported during the year ended June 30, 1998. The Company
recognizes applicable deferred origination fee revenue in periods when the
amount of loans subject to fees and either securitized or sold in whole loan
sales is in excess of loans subject to fees and originated during the same
period. Origination fees are deferred to future periods when loan originations
subject to fees exceed the level of loans securitized or sold in whole loan
sales in a period. Origination fee revenue during the years ended June 30, 2000
and 1998 includes $1.2 million and $800,000 of origination fees deferred to and
recognized in those periods. Origination fee revenue during the year ended
June 30, 1999 excludes $1.8 million of origination fees the recognition of which
was deferred to future periods. The $1.7 million, or 4.3% decrease in
origination fee revenue during the year ended June 30, 2000 from a year ago is
primarily attributable to recent changes in the
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Company's pricing strategies which place a higher emphasis on coupon rates
rather than points charged at origination and focus on higher credit quality
borrowers. The $5.4 million increase in origination fee income during the year
ended June 30, 1999 from the year ended June 30, 1998 reflects higher loan
origination volume in the Company's retail loan origination channel. The
weighted average points charged during the year ended June 30, 2000, 1999 and
1998 were 4.7%, 4.8% and 4.3%, respectively.
LOAN SERVICING. Loan servicing revenue consists of prepayment fees, late
charges and other fees retained by the Company, and servicing fees earned on
securitized pools, reduced by subservicing costs and amortization of the
Company's MSR's. See "--Certain Accounting Considerations." Future loan
servicing revenue will be negatively impacted by the costs associated with the
arrangements the Company entered into to reduce servicing advances on
securitization trusts. See "Item 1. Business--Loan Servicing." Loan servicing
revenue during the year ended June 30, 2000 was $15.7 million as compared to
$23.3 million and $10.6 million during the years ended June 30, 1999 and 1998,
respectively.
During the year ended June 30, 2000, the Company entered into arrangements
with an investment bank pursuant to which the investment bank purchased certain
servicing related advances and agreed to undertake the obligation to make a
substantial portion of the Company's advance obligations on its 1999
securitization trusts. During the fourth quarter of the year ended June 30,
1999, the Company entered into two arrangements designed to reduce its servicing
advance obligations. In the first arrangement, a loan servicing company
purchased certain servicing related advances and agreed to make future servicing
related advances with respect to an aggregate $388.0 million ($265.4 million at
June 30, 2000) in principal amount of loans. In the second arrangement, an
investment bank purchased certain servicing related advances and agreed to
undertake the obligation to make a substantial portion of the Company's advance
obligations on its pre-1999 securitization trusts. The decrease in loan
servicing revenue during the year ended June 30, 2000 from a year ago was due
primarily to expenses incurred due to these arrangements during the year ended
June 30, 2000 that were not in place during the entire year ended June 30, 1999.
To a lesser extent, the decrease is due to a decline in prepayment fee income
and in the balance of the loans serviced by the Company during the year ended
June 30, 2000 when compared to a year ago.
Loan servicing revenue increased to $23.3 million during the year ended
June 30, 1999 from $10.6 million during the year ended June 30, 1998. The
increase during the year ended June 30, 1999 was attributable to increases in
servicing fees, prepayment fees, and late charges and other fees on a higher
average servicing portfolios compared to the prior year.
The Company's loan servicing portfolio at June 30, 2000 declined 7.3%, or
approximately $280.0 million, from the $3.8 billion reported at June 30, 1999
reflecting loan servicing portfolio run-off during the fiscal year, partially
offset by the Company's $803.6 million of securitizations during the fiscal
year. Future growth of the Company's servicing portfolio will be impacted by the
Company's business strategy of loan dispositions through whole loan sales with
servicing released as well as securitizations, which will result in lower growth
than in fiscal 1998 and prior periods when the Company predominately sold its
loan production in securitizations and retained the servicing. Moreover, in the
securitization completed on September 21, 2000, the Company sold the servicing
rights and the rights to prepayment penalties for cash, and the Company may sell
servicing rights in future securitizations, depending on market conditions,
profitability and cash flows. Nevertheless, management believes that the
business of loan servicing provides a more consistent revenue stream and is less
cyclical than the business of loan origination and purchasing. See "--Risk
Factors--Our Right to Service Loans May be Terminated Because of the High
Delinquencies and Losses on the Loans in Our Servicing Portfolio."
INTEREST INCOME. Interest income includes interest on loans held for sale,
accretion income associated with the Company's residual interests and, to a
lesser extent, interest on short-term
29
<PAGE>
overnight investments. Interest income was $94.6 million during the year ended
June 30, 2000, compared to $70.5 million reported during the year ended
June 30, 1999 and $81.3 million reported during the year ended June 30, 1998.
Interest income increased $24.0 million, or 34.1% during the year ended
June 30, 2000 over the prior year due primarily to higher accretion on higher
average balances of the Company's residual interests and through use of a higher
discount rate in all of fiscal 2000, whereas during 1999 the Company's change in
its discount rate estimate affected the second half of that fiscal year. To a
lesser extent, interest income increased during the year ended June 30, 2000
over the year ended June 30, 1999 due to higher weighted average interest rates
on higher outstanding balances of loans held for sale during fiscal 2000 when
compared to such rates and balances during fiscal 1999.
Interest income decreased $10.7 million, or 13.2%, during the year ended
June 30, 1999 to $70.5 million from $81.3 million during the year ended
June 30, 1998 due primarily to lower average balances of residual interests
subject to accretion despite a higher discount rate utilized during the second
half of fiscal 1999. Additionally, the decline during fiscal 1999 from fiscal
1998 was attributable to interest earned on lower amounts of loans held for sale
by the Company during the period from origination or purchase until the date
sold by the Company due to the Company's heavy reliance on whole loan sales
during most of fiscal 1999, offset by increasing weighted average interest rates
on the loans held for sale.
EXPENSES
COMPENSATION EXPENSE. Compensation expense, which includes incentives, is
generally related to the Company's loan origination volume, as retail and broker
account executives earn incentives on funded loans. Compensation during the year
ended June 30, 2000 increased $13.1 million, or 16.3%, to $93.2 million from
$80.2 million during the year ended June 30, 1999. Compensation expense for the
year ended June 30, 2000 includes $2.2 million of deferred compensation costs
associated with loans originated in prior periods that were disposed of in
either whole loan sales or in securitizations during the period and also
includes $4.0 million of nonrecurring severance costs. Compensation expense for
the year ended June 30, 1999 excludes $6.5 million of direct compensation
expense associated with loan originations which were deferred to future periods
pending disposition of the loans in either whole loan sales or securitizations.
Net of the effects of the recognition or the deferral of direct compensatory
costs, compensation expense during the year ended June 30, 2000 increased
$4.4 million to $91.1 million from $86.6 million during the year ended June 30,
1999. This increase is attributable primarily to the aforementioned nonrecurring
severance costs, the increase in incentives paid to retail loan production
employees and, to a lesser extent, other incentive and bonus awards and the
hiring of certain new employees during the year ended June 30, 2000.
Compensation expense during 1999 decreased $14.6 million from $94.8 million
during the year ended June 30, 1998 to $80.2 million. This decrease was
primarily due to the Company's reduction in force in February 1999, a decrease
in compensation incentives as a consequence of the decline in loan originations
during 1999 and a significant reduction in incentive compensation due to the
Company's results of operations. Severance costs of approximately $500,000 were
recognized in the fiscal year ended June 30, 1999. Additionally, during the year
ended June 30, 1999, the Company deferred $6.5 million of direct compensation
expenses for loans originated but not yet sold.
PRODUCTION EXPENSE. Production expense, primarily advertising, outside
appraisal costs, travel and entertainment, and credit reporting fees decreased
$13.3 million, or 33.3%, to $26.7 million during the year ended June 30, 2000
from $40.1 million during the year ended June 30, 1999. The decrease during the
year ended June 30, 2000 from a year ago is due primarily to the Company's cost
reduction efforts, which include reducing its advertising expenses by improving
the efficiency and penetration of its advertising strategies through the
adoption of the decentralized marketing approach in its retail loan office
network. Additionally, during the first half of fiscal 2000, in an effort to
further reduce
30
<PAGE>
production costs, the Company commenced the practice of having prospective
borrowers pay for appraisal costs prior to the incurrence of the appraisal
expense during the loan origination process whenever possible. 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 during the year ended June 30, 1999 increased
$5.9 million to $40.1 million from $34.2 million during the year ended June 30,
1998. The increase in total production expense primarily reflected a rise in
advertising and the additional cost of outsourcing appraisal services compared
to using employee appraisals in the Company's retail unit in 1998, offset by a
decline in travel and entertainment costs. Production expense expressed as a
ratio of total loan origination volume for the years ended June 30, 2000, 1999
and 1998 was 1.3%, 1.8% and 1.4%, respectively. The decline in the ratio in the
year ended June 30, 2000 from the ratio during the year ended June 30, 1999
reflects the decrease in the Company's production expense during the fiscal
year. The increase in the ratio during the year ended June 30, 1999 from the
ratio during the year ended June 30, 1998 was primarily attributable to the
increased production expenses during the year ended June 30, 1999 over those
during the year ended June 30, 1998.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense was
$60.5 million during the year ended June 30, 2000 compared to $60.6 million
during the year ended June 30, 1999. General and administrative expenses
increased $19.9 million, or 49.0%, during the year ended June 30, 1999 over the
year ended June 30, 1998. General and administrative expense during the year
ended June 30, 2000 includes fees for outside professional advisors on specific
operational projects, primarily to support the two servicing advance facilities
the Company put into place to reduce its servicing advance obligations and
miscellaneous operational charges taken by the Company, offset partially by
declines in communication and miscellaneous expenses. As previously reported,
during the year ended June 30, 2000, 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
value which resulted in a write-down of $2.0 million which is included in
general and administrative expense. The increase in general and administrative
expense during the year ended June 30, 1999 over the year ended June 30, 1998
were primarily the result of increased occupancy and communication costs related
to the Company's core origination channel expansion, and increases in legal and
professional expenses related primarily to the negotiation and closing of equity
transactions with the Company's largest shareholder, Capital Z. As part of the
Company's ongoing savings program it ceased activities in certain 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
the Company agrees to sublet such space at lease rates significantly 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 charge to earnings.
INTEREST EXPENSE. Interest expense increased $8.2 million to $52.3 million
during the year ended June 30, 2000 from $44.1 million during the year ended
June 30, 1999 which, in turn, remained consistent with interest expense during
the year ended June 30, 1998. The increase during the year ended June 30, 2000
over the year ended June 30, 1999 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 markets. Interest expense is expected to
increase in future periods as the Company expands its loan production due to the
Company's continued reliance on external financing arrangements to fund its
operations.
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<PAGE>
1999 NONRECURRING CHARGE. During the fiscal year ended June 30, 1999, the
Company recorded a $37.0 million nonrecurring charge related to the Company's
servicing advances which are recorded as accounts receivable on the Company's
balance sheet. As previously reported, its nonrecurring charge relates to
payments made by the Company to the securitization trusts for which it acts as
servicer. As servicer of the loans it securitizes, the Company is obligated to
advance, or "loan," to the trusts delinquent interest. In addition, as servicer,
the Company advances to the trusts foreclosure-related expenses and certain tax
and insurance remittances relating to loans in securitized pools. The Company,
as servicer, is then entitled to recover these advances from regular monthly
cash flows into the trusts, including monthly payments, pay-offs and liquidation
proceeds on the related loan. Until recovered, the Company records the
cumulative advances as accounts receivable on its balance sheet. In early 1999,
the Company began to explore ways to reduce the cash burden of its servicing
advance obligations through various financing techniques. At the same time, the
Company determined that certain amounts recorded as accounts receivable
associated with the Company's securitization trusts were not recoverable from
the trust' monthly cash flows. As a result, accounts receivable were
written-down by $37.0 million.
INCOME TAXES. During the year ended June 30, 2000, the Company recorded an
income tax provision of $3.4 million substantially all of which related to the
Company's estimated tax on excess inclusion income on its REMIC trusts. The
provision reflects an effective rate of 2.8%. During the fiscal year ended
June 30, 1999, the Company recorded an estimated tax benefit of $30.2 million
due to its net operating losses during the year. The income tax benefit for the
1999 fiscal year reflects an effective rate of (10.9%) and is net of tax
valuation adjustments recorded to account for estimated nonrealizable deferred
tax assets. The investment in the Company by Capital Z in fiscal 1999 resulted
in a change in control for income tax purposes, thereby limiting the Company's
ability to use future net operating loss carryforwards and certain other future
deductions. The Company's provision for income taxes was $25.2 million during
the year ended 1998 reflecting an effective rate of 47.8%.
FINANCIAL CONDITION
LOANS HELD FOR SALE. The Company's portfolio of loans held for sale
decreased to $398.9 million at June 30, 2000 from $559.9 million at June 30,
1999. The decline is attributable to the Company's $803.6 million of
securitizations and $1.4 billion of whole loan sales in the secondary markets
during the year ended June 30, 2000, partially offset by the Company's loan
production during the same period.
ACCOUNTS RECEIVABLE. Accounts receivable, representing servicing fees,
servicing advances and other receivables, decreased to $52.7 million at
June 30, 2000 from $57.0 million at June 30, 1999. Included in accounts
receivable at June 30, 1999 was $24.8 million of estimated proceeds from an
investment by Capital Z which were 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. Net of the $24.8 million
investment receivable, the increase in the Company's accounts receivable since
June 30, 1999 is primarily attributable to advances on delinquent loans in the
two securitization trusts closed during the year ended June 30, 2000 and
continued advances on seriously delinquent loans, offset partially by the sale
of certain servicing advances during the fiscal year.
RESIDUAL INTERESTS. Residual interests decreased $41.3 million to
$291.0 million at June 30, 2000 from $332.3 million at June 30, 1999, reflecting
$77.5 million of residual interest write-downs recorded during the year ended
June 30, 2000, partially offset by residual interests recognized in the
Company's securitizations during fiscal year 2000, plus residual interest
accretion during the year ended June 30, 2000.
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<PAGE>
MORTGAGE SERVICING RIGHTS, NET. Mortgage servicing rights, net decreased to
$12.3 million at June 30, 2000 from $20.9 million at June 30, 1999 reflecting
amortization and a $5.0 million write-down of mortgage servicing rights during
the year ended June 30, 2000, net of the capitalization of mortgage servicing
rights on securitizations during the same period.
EQUIPMENT AND IMPROVEMENTS, NET. Equipment and improvements, net, decreased
to $10.5 million at June 30, 2000 from $13.5 million at June 30, 1999 due to
depreciation and amortization outpacing equipment and improvement acquisitions
during the year ended June 30, 2000.
PREPAID AND OTHER ASSETS. Prepaid and other assets decreased to
$14.7 million at June 30, 2000 from $15.0 million at June 30, 1999.
INCOME TAX REFUND RECEIVABLE. The $1.7 million income tax refund receivable
at June 30, 1999 were realized in cash during the three months ended
September 30, 1999.
BORROWINGS. Amounts outstanding under borrowings at June 30, 2000 decreased
to $275.5 million from $281.2 million and reflects the Company's $5.8 million
scheduled sinking fund payment on its 10.5% Senior Notes due 2002 during the
fiscal year ended June 30, 2000.
REVOLVING WAREHOUSE AND REPURCHASE FACILITIES. Amounts outstanding under
revolving warehouse and repurchase facilities decreased to $375.0 million at
June 30, 2000 from $536.0 million at June 30, 1999, primarily as a result of the
decrease in loans held for sale due to whole loan sales and securitizations
during the year ended June 30, 2000, partially offset by the Company's loan
production during the same period. At June 30, 2000 and June 30, 1999, the
Company was holding loans held for sale in anticipation of consummating a
securitization during the respective subsequent September quarters. 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) cash
reserve accounts or overcollateralization requirements in connection with the
securitization, (iv) ongoing administrative, operating and tax expenses,
(v) interest and principal payments under the Company's revolving 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.
RESIDUAL FORWARD SALE FACILITY
On August 31, 2000, the Company entered into the Residual Facility with CZI,
an affiliate of Capital Z, the Company's largest shareholder. Pursuant to the
terms of the Residual Facility, the Company may sell up to $75.0 million of its
residual interests for cash in future securitizations through the earliest of
(i) September 30, 2002, (ii) the full utilization of the $75.0 million amount of
the Residual Facility, or (iii) a termination event, as defined in the Residual
Facility.
On September 21, 2000, the Company sold a residual interest to CZI pursuant
to the Residual Facility for cash. It is the Company's expectation to sell to
CZI residual interests created in future securitizations as a means of enhancing
its working capital on a periodic basis.
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<PAGE>
WAREHOUSE AND REPURCHASE FACILITIES. The Company generally relies on
revolving warehouse and repurchase facilities to originate and purchase mortgage
loans and hold them prior to securitization or sale. At June 30, 2000, the
Company had committed revolving warehouse and repurchase facilities in the
amount of $615.0 million (excluding the $35.0 million non-revolving subline
described more fully below).
Of the $615.0 million of committed revolving warehouse and repurchase
facilities available to the Company at June 30, 2000, $250.0 million,
$200.0 million and $200.0 million expire on October 27, 2000, October 28, 2000
and January 31, 2001, respectively. Subsequent to June 30, 2000, the
$250.0 million revolving facility due to expire on October 27, 2000 was renewed
for an additional year and the committed amount of the line was increased by
$50.0 million to $300.0 million.
The Company is not permitted to use its revolving warehouse and repurchase
facilities to fund mortgage loans at closing; instead, the Company uses working
capital to close mortgage loans. After the mortgage loans are closed, the
Company pledges them under one of its other revolving warehouse or repurchase
facilities to replenish working capital. The Company is currently seeking a new
revolving warehouse or repurchase facility to fund mortgage loans at closing.
However, unless and until a new facility is negotiated, the Company is required
to fund mortgage loans exclusively out of working capital, and hold them until
such mortgage loans can be transferred to another facility or sold. As a result
of the recent $50.0 million investment, and the $460.0 million securitization,
the residual sale under the Residual Facility and the sale of servicing rights
and the rights to prepayment penalties completed September 21, 2000, the Company
believes it has sufficient cash to fund at closing its current loan production.
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, leverage,
and net income levels. Due to the $61.5 million loss for the quarter ended
March 31, 2000, the Company failed to meet certain existing financial covenants
under its revolving warehouse and repurchase facilities at March 31, 2000,
April 30, 2000 and May 31, 2000. However, the Company successfully sought and
obtained amendments to these financial covenants from its warehouse and
repurchase lenders to bring itself into compliance at March 31, 2000 and during
the three months ended June 30, 2000. If the Company is unable to meet these
financial covenants going forward, or to obtain subsequent amendments, 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. On February 25, 2000, the
Company entered into an arrangement with the same investment bank pursuant to
which the bank purchased certain additional cumulative advances and agreed to
undertake the obligation to make a substantial portion of the Company's advance
obligations on its 1999 securitization trusts.
The Company also requires working capital to originate mortgage loans.
Historically, the Company has had access to revolving warehouse and repurchase
facilities which advanced up to 100% of the
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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, all 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 $35.0 million non-revolving subline (the "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 subline. In connection therewith, the Company
agreed to pay Capital Z a $1 million fee which was remitted in September 2000.
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. Funded warehouse indebtedness is generally not
included in the indebtedness limitations. Securitization obligations are
generally not included in the indebtedness limitations. As a result of the net
loss for the year ended June 30, 2000, the Company is restricted from incurring
additional indebtedness as defined in the Indenture. The Company's revolving
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 substantially all of its previously unencumbered residual
interests in order to secure the subline. The Company does not anticipate having
additional residual interests available 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
securitization 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 Securitization and Whole Loan Market Would Hurt Our
Financial Performance."
The Company securitized $803.6 million of loans held for sale during the
year ended June 30, 2000 compared to $650.0 million and $2.0 billion of loans
during the years ended June 30, 1999 and 1998. The gain on sale recognized on
securitizations during the year ended June 30, 2000 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
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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 June 30, 2000, the Company was required to maintain
an additional $59.3 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 June 30, 2000,
$41.0 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 related service fees are
collected and applicable reserve or overcollateralization requirements are met.
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.
On June 10, 2000 and in the first of a two phase $50.0 million equity
investment by SFP, a partnership controlled by Capital Z (the "Supplemental
Investment"), the Company received $34.7 million of additional capital. In
return, the Company issued (i) 40.8 million shares of Series C Convertible
Preferred Stock at a price of $0.85, which reflected the average closing market
price for the five trading days prior to closing phase one and (ii) warrants to
purchase 5.0 million shares of Series C Convertible Preferred Stock at $0.85 per
share. Net proceeds to the Company, after issuance expenses, were
$34.4 million.
On July 12, 2000, in the second phase of the Supplemental Investment, the
Company received $15.3 million of additional capital. In return, the Company
issued 18.0 million shares of Series D Convertible Preferred Stock at as price
of $0.85. At the same time, the 40.8 million shares of Series C Convertible
Preferred Stock and the warrants to purchase 5.0 million shares of Series C
Convertible Preferred Stock issued in phase one were cancelled and the Company
issued an equivalent number of Series D Convertible Preferred Stock in
replacement thereof. Net proceeds to the Company, after issuance expenses, were
$14.3 million.
As a result of the Supplemental Investment, the Company intends to make a
distribution to the holders of the Company's Common Stock and Series C
Convertible Preferred Stock, in the form of a dividend of nontransferable
subscription rights to purchase shares of Series D Preferred Stock for $0.85 per
share. Capital Z has agreed that neither they nor any of their affiliates
(including SFP) will participate in the Rights Offering. Consequently, the
number of shares offered in the Rights Offering to Nonaffiliated Stockholders
will be approximately 19.8 million shares of Series D Preferred Stock. The
Company expects to complete the Rights Offering in the quarter ending
December 31, 2000.
In August 2000, the Company issued $1.1 million of preferred stock to
certain current and former management investors, and consultants to the Company.
The Company has previously 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 a rights offering and $20.8 million to
Capital Z pursuant to their standby commitment in October 1999 which was accrued
for consolidated financial statement purposes 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 500,000 shares of the Company's common
stock for $5.00 per share.
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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 1.3 million shares (as adjusted) of the Company's common stock at an
exercise price of $38.35 (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 June 30, 2000, the Company did not have the ability to pay such
distributions and does not expect to have the ability to pay dividends for the
foreseeable future.
The Company had cash and cash equivalents of approximately $10.2 million at
June 30, 2000. See "--Risk Factors--If We are Unable to Maintain Adequate
Financing Sources or Outside Sources of Cash are Not Sufficient, Our Ability to
Make and Service Loans will be Impaired and Our Revenues will Suffer."
The Company's primary sources of liquidity are expected to be fundings under
revolving warehouse and repurchase facilities, whole loan sales, the
monetization of the Company's servicing advances and sales of residual interests
under the Residual Facility. See "Liquidity and Capital Resources." If the
Company's access to warehouse lines, working capital or the securitization or
whole loan markets is restricted, 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.
RISK MANAGEMENT
At June 30, 2000, the Company had no hedge transactions in place. Subsequent
to June 30, 2000, the Company began using forward interest rate swap contracts
to hedge exposure to its fixed rates loans held for sale. The Company
continually monitors the interest rate environment and its fixed rate hedging
strategies; however, 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 of such loans, the
Company is exposed to interest rate risk. The majority of loans are securitized
within 90 days of origination or purchase. However, a portion of the loans are
held for sale or securitization for as long as 12 months (or longer, in very
limited circumstances) prior to securitization or sale. If interest rates rise
during the period that the mortgage loans are held, the spread between the
weighted average interest rate on the loans to be securitized and the
pass-through interest rates on the securities to be sold (the latter having
increased
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as a result of market rate movements) would narrow. Upon securitization, this
would result in a reduction of the Company's related gain on sale. The Company
is also exposed to rising interest rates for loans originated or purchased which
are held pending sale in the whole loan market. From time to time, the Company
mitigates 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. 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. With respect to the Company's
securitizations, gain on sale included hedge losses of $13.5 million and
$1.30 million during the years ended June 30, 1999 and 1998, respectively. At
June 30, 2000 and 1999, the Company had no hedge transactions in place.
The following table illustrates certain information about the Company's rate
sensitive assets and liabilities at June 30, 2000:
<TABLE>
<CAPTION>
2001 2002 2003 2004 2005 THEREAFTER TOTAL FAIR VALUE
-------- -------- -------- -------- -------- ---------- -------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
RATE SENSITIVE ASSETS:
Loans held for sale:
Fixed rate mortgage loans...... $ 25,016 $36,144 $28,449 $ 20,152 $14,030 $ 31,789 $155,580 $162,780
Weighted average rate.......... 10.79% 10.79% 10.79% 10.79% 10.79% 10.79% 10.79%
Variable rate mortgage loans... $ 23,109 $73,837 $48,747 $ 30,913 $19,869 $ 37,866 $234,341 $245,187
Weighted average rate.......... 10.50% 11.65% 12.85% 12.83% 12.82% 12.82% 10.48%
RATE SENSITIVE LIABILITIES:
Borrowings:
Fixed rate..................... $ 5,750 $ 5,750 $ -- $150,000 $ -- $113,970 $275,470 $123,452
Weighted average rate.......... 7.62% 7.56% 7.56% 5.50% 5.50% 5.50% 7.68%
Variable rate.................. $366,975 $ 8,040 $ -- $ -- $ -- $ -- $375,015 $375,015
Weighted average rate.......... 8.11% 7.99% -- -- -- -- 8.11%
</TABLE>
RATE SENSITIVE DERIVATIVE FINANCIAL INSTRUMENTS
RESIDUAL INTERESTS AND MSRS. The Company had residual interests of
$291.0 million and $332.3 million outstanding at June 30, 2000 and 1999,
respectively. The Company also had MSRs outstanding at June 30, 2000 and 1999 in
the amount of $12.3 million and $20.9 million, respectively. Both of these
instruments are recorded at estimated fair value at June 30, 2000 and 1999. 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% at June 30, 2000
and 1999. The weighted average life of the mortgage loans used for valuation at
June 30, 2000 was 3.1 years and at 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 agreements. As these amounts are short term in nature and/or
generally bear market rates of interest, the carrying amounts of these
instruments are reasonable estimates of their fair values. The carrying amount
of the Company's borrowings approximates fair value when valued using available
quoted market prices.
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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. These financial instruments
include commitments to extend credit to borrowers and commitments to purchase
loans from correspondents. The Company has a first or second lien position on
all of its loans, and the 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, 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. As of June 30, 2000 and 1999, the Company had total committed
revolving warehouse and repurchase facilities available in the amount of
$615.0 million (net of a $35.0 million subline) and $590.0 million,
respectively; the total amounts outstanding related to these facilities was
$375.0 million and $536.0 million at June 30, 2000 and 1999, respectively.
Revolving 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 securitized and 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 WE ARE UNABLE TO MAINTAIN ADEQUATE FINANCING SOURCES OR 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 of loans;
- 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;
- costs of expanding our loan production units; and
- Investments in technology initiatives and other capital improvements.
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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 three committed
lines with aggregate borrowing capacity of $665.0 million (excluding a
$35.0 million working capital subline). These facilities expire between
October 2000 and October 2001 and no assurances can be given that we will be
able to extend or replace these facilities at the times they mature.
We also raise cash through selling our loans in whole loan sales for cash
and in securitization transaction. We use the cash raised through loan
dispositions to provide us with the cash to pay off our revolving warehouse and
repurchase facilities and to fund new loans. We recently entered into a residual
sale facility which will allow us to raise up to $75.0 million in cash through
the sale of our residual interests created in future securitizations. The
residual sale facility expires at the earlier of (i) September 30, 2002
(ii) full use of the $75.0 million amount of the residual sale facility, or
(iii) a termination event, as defined in the residual sale facility. No
assurance can be given that we will be able to extend or replace this residual
sale facility upon its expiration nor that we will be able to complete whole
loan sales on terms favorable to us.
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. See "Risk Factors--High delinquencies on the loan in
our servicing portfolio may hurt our cash flows." We recently entered into a
transaction 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. Our agreement with the investment bank expires
in February 2001 and no assurance can be given that we will be able to extend or
replace this agreement. Without our agreement with the investment bank, or
similar alternative arrangements, our obligation to make future servicing
advances with cash will be substantially increased.
To the extent that we are unable to maintain existing, or arrange new,
revolving warehouse, repurchase or other credit facilities or obtain additional
commitments to sell whole loans for cash, we may have to curtail making loans.
See "Risk Factors--A prolonged interruption or reduction in the securitization
and whole loan market would hurt our financial performance." 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 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. If available at all, the type, timing and terms of financing
selected by us for our primary and potential sources of cash 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 the necessary sources of cash will be available
when needed. Even if the necessary sources of cash are available, the providers
of cash may impose terms that are not favorable to us. If the short-and
long-term external sources of cash needed to fund our operations, as described
above, are not available, we may be restricted in the amount of loans that we
will be able to produce and sell.
IF WE ARE UNABLE TO REFINANCE OUR BORROWINGS WHEN THEY BECOME DUE, OUR
FINANCIAL POSITION WOULD BE NEGATIVELY AFFECTED AND OUR ABILITY TO CONTINUE TO
OPERATE WOULD BE SIGNIFICANTLY JEOPARDIZED.
We currently have $150.0 million of borrowings due November 1, 2003 and
$114.0 million of borrowings due March 15, 2006. If we are unable to refinance
either or both of these borrowings when they become due, our financial position
would be negatively affected and our ability to continue to operate would be
significantly jeopardized.
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OUR RIGHT TO SERVICE LOANS MAY BE TERMINATED BECAUSE OF THE HIGH
DELINQUENCIES AND LOSSES ON THE LOANS IN OUR SERVICING PORTFOLIO.
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. 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. Generally, the Company enters into an agreement with the
monoline insurance company that 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 and provides that 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..
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.
At June 30, 2000, the dollar volume of loans delinquent more than 90 days in
ten of our securitization trusts exceeded the permitted delinquency 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 June 30, 2000 was
13.6% and at June 30, 1999 was 15.7%.
Nine of the ten trusts referred to above, which represent in the aggregate
17.6% of the dollar volume of our servicing portfolio, exceeded loss limits at
June 30, 2000.
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 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. Our agreement with the investment bank expires in February 2001 and
no assurance can be given that we will be able to extend or replace this
agreement. Without our agreement with the investment bank, or similar
alternative arrangements, our obligation to make future servicing advances with
cash will be substantially increased.
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
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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 June 30,
2000, we were required to maintain an additional $59.3 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
June 30, 2000, $41.0 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. Losses occur when the
cash we receive from the sale of foreclosed properties, less sales expenses, is
less than the principal balance of the loan previously secured by those
properties and related interest and servicing expenses and advances. 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 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 and related interest and servicing expenses and
advances in the event of liquidation. The total amount and severity of losses
not covered by the underlying properties could have a material adverse effect on
our results of operations and financial condition because they could affect our
right to service loans in securitizations (See "Risk Factors-Our right to
service loans may be terminated because of the high delinquencies and losses on
the loans in our servicing portfolio."). 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. As a result, borrowers will face higher
monthly payments due to interest rate increases on their adjustable rate loan,
even in a stable interest rate environment. 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. Higher risks of
delinquency may result when borrowers who may qualify for adjustable rate loans
with a teaser rate at the time of funding may not be able to afford the monthly
payments when the payment amount increases.
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FASTER THAN EXPECTED LEVELS OF LOAN PREPAYMENTS WILL HURT EARNINGS.
If actual prepayments occur more quickly than was projected at the time
loans were sold, the carrying value of our 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. See "Risk Factors-Faster than expected levels of loan
prepayments will hurt earnings."
43
<PAGE>
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 the interest rate can change during
any given period on an adjustable rate mortgage loan. 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 SECURITIZATION AND WHOLE LOAN
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.
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 instead of during the quarter in which they were
originated and would likely result in losses for the quarter in which they were
originated. 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.
44
<PAGE>
CHANGES IN THE VOLUME AND COST OF OUR BROKER LOANS MAY DECREASE OUR LOAN
PRODUCTION.
We depend on independent mortgage brokers for the origination 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
FannieMae and FreddieMac. 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,
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 broker programs depend largely on independent mortgage bankers and
brokers and other financial institutions for the origination 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 June 30, 2000, 21.9% and 11.6% of the loans we serviced were
collateralized by residential properties located in California and Florida,
respectively. Because of these concentrations, our financial
45
<PAGE>
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 and loss
severity 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, we may experience increased delinquencies or foreclosures
which would increase our servicing costs. 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 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.
We are also subject to various business risks after loans have been
securitized. Cash flows from the securitization trusts 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.
46
<PAGE>
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.
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.
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.
47
<PAGE>
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 August 31, 2000, entities controlled by Capital Z beneficially owned
senior preferred stock representing 47.3% of our combined voting power in the
election of directors and 91.4% 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are attached to this report:
Reports of Independent Auditors (Ernst & Young LLP, PricewaterhouseCoopers
LLP)
Consolidated Balance Sheet at June 30, 2000 and 1999
Consolidated Statement of Operations for the Years Ended June 30, 2000, 1999
and 1998
Consolidated Statement of Stockholders' Equity for the Years Ended June 30,
2000, 1999 and 1998
Consolidated Statement of Cash Flows for the Years Ended June 30, 2000, 1999
and 1998
Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Information regarding directors and executive officers of the Registrant
will appear in the proxy statement for the 2000 Annual Meeting of Stockholders
or an amendment to this Form 10-K, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will appear in the proxy
statement for the 2000 Annual Meeting of Stockholders or an amendment to this
Form 10-K, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management will appear in the proxy statement for the 2000 Annual Meeting of
Stockholders or an amendment to this Form 10-K, and is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions will
appear in the proxy statement for the 2000 Annual Meeting of Stockholders or an
amendment to this Form 10-K, and is incorporated by this reference.
48
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
(1) Consolidated Financial Statements: Financial Statements listed as
part of "Item 8. Financial Statements and Supplementary Data."
(2) Financial Statement Schedules: Financial Statement Schedules listed
in the "Exhibit Index" as Exhibits 11 and 27.
(3) Exhibits: All exhibits listed in the "Exhibit Index" are filed with
this report or are incorporated by reference into this report.
Management contracts and compensatory plans or arrangements are
filed, or incorporated by reference, as exhibits 10.1 through 10.20.
(b) The Company filed the following Current Reports on Form 8-K during the
last quarter of the fiscal year ended June 30, 2000:
(1) The Company filed a Current Report on Form 8-K on April 5, 2000
(dated April 4, 2000) reporting the appointment of Robert A. Spass as
a director of the Company.
(2) The Company filed a Current Report on Form 8-K on May 24, 2000 (dated
May 19, 2000) reporting the execution of a Preferred Stock Purchase
Agreement with Specialty Finance Partners as well as the Company's
third fiscal quarter operating results.
(3) The Company filed a Current Report on Form 8-K on June 9, 2000 (dated
June 7, 2000) reporting the execution of amendments to several of the
Company's warehouse lines, an amendment to the Preferred Stock
Purchase Agreement with Specialty Finance Partners and the details of
the closing of the first phase of the equity investment by Specialty
Finance Partners pursuant to the Preferred Stock Purchase Agreement.
49
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
AAMES FINANCIAL CORPORATION (Registrant)
By: /s/ A. JAY MEYERSON
-----------------------------------------
A. Jay Meyerson
Dated: September 28, 2000 CHIEF EXECUTIVE OFFICER
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ A. JAY MEYERSON Chief Executive Officer,
------------------------------------------- Director (Principal September 28, 2000
A. Jay Meyerson Executive Officer)
Executive Vice President--
/s/ JAMES HUSTON Finance and Chief
------------------------------------------- Financial Officer September 28, 2000
James Huston (Principal Financial and
Accounting Officer)
/s/ DAVID H. ELLIOTT
------------------------------------------- Director September 28, 2000
David H. Elliott
/s/ STEVEN M. GLUCKSTERN
------------------------------------------- Chairman of the Board and September 28, 2000
Steven M. Gluckstern Director
/s/ ADAM M. MIZEL
------------------------------------------- Director September 28, 2000
Adam M. Mizel
/s/ ERIC C. RAHE
------------------------------------------- Director September 28, 2000
Eric C. Rahe
/s/ MANI A. SADEGHI
------------------------------------------- Director September 28, 2000
Mani A. Sadeghi
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ ROBERT A. SPASS
------------------------------------------- Director September 28, 2000
Robert A. Spass
/s/ GEORGE C. ST. LAURENT, JR.
------------------------------------------- Director September 28, 2000
George C. St. Laurent, Jr.
/s/ CARY H. THOMPSON
------------------------------------------- Director September 28, 2000
Cary H. Thompson
</TABLE>
51
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Aames Financial Corporation
We have audited the accompanying consolidated balance sheets of Aames
Financial Corporation and subsidiaries (the Company) as of June 30, 2000 and
1999 and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for the years then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based upon our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Aames Financial Corporation and subsidiaries at June 30, 2000 and 1999, and the
consolidated results of their operations and their cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States.
/s/ ERNST & YOUNG LLP
Los Angeles, California
August 24, 2000
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Aames Financial Corporation
In our opinion, the accompanying consolidated statement of operations,
changes in stockholders' equity and cash flows present fairly, in all material
respects, the results of operations and the cash flows for the year ended
June 30, 1998 of Aames Financial Corporation and Subsidiaries (the Company), in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audit. We conducted our audit of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
/s/ PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
August 6, 1998
F-2
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
ASSETS
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
2000 1999
------------- --------------
<S> <C> <C>
Cash and cash equivalents................................... $ 10,179,000 $ 20,764,000
Loans held for sale, at lower of cost or market............. 398,921,000 559,869,000
Accounts receivable......................................... 52,713,000 56,964,000
Residual interests, at estimated fair value................. 290,956,000 332,327,000
Mortgage servicing rights, net.............................. 12,346,000 20,928,000
Equipment and improvements, net............................. 10,522,000 13,495,000
Prepaid and other........................................... 14,727,000 15,013,000
Income tax refund receivable................................ -- 1,737,000
------------- --------------
Total assets.............................................. $ 790,364,000 $1,021,097,000
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Borrowings.................................................. $ 275,470,000 $ 281,220,000
Revolving warehouse and repurchase facilities............... 375,015,000 535,997,000
Accounts payable and accrued expenses....................... 56,985,000 50,505,000
Income taxes payable........................................ 8,416,000 7,819,000
------------- --------------
Total liabilities....................................... 715,886,000 875,541,000
------------- --------------
Commitments and contingencies (Note 11)
Stockholders' equity:
Series A Preferred Stock, par value $0.001 per share;
500,000 shares authorized; none outstanding............. -- --
Series B Convertible Preferred Stock, par value $0.001 per
share; 26,704,000 and 100,000,000 shares authorized;
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;
60,977,000 and 15,009,000 shares outstanding............ 61,000 15,000
Common Stock, par value $0.001 per share; 400,000,000
shares authorized; 6,235,000 and 6,203,000 shares
outstanding............................................. 6,000 6,000
Additional paid-in capital................................ 401,652,000 342,278,000
Retained deficit.......................................... (327,268,000) (196,770,000)
------------- --------------
Total stockholders' equity.............................. 74,478,000 145,556,000
------------- --------------
Total liabilities and stockholders' equity.............. $ 790,364,000 $1,021,097,000
============= ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
--------------------------------------------
2000 1999 1998
------------- ------------- ------------
<S> <C> <C> <C>
Revenue:
Gain on sale of loans........................... $ 48,098,000 $ 44,855,000 $120,828,000
Valuation (write-down) of residual interests and
mortgage servicing rights..................... (82,490,000) (194,551,000) 19,495,000
Origination fees................................ 37,951,000 39,689,000 34,282,000
Loan servicing.................................. 15,654,000 23,329,000 10,634,000
Interest income................................. 94,569,000 70,525,000 81,250,000
------------- ------------- ------------
Total revenue including valuation
(write-down)................................ 113,782,000 (16,153,000) 266,489,000
------------- ------------- ------------
Expenses:
Compensation.................................... 93,239,000 80,167,000 94,820,000
Production...................................... 26,718,000 40,061,000 34,195,000
General and administrative...................... 60,489,000 60,635,000 40,686,000
Interest........................................ 52,339,000 44,089,000 43,982,000
Nonrecurring charges............................ -- 37,044,000 --
------------- ------------- ------------
Total expenses................................ 232,785,000 261,996,000 213,683,000
------------- ------------- ------------
Income (loss) before income taxes................. (119,003,000) (278,149,000) 52,806,000
Provision (benefit) for income taxes.............. 3,369,000 (30,182,000) 25,243,000
------------- ------------- ------------
Net income (loss)................................. $(122,372,000) $(247,967,000) $ 27,563,000
============= ============= ============
Net income (loss) per common share:
Basic........................................... $ (21.02) $ (40.31) $ 4.83
============= ============= ============
Diluted......................................... $ (21.02) $ (40.31) $ 4.36
============= ============= ============
Dividends per common share........................ $ -- $ 0.17 $ 0.66
============= ============= ============
Weighted average number of common shares
outstanding:
Basic........................................... 6,209,000 6,200,000 5,710,000
============= ============= ============
Diluted......................................... 6,209,000 6,200,000 7,150,000
============= ============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
SERIES B SERIES C
CONVERTIBLE CONVERTIBLE ADDITIONAL RETAINED
PREFERRED PREFERRED COMMON PAID-IN EARNINGS
STOCK STOCK STOCK CAPITAL (DEFICIT) TOTAL
----------- ----------- -------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1997................ $ -- $ -- $5,000 $209,379,000 $ 30,369,000 $ 239,753,000
Issuance of Common Stock......... -- -- 1,000 40,497,000 10,000 40,508,000
Dividends paid on Common Stock... -- -- -- -- (3,773,000) (3,773,000)
Net income....................... -- -- -- -- 27,563,000 27,563,000
------- ------- ------ ------------ ------------- -------------
As of June 30, 1998................ -- -- 6,000 249,876,000 54,169,000 304,051,000
Issuance of Common Stock......... -- -- -- 265,000 -- 265,000
Issuance of Series B Convertible
Preferred Stock................ 27,000 -- -- 26,677,000 -- 26,704,000
Issuance of Series C Convertible
Preferred Stock................ -- 15,000 -- 65,460,000 -- 65,475,000
Dividends paid on Common Stock... -- -- -- -- (1,022,000) (1,022,000)
Dividends accrued on Convertible
Preferred Stock................ -- -- -- -- (1,950,000) (1,950,000)
Net loss......................... -- -- -- -- (247,967,000) (247,967,000)
------- ------- ------ ------------ ------------- -------------
As of June 30, 1999................ 27,000 15,000 6,000 342,278,000 (196,770,000) 145,556,000
Issuance of Common Stock......... -- -- -- 2,000 -- 2,000
Issuance of Series C Convertible
Preferred Stock................ -- 46,000 -- 59,372,000 -- 59,418,000
Dividends accrued on Convertible
Preferred Stock................ -- -- -- -- (8,126,000) (8,126,000)
Net loss......................... -- -- -- -- (122,372,000) (122,372,000)
------- ------- ------ ------------ ------------- -------------
As of June 30, 2000................ $27,000 $61,000 $6,000 $401,652,000 $(327,268,000) $ 74,478,000
======= ======= ====== ============ ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
---------------------------------------------------
2000 1999 1998
--------------- --------------- ---------------
<S> <C> <C> <C>
Operating activities:
Net income (loss).......................... $ (122,372,000) $ (247,967,000) $ 27,563,000
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization............ 5,637,000 5,673,000 3,909,000
Gain on sale of loans.................... (34,596,000) (35,716,000) (121,098,000)
Write-down (valuation) of residual
interests.............................. 77,490,000 186,451,000 (19,495,000)
Accretion of residual interests.......... (50,692,000) (34,671,000) (41,008,000)
Mortgage servicing rights originated..... (5,175,000) (6,194,000) (19,513,000)
Mortgage servicing rights amortized...... 8,757,000 11,431,000 9,064,000
Mortgage servicing rights charged-off.... 5,000,000 8,100,000 --
Changes in assets and liabilities:
Loans held for sale originated or
purchased............................ (2,079,278,000) (2,193,635,000) (2,383,638,000)
Proceeds from sale of loans held for
sale................................. 2,240,226,000 1,831,968,000 2,428,423,000
Decrease (increase) in:
Accounts receivable.................. 4,251,000 (5,892,000) 8,108,000
Residual interests................... 49,169,000 39,976,000 30,310,000
Prepaid and other.................... 286,000 2,007,000 (2,071,000)
Income tax refund receivable......... 1,737,000 (1,737,000) --
Increase (decrease) in:
Accounts payable and accrued
expenses........................... (1,646,000) (1,409,000) 20,667,000
Deferred income taxes................ 597,000 (25,351,000) 9,118,000
--------------- --------------- ---------------
Net cash provided by (used in) operating
activities................................. 99,391,000 (466,966,000) (49,661,000)
--------------- --------------- ---------------
Investing activities:
Purchases of equipment and improvements.... (2,664,000) (5,229,000) (5,163,000)
Financing activities:
Net proceeds from issuance of convertible
preferred stock.......................... 59,418,000 92,179,000 --
Proceeds from sale of common stock or
exercise of options...................... 2,000 265,000 40,505,000
Reductions in borrowings................... (5,750,000) (5,770,000) --
Proceeds from (reductions in) revolving
warehouse and repurchase facilities...... (160,982,000) 394,985,000 3,512,000
Dividends paid............................. -- (1,022,000) (3,773,000)
--------------- --------------- ---------------
Net cash provided by (used in) financing
activities................................. (107,312,000) 480,637,000 40,244,000
--------------- --------------- ---------------
Net increase (decrease) in cash and cash
equivalents................................ (10,585,000) 8,442,000 (14,580,000)
Cash and cash equivalents at beginning of
period..................................... 20,764,000 12,322,000 26,902,000
--------------- --------------- ---------------
Cash and cash equivalents at end of period... $ 10,179,000 $ 20,764,000 $ 12,322,000
=============== =============== ===============
Supplemental disclosures:
Interest paid.............................. $ 53,392,000 $ 41,769,000 $ 44,501,000
Income taxes paid (refunded)............... $ 1,028,000 $ (4,470,000) $ 16,125,000
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Aames Financial Corporation (the "Company" or "Aames") operates in a single
industry segment as a consumer finance company primarily engaged, through its
subsidiaries, in the business of originating, purchasing, selling, and servicing
home equity mortgages secured by single family residences. 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. Loans originated by the Company are extended on the basis of
the equity in the borrower's property and the creditworthiness of the borrower.
At June 30, 2000, Aames operated 100 retail branch offices and seven regional
broker offices throughout the United States. The Company originates mortgage
loans on a nationwide basis through its two production channels--retail, broker
and, to a much lesser extent, through purchases of loans from approved
correspondents. During the years ended June 30, 2000 and 1999, the Company
originated and purchased $2.1 billion and $2.2 billion of mortgage loans,
respectively. During the years ended June 30, 2000 and 1999, the Company sold
and securitized $2.2 billion and $1.9 billion of mortgage loans, respectively.
The aggregate outstanding balance of mortgage loans serviced by the Company was
$3.6 billion and $3.8 billion at June 30, 2000 and 1999, respectively (which
includes $265.4 million and $413.0 million of mortgage loans at June 30, 2000
and 1999, respectively, serviced for the Company by unaffiliated subservicers
under subservicing agreements).
At June 30, 2000, Specialty Finance Partners ("SFP"), a partnership
controlled by Capital Z Financial Services Fund, II, L.P., a Bermuda partnership
(together with SFP, "Capital Z") owned preferred stock representing
approximately 47.3% of the Company's combined voting power in the election of
directors and approximately 90.3% of the combined voting power in all matters
other than the election of directors. Representatives or nominees of Capital Z
have five seats on the 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 the Company's direction and policies.
PRINCIPLES OF ACCOUNTING AND CONSOLIDATION
The consolidated financial statements of the Company include the accounts of
Aames and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments with an original
maturity of no more than three months to be cash equivalents.
F-7
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOANS HELD FOR SALE
Loans held for sale are mortgage loans the Company plans to securitize or
sell as whole loans and are carried at the lower of aggregate cost or market
value. Market value is determined by current investor yield requirements.
ACCOUNTS RECEIVABLE
Accounts receivable primarily consists primarily of interest advances and
other servicing related advances to securitization trusts.
EQUIPMENT AND IMPROVEMENTS, NET
Equipment and improvements, net, are stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are being recorded
utilizing straight-line and accelerated methods over the following estimated
useful lives:
<TABLE>
<S> <C>
Computer hardware..................................... Five years
Furniture and fixtures................................ Five to seven years
Computer software..................................... Three years
Lower of life of lease or
Leasehold improvements................................ asset
</TABLE>
REVENUE RECOGNITION
The Company depends on its ability to sell loans in the secondary markets,
as market conditions allow, 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.
The Company records a sale of loans and the resulting gain on sale of loans
when it surrenders control over the loans to a buyer (the "transferee"). Control
is surrendered when (i) the loans are isolated from the Company, put
presumptively beyond the reach of the Company and its creditors, even in a
bankruptcy or other receivership, (ii) either the transferee has the right to
pledge or exchange the loans or the transferee is a qualifying special purpose
entity and the beneficial interest holders in the qualifying special purpose
entity have the right to pledge or exchange the beneficial interests, and
(iii) the Company does not maintain effective control over the loans through an
agreement to repurchase or redeem the loans before their maturity or through an
agreement that entitles the Company to repurchase or redeem loans that are not
readily obtainable.
In a securitization, the Company conveys loans to a separate entity (such as
a trust) in exchange for cash proceeds and a residual interest in the trust. The
cash proceeds are raised through an offering of pass-through certificates or
bonds evidencing the right to receive principal payments and interest on the
certificate balance or 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
F-8
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, a monoline insurance fee, if any, and an estimate for loan
losses. 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) a future rate of
prepayment; (ii) credit losses; and (iii) a discount rate used to calculate
present value. The future cash flows represent management's best estimate.
Management monitors performance of the loans and changes in the estimates are
reflected in earnings. There can be no assurance of the accuracy of management's
estimates.
Additionally, upon sale or securitization of servicing retained mortgages,
the Company capitalizes mortgage servicing rights. The Company determines fair
value based on the present value of estimated net future cash flows related to
servicing income. The Company uses a discount rate of 15%. The servicing rights
are amortized in proportion to and over the period of estimated net future
servicing fee income. The Company periodically reviews capitalized servicing
rights for valuation impairment. At June 30, 2000 and 1999, there were no
valuation allowances on mortgage servicing rights.
On a quarterly basis, the Company reviews the fair value of the residual
interests by analyzing its prepayment, credit loss and discount rate assumptions
in relation to its actual experience and current rates of prepayment and credit
loss prevalent in the industry. The Company may adjust the value of the residual
interests or take a charge to earnings related to the residual interests, as
appropriate, to reflect a valuation or write-down of its residual interests
based upon the actual performance of the Company's residual interests as
compared to the Company's key assumptions and estimates used to determine fair
value. Although management believes that the assumptions to estimate the fair
values of its residual interests are reasonable, there can be no assurance as to
the accuracy of the assumptions or estimates.
ADVERTISING EXPENSE
The Company's policy is to charge advertising costs to expense when
incurred. The Company charged to expense $17.6 million, $29.0 million and
$23.0 million in fiscal years ended June 30, 2000, 1999 and 1998, respectively.
INCOME TAXES
Taxes are provided on substantially all income and expense items included in
earnings, regardless of the period in which such items are recognized for tax
purposes. The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns. In estimating future tax consequences, the Company
generally considers all expected future events other than the enactment of
changes in the tax law or rates.
F-9
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per share of common stock is computed using the
weighted average number of shares of common stock outstanding during each
period. Diluted earnings (loss) per share includes the effects of the conversion
of shares related to the Company's 5.5% Convertible Subordinated Debentures due
2006, preferred stock convertible into common shares as well as the average
number of stock options outstanding, except when their effect is antidilutive.
All references in the accompanying consolidated balance sheet, consolidated
statement of operations and notes to consolidated financial statements to the
number of common shares and per common share amounts have been restated to
reflect the one-for-five reverse stock split effected on April 14, 2000.
RISK MANAGEMENT
The Company's earnings may be directly affected by the level of and
fluctuation in interest rates in the Company's securitizations. No hedge
transactions were in place at and during the year ended June 30, 2000.
From time to time, the Company hedges its fixed rate loans and some variable
rate certificates or bonds in the securitization trusts. The Company has
utilized hedge products that included the sale of U.S. Treasury securities not
yet purchased, interest rate futures contracts, and the purchase of options to
sell U.S. Treasury securities. The Company also utilized interest rate caps. The
use, amount, and timing of hedging transactions are determined by members of the
Company's senior management.
RECLASSIFICATIONS
Certain amounts related to 1999 and 1998 have been reclassified to conform
to the 2000 presentation.
ADOPTION OF RECENT ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." ("SFAS 133"). 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. At June 30, 2000, the Company had no freestanding
derivative instruments in place and had no material amount of embedded
derivative instruments. The Company adopted SFAS 133 on July 1, 2000. Based upon
the Company's application of SFAS No. 133, its adoption had no materially
adverse effect on the Company's consolidated financial statements.
NOTE 2. CASH AND CASH EQUIVALENTS AND CASH HELD IN TRUST
At June 30, 2000, the Company had corporate cash and cash equivalents
available of $10.2 million, none of which was restricted. Cash equivalents
include $4.8 million of overnight investments at June 30, 2000.
F-10
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. CASH AND CASH EQUIVALENTS AND CASH HELD IN TRUST (CONTINUED)
The Company services loans on behalf of customers. In such capacity, certain
funds are collected and placed in segregated trust accounts which totaled
$90.4 million at June 30, 2000 and 1999. These accounts and corresponding
liabilities are not included in the accompanying consolidated balance sheet.
NOTE 3. LOANS HELD FOR SALE
The following summarizes the composition of the Company's loans held for
sale by interest rate type at June 30, 2000 and 1999:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
Fixed rate mortgages..................................... $155,580,000 $335,921,000
Adjustable rate mortgages................................ 243,341,000 223,948,000
------------ ------------
Loans held for sale.................................. $398,921,000 $559,869,000
============ ============
</TABLE>
NOTE 4. ACCOUNTS RECEIVABLE
At June 30, 2000 and 1999, accounts receivable was comprised of the
following:
<TABLE>
<CAPTION>
2000 1999
----------- -----------
<S> <C> <C>
Interest and servicing advances............................ $32,941,000 $17,774,000
Capital proceeds receivable................................ -- 24,750,000
Other receivables.......................................... 19,772,000 14,440,000
----------- -----------
Accounts receivable.................................... $52,713,000 $56,964,000
=========== ===========
</TABLE>
During the year ended June 30, 2000 and 1999, the Company entered into an
arrangements with an investment bank pursuant to which the investment bank
purchased certain cumulative advances and undertook the obligation to make a
substantial portion of the Company's advance obligations on its securitized
pools. As a result of these arrangements, during the years ended June 30, 2000
and 1999, the Company received approximately $15.0 million and $50.0 million,
respectively, in cash for certain advances.
During the year ended June 30, 1999, the Company reduced its advance
obligations by engaging a loan servicing company to subservice two of the
Company's securitization pools. The subservicer assumed the obligation to make
all future advances on those two pools. At the same time, the Company also sold
to the subservicer the outstanding advances on the two pools for approximately
$13.0 million.
At June 30, 1999, accounts receivable included $24.8 million of capital
proceeds receivable which were received in cash on August 3, 1999.
F-11
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. RESIDUAL INTERESTS
The activity in the residual interests during the years ended June 30, 2000
and 1999 is summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
Residual interests, at beginning of year................. $332,327,000 $490,542,000
Gain on sale of securitized loans........................ 34,596,000 35,716,000
Accretion................................................ 50,692,000 34,671,000
Cash received from trusts................................ (49,169,000) (39,976,000)
Write-down of residual interests......................... (77,490,000) (188,626,000)
------------ ------------
Residual interests, at end of year....................... $290,956,000 $332,327,000
============ ============
</TABLE>
The actual performance of the Company's residual interests as compared to
the key assumptions and estimates used to evaluate their carrying value resulted
in write-downs to the residual interests of $77.5 million and $188.6 million
during the years ended June 30, 2000 and 1999, respectively.
The $77.5 million valuation adjustment recorded during the year ended
June 30, 2000 was comprised of unfavorable adjustments of $86.3 million taken in
light of higher than expected credit loss experience and $12.3 million due to
the effects of rising interest rates on excess spreads which were offset by a
favorable $21.1 million adjustment due to actual prepayment rate trends compared
to prepayment rate assumptions.
The $188.6 million valuation adjustment recorded during the year ended
June 30, 1999 was comprised of unfavorable adjustments of $62.1 million,
$67.2 million and $64.5 million made to the rate of prepayment, credit loss and
discount rate assumptions, respectively, offset by a positive valuation
adjustment of $5.2 million.
The following table summarizes certain information about the securitization
trusts (dollars in thousands):
<TABLE>
<S> <C>
Aggregate principal balance of securitized loans at
the time of the securitizations.................... $7,016,205
Outstanding principal balance of securitized loans at
June 30, 2000...................................... $2,879,578
Outstanding principal balance of pass-through
certificates or bonds of the securitization trusts
at June 30, 2000................................... $2,626,422
Weighted average coupon rates at June 30, 2000 of:
Securitized loans.................................. 11.29%
Pass-through certificates or bonds................. 7.04%
</TABLE>
In connection with its securitization transactions, the Company initially
deposits with a trustee cash or the required overcollateralization amount and
subsequently deposits a portion of the excess spread collected on the related
loans. Residual interests at June 30, 2000 and 1999 include
overcollateralization of approximately $253.2 million and $265.9 million,
respectively. These amounts are subject to increase, as specified in the related
securitization documents. To the extent the overcollateralization exceeds
specified levels, distributions are made to the Company.
F-12
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. RESIDUAL INTERESTS (CONTINUED)
There is no active market with quoted prices for the Company's residual
interests. Therefore, the Company estimates the fair value of its residual
interests based upon the present value of expected future cash flows based on
certain prepayment, credit loss and discount rate assumptions. There can be no
assurance that the Company could realize the fair value of its residual
interests in a sale.
Certain historical data and key assumptions and estimates used by the
Company in its June 30, 2000 review of the residual interests were the
following:
<TABLE>
<S> <C>
Prepayments:
Actual weighted average annual prepayment rate, as
a percentage of outstanding principal balance of
securitized loans, during the year ended June 30,
2000............................................. 30.9%
Estimated peak annual prepayment rates, as a
percentage of outstanding principal balance of
securitized loans:
Fixed rate loans................................. 22.3% to 29.5%
Adjustable rate loans............................ 36.7% to 46.3%
Estimated weighted average life of securitized
loans............................................ 3.1 years
Credit losses:
Actual credit losses to date, as a percentage of
original principal balances of securitized
loans............................................ 2.6%
Future estimated prospective credit losses, as a
percentage of original principal balances of
securitized loans................................ 2.0%
Total actual and estimated prospective credit
losses, as a percentage of original principal
balance of securitized loans..................... 4.6%
Total actual credit losses to date and estimated
prospective credit losses (dollars in
thousands)....................................... $323,634
Discount rate........................................ 15.0%
</TABLE>
F-13
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. MORTGAGE SERVICING RIGHTS, NET
The activity in mortgage servicing rights during the years ended June 30,
2000 and 1999 is summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
Mortgage servicing rights, net, at beginning of
year........................................... $ 20,928,000 $ 32,090,000
Mortgage servicing rights:
Originated..................................... 5,175,000 6,194,000
Amortized...................................... (8,757,000) (11,431,000)
Charged-off.................................... (5,000,000) (5,925,000)
------------ ------------
Mortgage servicing rights, net, at end of year... $ 12,346,000 $ 20,928,000
============ ============
</TABLE>
The mortgage servicing rights are amortized over the estimated lives of the
loans to which they relate.
During the year ended June 30, 2000, the Company reduced the carrying value
of its mortgage servicing rights 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 servicing
portfolio. During the year ended June 30, 1999, in connection with the transfer
of servicing of two pools and a special servicing arrangement for two additional
pools with a subservicer, the Company reduced by approximately $5.9 million the
carrying value of the mortgage servicing rights associated with those pools.
NOTE 7. EQUIPMENT AND IMPROVEMENTS, NET
Equipment and improvements, net, consisted of the following at June 30, 2000
and 1999:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
Computer hardware................................ $ 12,119,000 $ 11,496,000
Furniture and fixtures........................... 8,578,000 8,623,000
Computer software................................ 7,802,000 6,340,000
Leasehold improvements........................... 2,525,000 2,575,000
------------ ------------
Total...................................... 31,024,000 29,034,000
Accumulated depreciation and amortization........ (20,502,000) (15,539,000)
------------ ------------
Equipment and improvements, net.................. $ 10,522,000 $ 13,495,000
============ ============
</TABLE>
F-14
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. BORROWINGS
Borrowings consisted of the following at June 30, 2000 and 1999:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
9.125% Senior Notes due 2003, guaranteed by each
of the restricted subsidiaries (as defined in
the Indenture) of the Company.................. $150,000,000 $150,000,000
5.5% Convertible Subordinated Debentures due
2006, convertible into 6.1 million shares of
common stock at $78.15 per share. The
Convertible Subordinated Debentures are
subordinate to all existing and future senior
indebtedness (as defined in the Indenture) of
the Company.................................... 113,970,000 113,970,000
10.5% Senior Notes due 2002, principal payments
of $5,750,000 required on February 1, 2001 and
2002........................................... 11,500,000 17,250,000
------------ ------------
Borrowings..................................... $275,470,000 $281,220,000
============ ============
</TABLE>
Maturities on borrowings are as follows:
<TABLE>
<CAPTION>
<S> <C>
Fiscal Years Ended June 30,
2001........................................................ $ 5,750,000
2002........................................................ 5,750,000
2003........................................................ --
2004........................................................ 150,000,000
2005........................................................ --
Thereafter.................................................. 113,970,000
------------
Total borrowings...................................... $275,470,000
============
</TABLE>
In October 1996, the Company completed an offering of its 9.125% Senior
Notes due 2003 which are guaranteed by all but one of the Company's wholly-owned
subsidiaries. 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 income
(loss) and net equity of such subsidiaries are substantially equivalent to the
total assets, net income (loss) and net equity of the Company on a consolidated
basis.
At June 30, 2000 and 1999, the Company had unamortized debt issuance costs
of $4.6 million and $5.9 million, respectively, related to the issuance of the
$23.0 million of 10.5% Senior Notes due 2002, the issuance of the
$115.0 million of 5.5% Convertible Subordinated Debentures due 2006 and the
issuance of the $150.0 million of 9.125% Senior Notes due 2003. Unamortized debt
issuance costs are included in prepaid and other assets in the accompanying
consolidated balance sheet and are amortized to expense over the terms of the
related debt issuances.
F-15
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. REVOLVING WAREHOUSE AND REPURCHASE FACILITIES
The Company utilizes revolving warehouse and repurchase facilities to
finance the origination of mortgage loans prior to sale or securitization. At
June 30, 2000 and 1999, the Company had total committed revolving warehouse and
repurchase facilities available in the amount of $615.0 million (net of a
$35.0 million non-revolving subline) and $590.0 million, respectively. Revolving
warehouse and repurchase facilities typically have a term of less than one year
and are designated to fund mortgage loans originated within specified
underwriting guidelines. 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, leverage and net income levels. Additionally, all of the
Company's revolving warehouse and repurchase facilities fund less than 100% of
the principal balance of the mortgage loans financed requiring the Company to
use working capital to fund the remaining portion of the principal balance of
the mortgage loans. The majority of the mortgage loans originated under the
facilities remain in the facilities for a period generally of up to 90 days at
which point they are securitized or sold to institutional investors.
Amounts outstanding under committed revolving warehouse and repurchase
facilities consisted of the following at June 30, 2000 and 1999:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
2000 1999
------------ ------------
<S> <C> <C>
Warehouse facility of $200.0 million (with a non-revolving
$35.0 million subline) from an investment bank,
collateralized by loans held for sale; expires on
January 31, 2001; bears interest at 1.5% over one month
LIBOR..................................................... $ 48,236,000 $ --
Repurchase facility of $250.0 million from an investment
bank, collateralized by loans held for sale; expires on
October 27, 2000; generally bears interest at 1.15%,
depending on collateral, over one month LIBOR............. 186,371,000 --
Repurchase facility of $200.0 million from an investment
bank, collateralized by loans held for sale; expires on
October 28, 2000; bears interest at 1.5% to 2.0% over one
month LIBOR, depending on document status................. 140,408,000 --
Warehouse facility of $90.0 million from an investment bank,
collateralized by loans held for sale; expired on February
9, 2000; bore interest at 1.5% over one month LIBOR....... -- 47,018,000
Repurchase facility of $300.0 million from an investment
bank; collateralized by loans held for sale; expired on
March 31, 2000; bore interest from 1.5% to 2.0%, depending
on document status, over one month LIBOR.................. -- 293,037,000
Repurchase facility of $200.0 million from a commercial
bank; collateralized by loans held for sale; expired on
February 29, 2000; bore interest from 1.25% to 1.5%, over
one month LIBOR, depending on document status............. -- 195,942,000
------------ ------------
Amounts outstanding under revolving warehouse and
repurchase facilities............................... $375,015,000 $535,997,000
============ ============
</TABLE>
F-16
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. REVOLVING WAREHOUSE AND REPURCHASE FACILITIES (CONTINUED)
At June 30, 2000, the balance outstanding under the non-revolving
$35.0 million subline was $27.5 million. The subline is secured by residual
interests of the Company and bears interest at 3.75% over one month LIBOR. The
subline has an initial 364-day term through January 31, 2001 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, if
certain repayment, financial and performance conditions are met by the Company.
At June 30, 2000, one month LIBOR was 6.64%.
The weighted-average interest rate on borrowings outstanding under revolving
warehouse and repurchase facilities at June 30, 2000 and 1999 were approximately
8.17% and 6.69%, respectively. During the year ended June 30, 2000, the average
amount of borrowings under revolving warehouse and repurchase facilities was
$417.4 million and the maximum outstanding under such lines at any one time
during the year ended June 30, 2000 was $685.4 million.
At June 30, 2000, included in prepaid and other assets in the accompanying
consolidated balance sheet was approximately $3.7 million of deferred commitment
fees relating to the Company's revolving warehouse and repurchase facilities
remaining to be amortized to expense over their remaining terms.
NOTE 10. INCOME TAXES
The provision (benefit) for income taxes consisted of the following for the
years ended June 30, 2000, 1999 and 1998:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------------------
2000 1999 1998
---------- ------------ -----------
<S> <C> <C> <C>
Current:
Federal.............................. $2,200,000 $ 1,200,000 $10,060,000
State................................ 572,000 400,000 3,249,000
---------- ------------ -----------
2,772,000 1,600,000 13,309,000
---------- ------------ -----------
Deferred:
Federal.............................. 597,000 (24,155,000) 6,814,000
State................................ -- (7,627,000) 5,120,000
---------- ------------ -----------
597,000 (31,782,000) 11,934,000
---------- ------------ -----------
Total............................ $3,369,000 $(30,182,000) $25,243,000
========== ============ ===========
</TABLE>
F-17
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. INCOME TAXES (CONTINUED)
Current and deferred taxes payable were comprised of the following at
June 30, 2000 and 1999:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
2000 1999
---------- -----------
<S> <C> <C>
Current taxes payable (receivable):
Federal........................................... $ -- $ --
State............................................. -- (1,737,000)
---------- -----------
-- (1,737,000)
---------- -----------
Deferred taxes payable:
Federal........................................... 8,416,000 7,819,000
State............................................. -- --
---------- -----------
8,416,000 7,819,000
---------- -----------
Total......................................... $8,416,000 $ 6,082,000
========== ===========
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities consisted of the
following at June 30, 2000 and 1999:
<TABLE>
<CAPTION>
JUNE 30,
----------------------------
2000 1999
------------- ------------
<S> <C> <C>
Deferred tax liabilities:
Mark-to-market................................ $ 3,305,000 $ 3,305,000
Mortgage servicing rights..................... 1,761,000 5,323,000
Other, net.................................... 1,351,000 1,351,000
------------- ------------
Total gross deferred tax liabilities...... 6,417,000 9,979,000
------------- ------------
Deferred tax assets:
Residual interests............................ (103,941,000) (63,483,000)
State taxes................................... (5,033,000) (5,033,000)
Allowance for doubtful accounts............... (3,195,000) (3,195,000)
Net operating loss carry forward.............. (21,095,000) (13,260,000)
Other......................................... (11,310,000) (11,310,000)
------------- ------------
Total gross deferred tax assets........... (144,574,000) (96,281,000)
Tax valuation allowance......................... 146,573,000 94,121,000
------------- ------------
Net deferred tax liabilities.................... $ 8,416,000 $ 7,819,000
============= ============
</TABLE>
F-18
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. INCOME TAXES (CONTINUED)
The estimated effective tax rates for the years ended June 30, 2000, 1999
and 1998 were as follows:
<TABLE>
<CAPTION>
2000
-------------------------------------------
TAX AFFECTED EFFECTIVE
PERMANENT PERMANENT TAX RATE
DIFFERENCES DIFFERENCES CALCULATION
------------ ------------ -------------
<S> <C> <C> <C>
Tax provision....................................... $ 3,369,000
Loss before income taxes............................ (119,003,000)
Effective tax rate.................................. (2.8)%
=============
Federal statutory rate.............................. (35.0)%
State pre-tax after permanent difference............ $(11,334,000) $(7,378,000) (6.2)
Tax valuation allowance............................. 126,512,000 52,123,000 43.8
Other, net.......................................... 200,000 130,000 .2
-------------
2.8 %
=============
</TABLE>
<TABLE>
<CAPTION>
1999
------------------------------------------
TAX AFFECTED EFFECTIVE
PERMANENT PERMANENT TAX RATE
DIFFERENCES DIFFERENCES CALCULATION
----------- ------------ -------------
<S> <C> <C> <C>
Tax benefit.......................................... $ (30,182,000)
Loss before income taxes............................. (278,149,000)
Effective tax rate................................... 10.9%
=============
Federal statutory rate............................... (35.0%)
State pre-tax after permanent difference............. $ -- $(21,142,000) (7.6)
Disallowed compensation.............................. 3,000,000 1,050,000 .4
Tax valuation allowance.............................. -- 87,174,000 31.3
Other, net........................................... 253,000 89,000 --
-------------
(10.9)%
=============
</TABLE>
<TABLE>
<CAPTION>
1998
----------------------------------------
TAX AFFECTED EFFECTIVE
PERMANENT PERMANENT TAX RATE
DIFFERENCES DIFFERENCES CALCULATION
----------- ------------ -----------
<S> <C> <C> <C>
Tax provision........................................... $25,243,000
Income before income taxes.............................. 52,806,000
Effective tax rate...................................... 47.8%
===========
Federal statutory rate.................................. 35.0%
State pre-tax after permanent difference................ $8,369,000 $5,439,000 10.3
Disallowed compensation................................. 3,398,000 1,189,300 2.3
Other, net.............................................. 253,940 132,250 0.2
-----------
47.8%
===========
</TABLE>
F-19
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. INCOME TAXES (CONTINUED)
The income tax refund receivable of $1.7 million was received during the
year ended June 30, 2000.
The investment in the Company by Capital Z resulted in a change of control
for income tax purposes thereby potentially limiting the Company's ability to
utilize net operating loss carry forwards and certain other future deductions.
The Company's residual interest in real estate mortgage investment conduits
("REMIC") creates excess inclusion income for tax purposes which may give rise
to a current income tax payable. Available loss carry forwards and operating
losses may not reduce taxable income below excess inclusion income earned from
the REMIC.
NOTE 11. COMMITMENTS AND CONTINGENCIES
The Company leases office space under operating leases expiring at various
dates through February 2012. Total rent expense related to operating leases
amounted to $10.3 million, $10.7 million and $9.1 million, for the years ended
June 30, 2000, 1999 and 1998, respectively. Certain leases have provisions for
renewal options and/or rental increases at specified increments or in relation
to increases in the Consumer Price Index (as defined).
At June 30, 2000, future minimum rental payments required under
non-cancelable operating leases that have initial or remaining terms in excess
of one year are as follows:
<TABLE>
<S> <C>
2001........................................................ $ 7,967,000
2002........................................................ 7,072,000
2003........................................................ 6,157,000
2004........................................................ 4,103,000
2005........................................................ 3,691,000
Thereafter.................................................. 26,424,000
-----------
$55,414,000
===========
</TABLE>
LITIGATION
In the ordinary course of its business, the Company is subject to various
claims made against it by borrowers, private investors and others arising from,
among other things, losses that are claimed to have been incurred as a result of
alleged breaches of fiduciary obligations, misrepresentations, errors and
omissions of employees and officers of the Company, incomplete documentation and
failures by the Company to comply with various laws and regulations applicable
to its business. The Company believes that liability with respect to any
currently asserted claims or legal action is not likely to be material to the
Company's consolidated financial position or results of operations; however, any
claims asserted or legal action in the future may result in expenses which could
have a material adverse effect on the Company's consolidated financial position
and results of operations.
F-20
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of financial
instruments as of June 30, 2000 and 1999 are made by the Company using available
market information, historical data, and appropriate valuation methodologies.
However, considerable judgment is required to interpret market and historical
data to develop the estimates of fair value. Accordingly, the estimates
presented herein are not necessarily indicative of the amounts the Company could
realize in a current market exchange.
The use of different market assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts.
<TABLE>
<CAPTION>
JUNE 30, 2000 JUNE 30, 1999
--------------------------- ---------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
BALANCE SHEET:
Cash and cash equivalents........... $ 10,179,000 $ 10,179,000 $ 20,764,000 $ 20,764,000
Loans held for sale................. 398,921,000 407,967,000 559,869,000 576,178,000
Accounts receivable................. 52,713,000 52,713,000 56,964,000 56,964,000
Residual interests, at estimated
fair value........................ 290,956,000 290,956,000 332,327,000 332,327,000
Mortgage servicing rights, net...... 12,346,000 12,346,000 20,928,000 20,928,000
Borrowings.......................... 275,470,000 123,452,000 281,220,000 171,888,000
Revolving warehouse and repurchase
facilities........................ 375,015,000 375,015,000 535,997,000 535,997,000
OFF BALANCE SHEET:
Hedge position notional amount
outstanding....................... -- -- -- --
</TABLE>
The fair value estimates as of June 30, 2000 and 1999 are based on pertinent
information available to management as of the respective dates. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been revalued for purposes
of these consolidated financial statements since those dates and, therefore,
current estimates of fair value may differ significantly from the amounts
presented herein.
The following describes the methods and assumptions used by the Company in
estimating fair values:
- Cash and cash equivalents are based on the carrying amount which is a
reasonable estimate of the fair value.
- Loans held for sale are based on current investor yield requirements.
- Accounts receivable are generally short term in nature, therefore the
carrying value approximates fair value.
- Residual interests and mortgage servicing rights are based on the present
value of expected future cash flows using assumptions based on the
Company's historical experience, industry information and estimated rates
of future prepayment and credit loss.
- Borrowings are based on the quoted market prices for the same or similar
issues or on the current rates offered to the Company for debt of the same
remaining maturities.
F-21
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
- Amounts outstanding under revolving warehouse and repurchase facilities
are short term in nature and generally bear market rates of interest and,
therefore, are based on the carrying amount which is a reasonable estimate
of fair value.
- Hedge positions are based on quoted market prices.
NOTE 13. EMPLOYEE BENEFIT PLANS
401(K) RETIREMENT SAVINGS PLAN
The Company sponsors a 401(k) Retirement Savings Plan, a defined
contribution plan. Substantially all employees are eligible to participate in
the plan after reaching the age of 21 and completion of six months of service.
Contributions are made from employees' elected salary deferrals. Employer
contributions are determined at the beginning of the plan year at the option of
the employer. Contributions to the Plan by the Company during the years ended
June 30, 2000, 1999 and 1998 were $321,000, $-0- and $549,000, respectively.
DEFERRED COMPENSATION PLAN
During the year ended June 30, 1999, the Company terminated the Deferred
Compensation Plan which had been implemented in April 1997. During the year
ended June 30, 1998, the Company made $203,700 of discretionary contributions to
the plan.
STOCK-BASED COMPENSATION
The Company's Board of Directors adopted the Aames Financial Corporation
Stock Option Plan (the "1999 Plan") as of February 10, 1999, as amended, which
was subsequently approved by the stockholders during the year ended June 30,
2000. The 1999 Plan supercedes the Company's 1991 Stock Incentive Plan, 1995
Stock Incentive Plan, 1996 Stock Incentive Plan, 1997 Stock Option Plan and 1997
Non-Qualified Stock Option Plan. The 1999 Plan provides for the issuance of
options to purchase shares of the Company's common stock to officers, key
executives and consultants of the Company. Under the 1999 Plan, the Company may
grant incentive and non-qualified options to eligible participants that may vest
immediately on the date of grant or in accordance with a vesting schedule, as
determined in the sole discretion of the Compensation Committee of the Company's
Board of Directors. The exercise price is based on the 20-day average closing
price of the common stock on the day before the date of grant. Each option plan
provides for a term of 10 years. Subject to adjustment for stock splits, stock
dividends and other similar events at June 30, 2000 there were 2,922,401 shares
reserved for issuance under the 1999 Plan.
At June 30, 1999, the Company had reserved 563,936 shares of the common
stock for issuance under its 1991 Stock Incentive Plan, 1995 Stock Incentive
Plan, 1996 Stock Incentive Plan, 1997 Stock Option Plan and 1997 Non-Qualified
Stock Option Plan (the "Terminated Plans"). The Terminated Plans were terminated
by the Company in February 1999; however, options granted prior to February 1999
under the Terminated Plans will remain outstanding until they expire. The
Company has also granted options outside of these plans, on terms established by
the Compensation Committee. A
F-22
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13. EMPLOYEE BENEFIT PLANS (CONTINUED)
summary of the Company's stock option plans and arrangements as of June 30,
2000, 1999 and 1998 and changes during the years then ended are as follows:
<TABLE>
<CAPTION>
OPTION OPTION
SHARES PRICE RANGE
--------- -------------
<S> <C> <C>
2000
Outstanding at beginning of year................... 1,005,100 $ 0.95-147.90
Granted.......................................... 2,873,078 3.95-5.00
Exercised........................................ (5,797) 1.00-1.00
Forfeited........................................ (743,602) 1.00-144.60
--------- -------------
Outstanding at end of year......................... 3,128,779 $ 1.00-147.90
========= =============
1999
Outstanding at beginning of year................... 914,134 $ 0.95-148.50
Granted.......................................... 182,336 66.90
Exercised........................................ (10,653) 19.45-39.70
Forfeited........................................ (80,717) 15.20-148.50
--------- -------------
Outstanding at end of year......................... 1,005,100 $ 0.95-147.90
========= =============
1998
Outstanding at beginning of year................... 836,498 $ 0.95-148.50
Granted.......................................... 216,818 59.05-99.70
Exercised........................................ (83,883) 16.65-68.15
Forfeited........................................ (55,299) 1.00-144.60
--------- -------------
Outstanding at end of year......................... 914,134 $ 0.95-148.50
========= =============
</TABLE>
The number of options exercisable at June 30, 2000 and 1999, was 893,994 and
599,466, respectively. The weighted-average fair value of options granted during
2000 and 1999 was $1.96 and $39.95, respectively.
The Company applies Accounting Principles Board Opinion 25 and related
interpretations in accounting for its stock-based compensation plans and
arrangements. No compensation cost has been recognized for its stock option
plan. If compensation cost for the stock option plan and arrangements had been
determined based on the fair value at the grant dates for awards under this plan
consistent
F-23
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13. EMPLOYEE BENEFIT PLANS (CONTINUED)
with the method prescribed by SFAS 123, the Company's net income (loss) and
earnings (loss) per share would have been reflected to the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
JUNE 30,
-------------------------------------------
2000 1999 1998
------------- ------------- -----------
<S> <C> <C> <C>
Net income (loss):
As reported...................................... $(122,372,000) $(247,967,000) $27,563,000
Pro forma........................................ (122,619,000) (249,552,000) 26,511,000
Basic earnings (loss) per share:
As reported...................................... (21.02) (40.31) 4.83
Pro forma........................................ (21.06) (40.56) 4.63
Diluted earnings (loss) per share:
As reported...................................... (21.02) (40.31) 4.36
Pro forma........................................ (21.06) (40.56) 4.21
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
JUNE 30,
---------------------
2000 1999
--------- ---------
<S> <C> <C>
Dividend yield.......................................... 0.00% 0.00%
Expected volatility..................................... 83.00% 70.00%
Risk-free interest rate................................. 5.97% 5.47%
Expected life of option................................. 4.5 years 4.5 years
</TABLE>
NOTE 14. STOCKHOLDERS' EQUITY
YEAR ENDED JUNE 30, 2000
During the year ended June 30, 2000, Company received $60.8 million of
additional capital. Net proceeds to the Company, after issuance expenses, were
$59.4 million. The additional capital was received in a series of transactions
with SFP, a partnership controlled by Capital Z, existing shareholders and
management of the Company. Such transactions are summarized below.
In the first of a two-phase $50.0 million investment by Capital Z, the
Company issued 40.8 million shares of Series C Convertible Preferred Stock, par
value $0.001 per share, (the "Series C Stock") for $0.85 per share to Capital Z
and received $34.7 million, and issued warrants to Capital Z to purchase
5.0 million shares of the Series C Stock at $0.85 per share. Net proceeds to the
Company, after issuance expenses, were $34.3 million.
Subsequently, in the second phase which occurred on July 12, 2000, the
Company issued 18.0 million of Series D Convertible Preferred Stock, par value
$0.001 per share, (the "Series D Stock"), to Capital Z for $0.85 per share, its
stated value, and received $15.3 million. Net proceeds, after issuance expenses,
were $14.3 million. At the same time, Capital Z exchanged the 40.8 million
shares of Series C Stock and the warrants to purchase 5.0 million shares of
Series C Stock received in the first phase for an equal number of shares and
warrants to purchase Series D Stock.
F-24
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14. STOCKHOLDERS' EQUITY (CONTINUED)
The Company issued 212,000 shares of the Series C for $5.00 per share and
received $1.1 million from members of management. No issuance expenses were
incurred in this transaction.
The Company received $4.2 million of additional capital from existing owners
of the Company's Common Stock in connection with its rights offering of up to
6.2 million shares of the Series C Stock to stockholders (the "Rights
Offering"). The Company also received $20.8 million of additional 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 5.0 million shares in
connection with the Rights Offering and the Standby Commitment. Net proceeds to
the Company, after issuance expenses, were approximately $24.0 million.
YEAR ENDED JUNE 30, 1999
During the year ended June 30, 1999, Company received $102.1 million of
additional capital. Net proceeds to the Company, after issuance expenses, were
$92.4 million. The additional capital was received in a series of transactions
with Capital Z, designees of Capital Z, management of the Company, existing
shareholders and holders of the Company's convertible debt. The Company also
issued warrants to purchase 500,000 shares of the Company's Common Stock for
$5.00 per share to Capital Z and its affiliates. Such transactions are
summarized below.
The Company issued 27,000 shares of Series B Convertible Preferred Stock
(the "Series B Stock") and 15,000 shares of the Series C Stock and received
$101.8 million. Of the $101.8 million, $100.0 million was received from Capital
Z, $1.8 million was received from certain designees of Capital Z and the
Company's former Chief Executive Officer and a director of the Company pursuant
to his employment contract with the Company. Net proceeds to the Company, after
issuance expenses, were $92.2 million. Of the $101.8 million of additional
capital, $25.0 million was received in cash on August 3, 1999, but was recorded
in the accompanying consolidated balance sheet at June 30, 1999 as an account
receivable and as stockholders' equity pursuant to the FASB's Emerging Issues
Task Force Issue No. 85-1.
$265,000 of additional capital in the form of Common Stock was received
through the exercise of Common Stock options or through the conversion of the
Company's 5.5% Convertible Subordinated Debentures.
YEAR ENDED JUNE 30, 1998
The Company issued 560,000 shares of its Common Stock, or 9.9% of the
Company's then outstanding shares, at a purchase price of $68.8125 per share to
private entities and received approximately $38.5 million in net proceeds. The
Company also issued warrants to these entities to purchase an additional 9.9% of
the Company's Common Stock at an exercise price of $26.34. The warrants are
subject to customary anti-dilution provisions, exercisable only upon a change in
control of the Company and expire in April 2001.
Additionally, the Company received $2.0 million of additional capital
through the exercise of Common Stock options or through the conversion of the
Company's 5.5% Convertible Subordinated Debentures.
F-25
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14. STOCKHOLDERS' EQUITY (CONTINUED)
OTHER INFORMATION
All authorized and outstanding Series B and Series C Stock share amounts in
the accompanying consolidated financial statements have been retroactively
restated to reflect the 1,000-for-1 stock split effected by the Company on
September 24, 1999. Outstanding Common Stock and Series C share amounts and per
share information in the accompanying consolidated financial statements have
been retroactively restated for the 1-for-5 reverse stock split effected on
April 14, 2000.
The Company's Series B, Series C and Series D Stock rank senior in right to
dividends and liquidation to all classes of the Company's common and other
preferred stock. The Series C and Series D Stock does not have the right to vote
for directors.
The Series B, Series C and Series D Stock currently accrue and accumulate
dividends at a rate of 6.5% which increases to 8.125% in February 2001. At
June 30, 2000, aggregate accrued and unpaid dividends on the Company's
convertible preferred stock were $10.1 million. In November 1998, the Board of
Directors decided to suspend cash dividends on the common stock until the
Company's earnings and cash flows improved. Credit agreements generally limit
the Company's ability to pay dividends if such payment would result in an event
of default under the agreements or would otherwise cause a breach of a net worth
or liquidity covenants. The Company's Indenture relating to its 9.125% Senior
Notes due 2003 prohibits the payment of dividends if the aggregate amount of
such dividends since October 26, 1996 exceeds the sum of (a) 25% of the
Company's net income during that period (minus 100% of any deficit); (b) net
cash proceeds from any securities issuances; and (c) proceeds from the sale of
certain investments. The Company's Indenture of Trust relating to its 10.50%
Senior Notes due 2002 restricts the payment of dividends to an amount which does
not exceed (i) $2.0 million, plus (ii) 50% of the Company's aggregate net income
for each fiscal year after the year ended June 30, 1994 (minus 100% of net
losses for any fiscal year), plus (iii) 100% of the net proceeds received by the
Company on offerings of its equity securities after December 31, 1994. Under the
most restrictive of these limitations, the Company will be prohibited from
paying cash dividends on its capital stock for the foreseeable future.
NOTE 15. TRANSACTIONS INVOLVING DIRECTORS, OFFICERS AND AFFILIATES
During the years ended June 30, 2000 and 1999, the Company incurred
management fees and out-of-pocket expenses in the amount of $2.5 million and
$1.2 million, respectively, relating to advisory services rendered by Equifin
Capital Management, LLC ("Equifin"), a company whose principal officer also
serves as a director of the Company.
In connection with a recent $50.0 million investment in the Company by
Capital Z, the Company paid an $800,000 transaction fee to Equifin. Such
transaction fee was deducted from the capital proceeds received.
Included in accounts payable and accrued expenses in the accompanying
consolidated balance sheet is a $1.0 million fee owed to Capital Z for Capital
Z's agreement to act as guarantor on a subline to one of the Company's revolving
warehouse and repurchase facilities. In connection with capital contributions
during the year ended June 30, 1999, the Company paid a transaction fee and a
commitment fee of $1.0 million and $2.0 million, respectively, to Capital Z, and
paid a $250,000 transaction fee to Equifin. The transaction fees were deducted
from capital proceeds received. During
F-26
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15. TRANSACTIONS INVOLVING DIRECTORS, OFFICERS AND AFFILIATES (CONTINUED)
the years ended June 30, 2000 and 1999, the Company reimbursed Capital Z $81,000
and $262,000, respectively, for out-of-pocket expenses.
During the year ended June 30, 2000, the Company concluded severance
arrangements with certain former members of management that had employment or
severance agreements that provided for enhanced severance and other benefits
upon a change in control, as defined in the agreements. Included in the
accompanying consolidated statement of operations for the year ended June 30,
2000 is approximately $4.0 million of expense related to such settlements. At
June 30, 2000, the Company was committed to remit an additional $650,000 to
former officers during the year ended June 30, 2001.
During the year ended June 30, 1999, and as a means to induce its then
president to enter into a new employment agreement, the Company paid the
president a bonus of approximately $1.5 million, the receipt of which the
president had deferred since June 1998.
In 1999, the Company terminated the Executive and Director Loan Program
under which directors and executive officers of the Company were entitled to
obtain a mortgage loan from the Company at the Company's cost of funds plus 25
basis points as determined by an approved, independent investment banking firm.
From time to time certain officers, directors and employees of the Company
previously acted as private investors in loan transactions originated by the
Company. The Company discontinued its private investor program during the year
ended June 30, 1998.
NOTE 16. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES
SECURITIZATIONS--HEDGING INTEREST RATE RISK
The most significant variable in the determination of gain on sale in a
securitization is the spread between the weighted average coupon on the
securitized loans and the pass-through interest rate. In the interim period
between loan origination or purchase and securitization of such loans, the
Company is exposed to interest rate risk. The majority of loans are securitized
within 90 days of origination or purchase. However, a portion of the loans are
held for sale or securitization for as long as twelve months (or longer, in very
limited circumstances) prior to securitization. If interest rates rise during
the period that the mortgage loans are held, the spread between the weighted
average interest rate on the loans to be securitized and the pass-through
interest rates on the securities to be sold (the latter having increased as a
result of market interest rate movements) would narrow. From time to time, the
Company mitigates this exposure through agreements with third parties that sell
United States Treasury securities not yet purchased, forward interest rate swap
contracts and the purchase of Treasury put options. 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 June 30, 2000 and 1999, the Company did not have any derivatives or hedge
transactions in place.
F-27
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 16. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES (CONTINUED)
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 and securitized loans.
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 67%
CLTV 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.
NOTE 17. NET INCOME (LOSS) PER SHARE
The following table sets forth information regarding net loss per common
share for the years ended June 30, 2000, 1999 and 1998 (Dollars and weighted
average number of shares in thousands):
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------------------
2000 1999 1998
--------- --------- --------
<S> <C> <C> <C>
Basic net income (loss) per common share:
Net income (loss)......................................... (122,372) (247,967) 27,563
Plus: Accrued dividends on Series B and C Convertible
Preferred
Stock................................................ (8,126) (1,950) --
--------- --------- -------
Basic net income (loss)..................................... (130,498) (249,917) 27,563
Plus: Interest on convertible subordinated debentures..... -- -- 3,645
--------- --------- -------
Diluted net income (loss)................................... (130,498) (249,917) 31,208
========= ========= =======
Basic weighted average number of common shares
outstanding............................................... 6,209 6,200 5,710
========= ========= =======
Basic weighted average number of common shares
outstanding............................................... 6,209 6,200 5,710
Plus: Options............................................. -- -- 219
Convertible Shares................................... -- -- 1,221
--------- --------- -------
Diluted weighted average number of common shares
outstanding............................................... 6,209 6,200 7,150
========= ========= =======
Earnings (loss) per share:
Basic..................................................... $ (21.02) $ (40.31) $ 4.83
========= ========= =======
Diluted................................................... $ (21.02) $ (40.31) $ 4.36
========= ========= =======
</TABLE>
NOTE 18. NONRECURRING CHARGES
During the year ended June 30, 1999, the Company recorded a $37.0 million
one-time charge related to advances.
F-28
<PAGE>
AAMES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 19. QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of unaudited quarterly operating results for the years ended
June 30, 2000 and 1999 follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED,
------------------------------------------
SEPT. 30 DEC. 31 MAR. 31 JUNE 30
-------- --------- -------- --------
<S> <C> <C> <C> <C>
2000
Revenue.............................................. $60,938 12,916 (1,991) 41,919
Income (loss) before income taxes.................... 1,366 (46,345) (60,932) (13,092)
Net income (loss).................................... 791 (47,695) (61,465) (14,003)
Loss per share--diluted.............................. (0.10) (8.00) (10.25) (2.64)
1999
Revenue.............................................. $57,761 $(154,423) $ 36,814 $ 43,695
Loss before income taxes............................. (3,233) (208,076) (52,153) (14,687)
Net loss............................................. (2,156) (195,745) (35,979) (14,087)
Loss per share--diluted.............................. (0.35) (31.56) (5.91) (2.47)
</TABLE>
NOTE 20. SUBSEQUENT EVENTS (UNAUDITED)
On September 21, 2000, the Company sold $460.0 million of loans held for
sale in the form of a securitization and sold for cash the residual interest
created in the securitization. The Company also sold its servicing rights and
the rights to prepayment penalties under the securitization for cash.
F-29
<PAGE>
EXHIBIT INDEX
<TABLE>
<C> <S>
2.1 Agreement and Plan of Reorganization, dated as of August 12,
1996, as amended by Amendment No. 1, dated August 28, 1996
by and among Registrant, Aames Acquisition Corporation, One
Stop Mortgage, Inc. and Neil B. Kornswiet (1)
3.1 Certificate of Incorporation of Registrant, as amended (2)
3.2 Bylaws of Registrant, as amended (3)
4.1 Specimen certificate evidencing Common Stock of Registrant
(2)
4.2 Specimen certificate evidencing Series B Convertible
Preferred Stock of Registrant (2)
4.3 Certificate of Designations for Series B Convertible
Preferred Stock of Registrant, as amended (4)
4.4 Specimen certificate evidencing Series C Convertible
Preferred Stock of Registrant (2)
4.5 Certificate of Designations for Series C Convertible
Preferred Stock of Registrant, as amended (4)
4.6 Specimen certificate evidencing Series D Convertible
Preferred Stock of Registrant (2)
4.7 Certificate of Designations for Series C Convertible
Preferred Stock of Registrant, as amended (4)
4.8(a) Rights Agreement, dated as of June 21, 1996 between
Registrant and Wells Fargo Bank, as rights agent (5)
4.8(b) Amendment to Rights Agreement, dated as of April 27, 1998
(6)
4.8(c) Amendment to Rights Agreement, dated as of December 23, 1998
(7)
4.9(a) Indenture of Trust, dated February 1, 1995, between
Registrant and Bankers Trust Company of California, N.A.,
relating to Registrant's 10.50% Senior Notes due 2002 (8)
4.9(b) Supplemental Indenture of Trust, dated as of April 25, 1995
to Exhibit 4.9(a) (9)
4.10 Indenture, dated as of February 26, 1996, between Registrant
and The Chase Manhattan Bank, N.A., relating to Registrant's
5.5% Convertible Subordinated Debentures due 2006 (10)
4.11(a) First Supplemental Indenture, dated as of October 21, 1996,
between Registrant, The Chase Manhattan Bank and certain
wholly owned subsidiaries of Registrant, relating to
Registrant's 9.125% Senior Notes due 2003 (10)
4.11(b) Second Supplemental Indenture, dated as of February 10,
1999, between Registrant, The Chase Manhattan Bank and
certain wholly owned subsidiaries of Registrant, relating to
Registrant's 9.125% Senior Notes due 2003 (11)
10.1 Form of Director and Officer Indemnification Agreement (12)
10.2 Employment Agreement between Registrant and A. Jay Meyerson
(2)
10.3 Letter Agreement, dated as of January 5, 2000, between the
Registrant and Cary H. Thompson (2)
10.4 Stock Option Agreement, dated as of March 10, 1996, between
Registrant and Cary H. Thompson (13)
10.5 Warrant to purchase Common Stock, dated as of August 3,
1999, granted by the Registrant to Steven M. Gluckstern (2)
10.6 Warrant to purchase Common Stock, dated as of August 3,
1999, granted by the Registrant to Adam M. Mizel (2)
10.7 Warrant to purchase Common Stock, dated as of August 3,
1999, granted by the Registrant to Eric C. Rahe (2)
</TABLE>
<PAGE>
<TABLE>
<C> <S>
10.8 Warrant to purchase Common Stock, dated as of August 3,
1999, granted by the Registrant to Mani A. Sadeghi (2)
10.9 Warrant to purchase Common Stock, dated as of August 3,
1999, granted by the Registrant to Robert A. Spass (2)
10.10(a) Non-Financed Management Investment Agreement, dated as of
August 23, 2000, between the Registrant and A. Jay Meyerson
(2)
10.10(b) Financed Management Investment Agreement, dated as of August
23, 2000, between the Registrant and A. Jay Meyerson (2)
10.10(c) Secured Promissory Note, dated as of August 23, 2000, given
by A. Jay Meyerson to the Registrant (2)
10.10(d) Pledge Agreement, dated as of August 23, 2000, between the
Registrant and A. Jay Meyerson (2)
10.11(a) Management Investment Agreement, dated as of October 1,
1999, between the Registrant and William Cook (2)
10.11(b) Management Investment Agreement, dated as of October 1,
1999, between the Registrant and William Cook (2)
10.11(c) Secured Promissory Note, dated as of October 1, 1999, given
by William Cook to the Registrant (2)
10.11(d) Pledge Agreement, dated as of October 1, 1999, between the
Registrant and William Cook (2)
10.12(a) Management Investment Agreement, dated as of October 1,
1999, between the Registrant and John Kohler (2)
10.12(b) Secured Promissory Note, dated as of October 1, 1999, given
by John Kohler to the Registrant (2)
10.12(c) Pledge Agreement, dated as of October 1, 1999, between the
Registrant and John Kohler (2)
10.13(a) Management Investment Agreement, dated as of October 1,
1999, between the Registrant and Neil Notkin (2)
10.13(b) Secured Promissory Note, dated as of October 1, 1999, given
by Neil Notkin to the Registrant (2)
10.13(c) Pledge Agreement, dated as of October 1, 1999, between the
Registrant and Neil Notkin (2)
10.14(a) Management Investment Agreement, dated as of October 1,
1999, between the Registrant and Geoffrey Sanders (2)
10.14(b) Secured Promissory Note, dated as of October 1, 1999, given
by Geoffrey Sanders to the Registrant (2)
10.14(c) Pledge Agreement, dated as of October 1, 1999, between the
Registrant and Geoffrey Sanders (2)
10.15 1991 Stock Incentive Plan, as amended (14)
10.16 1995 Stock Incentive Plan (13)
10.17(a) 1996 Stock Incentive Plan (15)
10.17(b) Amendment No. 1 to Exhibit 10.17(a) (12)
10.18 1997 Stock Option Plan (16)
10.19 1997 Non-Qualified Stock Option Plan (amended and restated
effective May 22, 1998) (16)
10.20 Amended and Restated 1999 Stock Option Plan (17)
</TABLE>
<PAGE>
<TABLE>
<C> <S>
10.21 Office Lease, dated as of September 15, 1998, between
Colonnade Wilshire Corp. and the Registrant, for the
premises located at 3731 Wilshire Boulevard, Los Angeles,
California. (3)
10.22(a) Office Building Lease, dated as of August 7, 1996, between
Registrant and California Plaza IIA, LLC, for the premises
located at 350 S. Grand Avenue, Los Angeles, California (12)
10.22(b) First Amendment, dated as of August 15, 1997, to Exhibit
10.22(a) (12)
10.23(a) Preferred Stock Purchase Agreement, dated as of December 23,
1998, between Registrant and Capital Z Financial Services
Fund II, L.P. (7)
10.23(b) Amendment No. 1 to Exhibit 10.23(a) (11)
10.23(c) Amendment No. 2 to Exhibit 10.23(a) (3)
10.23(d) Amendment No. 3 to Exhibit 10.23(a) (3)
10.23(e) Amendment No. 4 to Exhibit 10.23(a) (3)
10.24(a) Registration Rights Agreement, dated as of February 10,
2000, between the Registrant and Capital Z Financial
Services Fund II, L.P. (18)
10.24(b) Supplement No. 1, dated as of June 7, 2000, to Exhibit
10.24(a) (2)
10.25(a) Preferred Stock Purchase Agreement, dated as of May 19,
2000, between the Registrant and Specialty Finance Partners
(19)
10.25(b) Letter Agreement, dated June 7, 2000, between the Registrant
and Specialty Finance Partners regarding Exhibit 10.25(a)
(20)
10.26(a) Agreement for Management Advisory Services, dated as of
February 10, 1999 between Registrant and Equifin Capital
Management, LLC (21)
10.26(b) Amendment No. 1, dated June 7, 2000, to Exhibit 10.26(a) (2)
10.27 Warrant to Purchase Common Stock of the Registrant, dated as
of January 4, 1999, granted by the Registrant to Capital Z
Management LLC (22)
10.28 Warrant to Purchase Series D Convertible Preferred Stock of
the Registrant, dated as of July 12, 2000, granted by the
Registrant to Specialty Finance Partners (2)
10.29 Historical Advance Purchase Agreement, dated as of June 10,
1999, between ACC and Steamboat Financial Partnership I,
L.P. (3)
10.31 Historical Advance Purchase Agreement, dated as of June 17,
1999, between ACC and Steamboat Financial Partnership I,
L.P. (3)
10.31(a) Limited Partnership Agreement of Steamboat Financial
Partnership I, L.P., dated as of June 10, 1999, between
Random Properties Acquisition Corp. IV, ACC and Greenwich
Capital Derivatives, Inc. (3)
10.31(b) Amendment No. 1 to Exhibit 10.31(a) (21)
10.32 Historical Advance Purchase Agreement between ACC and
Steamboat Financial Partnership, L.P., dated as of February
24, 2000 (21)
10.33 Delinquency Advance Purchase Agreement, dated as of May 13,
1999, between ACC and Fairbanks Capital Corp. (3)
10.34 Sub-Servicing Agreement 1997-1, dated as of April 21, 1999,
between ACC and Fairbanks Capital Corp. (3)
10.35 Sub-Servicing Agreement 1996-D, dated as of April 21, 1999,
between ACC and Fairbanks Capital Corp. (3)
10.36(a) Master Loan and Security Agreement, dated as of October 29,
1999, between Aames Capital Corporation and Morgan Stanley
Mortgage Capital, Inc. (23)
10.36(b) First Amendment to Master Loan and Security Agreement, dated
as of December 30, 1999, to Exhibit 10.36(a) (24)
</TABLE>
<PAGE>
<TABLE>
<C> <S>
10.36(c) Amendment No. 2 to the Master Loan and Security Agreement,
dated as of April 4, 2000 to 10.36(a) (24)
10.36(d) Third Amendment, dated as of June 6, 2000, to Exhibit
10.36(a) (20)
10.36(e) Fourth Amendment, dated as of June 8, 2000, to Exhibit
10.36(a) (2)
10.36(f) Fifth Amendment, dated as of August 31, 2000, to Exhibit
10.36(a) (2)
10.37(a) Second Amended and Restated Master Repurchase Agreement
Governing Purchases and Sales of Mortgage Loans, dated as of
April 28, 2000, between Aames Capital Corporation,
Registrant's wholly owned subsidiary ('ACC') and Lehman
Commercial Paper, Inc. (21)
10.37(b) Guaranty, dated as of April 28, 2000, between Registrant and
Lehman Commercial Paper, Inc., with respect to Exhibit
10.37(a). (21)
10.38(a) Warehouse Loan and Security Agreement, dated as of February
10, 2000, between ACC and Greenwich Capital Financial
Products, Inc. (21)
10.38(b) Guaranty, dated as of February 10, 2000, between Registrant
and Greenwich Capital Financial Products, Inc., with respect
to Exhibit 10.38(a) (21)
10.38(c) Amendment No. 1 to Guaranty, dated as of April 28, 2000,
between Registrant and Greenwich Capital Financial Products,
Inc., with respect to Exhibit 10.38(b) (21)
10.39 Residual Forward Sale Facility, dated as of August 31, 2000,
between Registrant and Capital Z Investments L.P. (2)
11 Computation of Per Share Earnings (Loss) (2)
21 Subsidiaries of the Registrant (2)
23.1 Consent of Ernst & Young LLP (2)
23.2 Consent of PricewaterhouseCoopers LLP (2)
27 Financial Data Schedule (2)
</TABLE>
------------------------
(1) Incorporated by reference from Registrant's Current Report on Form 8-K
dated as of, and filed with the Commission on, September 12, 1996
(2) Filed herewith
(3) Incorporated by reference from Registrant's Annual Report on Form 10-K for
the year ended June 30, 1999 and filed with the Commission on September 3,
1999
(4) Included in Exhibit 3.1 hereto
(5) Incorporated by reference from Registrant's Registration Statement on Form
8-A, File No. 33-13660, filed with the Commission on July 12, 1996
(6) Incorporated by reference from Registrant's Registration Statement on Form
8-A/A dated as of, and filed with the Commission on, April 27, 1998
(7) Incorporated by reference from Registrant's Current Report on Form 8-K
dated as of December 23, 1998 and filed with the Commission on December 31,
1999
(8) Incorporated by reference from Registrant's Registration Statement on Form
S-2, File No. 33-88516
(9) Incorporated by reference from Registrant's Annual Report on Form 10-K for
the year ended June 30, 1995 and on file with the Commission
(10) Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1996 and filed with the Commission on July
3, 1996
(11) Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
for the quarter ended December 31, 1998 and filed with the Commission on
February 22, 1999
<PAGE>
(12) Incorporated by reference from Registrant's Annual Report on Form 10-K for
the year ended June 30, 1997 and filed with the Commission on September
29, 1997
(13) Incorporated by reference from Registrant's Annual Report on Form 10-K for
the year ended June 30, 1996 and filed with the Commission on September
16, 1996
(14) Incorporated by reference from Registrant's Registration Statement on Form
S-1, File No. 33-62400
(15) Incorporated by reference from Registrant's Registration Statement on Form
S-8 dated as of, and filed with the Commission on, January 13, 1997
(16) Incorporated by reference from Registrant's Registration Statement on Form
S-8 dated as of, and filed with the Commission on, June 25, 1998
(17) Incorporated by reference from Registrant's Registration Statement on Form
S-8 dated as of, and filed with the Commission on, September 15, 2000
(18) Incorporated by reference to the Form of Warrant to Purchase Common Stock
of the Registrant, filed as Exhibit F to Exhibit 10.1 of the Registrant's
Current Report on Form 8-K, dated as of December 23, 1998 and filed with
the Commission on December 31, 1998
(19) Incorporated by reference from Registrant's Current Report on Form 8-K
dated as of May 19, 2000 and filed with the Commission on May 24, 2000
(20) Incorporated by reference from Registrant's Current Report on Form 8-K
dated as of June 7, 2000 and filed with the Commission on June 9, 2000
(21) Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2000 and filed with the Commission on May
22, 2000
(22) Incorporated by reference to the Form of Warrant to Purchase Common Stock
of the Registrant, filed as Exhibit C to Exhibit 10.1 of the Registrant's
Current Report on Form 8-K, dated as of December 23, 1998 and filed with
the Commission on December 31, 1998
(23) Incorporated by reference from Registrant's Current Report on Form 8-K
dated as of October 29, 1999 and filed with the Commission on January 14,
2000
(24) Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
for the quarter ended December 31, 1999 and filed with the Commission on
February 14, 2000
