<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
AMENDMENT NO. 1 TO
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 30, 1999
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________
Commission File Number 000-21786
---------
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
STATE OF DELAWARE 57-0962375
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7909 Parklane Road, Columbia, SC 29223
- --------------------------------------------------------------------------------
(Address of Principal Executive Office) (Zip Code)
Registrant's telephone number, including area code (803)741-3000
-------------
Indicate by check mark whether the registrant 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 each shorter period that the registrant was
required to file such reports) and has been subject to such filing requirements
for the past 90 days.
YES X NO
--- ---
The number of shares of common stock of the Registrant outstanding as of July
31, 1999, was 21,292,315.
Page 1
<PAGE> 2
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
Form 10-Q/A for the quarter ended June 30, 1999
TABLE OF CONTENTS OF INFORMATION REQUIRED IN REPORT
PAGE
----
ITEM 2. Management's Discussion and Analysis of 3
Financial Condition and Results of Operations
SIGNATURES 44
2
<PAGE> 3
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This 10-Q/A is being filed to revise the first sentence of the 9th
paragraph under Liquidity and Capital Resources which discusses the Company's
stock repurchase program. The following discussion and analysis should be read
in conjunction with the Financial Information, the Consolidated Financial
Statements of Resource Bancshares Mortgage Group, Inc. (the Company) (and the
notes thereto) and the other information included or incorporated by reference
into the Company's 1998 Annual Report on Form 10-K and the interim Consolidated
Financial Statements contained herein. Statements included in this discussion
and analysis (or elsewhere in this document) which are not statements of
historical fact are intended to be, and are hereby identified as, "forward
looking statements" for purposes of the safe harbor provided by Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Readers are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
a number of risks and uncertainties, and that actual results could differ
materially from those indicated by such forward-looking statements. Important
factors that could cause actual results to differ materially from those
indicated by such forward-looking statements include, but are not limited to,
the following which are described in the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, in this filing or from time to time in
other reports filed by the Company with the Securities and Exchange Commission:
(i) interest rate risks; (ii) changes in economic conditions; (iii) competition;
(iv) possible changes in regulations and related matters; (v) litigation
affecting the mortgage banking business; (vi) delinquency and default risks;
(vii) changes in the market for servicing rights, mortgage loans and leases,
(viii) environmental matters; (ix) changes in the demand for mortgage loans and
leases, (x) changes in the value of residual interests in subprime
securitizations, (xi) prepayment risks, (xii) Year 2000 risks, (xiii) possible
changes in accounting estimates, (xiv) availability of funding sources and (xv)
other risks and uncertainties. The Company disclaims any obligation to update
any forward-looking statements.
THE COMPANY
The Company is a diversified financial services company engaged
primarily in the business of mortgage banking, through the purchase (via a
nationwide network of correspondents and brokers), sale and servicing of
agency-eligible and subprime residential, single-family, first-mortgage loans
and the purchase and sale of servicing rights associated with agency-eligible
loans. In addition, the Company originates, sells and services small-ticket
commercial equipment leases and originates, sells, underwrites for investors and
services commercial mortgage loans.
LOAN AND LEASE PRODUCTION
The Company purchases agency-eligible residential mortgage loans from
its correspondents and through its wholesale division and, until the sale of its
retail production platform in May 1998, originated mortgage loans through its
retail division. The Company also purchases and originates subprime mortgage
loans and commercial mortgage loans and leases small-ticket equipment items.
3
<PAGE> 4
A summary of production by source for the periods indicated is set
forth below:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
------------------------- ------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Agency-Eligible Loan Production:
Correspondent $4,120,525 $5,659,460 $1,692,504 $2,764,060
Wholesale 1,155,730 1,483,489 443,908 748,629
Retail -- 264,059 -- 76,178
---------- ---------- ---------- ----------
Total Agency-Eligible Loan Production 5,276,255 7,407,008 2,136,412 3,588,867
Subprime Loan Production 369,855 252,132 185,744 146,146
Commercial Mortgage (for Investors and
Conduits) Loan Production 308,102 362,622 157,950 170,107
Lease Production 44,865 33,543 24,340 20,703
---------- ---------- ---------- ----------
Total Mortgage Loan and Lease Production $5,999,077 $8,055,305 $2,504,446 $3,925,823
========== ========== ========== ==========
</TABLE>
Initially, the Company was focused exclusively on purchasing
agency-eligible mortgage loans through its correspondents. In order to diversify
its sources of residential loan volume, the Company started a wholesale
operation in 1994, a retail operation in 1995 and a subprime division in 1997.
Management anticipates that its higher margin wholesale and subprime production
will account for an increasing percentage of total residential mortgage loan
production as those divisions are expanded more rapidly than correspondent
operations. In order to further diversify its sources of production and revenue,
the Company acquired Resource Bancshares Corporation (RBC) in December 1997.
Through RBC, the Company originates small-ticket commercial equipment leases and
commercial mortgage loans. These two sources of production accounted for
approximately 6% and 7% of the Company's total production for the six months
ended June 30, 1999 and the second quarter of 1999, respectively.
A summary of key information relevant to industry residential mortgage
loan production activity is set forth below:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE QUARTER ENDED JUNE 30,
------------------------------------
1999 1998
------------ ------------
<S> <C> <C>
U. S. 1-4 Family Mortgage Originations Statistics (1):
U. S. 1-4 Family Mortgage Originations $368,000,000 $352,000,000
Adjustable Rate Mortgage Market Share 16.00% 14.00%
Estimated Fixed Rate Mortgage Originations $309,000,000 $303,000,000
Company Information:
Residential Loan Production $ 2,322,156 $ 3,588,867
Estimated Company Market Share 0.63% 1.02%
</TABLE>
(1) Source: Mortgage Bankers Association of America, Economics Department.
The Company's total residential mortgage production decreased by 36% to
$2.3 billion for the second quarter of 1999 from $3.6 billion for the second
quarter of 1998. This decrease is primarily due to the overall level of
competition in the marketplace among residential mortgage originators.
4
<PAGE> 5
Correspondent Loan Production
The Company purchases closed mortgage loans through its network of
approved correspondent lenders. Correspondents are primarily mortgage lenders,
larger mortgage brokers and smaller savings and loan associations and commercial
banks that have met the Company's approval requirements.
A summary of key information relevant to the Company's correspondent
residential loan production activities is set forth below:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
------------------------------ ------------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Correspondent Loan Production $ 4,120,525 $ 5,659,460 $ 1,692,504 $ 2,764,060
Estimated Correspondent Market Share (1) 0.57% 0.85% 0.46% 0.79%
Approved Correspondents 867 901 867 901
Correspondent Division Expenses 32,365 31,333 15,303 16,594
</TABLE>
(1) Source: Mortgage Bankers Association of America, Economics Department.
The Company's correspondent loan production decreased by 39% to $1.7
billion for the second quarter of 1999 from $2.8 billion for the second quarter
of 1998. This decrease in production is primarily due to the current level of
competition in the market place as well as a rise in mortgage interest rates
during the second quarter of 1999. While production declined 39% from quarter to
quarter, correspondent division expenses declined by only 8%. This is primarily
due to the fact that corporate overhead expenses are allocated to the
correspondent division. These costs are primarily fixed in nature and did not
decline with the decline in production. The number of approved correspondent
lenders decreased 4% from quarter to quarter as the Company focused on
maintenance of those correspondent relationships most compatible with the
Company's overall business strategies.
Wholesale Loan Production
The wholesale division receives loan applications through brokers,
underwrites the loans, funds the loans at closing and prepares all closing
documentation. The wholesale branches handle all shipping and follow-up
procedures on loans. Typically mortgage brokers are responsible for taking
applications and accumulating the information precedent to the Company's
processing of the loans. Although the establishment of wholesale branch offices
involves the incurrence of fixed expenses associated with maintaining those
offices, wholesale operations also provide for higher profit margins than
correspondent loan production. Additionally, each branch office can serve a
relatively sizable geographic area by establishing relationships with large
numbers of independent mortgage loan brokers who bear much of the cost of
identifying and interacting directly with loan applicants. A summary of key
information relevant to the Company's wholesale production activities is set
forth below:
5
<PAGE> 6
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
-------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Wholesale Loan Production $1,155,730 $1,483,489 $ 443,908 $ 748,629
Estimated Wholesale Market Share (1) 0.16% 0.22% 0.12% 0.21%
Wholesale Division Direct Operating Expenses $ 8,474 $ 7,740 $ 3,917 $ 3,943
Approved Brokers 3,669 3,085 3,669 3,085
Number of Branches 17 15 17 15
Number of Employees 186 153 186 153
</TABLE>
(1) Source: Mortgage Bankers Association of America, Economics Department.
Wholesale loan production decreased 41% ($304.7 million) from $748.6
million for the second quarter of 1998 to $443.9 million for the second quarter
of 1999 primarily as a result of increased competition in the marketplace, and
an industry wide decline in refinancings.
Strategically, management anticipates focusing over the longer term on
continued expansion of its wholesale presence nationwide due to the relatively
higher margins attributable to this channel. Management anticipates that the
wholesale division will account for an increasing percentage of the Company's
total loan production.
Retail Loan Production
Effective May 1, 1998, the Company sold its retail production franchise
to CFS Bank. Retail loan production and retail divisional direct operating
expenses for the six months ended June 30, 1998 were $264.1 million and $5.6
million, respectively.
Subprime Loan Production
In 1997, the Company began its initial expansion into subprime lending
activities. The Company does subprime business under the name of its
wholly-owned subsidiary, Meritage Mortgage Corporation. Management anticipates
continuing near term increases in subprime production volumes as the Company
begins to offer select subprime loan products through its existing nationwide
correspondent production channel.
6
<PAGE> 7
A summary of key information relevant to the Company's subprime
production activities is set forth below:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
------------------------ ----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Subprime Loan Production $369,855 $252,132 $185,744 $146,146
Estimated Subprime Market Share (1) 0.05% 0.04% 0.05% 0.04%
Subprime Division Direct Operating Expenses $ 12,497 $ 10,575 $ 6,542 $ 5,952
Number of Brokers 2,182 1,659 2,182 1,659
Number of Employees 332 220 332 220
Number of Branches 19 17 19 17
</TABLE>
(1) Source: Mortgage Bankers Association of America, Economics Department.
The Company continues to expand its subprime operations. The Company
increased its number of brokers by 523 and added two new subprime branches
between June 30, 1998 and June 30, 1999. As a result, subprime production
increased approximately 27% from quarter to quarter. As a result of excess
operational capacity, subprime direct operating costs increased by only 10% from
quarter to quarter.
Commercial Mortgage Production
The Company's subsidiary, Laureate Capital Corp.(Laureate), originates
commercial mortgage loans for various insurance companies and other investors.
Commercial mortgage loans are generally originated in the name of the investor
and, in most instances, Laureate retains the right to service the loans under a
servicing agreement. A summary of key information relevant to the Company's
commercial mortgage production activities is set forth below:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
------------------------ ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Commercial Mortgage Production $308,102 $362,622 $157,950 $170,107
Commercial Mortgage Division Direct Operating Expenses $ 5,704 $ 4,806 $ 2,809 $ 2,356
Number of Branches 13 11 13 11
Number of Employees 94 75 94 75
</TABLE>
Lease Production
The Company's leasing division, Republic Leasing, originates and
services small-ticket commercial equipment leases. Substantially all of Republic
Leasing's lease receivables are acquired from independent brokers who operate
throughout the continental United States. A summary of key information relevant
to the Company's lease production activities is set forth below:
7
<PAGE> 8
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
------------------------ ---------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Lease Production $44,865 $33,543 $24,340 $20,703
Lease Division Direct Operating Expenses $ 2,923 $ 2,460 $ 1,426 $ 1,240
Number of Brokers 198 210 198 210
Number of Employees 66 61 66 61
</TABLE>
SERVICING
Agency-Eligible Mortgage Servicing
Agency-eligible mortgage servicing includes collecting and remitting
mortgage loan payments, accounting for principal and interest, holding escrow
funds for payment of mortgage-related expenses such as taxes and insurance,
making advances to cover delinquent payments, making inspections as required of
the mortgaged premises, contacting delinquent mortgagors, supervising
foreclosures and property dispositions in the event of unremedied defaults and
generally administering mortgage loans.
The Company is somewhat unique in that its strategy is to sell
substantially all of its produced agency-eligible mortgage servicing rights to
other approved servicers. In that regard, the Company believes it is the largest
national supplier of agency-eligible servicing rights to the still-consolidating
mega-servicers. Typically, the Company sells its agency-eligible mortgage
servicing rights within 90 to 180 days of purchase or origination. However, for
strategic reasons, the Company also strives to maintain a servicing portfolio
whose size is determined by reference to the Company's cash operating costs
which, in turn, are largely determined by the size of its loan production
platform. By continuing to focus on the low-cost correspondent and wholesale
production channels, the Company is able to minimize the cash operating costs of
its loan production platform and thus the strategically required size of its
agency-eligible loan servicing operation.
A summary of key information relevant to the Company's agency-eligible
loan servicing activities is set forth below:
8
<PAGE> 9
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
------------------------------ ------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Underlying Unpaid Principal Balances:
Beginning Balance * $ 9,865,100 $ 7,125,222 $ 9,735,754 $ 7,980,181
Agency-Eligible Loan Production (net of
servicing-released production) * 5,265,702 7,831,922 2,132,353 3,589,235
Bulk Acquisitions* -- 122,467 -- 122,467
Net Change in Work-in-Progress* 196,507 (67,610) 6,052 337,045
Sales of Servicing* (6,104,726) (4,804,235) (3,101,473) (2,269,219)
Paid-In-Full Loans* (649,056) (650,891) (283,327) (284,255)
Amortization, Curtailments and Other, net* (162,837) (187,549) (78,669) (106,128)
------------ ------------ ------------ ------------
Ending Balance* 8,410,690 9,369,326 8,410,690 9,369,326
Subservicing Ending Balance 3,111,358 2,624,893 3,111,358 2,624,893
------------ ------------ ------------ ------------
Total Underlying Unpaid Principal Balances $ 11,522,048 $ 11,994,219 $ 11,522,048 $ 11,994,219
============ ============ ============ ============
</TABLE>
* These numbers and statistics apply to the Company's owned agency-eligible
servicing portfolio and therefore exclude the subservicing portfolio.
Of the $8.4 billion and $9.3 billion unpaid principal balance at June
30, 1999 and 1998, approximately $5.9 billion and $5.1 billion, respectively,
are classified as available for sale, while $2.5 billion and $4.2 billion,
respectively, are classified as held for sale.
A summary of agency-eligible servicing statistics follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
------------------------------ ------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Average Underlying Unpaid Principal Balances
(including subservicing) $ 13,110,771 $ 10,888,995 $ 12,739,230 $ 11,451,709
Weighted Average Note Rate* 7.30% 7.44% 7.30% 7.44%
Weighted Average Servicing Fee* 0.43% 0.39% 0.43% 0.39%
Delinquency (30+ days) Including Bankruptcies
and Foreclosures* 2.27% 2.29% 2.27% 2.29%
Number of Servicing Division Employees 149 160 149 160
</TABLE>
* These numbers and statistics apply to the Company's owned agency-eligible
servicing portfolio and therefore exclude the subservicing portfolio.
The $1.29 billion, or 11%, increase in the average underlying unpaid
principal balance of agency-eligible mortgage loans being serviced and
subserviced for the second quarter of 1999 as compared to the second quarter of
1998 is primarily related to the Company's increased loan production volumes
during the latter part of 1998. Since the Company generally sells servicing
rights related to the agency-eligible loans it produces within 90 to 180 days of
purchase or origination, increased production volumes generally result in a
higher volume of mortgage servicing rights held in inventory pending sale. In
addition during 1998 and the first six months of 1999, the Company decided to
retain a portion of the servicing rights associated with its production.
9
<PAGE> 10
Commercial Mortgage Servicing
Laureate originates commercial mortgage loans for investors and in most
cases, Laureate retains the right to service the loans. A summary of key
information relevant to the Company's commercial mortgage servicing activities
is set forth below:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT JUNE 30,
----------------------------------
1999 1998
------------- -------------
<S> <C> <C>
Commercial Mortgage Loan Servicing Portfolio $ 3,951,343 $ 3,043,477
Weighted Average Note Rate 8.07% 8.29%
Delinquencies (30+ Days) 0.50% 0.74%
</TABLE>
Lease Servicing
The Company's leasing division services leases that are owned by the
Company and also services leases for investors. A summary of key information
relevant to the Company's lease servicing activity is set forth below:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT JUNE 30,
------------------------
1999 1998
-------- --------
<S> <C> <C>
Owned Lease Servicing Portfolio $124,139 $ 70,581
Serviced For Investors Servicing Portfolio 24,068 54,423
-------- --------
Total Managed Lease Servicing Portfolio $148,207 $125,004
======== ========
Weighted Average Net Yield For Managed
Lease Servicing Portfolio 10.76% 10.74%
Delinquencies (30+ Days) Managed Lease
Servicing Portfolio 1.49% 2.45%
</TABLE>
Consolidated Coverage Ratios
A summary of the Company's consolidated ratios of servicing fees and
interest income from owned leases to cash operating expenses net of amortization
and depreciation follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) AT OR FOR THE SIX MONTHS AT OR FOR THE QUARTER
ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Total Company Servicing Fees $ 24,995 $ 19,715 $ 11,997 $ 10,412
Net Interest Income from Owned Leases 3,389 1,982 1,744 1,036
-------- -------- -------- --------
Total Servicing Fees and Interest from Owned Leases $ 28,384 $ 21,697 $ 13,741 $ 11,448
-------- -------- -------- --------
Total Company Operating Expenses $ 85,334 $ 79,956 $ 41,804 $ 41,041
Total Company Amortization and Depreciation (20,778) (14,886) (10,240) (7,902)
-------- -------- -------- --------
Total Company Operating Expenses, Net of
Amortization and Depreciation $ 64,556 $ 65,070 $ 31,564 $ 33,139
-------- -------- -------- --------
Coverage Ratio 44% 33% 44% 35%
======== ======== ======== ========
</TABLE>
Although the Company's coverage ratio is still below the Company's
target level of between 50% and 80%, there was improvement in the coverage ratio
for the second quarter and six months ended June 30, 1999 primarily due to the
decline in production. Effective May 1, 1998,
10
<PAGE> 11
the Company sold its retail production franchise, which accounted for $5.6
million and $1.7 million of the Company's cash operating expenses for the six
months and quarter ended June 30, 1998, respectively. Without retail division
operating expenses, the Company's coverage ratio would have been 36% for both
the six months and quarter ended June 30, 1998. As market conditions permit,
management would expect to bring this ratio back in line with the stated
objective.
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS
ENDED JUNE 30, 1998
SUMMARY BY OPERATING DIVISION
Net income per common share on a diluted basis for the first six months
of 1999 was $0.66 as compared to $0.97 for the first six months of 1998. This
32% decrease in net income per common share was less than the 36% decrease in
net income primarily due to the impact of the Company's stock repurchase program
which reduced the number of weighted average shares outstanding across
comparative periods. Following is a summary of the allocated revenues and
expenses for each of the Company's operating divisions for the six months ended
June 30, 1999 and 1998, respectively:
<TABLE>
<CAPTION>
($ IN THOUSANDS) RESIDENTIAL
-----------------------------------
MORTGAGE PRODUCTION
---------------------- AGENCY -
AGENCY - ELIGIBLE COMMERCIAL
FOR THE SIX MONTHS ENDED JUNE 30, 1999* ELIGIBLE SUBPRIME SERVICING MORTGAGE LEASING OTHER CONSOLIDATED
- --------------------------------------- --------- ---------- --------- ---------- --------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net interest income $ 6,097 $ 7,456 $ (2,383) $ 214 $ 3,389 $ 124 $ 14,897
Net gain on sale of mortgage loans 50,078 10,374 3,025 63,477
Gain on sale of mortgage servicing rights 4,823 4,823
Servicing fees 22,242 2,133 327 293 24,995
Other income 458 (1,559) 344 31 534 9 (183)
--------- --------- --------- --------- --------- --------- ---------
Total revenues 56,633 16,271 25,026 5,403 4,250 426 108,009
--------- --------- --------- --------- --------- --------- ---------
Salary and employee benefits 23,651 6,784 1,805 3,248 1,353 370 37,211
Occupancy expense 4,328 1,252 207 541 214 96 6,638
Amortization and provision for impairment
of mortgage servicing rights 17,320 982 18,302
General and administrative expenses 12,860 4,461 3,478 933 1,356 95 23,183
--------- --------- --------- --------- --------- --------- ---------
Total expenses 40,839 12,497 22,810 5,704 2,923 561 85,334
--------- --------- --------- --------- --------- --------- ---------
Income before income taxes 15,794 3,774 2,216 (301) 1,327 (135) 22,675
Income tax expense (5,644) (1,349) (792) 91 (543) 59 (8,178)
--------- --------- --------- --------- --------- --------- ---------
Net income $ 10,150 $ 2,425 $ 1,424 $ (210) $ 784 $ (76) $ 14,497
========= ========= ========= ========= ========= ========= =========
</TABLE>
11
<PAGE> 12
<TABLE>
<CAPTION>
($ IN THOUSANDS) RESIDENTIAL
-----------------------------------
MORTGAGE PRODUCTION
---------------------- AGENCY -
AGENCY - ELIGIBLE COMMERCIAL
FOR THE SIX MONTHS ENDED JUNE 30, 1998* ELIGIBLE SUBPRIME SERVICING MORTGAGE LEASING OTHER CONSOLIDATED
- --------------------------------------- --------- --------- --------- ---------- --------- --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net interest income $ 3,869 $ 3,413 $ 260 $ 1,982 $ 227 $ 9,751
Net gain on sale of mortgage loans 66,765 13,382 3,482 83,629
Gain on sale of mortgage servicing rights $ 1,080 1,080
Servicing fees 17,230 1,812 509 164 19,715
Other income 1,695 137 141 (2) 425 501 2,897
--------- --------- --------- --------- --------- --------- ---------
Total revenues 72,329 16,932 18,451 5,552 2,916 892 117,072
--------- --------- --------- --------- --------- --------- ---------
Salary and employee benefits 28,031 7,589 1,648 2,920 1,030 344 41,562
Occupancy expense 3,692 871 218 389 166 95 5,431
Amortization and provision for impairment
of mortgage servicing rights 11,649 654 12,303
General and administrative expenses 12,945 2,115 3,117 843 1,264 376 20,660
--------- --------- --------- --------- --------- --------- ---------
Total expenses 44,668 10,575 16,632 4,806 2,460 815 79,956
--------- --------- --------- --------- --------- --------- ---------
Income before income taxes 27,661 6,357 1,819 746 456 77 37,116
Income tax expense (10,940) (2,249) (710) (282) (188) (54) (14,423)
--------- --------- --------- --------- --------- --------- ---------
Net income $ 16,721 $ 4,108 $ 1,109 $ 464 $ 268 $ 23 $ 22,693
========= ========= ========= ========= ========= ========= =========
</TABLE>
*Revenues and expenses have been allocated on a direct basis to the extent
possible. Corporate overhead expenses have been allocated to agency-eligible
mortgage production. Management believes that these and all other revenues and
expenses have been allocated to the respective divisions on a reasonable basis.
AGENCY-ELIGIBLE MORTGAGE OPERATIONS
Following is a comparison of the revenues and expenses allocated to the
Company's agency-eligible mortgage production operations.
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Net interest income $ 6,097 $ 3,869
Net gain on sale of mortgage loans 50,078 66,765
Other income 458 1,695
---------- ----------
Total production revenue 56,633 72,329
---------- ----------
Salary and employee benefits 23,651 28,031
Occupancy expense 4,328 3,692
General and administrative expenses 12,860 12,945
---------- ----------
Total production expenses 40,839 44,668
---------- ----------
Net pre-tax production margin $ 15,794 $ 27,661
---------- ----------
Production $5,276,255 $7,407,008
Pool delivery 5,710,345 7,171,373
Total production revenue to pool delivery 99 bps 101 bps
Total production expenses to production 77 bps 60 bps
---------- ----------
Net pre-tax production margin 22 bps 41 bps
========== ==========
</TABLE>
Summary
The production revenue to pool delivery ratio decreased two basis
points, or 2%, for the first six months of 1999 as compared to the first six
months of 1998. Net gain on sale of mortgage
12
<PAGE> 13
loans (88 basis points for 1999 versus 93 basis points for 1998) declined
primarily due to compressed margins attributable to an aggressive competitive
pricing environment in the correspondent channel and lower overall
agency-eligible production volume. Net interest income increased from 5 basis
points in 1998 to 11 basis points in 1999 primarily as a result of the generally
steeper yield curve environment. The production expenses to production ratio
increased 17 basis points, or 28%, for the first six months of 1999 as compared
to the first six months of 1998. This was due to a 29% decrease in production
volumes while operating expenses were decreased by only 9%. As a consequence of
the foregoing, the Company's net agency-eligible pre-tax production margin
decreased 19 basis points, or 46%, to 22 basis points while in absolute dollars
it decreased $11.9 million, or 43%.
Net Interest Income
The following table analyzes net interest income allocated to the
Company's agency-eligible mortgage production activities in terms of rate and
volume variances of the interest spread (the difference between interest rates
earned on loans and mortgage-backed securities and interest rates paid on
interest-bearing sources of funds) for the six months ended June 30, 1999 and
1998, respectively.
<TABLE>
<CAPTION>
($ in thousands) Variance
Average Volume Average Rate Interest Attributable to
- --------------------------------------- ----------------- ------------------------------
1999 1998 1999 1998 1999 1998 Variance Rate Volume
- --------------------------------------- --------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Mortgages Held for Sale and
$ 889,631 $11,178,375 6.59% 6.89% Mortgage-Backed Securities $29,330 $40,592 $(11,262) $(1,316) $(9,946)
- --------------------------------------- --------------------------------------------------
INTEREST EXPENSE
$ 386,100 $ 464,620 3.62% 4.62% Warehouse Line $ 6,923 $10,643 $ (3,720) $(1,921) $(1,799)
492,144 681,723 5.15% 5.88% Gestation Line 12,559 19,869 (7,310) (1,785) (5,525)
120,119 94,282 5.85% 6.79% Servicing Secured Line 3,486 3,174 312 (558) 870
29,790 33,067 5.22% 5.89% Servicing Receivables Line 771 966 (195) (99) (96)
7,728 6,731 8.22% 7.88% Other Borrowings 315 263 52 13 39
Facility Fees & Other Charges 1,418 1,808 (390) (390)
- --------------------------------------- --------------------------------------------------
$1,035,881 $ 1,280,423 4.96% 5.78% Total Interest Expense $25,472 $36,723 $(11,251) $(4,350) $ 6,901)
- --------------------------------------- --------------------------------------------------
Net Interest Income Before
1.63% 1.11% Interdivisional Allocations $ 3,858 $ 3,869 $ (11) $ 3,034 $(3,045)
============ ==================================================
Allocation to Agency-Eligible
Servicing Division 2,239 N/A
-----------------
Net Interest Income $ 6,097 $ 3,869
=================
</TABLE>
Net interest income from agency-eligible production before
interdivisional allocations remained constant at $3.9 million for the first six
months of both 1999 and 1998. The 52 basis point increase in the interest-rate
spread was primarily the result of the steeper yield curve environment in the
first six months of 1999 compared to the first six months of 1998. The Company's
mortgages and mortgage-backed securities are generally sold and replaced within
30 to 35 days. Accordingly, the Company generally borrows at rates based upon
short-term indices, while its asset yields are primarily based upon long-term
mortgage rates.
Net Gain on Sale of Agency-eligible Mortgage Loans
A reconciliation of gain on sale of agency-eligible mortgage loans for
the periods indicated follows:
13
<PAGE> 14
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Gross proceeds on sales of mortgage loans $ 5,726,984 $ 7,239,752
Initial unadjusted acquisition cost of mortgage loans sold, net
of hedge results 5,724,786 7,237,275
----------- -----------
Unadjusted gain on sale of mortgage loans 2,198 2,477
Loan origination and correspondent program administrative
fees 13,148 19,836
----------- -----------
Unadjusted aggregate margin 15,346 22,313
Acquisition basis allocated to mortgage servicing rights (SFAS
No. 125) 35,782 43,856
Net deferred costs and administrative fees recognized (1,050) 596
----------- -----------
Net gain on sale of agency-eligible mortgage loans $ 50,078 $ 66,765
=========== ===========
</TABLE>
Net gain on sale of agency-eligible mortgage loans decreased $16.7
million (25%) from $66.8 million for the first six months of 1998 to $50.1
million for the first six months of 1999. The decrease is primarily due to
compressed margins attributable to an aggressive competitive pricing environment
in the correspondent channel and lower overall agency-eligible production
volume.
Other Income
In November 1998, the Company formed a captive insurance company, MG
Reinsurance Company (MG Reinsurance). MG Reinsurance is licensed as a property
and casualty insurer and operates as a monoline captive insurance company
assuming reinsurance for agency-eligible mortgage loans initially purchased or
produced by the Company. During the first six months of 1999, the Company
recognized premium and investment income of approximately $0.4 million that has
been included as other income in the agency-eligible production segment. The
primary reason for the $1.2 million decline in other income from period to
period is due to the nonrecurring gain of $1.5 million from the sale of the
retail production franchise in the first six months of 1998.
Salary and Employee Benefits
Salary and employee benefits for the six months ended June 30, 1999
declined $4.4 million or 16% as compared to the six months ended June 30, 1998.
The agency-eligible production decline led to declines in variable compensation
costs such as commissions, incentives, overtime, and contract labor.
SUBPRIME MORTGAGE OPERATIONS
Following is an analysis of the revenues and expenses allocated to the
Company's subprime mortgage production operations.
14
<PAGE> 15
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Net interest income $ 7,456 $ 3,413
Net gain on sale of mortgage loans 10,374 13,382
Other income (1,559) 137
--------- ---------
Total production revenue 16,271 16,932
--------- ---------
Salary and employee benefits 6,784 7,589
Occupancy expense 1,252 871
General and administrative expenses 4,461 2,115
--------- ---------
Total production expenses 12,497 10,575
========= =========
Net pre-tax production margin $ 3,774 $ 6,357
========= =========
Production $ 369,855 $ 252,132
Whole loan sales and securitizations 322,910 214,971
Total production revenue to whole loan sales and securitizations 504 bps 788 bps
Total production expenses to production 338 bps 419 bps
--------- ---------
Net pre-tax production margin 166 bps 369 bps
========= =========
</TABLE>
Summary
During the first six months of 1999, the Company produced $369.9
million of subprime loans and sold $196.9 million in whole loan transactions and
delivered $126.0 million into the secondary markets through securitization
transactions. At June 30, 1999, the Company had unsold subprime mortgage loans
of $145.1 million. Overall, the subprime division operated during the first six
months of 1999 at a 1.66% pre-tax production margin. The pretax margin decline
of 203 basis points from the six months ended June 30, 1999, to the six months
ended June 30, 1998, is primarily attributable to a 259 basis point decline in
the gain on sale of subprime mortgage loans. This decline is primarily
attributable to compressed margins in the subprime market during the first six
months of 1999.
Net Interest Income
The following table analyzes net interest income allocated to the
Company's subprime mortgage production activities in terms of rate and volume
variances of the interest spread (the difference between interest rates earned
on loans and residual certificates and interest rates paid on interest-bearing
sources of funds) for the six months ended June 30, 1999 and 1998, respectively.
15
<PAGE> 16
<TABLE>
<CAPTION>
($ in thousands) Variance
Average Volume Average Rate Interest Attributable to
- ------------------------------------ ---------------- ---------------
1999 1998 1999 1998 1999 1998 Variance Rate Volume
- ------------------------------------ ------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Mortgages Held for Sale and
$232,845 $111,877 10.24% 9.72% Residual Certificates $11,916 $5,439 $6,477 $ 596 $5,881
- ------------------------------------ ------------------------------------------
INTEREST EXPENSE
$170,984 $ 69,590 5.43% 5.87% Total Interest Expense $ 4,604 $2,026 $2,578 $(374) 2,952
- ------------------------------------ ------------------------------------------
Net Interest Income Before
4.81% 3.85% Interdivisional Allocations $ 7,312 $3,413 $3,899 $ 970 $2,929
------------- ------------------------------------------
Allocation to Agency-Eligible
Servicing Division 144 N/A
----------------
Net Interest Income $ 7,456 $3,413
================
</TABLE>
Net interest income from subprime products increased 114% to $7.3
million for the first six months of 1999 as compared to $3.4 million for the
first six months of 1998. This was primarily the result of the increase in
subprime loan production volume and the generally steeper yield curve
environment and an increase in accretion income earned on residual interests
from $1.4 million for the six months ended June 30, 1998 to $3.0 million for the
six months ended June 30, 1999.
Net Gain on Securitization and Sale of Subprime Mortgage Loans
A reconciliation of the gain on securitization of subprime mortgage
loans for the periods indicated follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Gross proceeds on securitization of subprime mortgage loans $ 124,242 $ 124,237
Initial acquisition cost of subprime mortgage loans securitized,
net of fees 126,043 126,975
--------- ---------
Unadjusted loss on securitization of subprime mortgage loans (1,801) (2,738)
Initial capitalization of residual certificates 8,867 9,262
Net deferred costs and administrative fees recognized (2,008) N/A
--------- ---------
Net gain on securitization of subprime mortgage loans $ 5,058 $ 6,524
========= =========
</TABLE>
The Company assesses the fair value of residual certificates quarterly,
based on an independent third party valuation and other factors. This valuation
is based on the discounted cash flows expected to be available to the holder of
the residual certificates. Significant assumptions used at June 30, 1999 for all
residual certificates then held by the Company include a discount rate of 13%, a
constant default rate of 3% and a loss severity rate of 25%, and ramping periods
are based on prepayment penalty periods and adjustable rate mortgage first reset
dates. Constant prepayment rate assumptions specific to the individual
certificates for purposes of the June 30, 1999 valuations are set forth below:
<TABLE>
<CAPTION>
1997-1 1997-2 1998-1 1998-2 1999-1 OTHER
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Prepayment Speeds
Fixed rate mortgages 32% cpr 30% cpr 28% cpr 28% cpr 28% cpr 32% cpr
Adjustable rate mortgages 32% cpr 30% cpr 28% cpr 28% cpr 28% cpr 24% cpr
</TABLE>
16
<PAGE> 17
The assumptions used in the independent third party valuation above are
estimated based on current conditions for similar instruments that are subject
to prepayment and credit risks. Other factors evaluated in the determination of
fair value include credit and collateral quality of the underlying loans,
current economic conditions and various fees and costs (such as prepayment
penalties) associated with ownership of the residual certificate including
actual credit history of the individual residual certificates. Although the
Company believes that the fair values of its residual certificates are
reasonable given current market conditions, the assumptions used are estimates
and actual experience may vary from these estimates. Differences in the actual
prepayment speed and loss experience from the assumptions used, could have a
significant effect on the fair value of the residual certificates.
As summarized in the following analysis, the recorded residual values
imply that the Company's securitizations are valued at 1.48 times the implied
excess yield at June 30, 1999, as compared to the 1.41 multiple implied at March
31, 1999. The table below represents balances as of June 30, 1999, unless
otherwise noted.
<TABLE>
<CAPTION>
($ IN THOUSANDS) SECURITIZATIONS
-------------------------------------------------------------- -------- ------- --------
1997-1 1997-2 1998-1 1998-2 1999-1 Subtotal Other Total
------- ------- -------- -------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Residual Certificates $ 6,816 $ 8,663 $ 11,668 $ 13,531 $ 8,219 $ 48,897 $ 2,000 $ 50,897
Bonds $39,572 (*) $57,113 (*) $102,499 (*) $160,969 (*) $124,367 (**) $484,520 $31,446 (*) $515,966
------- ------- -------- -------- -------- -------- ------- --------
Subtotal $46,388 $65,776 $114,167 $174,500 $132,586 $533,417 $33,446 $566,863
Unpaid Principal Balance $44,430 (*) $61,967 (*) $106,868 (*) $163,412 (*) $124,459 (**) $501,136 $34,478 (*) $535,614
------- ------- -------- -------- -------- -------- ------- --------
Implied Price 104.41 106.15 106.83 106.79 106.53 106.44 97.01 105.84
------- ------- -------- -------- -------- -------- ------- --------
Collateral Yield 10.43 10.05 9.76 9.72 9.85 9.86 11.53 9.93
Collateral Equivalent
Securitization Costs (0.71) (0.65) (0.60) (0.60) (0.63) (0.62) (0.50) (0.62)
Collateral Equivalent
Bond Rate (4.75) (4.95) (5.06) (5.65) (5.39) (5.29) (6.94) (5.36)
------- ------- -------- -------- -------- -------- ------- --------
Implied Collateral
Equivalent Excess Yield 4.97 4.45 4.10 3.47 3.83 3.95 4.09 3.95
------- ------- -------- -------- -------- -------- ------- --------
Implied Premium Above Par 4.41 6.15 6.83 6.79 6.53 6.44 -- 5.83
Implied Collateral
Equivalent Excess Yield 4.97 4.45 4.10 3.47 3.83 3.95 4.09 3.95
------- ------- -------- -------- -------- -------- ------- --------
Multiple 0.89 x 1.38 x 1.67 x 1.96 x 1.70 x 1.63 x -- x 1.48 x
------- ------- -------- -------- -------- -------- ------- --------
</TABLE>
* Amounts were based upon trustee statements dated June 25, 1999 that covered
the period ended May 31, 1999.
** Amounts were based upon trustee statements dated July 25, 1999 that covered
the period ended June 30, 1999.
The Company sold subprime mortgage loans on a whole loan basis during
the first six months of 1999 and 1998. Whole loans are generally sold without
recourse to third parties with the gain or loss being calculated based on the
difference between the carrying value of the loans sold and the gross proceeds
received from the purchaser less expenses. Generally, no interest in these loans
is retained by the Company.
17
<PAGE> 18
A reconciliation of the gain on subprime mortgage whole loan sales for
the periods indicated follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Gross proceeds on whole loan sales of subprime mortgage loans $ 204,317 $ 96,577
Initial acquisition cost of subprime mortgage loans sold, net of
fees 196,867 89,719
--------- ---------
Unadjusted gain on whole loan sales of subprime mortgage loans 7,450 6,858
Net deferred costs and administrative fees recognized (2,134) --
--------- ---------
Net gain on whole loan sales of subprime mortgage loans $ 5,316 $ 6,858
========= =========
</TABLE>
The $1.5 million decrease in the net gain on whole loan sales of
subprime mortgage loans from the first six months of 1998 gain of $6.9 million
to $5.3 million reported for the first six months of 1999 is primarily due to
compressed margins in the subprime market during the first six months of 1999.
Also, in response to the growth in the subprime division, management reassessed
its application of estimates related to Statement of Financial Accounting
Standard No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases" in the third
quarter of 1998. This resulted in a $2.1 million reduction in the net gain on
whole loan sales of subprime mortgage loans in the first six months of 1999. Had
this application occurred at June 30, 1998 approximately $0.8 million in
net cost and administrative fees also would have been deferred during that six
month period.
A summary of key information relevant to the subprime residual assets is set
forth below:
<TABLE>
<CAPTION>
($ IN THOUSANDS) SECURITIZATIONS
-------------------------------------------------------------- -------- --------
1997-1 1997-2 1998-1 1998-2 1999-1 OTHER TOTAL
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Residual Certificates:
Balance at December 31, 1998 $ 7,997 $ 9,702 $ 10,815 $ 12,569 $ -- $ 4,700 $ 45,783
Initial Capitalization of
Residual Certificates -- -- -- -- 8,867 -- 8,867
Accretion income 582 633 641 736 -- 363 2,955
Mark to market (602) (92) 212 226 (648) (3,063) (3,967)
Cash Flow (1,161) (1,581) -- -- -- -- (2,742)
-------- -------- -------- -------- -------- -------- --------
Balance at June 30, 1999 $ 6,816 $ 8,662 $ 11,668 $ 13,531 $ 8,219 $ 2,000 $ 50,896
======== ======== ======== ======== ======== ======== ========
</TABLE>
Other Income
The Company generally retains residual certificates in connection with
the securitization of subprime loans. These residual certificates are adjusted
to approximate market value each quarter. For the six months ended June 30, 1999
and June 30, 1998, respectively, mark-to-market gain (loss) on residuals was
approximately ($2.1) million and $0.1 million, respectively. This amount is
reflected as other income (loss) within the subprime division. Mark to market
adjustments on the residuals were the primary reason for the $1.7 million
decline in other income for the six months ended June 30, 1999 as compared to
the six months ended June 30, 1998.
General and Administrative Expenses
General and administrative expenses increased by $2.3 million when
comparing the first six months of 1999 with the first six months of 1998. This
is primarily attributable to an increase in subprime loan provision expense of
$0.9 million and a 47% increase in subprime production.
18
<PAGE> 19
AGENCY-ELIGIBLE MORTGAGE SERVICING
Following is a summary of the revenues and expenses allocated to the
Company's agency-eligible mortgage servicing operations for the six months ended
June 30, 1999 and 1998:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30,
--------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Net interest expense $ (2,383) $ --
Loan servicing fees 22,242 17,230
Other income 344 141
------------ ------------
Servicing revenues 20,203 17,371
------------ ------------
Salary and employee benefits 1,805 1,648
Occupancy expense 207 218
Amortization and provision for impairment of mortgage
servicing rights 17,320 11,649
General and administrative expenses 3,478 3,117
------------ ------------
Total loan servicing expenses 22,810 16,632
------------ ------------
Net pre-tax servicing margin (2,607) 739
Gain on sale of mortgage servicing rights 4,823 1,080
============ ============
Net pre-tax servicing contribution $ 2,216 $ 1,819
============ ============
Average servicing portfolio $ 10,004,227 $ 8,519,521
Servicing sold 6,104,726 4,804,235
Net pre-tax servicing margin to average servicing portfolio (5) bps 2 bps
Gain on sale of servicing to servicing sold 8 bps 2 bps
</TABLE>
Summary
The ratio of net pre-tax servicing margin to the average servicing
portfolio declined seven basis points primarily due to the allocation of net
interest expense to the agency-eligible servicing division, which began during
the first quarter of 1999. Had the $2.4 million in interest expense not been
allocated to the agency-eligible servicing division in the first six months of
1999, the net pre-tax servicing margin to average servicing portfolio would have
been (1) basis point. The six basis point increase in the gain on sale of
servicing sold is primarily attributable to better execution of servicing sales
in the marketplace. Loan servicing fees were $22.2 million for the first six
months of 1999, compared to $17.2 million for the first six months of 1998, an
increase of 29%. This increase is primarily related to an increase in the
average aggregate underlying unpaid principal balance of mortgage loans serviced
to $10.0 billion during the first six months of 1999 from $8.5 billion during
the first six months of 1998, an increase of 17%. Similarly, amortization and
provision for impairment of mortgage servicing rights also increased to $17.3
million during the first six months of 1999 from $11.6 million during the first
six months of 1998, an increase of 49%. The increase in amortization is
primarily attributable to the growth in the average balance of mortgage loans
serviced as well as a $0.9 million increase in the provision for potential
impairment of mortgage servicing rights.
Given current market conditions, management regularly assesses market
prepay trends and adjusts amortization accordingly. Management believes that the
value of mortgage servicing
19
<PAGE> 20
rights are reasonable in light of current market conditions. However, there can
be no guarantee that market conditions will not change such that mortgage
servicing right valuations will require additional amortization or impairment
charges.
Net Interest Expense
During the first six months of 1999, the Company began to allocate
interest expense to the agency-eligible servicing division. The net interest
expense is comprised of benefits on escrow accounts of $4.1 million that is
offset by $6.5 million in allocated interest expense. Had the Company allocated
interest expense to the agency-eligible servicing division during the first six
months of 1998, net interest expense would have been $4.2 million. The net
interest expense would have been comprised of benefit from escrows of $6.8
million that would have been offset by $11.0 million in interest expense.
Gain on Sale of Mortgage Servicing Rights
A reconciliation of the components of gain on sale of mortgage
servicing rights for the periods indicated follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Underlying unpaid principal balances of agency-eligible
mortgage loans on which servicing rights were sold
during the period $ 6,104,726 $ 4,804,235
=========== ===========
Gross proceeds from sales of mortgage servicing rights $ 163,046 $ 110,661
Initial acquisition basis, net of amortization and hedge
results 118,942 85,940
----------- -----------
Unadjusted gain on sale of mortgage servicing rights 44,104
24,721
Acquisition basis allocated from mortgage loans, net of
amortization (SFAS No. 125) (39,281) (23,641)
----------- -----------
Gain on sale of mortgage servicing rights $ 4,823 $ 1,080
=========== ===========
</TABLE>
Gain on sale of mortgage servicing rights increased $3.7 million from
$1.1 million for the first six months of 1998 to $4.8 million for the first six
months of 1999. The increase in the gain on sale of mortgage servicing rights is
primarily attributable to rising mortgage interest rates and to the increase in
volume sold, which benefited execution of servicing sales into the secondary
markets.
COMMERCIAL MORTGAGE OPERATIONS
Following is a summary of the revenues and expenses allocated to the
Company's commercial mortgage production operations.
20
<PAGE> 21
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
($ IN THOUSANDS) 1999 1998
----------- -----------
<S> <C> <C>
Net interest income $ 214 $ 260
Net gain on sale of mortgage loans 3,025 3,482
Other income 31 (2)
----------- -----------
Total production revenue 3,270 3,740
----------- -----------
Salary and employee benefits 3,248 2,920
Occupancy expense 541 389
General and administrative expenses 933 843
----------- -----------
Total production expenses 4,722 4,152
----------- -----------
Net pre-tax production margin (1,452) (412)
----------- -----------
Servicing fees 2,133 1,812
Amortization of mortgage servicing rights 982 654
----------- -----------
Net pre-tax servicing margin 1,151 1,158
----------- -----------
Pre-tax income $ (301) $ 746
----------- -----------
Production $ 308,102 $ 362,622
Whole loan sales 320,627 362,622
Average commercial mortgage servicing portfolio 3,591,677 $ 2,862,729
Total production revenue to whole loan sales 102 bps 103 bps
Total production expenses to production 153 bps 114 bps
----------- -----------
Net pre-tax production margin (51)bps (11) bps
----------- -----------
Servicing fees to average commercial mortgage servicing portfolio 12 bps 13 bps
Amortization of mortgage servicing rights to average commercial
mortgage servicing portfolio 6 bps 5 bps
----------- -----------
Net pre-tax servicing margin 6 bps 8 bps
----------- -----------
</TABLE>
Laureate originates commercial mortgage loans for various insurance
companies and other investors, primarily in Alabama, Florida, Indiana, North
Carolina, Pennsylvania, South Carolina, Tennessee and Virginia. Substantially
all loans originated by Laureate have been originated in the name of the
investor, and in most cases, Laureate has retained the right to service the
loans under a servicing agreement with the investor. Most commercial mortgage
loan servicing agreements are short-term, and retention of the servicing
contract is dependent on maintaining the investor relationship.
Net Gain on Sale of Commercial Mortgage Loans
A reconciliation of gain on sale of commercial mortgage loans for the
periods indicated follows:
21
<PAGE> 22
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
-------- --------
<S> <C> <C>
Gross proceeds on sales of commercial mortgage loans $320,627 $362,622
Initial unadjusted acquisition cost of commercial mortgage
loans sold 320,627 362,622
-------- --------
Unadjusted gain on sale of commercial mortgage loans -- --
Commercial mortgage and origination fees 2,312 2,981
-------- --------
Unadjusted aggregate margin 2,312 2,981
Initial acquisition cost allocated to basis in commercial
mortgage servicing rights (SFAS No. 125) 713 501
-------- --------
Net gain on sale of commercial mortgage loans $ 3,025 $ 3,482
======== ========
</TABLE>
The net gain on sale of commercial mortgage loans decreased $0.5
million (13%) from $3.5 million for the first six months of 1998 to $3.0 million
for the first six months of 1999. The decrease is primarily attributable to the
12% decline in the volume sold for the first six months of 1999 as compared to
the first six months of 1998.
LEASING OPERATIONS
Following is a summary of the revenues and expenses allocated to the
Company's small-ticket equipment leasing operations for the periods indicated:
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
($ IN THOUSANDS) 1999 1998
--------- ---------
<S> <C> <C>
Net interest income $ 3,389 $ 1,982
Other income 534 425
--------- ---------
Leasing production revenue 3,923 2,407
--------- ---------
Salary and employee benefits 1,353 1,030
Occupancy expense 214 166
General and administrative expenses 1,356 1,264
--------- ---------
Total lease operating expenses 2,923 2,460
--------- ---------
Net pre-tax leasing production margin 1,000 (53)
--------- ---------
Servicing fees 327 509
--------- ---------
Net pre-tax leasing margin $ 1,327 $ 456
--------- ---------
Average owned leasing portfolio $ 110,948 $ 59,129
Average serviced leasing portfolio 30,623 62,595
--------- ---------
Average managed leasing portfolio $ 141,571 $ 121,724
========= =========
Leasing production revenue to average owned portfolio 707 bps 814 bps
Leasing operating expenses to average owned portfolio 527 bps 832 bps
--------- ---------
Net pre-tax leasing production margin 180 bps (18)bps
========= =========
Servicing fees to average serviced leasing portfolio 214 bps 163 bps
</TABLE>
22
<PAGE> 23
Substantially all of the Company's lease receivables are acquired from
independent brokers who operate throughout the continental United States and
referrals from independent banks. The Company has made an effort to increase the
owned portfolio. As it has increased its owned portfolio more cost efficiencies
have been achieved thereby increasing the net pre-tax leasing production margin.
Net Interest Income
Net interest income for the first six months of 1999 was $3.4 million
as compared to $2.0 million for the first six months of 1998. This is an
annualized net interest margin of 4.29% and 3.74% for the first six months of
1999 and the first six months of 1998, respectively, based upon average lease
receivables owned of $110.9 million and $59.1 million, respectively, and average
debt outstanding of $91.5 and $34.4 million, respectively.
RESULTS OF OPERATIONS - QUARTER ENDED JUNE 30, 1999 COMPARED TO QUARTER ENDED
JUNE 30, 1998
SUMMARY BY OPERATING DIVISION
Net income per common share on a diluted basis for the second quarter
of 1999 was $0.16 as compared to $0.56 for the second quarter of 1998. This 71%
decrease in net income per common share was less than the 76% decrease in net
income primarily due to the impact of the Company's stock repurchase program
which reduced the number of weighted average shares outstanding across
comparative periods. Following is a summary of the allocated revenues and
expenses for each of the Company's operating divisions for the second quarter
ended June 30, 1999 and 1998, respectively:
<TABLE>
<CAPTION>
($ IN THOUSANDS) RESIDENTIAL
---------------------------------
MORTGAGE PRODUCTION
-------------------- AGENCY -
AGENCY - ELIGIBLE COMMERCIAL
FOR THE QUARTER ENDED JUNE 30, 1999(*) ELIGIBLE SUBPRIME SERVICING MORTGAGE LEASING OTHER CONSOLIDATED
- -------------------------------------- -------- -------- --------- ---------- -------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net interest income $ 2,508 $ 3,983 $ (994) $ 120 $ 1,744 $ 62 $ 7,423
Net gain on sale of mortgage loans 16,885 7,517 1,786 26,188
Gain on sale of mortgage servicing rights 1,825 1,825
Servicing fees 10,539 1,158 166 134 11,997
Other income (276) (627) 183 20 383 5 (312)
-------- -------- -------- -------- -------- -------- --------
Total revenues 19,117 10,873 11,553 3,084 2,293 201 47,121
-------- -------- -------- -------- -------- -------- --------
Salary and employee benefits 9,950 3,483 907 1,510 713 151 16,714
Occupancy expense 2,264 669 100 278 110 44 3,465
Amortization and provision for impairment
of mortgage servicing rights 8,887 518 9,405
General and administrative expenses 7,006 2,390 1,700 503 603 18 12,220
-------- -------- -------- -------- -------- -------- --------
Total expenses 19,220 6,542 11,594 2,809 1,426 213 41,804
-------- -------- -------- -------- -------- -------- --------
Income before income taxes (103) 4,331 (41) 275 867 (12) 5,317
Income tax expense 5 (1,546) 10 (128) (351) 29 (1,981)
-------- -------- -------- -------- -------- -------- --------
Net income $ (98) $ 2,785 $ (31) $ 147 $ 516 $ 17 $ 3,336
======== ======== ======== ======== ======== ======== ========
</TABLE>
23
<PAGE> 24
<TABLE>
<CAPTION>
($ IN THOUSANDS) RESIDENTIAL
--------------------------------
MORTGAGE PRODUCTION
-------------------- AGENCY -
AGENCY - ELIGIBLE COMMERCIAL
FOR THE QUARTER ENDED JUNE 30, 1998(*) ELIGIBLE SUBPRIME SERVICING MORTGAGE LEASING OTHER CONSOLIDATED
- -------------------------------------- -------- -------- --------- ---------- -------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net interest income $ 2,133 $ 2,066 $ 131 $ 1,036 $ 93 $ 5,459
Net gain on sale of mortgage loans 35,724 7,211 1,520 44,455
Gain on sale of mortgage servicing rights $ 452 452
Servicing fees 9,110 897 241 164 10,412
Other income 1,608 (258) 48 (4) 206 323 1,923
-------- -------- -------- -------- -------- -------- --------
Total revenues 39,465 9,019 9,610 2,544 1,483 580 62,701
-------- -------- -------- -------- -------- -------- --------
Salary and employee benefits 13,690 4,290 820 1,399 477 172 20,848
Occupancy expense 1,720 499 98 203 86 45 2,651
Amortization and provision for impairment
of mortgage servicing rights 6,347 327 6,674
General and administrative expenses 6,803 1,163 1,597 427 677 201 10,868
-------- -------- -------- -------- -------- -------- --------
Total expenses 22,213 5,952 8,862 2,356 1,240 418 41,041
-------- -------- -------- -------- -------- -------- --------
Income before income taxes 17,252 3,067 748 188 243 162 21,660
Income tax expense (6,983) (998) (303) (70) (107) (87) (8,548)
-------- -------- -------- -------- -------- -------- --------
Net income $ 10,269 $ 2,069 $ 445 $ 118 $ 136 $ 75 $ 13,112
======== ======== ======== ======== ======== ======== ========
</TABLE>
*Revenues and expenses have been allocated on a direct basis to the extent
possible. Corporate overhead expenses have been allocated to agency-eligible
mortgage production. Management believes that these and all other revenues and
expenses have been allocated to the respective divisions on a reasonable basis.
AGENCY-ELIGIBLE MORTGAGE OPERATIONS
Following is a comparison of the revenues and expenses allocated to the
Company's agency-eligible mortgage production operations.
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE QUARTER ENDED JUNE 30,
------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net interest income $ 2,508 $ 2,133
Net gain on sale of mortgage loans 16,885 35,724
Other income (276) 1,608
----------- -----------
Total production revenue 19,117 39,465
----------- -----------
Salary and employee benefits 9,950 13,690
Occupancy expense 2,264 1,720
General and administrative expenses 7,006 6,803
----------- -----------
Total production expenses 19,220 22,213
----------- -----------
Net pre-tax production margin $ (103) $ 17,252
----------- -----------
Production $ 2,136,412 $ 3,588,867
Pool delivery 2,292,046 3,851,991
Total production revenue to pool delivery 83 bps 102 bps
Total production expenses to production 90 bps 62 bps
----------- -----------
Net pre-tax production margin (7) bps 40 bps
=========== ===========
</TABLE>
24
<PAGE> 25
Summary
The production revenue to pool delivery ratio decreased 19 basis
points, or 19%, for the second quarter of 1999 as compared to the second quarter
of 1998. Generally, net gain on sale of mortgage loans (74 basis points for 1999
versus 93 basis points for 1998) declined primarily due to compressed margins
attributable to an aggressive competitive pricing environment in the
correspondent channel and lower overall agency-eligible production volume. Net
interest income increased from 6 basis points in 1998 to 11 basis points in 1999
primarily as a result of the generally steeper yield curve environment. The
production expenses to production ratio increased 28 basis points, or 45%, for
the second quarter of 1999 as compared to the second quarter of 1998. As a
consequence of the foregoing, the Company's net agency-eligible pre-tax
production margin decreased 47 basis point, or 118%, to (7) basis points while
in absolute dollars it decreased $17.4 million, or 101%.
Net Interest Income
The following table analyzes net interest income allocated to the
Company's agency-eligible mortgage production activities in terms of rate and
volume variances of the interest spread (the difference between interest rates
earned on loans and mortgage-backed securities and interest rates paid on
interest-bearing sources of funds) for the quarter ended June 30, 1999 and 1998,
respectively.
<TABLE>
<CAPTION>
($ IN THOUSANDS) VARIANCE
AVERAGE VOLUME AVERAGE RATE INTEREST ATTRIBUTABLE TO
-------------------------------------------- ------------------ -----------------
1999 1998 1999 1998 1999 1998 VARIANCE RATE VOLUME
-------------------------------------------- ------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest Income
Mortgages Held for Sale and
$727,722 $1,217,037 6.53% 7.05% Mortgage-Backed Securities $11,874 $21,461 $(9,587) $ (959) $(8,628)
-------------------------------------------- ------------------------------------------------
Interest Expense
$337,058 $ 446,797 2.93% 4.67% Warehouse Line $ 2,460 $ 5,200 $(2,740) $(1,463) $(1,277)
380,946 738,672 5.14% 5.91% Gestation Line 4,882 10,884 (6,002) (731) (5,271)
112,631 98,038 5.79% 6.89% Servicing Secured Line 1,625 1,684 (59) (310) 251
31,283 30,066 5.23% 5.86% Servicing Receivables Line 408 439 (31) (49) 18
7,025 6,927 8.16% 7.59% Other Borrowings 143 131 12 10 2
Facility Fees & Other Charges 698 990 (292) (292)
-------------------------------------------- ------------------------------------------------
$868,943 $1,320,500 4.72% 5.87% Total Interest Expense $10,216 $19,328 $(9,112) $(2,543) $(6,569)
-------------------------------------------- ------------------------------------------------
Net Interest Income Before
1.81% 1.18% Interdivisional Allocations $ 1,658 $ 2,133 $ (475) $ 1,584 $(2,059)
=============== ================================================
Allocation to Agency-Eligible
Servicing Division 850 N/A
------------------
Net Interest Income $ 2,508 $ 2,133
==================
</TABLE>
Net interest income before interdivisional allocations from
agency-eligible production decreased 22% to $1.7 million for the second quarter
of 1999 compared to $2.1 million for the second quarter of 1998. The 63 basis
point increase in the interest-rate spread was primarily the result of the
steeper yield curve environment in the second quarter of 1999 compared to the
second quarter of 1998. The Company's mortgages and mortgage-backed securities
are generally sold and replaced within 30 to 35 days. Accordingly, the Company
generally borrows at rates based upon short-term indices, while its asset yields
are primarily based upon long-term mortgage rates.
25
<PAGE> 26
Net Gain on Sale of Agency-eligible Mortgage Loans
A reconciliation of gain on sale of agency-eligible mortgage loans for
the periods indicated follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE QUARTER ENDED JUNE 30,
------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Gross proceeds on sales of mortgage loans $ 2,297,236 $ 3,877,635
Initial unadjusted acquisition cost of mortgage loans sold, net
of hedge results 2,298,209 3,875,380
----------- -----------
Unadjusted gain on sale of mortgage loans (973) 2,255
Loan origination and correspondent program administrative
fees 4,810 10,866
----------- -----------
Unadjusted aggregate margin 3,837 13,121
Acquisition basis allocated to mortgage servicing rights (SFAS
No. 125) 13,433 23,216
Net change in deferred administrative fees (385) (613)
----------- -----------
Net gain on sale of agency-eligible mortgage loans $ 16,885 $ 35,724
=========== ===========
</TABLE>
Net gain on sale of agency-eligible mortgage loans decreased $18.8
million (53%) from $35.7 million for the second quarter of 1998 to $16.9 million
for the second quarter of 1999. The decrease is primarily due to compressed
margins attributable to an aggressive competitive pricing environment in the
correspondent channel and lower overall agency-eligible production volume.
Salary and Employee Benefits
Salary and Employee Benefits for the quarter ended June 30, 1999
declined $3.7 million or 27% as compared to the quarter ended June 30, 1998.
This production decline led to declines in variable compensation costs such as
commissions, incentives, overtime, and contract labor. The 1998 salary and
employee benefits cost also includes costs from the retail production franchise
prior to the May 1, 1998 sale.
26
<PAGE> 27
SUBPRIME MORTGAGE OPERATIONS
Following is an analysis of the revenues and expenses allocated to the
Company's subprime mortgage production operations:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE QUARTER ENDED JUNE 30,
------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Net interest income $ 3,983 $ 2,066
Net gain on sale of mortgage loans 7,517 7,211
Other income (loss) (627) (258)
--------- ---------
Total production revenue 10,873 9,019
--------- ---------
Salary and employee benefits 3,483 4,290
Occupancy expense 669 499
General and administrative expenses 2,390 1,163
--------- ---------
Total production expenses 6,542 5,952
--------- ---------
Net pre-tax production margin $ 4,331 $ 3,067
========= =========
Production $ 185,744 $ 146,146
Whole loan sales and securitizations 224,286 128,268
Total production revenue to whole loan sales and securitizations 485 bps 703 bps
Total production expenses to production 352 bps 407 bps
--------- ---------
Net pre-tax production margin 133 bps 296 bps
========= =========
</TABLE>
Summary
During the second quarter of 1999, the Company produced $185.7 million
of subprime loans and sold $98.2 million in whole loan transactions and
delivered $126.1 million in the secondary markets through securitization
transactions. Overall, the subprime division operated during the second quarter
of 1999 at a 1.33% pre-tax production margin. At June 30, 1999, the Company had
unsold subprime mortgage loans of $145.1 million. The pretax margin decline of
163 basis points from the quarter ended June 30, 1999, to the quarter ended June
30, 1998, is primarily attributed to a 227 basis point decline in the gain on
sale of subprime mortgage loans. This decline is primarily attributed to
compressed margins in the subprime market during the second quarter of 1999.
Net Interest Income
The following table analyzes net interest income allocated to the
Company's subprime mortgage production activities in terms of rate and volume
variances of the interest spread (the difference between interest rates earned
on loans and residual certificates and interest rates paid on interest-bearing
sources of funds) for the quarter ended June 30, 1999 and 1998, respectively.
27
<PAGE> 28
<TABLE>
<CAPTION>
($ in thousands) Variance
Average Volume Average Rate Interest Attributable to
- ----------------------------------- -------------- ---------------
1999 1998 1999 1998 1999 1998 Variance Rate Volume
- ----------------------------------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Mortgages Held for Sale and
$259,927 $140,149 10.14% 9.83% Residual Certificates $6,590 $3,445 $3,145 $ 201 $2,944
- ----------------------------------- ----------------------------------------
INTEREST EXPENSE
$197,577 $ 94,883 5.58% 5.83% Total Interest Expense $2,751 $1,379 $1,372 $(121) 1,493
- ----------------------------------- ----------------------------------------
Net Interest Income Before
Interdivisional Allocations 3,839 2,066 $1,773 $ 322 $1,451
----------------------------------------
Allocation to Agency-Eligible
Servicing Division 144 N/A
--------------
4.56% 4.00% Net Interest Income $3,983 $2,066
============ ==============
</TABLE>
Net interest income from subprime products increased 86% to $3.8
million for the second quarter of 1999 as compared to $2.1 million for the
second quarter of 1998. This was primarily the result of the increase in
subprime loan production volume and the generally steeper yield curve
environment and an increase in accretion income from $0.7 million for the
quarter ended June 30, 1998 to $1.5 million for the quarter ended June 30, 1999.
Net Gain on Securitization and Sale of Subprime Mortgage Loans
A reconciliation of the gain on securitization of subprime mortgage
loans for the periods indicated follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE QUARTER ENDED JUNE 30,
------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Gross proceeds on securitization of subprime mortgage loans $ 124,242 $ 99,370
Initial acquisition cost of subprime mortgage loans securitized,
net of fees 126,043 101,599
--------- ---------
Unadjusted loss on securitization of subprime mortgage loans (1,801) (2,229)
Initial capitalization of residual certificates 8,867 7,075
Net deferred costs and administrative fees recognized (2,008) N/A
--------- ---------
Net gain on securitization of subprime mortgage loans $ 5,058 $ 4,846
========= =========
</TABLE>
The Company sold subprime mortgage loans on a whole loan basis during
the second quarters of 1999 and 1998. Whole loans are generally sold without
recourse to third parties with the gain or loss being calculated based on the
difference between the carrying value of the loans sold and the gross proceeds
received from the purchaser less expenses. Generally, no interest in these loans
is retained by the Company. Also, in response to the growth in the subprime
division, management reassessed its application of estimates related to
Statement of Financial Accounting Standard No. 91, "Accounting for Nonrefundable
Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases" (SFAS No. 91) in the third quarter of 1998. This resulted in a
$2.0 million reduction in the net gain on securitization of subprime mortgage
loans in the second quarter of 1999. Had this application occurred at June 30,
1998 approximately $0.7 million in net costs and administrative fees also would
have been deferred during the second quarter of 1998.
28
<PAGE> 29
A reconciliation of the gain on subprime mortgage whole loan sales for
the periods indicated follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE QUARTER ENDED JUNE 30,
------------------------------
1999 1998
--------- ---------
<S> <C> <C>
Gross proceeds on whole loan sales of subprime mortgage loans $ 102,267 $ 30,620
Initial acquisition cost of subprime mortgage loans sold, net of
fees 98,243 28,255
--------- ---------
Unadjusted gain on whole loan sales of subprime mortgage loans 4,024 2,365
Net change in costs and deferred administrative fees recognized (1,565) N/A
--------- ---------
Net gain on whole loan sales of subprime mortgage loans $ 2,459 $ 2,365
========= =========
</TABLE>
The Company reported only a slight increase ($0.1 million) in the net
gain on whole loan sales of subprime mortgage loans primarily due to compressed
margins in the subprime market during the second quarter of 1999. As part of the
reassessment of the application of estimates related to SFAS No. 91 in the third
quarter of 1998, a $1.6 million reduction in the net gain on whole loan sales of
subprime mortgage loans was taken in the second quarter of 1999. Had this
application occurred at June 30, 1998 approximately $0.2 million in net costs
and administrative fees also would have been deferred during the second quarter
of 1998.
Other Income
The Company generally retains residual certificates in connection with
the securitization of subprime loans. These residual certificates are adjusted
to approximate market value each quarter. For the quarters ended June 30, 1999
and June 30, 1998, respectively, mark-to-market gain (loss) on residuals was
approximately $(0.8) million and $0.5 million, respectively. This amount is
reflected as other income (loss) within the subprime division.
AGENCY-ELIGIBLE MORTGAGE SERVICING
Following is a summary of the revenues and expenses allocated to the
Company's agency-eligible mortgage servicing operations for the quarters ended
June 30, 1999 and 1998:
29
<PAGE> 30
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE QUARTER ENDED JUNE 30,
------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net interest expense $ (994) $ --
Loan servicing fees 10,539 9,110
Other income 183 48
----------- -----------
Servicing revenues 9,728 9,158
----------- -----------
Salary and employee benefits 907 820
Occupancy expense 100 98
Amortization and provision for impairment of mortgage
servicing rights 8,887 6,347
General and administrative expenses 1,700 1,597
----------- -----------
Total loan servicing expenses 11,594 8,862
----------- -----------
Net pre-tax servicing margin (1,866) 296
Gain on sale of mortgage servicing rights 1,825 452
----------- -----------
Net pre-tax servicing contribution $ (41) $ 748
=========== ===========
Average servicing portfolio $ 9,623,230 $ 9,107,296
Servicing sold 3,101,473 2,269,219
Net pre-tax servicing margin to average servicing portfolio (8) bps 1 bps
Gain on sale of servicing to servicing sold 6 bps 2 bps
</TABLE>
Summary
The ratio of net pre-tax servicing margin to the average servicing
portfolio declined nine basis points primarily due to the allocation of net
interest expense to the agency-eligible servicing division, which began during
the first quarter of 1999. Had the $(1.0) million in interest expense not been
allocated to the agency-eligible servicing division in the second quarter of
1999, the net pre-tax servicing margin to average servicing portfolio would have
been (4) basis points. The 4 basis point increase in the gain on sale of
servicing sold is primarily attributable to better execution of servicing sales
in the marketplace. Loan servicing fees were $10.5 million for the second
quarter of 1999, compared to $9.1 million for the second quarter of 1998, an
increase of 16%. This increase is primarily related to an increase in the
average aggregate underlying unpaid principal balance of mortgage loans serviced
to $9.6 billion during the second quarter of 1999 from $9.1 billion during the
second quarter of 1998, an increase of 6%. Similarly, amortization and provision
for impairment of mortgage servicing rights also increased to $8.9 million
during the second quarter of 1999 from $6.3 million during the second quarter of
1998, an increase of 40%. The increase in amortization is primarily attributable
to the growth in the average balance of the mortgage loans serviced as well as a
$0.9 million increase in the provision for potential impairment of mortgage
servicing rights.
Given current market conditions, management regularly assesses market
prepay trends and adjusts amortization accordingly. Management believes that the
value of mortgage servicing rights are reasonable in light of current market
conditions. However, there can be no guarantee that market conditions will not
change such that mortgage servicing right valuations will require additional
amortization or impairment charges.
30
<PAGE> 31
Net Interest Expense
During the second quarter of 1999, the Company began to allocate
interest expense to the agency-eligible servicing division. The net interest
expense is comprised of benefits on escrow accounts of $2.1 million that is
offset by $3.1 million in allocated interest expense.
Gain on Sale of Mortgage Servicing Rights
A reconciliation of the components of gain on sale of mortgage
servicing rights for the periods indicated follows:
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE QUARTER ENDED JUNE 30,
------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Underlying unpaid principal balances of agency-eligible
mortgage loans on which servicing rights were sold
during the period $ 3,101,473 $ 2,269,219
=========== ===========
Gross proceeds from sales of mortgage servicing rights $ 84,158 $ 54,294
Initial acquisition basis, net of amortization and hedge
results 62,000 42,909
----------- -----------
Unadjusted gain on sale of mortgage servicing rights 22,158 11,385
Acquisition basis allocated from mortgage loans, net of
amortization (SFAS No. 125) (20,333) (10,933)
----------- -----------
Gain on sale of mortgage servicing rights $ 1,825 $ 452
=========== ===========
</TABLE>
Gain on sale of mortgage servicing rights increased $1.4 million from
$0.5 million for the second quarter of 1998 to $1.8 million for the second
quarter of 1999. The increase in the gain on sale of mortgage servicing rights
is primarily attributable to rising rates and the increase in volume sold, which
benefited the current quarter's execution of servicing sales into the secondary
markets.
COMMERCIAL MORTGAGE OPERATIONS
Following is a summary of the revenues and expenses allocated to the
Company's commercial mortgage production operations:
31
<PAGE> 32
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED JUNE 30,
------------------------------
($ IN THOUSANDS) 1999 1998
----------- -----------
<S> <C> <C>
Net interest income $ 120 $ 131
Net gain on sale of mortgage loans 1,786 1,520
Other income 20 (4)
----------- -----------
Total production revenue 1,926 1,647
----------- -----------
Salary and employee benefits 1,510 1,399
Occupancy expense 278 203
General and administrative expenses 503 427
----------- -----------
Total production expenses 2,291 2,029
----------- -----------
Net pre-tax production margin (365) (382)
----------- -----------
Servicing fees 1,158 897
Amortization of mortgage servicing rights 518 327
----------- -----------
Net pre-tax servicing margin 640 570
----------- -----------
Pre-tax income $ 275 $ 188
----------- -----------
Production $ 157,950 $ 170,107
Whole loan sales 155,365 170,107
Average commercial mortgage servicing portfolio 3,807,645 $ 2,907,213
Total production revenue to whole loan sales 124 bps 97 bps
Total production expenses to production 145 bps 119 bps
----------- -----------
Net pre-tax production margin (21)bps (22) bps
----------- -----------
Servicing fees to average commercial mortgage servicing portfolio 12 bps 12 bps
Amortization of mortgage servicing rights to average commercial
mortgage servicing portfolio 5 bps 4 bps
----------- -----------
Net pre-tax servicing margin 7 bps 8 bps
----------- -----------
</TABLE>
Laureate originates commercial mortgage loans for various insurance
companies and other investors, primarily in Alabama, Florida, Indiana, North
Carolina, Pennsylvania, South Carolina, Tennessee and Virginia. Substantially
all loans originated by Laureate have been originated in the name of the
investor, and in most cases, Laureate has retained the right to service the
loans under a servicing agreement with the investor. Most commercial mortgage
loan servicing agreements are short-term, and retention of the servicing
contract is dependent on maintaining the investor relationship.
Net Gain on Sale of Commercial Mortgage Loans
A reconciliation of gain on sale of commercial mortgage loans for the
periods indicated follows:
32
<PAGE> 33
<TABLE>
<CAPTION>
($ IN THOUSANDS) FOR THE QUARTER ENDED JUNE 30,
------------------------------
1999 1998
-------- --------
<S> <C> <C>
Gross proceeds on sales of commercial mortgage loans $155,365 $170,107
Initial unadjusted acquisition cost of commercial mortgage
loans sold 155,365 170,107
-------- --------
Unadjusted gain on sale of commercial mortgage loans N/A N/A
Commercial mortgage and origination fees 1,463 1,316
-------- --------
Unadjusted aggregate margin 1,463 1,316
Initial acquisition cost allocated to basis in commercial
mortgage servicing rights (SFAS No. 125) 323 204
-------- --------
Net gain on sale of commercial mortgage loans $ 1,786 $ 1,520
======== ========
</TABLE>
The net gain on sale of commercial mortgage loans increased $0.3
million (18%) from $1.5 million for the second quarter of 1998 to $1.8 million
for the second quarter of 1999. The increase is primarily attributable to
slightly higher margins on sales of commercial mortgage loans during the second
quarter of 1999.
LEASING OPERATIONS
Following is a summary of the revenues and expenses allocated to the
Company's small-ticket equipment leasing operations for the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED JUNE 30,
------------------------------
($ IN THOUSANDS) 1999 1998
-------- --------
<S> <C> <C>
Net interest income $ 1,744 $ 1,036
Other income 383 206
-------- --------
Leasing production revenue 2,127 1,242
-------- --------
Salary and employee benefits 713 477
Occupancy expense 110 86
General and administrative expenses 603 677
-------- --------
Total lease operating expenses 1,426 1,240
-------- --------
Net pre-tax leasing production margin 701 2
-------- --------
Servicing fees 166 241
-------- --------
Net pre-tax leasing margin $ 867 $ 243
-------- --------
Average owned leasing portfolio $117,344 $ 62,702
Average serviced leasing portfolio 27,215 59,249
-------- --------
Average managed leasing portfolio $144,559 $121,951
======== ========
Leasing production revenue to average owned portfolio 725 bps 792 bps
Leasing operating expenses to average owned portfolio 486 bps 791 bps
-------- --------
Net pre-tax leasing production margin 239 bps 1 bps
======== ========
Servicing fees to average serviced leasing portfolio 243 bps 163 bps
</TABLE>
33
<PAGE> 34
Substantially all of the Company's lease receivables are acquired from
independent brokers who operate throughout the continental United States and
referrals from independent banks. The Company has made an effort to increase the
owned portfolio. As it has increased its owned portfolio more cost efficiencies
have been achieved thereby increasing the net pre-tax leasing production margin.
Net Interest Income
Net interest income for the second quarter of 1999 was $1.7 million as
compared to $1.0 million for the second quarter of 1998. This is an annualized
net interest margin of 2.72% and 3.6% for the second quarter of 1999 and the
second quarter of 1998, respectively, based upon average lease receivables owned
of $117.3 million and $62.7 million, respectively, and average debt outstanding
of $80.3 and $38.6 million, respectively.
34
<PAGE> 35
FINANCIAL CONDITION
During second quarter of 1999, the Company experienced a 28% decrease
in the volume of production originated and acquired compared to first quarter
1999. Production decreased to $2.5 billion during second quarter of 1999 from
$3.5 billion during first quarter 1999. The June 30, 1999, locked residential
mortgage application pipeline (mortgage loans not yet closed but for which the
interest rate has been locked) was approximately $0.6 billion and the
application pipeline (mortgage loans for which the interest rate has not yet
been locked) was approximately $0.3 billion.
Mortgage loans held-for-sale and mortgage-backed securities totaled
$0.8 billion at June 30, 1999, versus $1.4 billion at December 31, 1998, a
decrease of 45%. The Company's servicing portfolio (exclusive of loans under
subservicing agreements) decreased to $8.4 billion at June 30, 1999, from $9.9
billion at December 31, 1998.
Short-term borrowings, which are the Company's primary source of funds,
totaled $1.0 billion at June 30, 1999, compared to $1.6 billion at December 31,
1998, a decrease of 39%. The decrease in the balance outstanding at June 30,
1999, resulted from decreased funding requirements related to the decrease in
the balance of mortgage loans held-for-sale and mortgage-backed securities.
Other liabilities totaled $118 million as of June 30, 1999, compared to the
December 31, 1998 balance of $115 million, a decrease of 3%.
The Company continues to face the same challenges as other companies
within the mortgage banking industry and as such is not immune from significant
volume declines precipitated by a rise in interest rates or other factors beyond
the Company's control.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary cash-flow requirement involves the funding of
loan production, which is met primarily through external borrowings. In August
1999 the Company and its wholly owned subsidiaries RBMG, Inc. and Meritage
Mortgage Corporation, RBMG Asset Management Company, Inc. (not including the
Company, the Restricted Group), have entered into a $540 million warehouse line
of credit provided by a syndicate of unaffiliated banks that expires in July
2000. The credit agreement includes covenants requiring the Restricted Group to
maintain (i) a minimum net worth of $170 million, plus the Restricted Group's
net income subsequent to June 30, 1999, plus 90% of capital contributions to the
Restricted Group and minus restricted payments, (ii) a ratio of total Restricted
Group liabilities to tangible net worth of not more than 8.0 to 1.0, excluding
debt incurred pursuant to gestation and repurchase financing agreements, (iii)
RBMG, Inc.'s eligibility as a servicer of Ginnie Mae, FHA, VA, Fannie Mae and
Freddie Mac mortgage loans and (iv) a mortgage servicing rights portfolio with
an underlying unpaid principal balance of at least $5 billion. The provisions of
the agreement also restrict the Restricted Group's ability to engage
significantly in any type of business unrelated to the mortgage banking and
lending business and the servicing of mortgage loans.
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<PAGE> 36
In August the Company and Restricted Group also entered into a $210
million subprime revolving credit facility and a $250 servicing revolving credit
facility, which expire in July 2000. These facilities include covenants
identical to those described above with respect to the warehouse line of credit.
The Restricted Group was in compliance with the debt covenants in place
at June 30, 1999 on a proforma basis. Although management anticipates continued
compliance with current debt convenants, there can be no assurance that the
Restricted Group will be able to comply with the debt covenants specified for
each of these financing agreements. Failure to comply could result in the loss
of the related financing.
Asset Management Company, a wholly-owned subsidiary of Meritage
Mortgage Corporation, and a bank are parties to a master repurchase agreement,
pursuant to the terms of which Asset Management Co. is entitled from time to
time to deliver eligible subprime mortgage loans in an aggregate principal
amount of up to $150 million to the bank. The master repurchase agreement has
been extended through August 31, 1999 and is in the process of being renewed.
The Company has entered into an uncommitted gestation financing
arrangement. The interest rate on funds borrowed pursuant to the gestation line
is based on a spread over the Federal Funds rate. The gestation line has a
funding limit of $1.2 billion.
The Company entered into a $6.6 million note agreement in May 1997.
This debt is secured by the Company's corporate headquarters. The terms of the
agreement require the Company to make 120 equal monthly principal and interest
payments based upon a fixed interest rate of 8.07%. The note contains covenants
similar to those previously described.
The Company entered into a $10.0 million unsecured line of credit
agreement that expires in July 2000. The interest rate on funds borrowed is
based upon prime.
Republic Leasing Company, Inc. (RLC), a wholly-owned subsidiary of the
Company, has a $200 million credit facility to provide financing for its leasing
portfolio. The warehouse credit agreement matures in August 2000 and contains
various covenants regarding characteristics of the collateral and the
performance of the leases originated and serviced by RLC and that require the
Company to maintain a minimum net worth of $60 million and that RLC maintain a
ratio of total liabilities to net worth of no more than 10.0 to 1.0.
The Company has been repurchasing its stock pursuant to Board authority
since March 1998 and as of June 30, 1999 the Company had remaining authority to
repurchase up to $3 million of the Company's common stock in either open market
transactions or in private or block trades. Decisions regarding the amount and
timing of repurchases will be made by management based upon market conditions
and other factors. The repurchase authority will enable the Company to
repurchase shares to meet the Company's obligations pursuant to existing bonus,
stock option, dividend reinvestment and employee stock purchase and ESOP plans.
The Company's primary objective is to offset the potentially dilutive effect
that option exercises and stock issuances under these plans might otherwise
have. Shares repurchased are maintained in the Company's treasury
36
<PAGE> 37
account and are not retired. At June 30, 1999, there were 2,713,986 shares held
in the Company's treasury account at an average cost of $12.54 per share.
DIVISIONAL ANALYSIS OF PRE-TAX FUNDS GENERATED FROM OPERATIONS
The analyses which follow are included solely to assist investors in
obtaining a better understanding of the material elements of the Company's funds
generated by operations at a divisional level. It is intended as a supplement,
and not an alternative to, and should be read in conjunction with, the
Consolidated Statement of Cash Flows which provides information concerning
elements of the Company's cash flows.
SUMMARY
On a combined divisional basis, during the first six months of 1999 and
1998, the Company generated approximately $46.6 million and $23.6 million,
respectively, of positive funds from operations.
<TABLE>
<CAPTION>
($ in thousands) FOR THE SIX MONTHS ENDED JUNE 30,
------------------------------------
1999 1998
-------- --------
<S> <C> <C>
Agency-eligible production $ 27,180 $ 9,582
Agency-eligible servicing 16,565 13,437
Subprime production 1,250 (1,104)
Commercial mortgage 155 1,083
Leasing 1,480 582
-------- --------
$ 46,630 $ 23,580
======== ========
</TABLE>
Except for the subprime mortgage division, each of the Company's
divisions produced positive operating funds during both quarters. The combined
positive operating funds were invested to reduce indebtedness, pay dividends,
repurchase stock and purchase fixed assets.
AGENCY-ELIGIBLE PRODUCTION
Generally, the Company purchases agency-eligible mortgage loans which
are resold with the rights to service the loans being retained by the Company.
The Company then separately sells a large percentage of the servicing rights so
produced. At the time loans are sold, current accounting principles require
capitalization of the estimated fair value of the retained mortgage servicing
rights. Accordingly, amounts reported as gains on sale of agency-eligible
mortgage loans may not represent positive funds flow to the extent that the
associated servicing rights are not sold for cash but are instead retained and
capitalized. In this context, the table below reconciles the major elements of
pre-tax operating funds flow allocable to agency-eligible production activities.
37
<PAGE> 38
<TABLE>
<CAPTION>
($ in thousands) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
-------- --------
<S> <C> <C>
Income before income taxes $ 15,794 $ 27,661
Deduct:
Net gain on sale of mortgage loans, as reported (50,078) (66,765)
Add back:
Cash gains on sale of mortgage loans 15,346 22,313
Cash gains on sale of mortgage servicing rights 44,104 24,721
Depreciation 2,014 1,652
-------- --------
$ 27,180 $ 9,582
======== ========
</TABLE>
AGENCY-ELIGIBLE SERVICING
The Company's current strategy is to position itself as a national
supplier of agency-eligible servicing rights to the still consolidating mortgage
servicing industry. Accordingly, the Company generally sells a significant
percentage of its produced mortgage servicing rights to other approved servicers
under forward committed bulk purchase agreements. However, the Company maintains
a relatively small mortgage servicing portfolio. As discussed above, mortgage
servicing rights produced or purchased are initially capitalized and
subsequently must be amortized to expense. Much like depreciation, such
amortization charges are "non-cash". In this context, the table below reconciles
the major elements of pre-tax operating funds flow allocable to agency-eligible
mortgage servicing activities.
<TABLE>
<CAPTION>
($ in thousands) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
-------- --------
<S> <C> <C>
Income before income taxes $ 2,216 $ 1,819
Deduct:
Net gain on sale of mortgage servicing
rights, as reported (4,823) (1,080)
Add back:
Amortization and provision for impairment of
mortgage servicing rights 17,320 11,649
Depreciation 1,852 1,049
-------- --------
$ 16,565 $ 13,437
======== ========
</TABLE>
SUBPRIME PRODUCTION
Generally, the Company purchases subprime loans through a wholesale
broker network. The Company then separately sells or securitizes the loans so
produced. At the time loans are securitized, existing accounting principles
require capitalization of the estimated fair value of future cash flows to be
received in connection with retention by the Company of a residual interest in
the securitized loans. Accordingly, amounts reported as gains on sale of
subprime mortgage loans may not represent cash gains to the extent that
associated residual interests are retained and capitalized. In this context, the
table below reconciles the major elements of pre-tax operating funds flow
allocable to subprime mortgage production activities.
38
<PAGE> 39
<TABLE>
<CAPTION>
($ in thousands) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
-------- --------
<S> <C> <C>
Income before income taxes $ 3,774 $ 6,357
Deduct:
Net gain on sale of subprime loans, as reported (10,374) (13,382)
Accretion income on residuals (2,955) (1,361)
Add back:
Cash gains on sale of whole subprime loans 7,450 6,858
Cash received from investments in residual certificates 2,741 --
Depreciation and amortization
of goodwill and intangibles 614 424
-------- --------
$ 1,250 $ (1,104)
======== ========
</TABLE>
COMMERCIAL MORTGAGE
Generally, the Company originates commercial mortgage loans for
conduits, insurance companies and other investors. The Company either table
funds the loans or originates the loans pursuant to pre-existing investor
commitments to purchase the loans so originated. Similar to the agency-eligible
operation, the Company generally retains the right to service the loans under
various servicing agreements. At the time loans are sold, current accounting
principles require capitalization of the estimated fair value of mortgage
servicing rights produced. Accordingly, amounts reported as gains on sale of
commercial mortgage loans may not represent cash gains to the extent that the
associated servicing rights are not sold for cash but are instead retained and
capitalized. Mortgage servicing rights initially capitalized must be amortized
subsequently to expense. Much like depreciation, such amortization charges are
"non-cash". In this context, the table below reconciles the major elements of
pre-tax operating funds flow allocable to commercial mortgage production and
servicing activities.
<TABLE>
<CAPTION>
($ in thousands) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
------- -------
<S> <C> <C>
Income before income taxes $ (301) $ 746
Deduct:
Net gain on sale of commercial loans,
as reported (3,025) (3,482)
Add back:
Cash gains on sale of whole
commercial loans 2,981
2,312
Amortization and provision for impairment of
commercial mortgage servicing rights 982 654
Depreciation and amortization of
goodwill and intangibles 187 184
------- -------
$ 155 $ 1,083
======= =======
</TABLE>
39
<PAGE> 40
LEASING
Generally, the Company originates small-ticket equipment leases for
commercial customers that are retained as investments by the Company.
Investments in leases originated and retained are financed through a borrowing
facility at draw rates that approximate the net cash investment in the lease.
Accordingly, financing activities related to growth in the balance of leases
held for investment does not significantly impact operating cash flow. In this
context, the table below reconciles the major elements of operating funds flow
allocable to leasing activities.
<TABLE>
<CAPTION>
($ in thousands) FOR THE SIX MONTHS ENDED JUNE 30,
---------------------------------
1999 1998
------ ------
<S> <C> <C>
Income before income taxes $1,327 $ 456
Add back:
Depreciation and amortization of
goodwill and intangibles 153 126
------ ------
$1,480 $ 582
====== ======
</TABLE>
YEAR 2000
The Company recognizes the need to address the potentially adverse
impact that Year 2000 issues might have on its business operations. The
Company's compliance efforts are ongoing under the guidance of its Director of
Systems Operations and involve employees throughout the Company as well as
outside consultants and contractors. The Company's Year 2000 Project leadership
team meets with the Company's executive management weekly and the Board of
Directors is routinely updated on the status of the Company's efforts.
OVERVIEW OF THE COMPANY'S STATE OF READINESS
The Company has reviewed its critical information technology and
non-information technology systems and summarizes its state of readiness as
follows:
- - The Company's growth motivated a generalized review of the adequacy of
its existing software environment and technological infrastructure to
meet the Company's long-term operating requirements. Accordingly, the
Company undertook an 18-month project to design and implement the
Cybertek LoanXchange Mortgage Processing System (LoanXchange). Testing
and implementation of this Year 2000 compliant system has been
completed and the system is now in use.
- - The Company's internally developed applications have been remediated
and are now Year 2000 compliant. The remediated versions were also
modified to work in conjunction with the LoanXchange system.
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<PAGE> 41
- - The Company uses various applications that were purchased or are used
in a service bureau relationship with third parties. Compliant versions
have been placed into production for all but two of these applications.
- - The Company's new lock-box hardware and software has been installed and
successfully tested, and will be placed into production during the
third quarter. The final piece of software has been installed in a test
environment and will be moved into production during September of 1999.
- - The Company uses desktop software at each PC. Implementation of a
standardized package that delivers Year 2000 compliant desktop software
is near completion with completion scheduled for August of 1999.
Remaining work consists primarily of installing NT 4 on the desktops.
- - The Company uses computer hardware, including servers, desktop PCs and
network infrastructure components. Remediation and upgrade of all data
center hardware and network infrastructure to Year 2000 compliant
hardware are complete. Desktop hardware is 95% complete with the
rollout of 1,200 new desktops with completion scheduled for the third
quarter of 1999.
REVIEW OF MISSION CRITICAL BUSINESS SPECIFIC YEAR 2000 COMPLIANCE STATUS
AGENCY-ELIGIBLE MORTGAGE PRODUCTION mission critical applications have
been remediated or replaced by our new enterprise system, LoanXchange.
MORTGAGE SERVICING - The only mission critical system is the Alltel
servicing system which is used by the Company through a third-party service
bureau relationship. Alltel has issued the Company a letter stating that it has
completed modification of all systems used by the Company bringing them to Year
2000 compliance. Alltel is the largest vendor of servicing systems in the United
States. Alltel and the Company participated in an industry sponsored testing
program and the Company has received confirmation of the successful testing.
LAUREATE CAPITAL CORP. - The Company operates its commercial mortgage
origination and servicing business through its subsidiary, Laureate Capital
Corp. (Laureate) Upgrade of Laureate's mission critical McCracken commercial
mortgage servicing system to a Year 2000 compliant version has been completed
and Laureate's mission critical systems are now Year 2000 compliant.
REPUBLIC LEASING COMPANY, INC. - The Company operates its leasing
business through its subsidiary Republic Leasing Company, Inc. (Republic
Leasing). Republic Leasing's mission critical systems are Year 2000 compliant.
MERITAGE MORTGAGE CORPORATION - The Company operates substantially all
of its subprime loan origination business through its subsidiary, Meritage
Mortgage Corporation (Meritage).
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<PAGE> 42
Upgrade of Meritage's mission critical Contour front-end loan processing system
to a Year 2000 compliant version has been completed and Meritage's mission
critical systems are now Year 2000 compliant.
OTHER - The Company and all of its subsidiaries use the same general
ledger, accounts payable and human resources systems. All of such systems are
Year 2000 compliant. The HVAC system at the Company's home office is not
compliant and will be replaced.
THIRD PARTY SUPPLIERS
Mission critical third party suppliers are Fannie Mae, Freddie Mac and
Alltel. Software supplied to the Company by Fannie Mae and Freddie Mac has been
certified as compliant and the Company has installed the compliant versions. In
addition, Fannie Mae, Freddie Mac and the Company participated in an industry
sponsored testing program and the Company has received confirmation of the
successful testing. As discussed above, Alltel has also stated that its software
and systems are compliant and the industry sponsored test program was
successfully completed.
TRADING PARTNERS
The Company is communicating with suppliers, dealers, financial
institutions and others with whom it does business to coordinate Year 2000
compliance. However, the Company's residential mortgage business is conducted
through relationships with over 6,000 correspondents and brokers. The primary
points of interaction with these customers relate to loan registration, loan
locking and loan closing activities. These activities are initiated via phone
and fax and through a compliant and proprietary interface that is made available
over the Internet. The Company is not undertaking a readiness review of these
relationships based on its assessment that the Year 2000 issue is not likely to
have a material impact on the Company's ability to interact with these trading
partners.
FINANCIAL IMPACT
Direct costs associated exclusively with achieving Year 2000 compliance
are expected to be between $0.5 and $1 million dollars and will be paid out of
cash flow. Additional system costs exceeding $8 million that are not directly
related to Year 2000 but, that relate to upgrades noted above, serve to solve
Year 2000 issues. Direct costs associated with the work performed to date were
approximately $700 thousand through June 30, 1999. The Year 2000 effort is
expected to use approximately 5% of Information Technology's 1999 budget.
RISKS AND CONTINGENCY PLANNING
The costs of the project and the date on which the Company believes it
will complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources and other factors.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer code and unforeseen circumstances causing the
Company to allocate its resources elsewhere.
42
<PAGE> 43
Failure by either the Company or third parties to achieve Year 2000
compliance could cause short-term operational inconveniences and inefficiencies
for the Company. This may temporarily divert management's time and attention
from ordinary business activities. To the extent reasonably achievable, the
Company will seek to prevent or mitigate the effects of such possible failures
through its contingency planning efforts.
43
<PAGE> 44
Pursuant to the requirements 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.
RESOURCE BANCSHARES MORTGAGE GROUP, INC.
----------------------------------------
(Registrant)
/s/ Steven F. Herbert
------------------------------------------------------------
Steven F. Herbert
Corporate Senior Executive Vice President and
Corporate Chief Financial Officer
(signing in the capacity of (i) duly authorized officer of
the registrant and (ii) principal financial officer of the
registrant)
DATED: September 1, 1999
44
