<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended September 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File No. 0-25744
HOMEOWNERS FINANCIAL CORP.
(Name of small business issuer in its charter)
Delaware 13-2747380
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2075 West Big Beaver Road, Suite 550, Troy, Michigan 48084
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (800) 723-6001
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act: Common
Stock, Class A Common Stock Purchase Warrants
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act, during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports) and
(2) has been subject to such filing requirements for the past 90 days.
Yes _X_ No ___
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained herein, and no disclosure will be contained to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB.[ ]
The Issuer's revenues for its fiscal year ended September 30, 1996 were
$3,237,000
The aggregate market value of the voting stock held by non-affiliates (1) of the
registrant based on the last sale price of such stock, as of January 16, 1997 is
$5,969,439 based upon $3.00 multiplied by the 1,989,813 Shares of Registrant's
Common Stock held by non-affiliates.
The number of shares outstanding of each of the registrant's classes of common
stock, as of September 30, 1996 and January 16, 1997 was 4,131,213 shares and
4,133,313 shares, respectively, all of one class of $.01 par value Common Stock.
(1) Affiliates for purposes of this item refers to those persons who, during the
preceding three months, were officers, directors and/or owners of 5% or more of
the Company's outstanding stock.
DOCUMENTS INCORPORATED BY REFERENCE See Item 13. Transitional Small
Business Disclosure Format (check one): Yes ___ No _X_
<PAGE> 2
HOMEOWNERS FINANCIAL CORP.
Form 10-KSB
Year Ended September 30, 1996
Table of Contents
PART I Page
- ------ ----
Item 1. Business............................................................1
Item 2. Properties.........................................................23
Item 3. Legal Proceedings..................................................24
Item 4. Submission of Matters to a Vote of
Security Holders................................................ 25
Part II
- -------
Item 5. Market for Common
Equity and Related Stockholder Matters...........................25
Item 6. Management's Discussion and Analysis of
Financial Condition and Results of Operations....................26
Item 7. Financial Statements...............................................41
Item 8. Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosures..........................................41
Part III
- --------
Item 9. Directors, Executive Officers, Promoters
and Control Persons; Compliance with
Section 16(a) of the Exchange Act..............................42
Item 10. Executive Compensation.............................................44
Item 11. Security Ownership of Certain Beneficial
Owners and Management............................................46
Item 12. Certain Relationships and Related
Transactions.....................................................48
Part IV
- -------
Item 13. Exhibits and Reports on Form 8-K...................................49
Signatures..................................................................51
Supplemental Information and Exhibits.......................................52
Financial Statements.......................................................F-1
<PAGE> 3
PART I
Item 1. Business.
GENERAL
Homeowners Financial Corp. (the "Company") is a full service mortgage banking
company that services, originates, acquires and markets mortgage loans secured
primarily by residential properties located in 48 states and the District of
Columbia. All of the Company's substantive operations are conducted by
Developers Mortgage Corp. ("DMC"), a wholly-owned subsidiary, and by Home Owners
Funding Corp. of America ("HOFCA"), a subsidiary of FIS, Inc. ("FIS"). FIS is a
wholly-owned subsidiary of the Company. During the fiscal year ended September
30, 1996, the Company's primary sources of revenues were mortgage loan servicing
(77.8%) and mortgage loan originations (9.0%). The Company utilizes Homeowner's
Financial Structured Finance Corporation, a wholly-owned subsidiary, solely for
issuing certain mortgage pass-through securities. During the year ended
September 30, 1996, the Company realized a net loss of $.7 million on revenues
of $3.2 million.
The Company's principal business activities are mortgage loan servicing and
mortgage loan origination. Mortgage loan servicing includes collecting and
processing homeowners' monthly mortgage loan payments, remitting payments of
principal and interest to the investors who invested in the mortgages ("Mortgage
Investors"), maintaining escrow accounts for the payment of taxes and insurance
on behalf of borrowers, processing loan defaults and other general
administrative functions.
As of September 30, 1996, the Company's mortgage loan servicing portfolio
aggregated approximately $587.6 million in unpaid principal balance.
During the year ended September 30, 1996, mortgage loans originated by the
Company totalled $19.1 million.
The Company originates mortgage loans on a retail and wholesale basis. The
Company receives an origination fee for each retail loan it closes and also
earns fees for other origination functions. The Company sells the mortgage loans
it originates to Mortgage Investors in the secondary mortgage market ("Secondary
Market") and, from time to time, retains the servicing rights associated with
the loans. The Company does not speculate on fluctuations in interest rates and,
therefore, uses forward sales commitments to hedge against such fluctuations.
When the Company retains mortgage loan servicing rights, the rights are then
added to the Company's mortgage loan servicing portfolio, and the Company
- 1 -
<PAGE> 4
receives mortgage loan servicing income over the life of the loans. The Company
typically holds the loans for 7 to 90 days prior to delivering them to Mortgage
Investors in the Secondary Market and generally earns a net interest spread on
the loans during that time period.
Unless the text indicates otherwise: (i) all references herein to the
Company, include its three subsidiaries and HOFCA; and (ii) all data related to
mortgage banking operations includes the operations of HOFCA and DMC and the
mortgage loan servicing rights acquired from Aurora Service Corp. ("ASC") (the
servicing rights acquired from ASC are hereinafter referred to as "ASC-PMSR"),
even though the foregoing companies and assets were not necessarily owned by the
Company for all or part of the periods discussed.
MORTGAGE LOAN SERVICING
MORTGAGE LOAN SERVICING
Mortgage loan servicing primarily consists of receiving payments from
mortgagors on mortgage loans; remitting principal and interest to various
Mortgage Investors; receiving, escrowing and paying real estate taxes and
homeowner's insurance; monitoring escrow accounts on certain loans and adjusting
monthly payments to reflect changes in amounts required to be escrowed and, with
regard to adjustable rate mortgages ("ARMs"), changes in interest rates. The
Company also acts to rectify payment delinquencies through collection and, if
necessary, foreclosure.
Mortgage Investors include the Federal National Mortgage Association
("FNMA"), the Federal Home Loan Mortgage Corporation ("FHLMC") and the
Government National Mortgage Association ("GNMA") (collectively, the "Agencies")
and other private investors that include, but are not limited to, brokerage
houses, banks, savings and loan associations, insurance companies and other
institutional and individual financial investors.
Servicing of mortgage loans is generally done in accordance with the terms of
a servicing agreement (or in the case of servicing done on behalf of Agencies,
Seller/Servicer Agreements) ("Servicing Agreements"). Servicing Agreements
provide the general terms and framework under which loan servicing is to be
performed and provide mechanisms for reporting the results of, among other
things, each month's mortgage loan servicing activity to the Mortgage Investors.
Servicing Agreements also delineate the compensation available to the Company
for servicing the loans, including but not limited to servicing fees, late
charges and other forms of ancillary income, as well as the expenses which the
Company is responsible for and any risk of loss to which the Company has
accepted exposure. Such Agreements may give the Mortgage Investor certain rights
to seize, without compensation to the Company, the mortgage loan servicing
rights for violations and/or breaches in the Agreement.
- 2 -
<PAGE> 5
The following represents information with regard to loan servicing activities
for the major Mortgage Investors as of September 30, 1996.
<TABLE>
<CAPTION>
UNPAID
PRINCIPAL PERCENTAGE
INVESTOR NAME BALANCE (UPB) OF UPB
- ------------- ------------- ----------
($000,000)
<S> <C> <C>
FHLMC $309.0 52.59%
FNMA 115.8 19.71%
Riggs 44.3 7.54%
Virginia Housing 31.8 5.41%
MAGNA Funding 26.0 4.42%
GNMA 0.5 0.09%
Other 60.2 10.24%
------ -------
Total $587.6 100.00%
====== =======
</TABLE>
As of September 30, 1996, the Company's mortgage loan servicing portfolio
aggregated approximately $587.6 million in unpaid principal balance and
consisted of the following:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
UNPAID PRINCIPAL NUMBER AVERAGE AVERAGE REMAINING
BALANCE 9/30/96 OF LOANS LOAN SIZE INTEREST TERM
---------------- -------- --------- -------- ---------
($000,000) ($000)
<S> <C> <C> <C> <C>
$587.6 9,130 $64.4 7.89% 244.1
</TABLE>
Mortgage loan servicing fees consist of a small portion of the interest
collected on the outstanding principal balances on the mortgages being serviced.
Excluded from such fees are additional income derived from late charges and
charges for other ancillary mortgage loan servicing activities. The Company also
receives revenues from interest income earned on mortgage loans while they are
held pending sale to Mortgage Investors in the secondary market (as hereinafter
defined), gains on the bulk sale of mortgage loans and gains from the bulk sale
of mortgage servicing rights. Such service fees are collected as part of regular
mortgage payments.
- 3 -
<PAGE> 6
As of September 30, 1996, the Company's mortgage loan servicing fees (in
basis points) averaged as follows:
<TABLE>
<CAPTION>
MANUFACTURED 1-4 SINGLE MULTI-
HOUSING FAMILY RESIDENCES FAMILY
------------ ----------------- ------
<S> <C> <C>
140.2 33.2 7.9
</TABLE>
The Company analyzes the rate at which it anticipates the various
underlying mortgage loans may prepay. If loans prepay faster than anticipated,
the Company will realize less income over time than it anticipates. When
analyzing loan portfolios for purchase, the time which a loan can be expected to
produce income is an important factor in determining the value of those rights.
Generally, loans with a shorter life have less value than those with a longer
expected life.
In an attempt to determine the estimated life of a specific loan or group
of loans (sometimes referred to as pools or portfolios), the Company reviews
established criteria regarding such prepayments as made available from various
brokerage houses for such loan groups as FNMA, GNMA, FHLMC and others. These
brokerage houses estimate the speed at which loans will prepay based on, among
other things, interest rate changes ("Speeds"). Speeds are calculated from
mathematical algorithms based upon, in many cases, actual experience of the
portfolio or, in other cases, assumed portfolio characteristics. These estimated
Speeds are then useful in determining the length of time that the income stream
will be available after purchase of the mortgage loan servicing rights.
SUB-SERVICING. Sub-servicing consists of providing certain loan administration
services on behalf of another entity that has ownership of the mortgage loan
servicing rights and primary servicing responsibility for specified loans.
Sub-servicing fees are usually agreed to be paid on a per loan basis calculated
as a monthly or annual dollar amount, rather than as a percentage of monthly
loan collections. Although sub-servicing fees are typically less than would be
received for primary servicing, such arrangements can be attractive for several
reasons. First, no capitalized expense or third-party financing is normally
required to acquire such sub-servicing rights. Second, sub-servicing can be used
to employ otherwise under-utilized servicing capacity. Third, risk of default
and liability for advances is generally borne by the primary servicer.
Currently, sub-servicing does not provide a significant portion of the Company's
revenues.
- 4 -
<PAGE> 7
SELECTED MORTGAGE SERVICING PORTFOLIO DATA
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, AS OF SEPTEMBER 30,
1996 1995
AGGREGATE % OF AGGREGATE % OF
PRINCIPAL BAL TOTAL PRINCIPAL BAL TOTAL
------------- ------ ------------- ------
(IN $000) (IN $000)
<S> <C> <C> <C> <C> <C> <C>
Loan Type:
Federal Housing
Administration ("FHA") $ 58,024.8 9.88% $ 64,472.1 9.36%
Department of Veterans
Affairs ("VA") (subserviced) 10,996.0 1.87% 14,034.2 2.04%
Multi family 52,589.3 8.95% 53,176.0 7.72%
Land contracts -0- 0.00% 21,579.7 3.13%
Conventional 465,994.0 79.30% 535,196.4 77.75%
---------- ------ ---------- ------
Total Servicing
Portfolio $587,604.1 100.00% $688,458.4 100.00%
========== ======= ========== =======
Number of Loans 9,130 12,248
Avg. Loan Size $64,360 $56,210
Weighted Avg.
Interest Rate 7.89% 7.85%
Weighted Avg.
Remaining Maturity 244.1 240.2
</TABLE>
The Company is a nationwide servicer with loans in 48 states and the
District of Columbia. At September 30, 1996, the servicing portfolio included
predominantly fixed rate loans, with ARMs making up only 3.4% of the total
number of loans and 4.1% of the outstanding principal balance. Other loan types
(buydowns, graduated payment mortgages, call/balloon loans and government
subsidy loans) represented 2.1% of the total number of loans and 3.7% of the
outstanding principal balance.
The following table sets forth certain information regarding the interest
rate composition of the Company's servicing portfolio at September 30, 1996.
- 5 -
<PAGE> 8
BREAKDOWN BY INTEREST RATE OF
MORTGAGE SERVICING PORTFOLIO
<TABLE>
<CAPTION>
PERCENT
LOAN PERCENT PRINCIPAL OF PRINCIPAL
INTEREST RATE COUNT OF LOAN BALANCE BALANCE
- ------------- ----- ------- --------- ------------
($000,000)
<S> <C> <C> <C> <C>
0.00 to 6.99% 1,538 16.85% $118.8 20.22%
7.00 to 7.99% 2,587 28.33% 253.1 43.07%
8.00 to 8.99% 2,229 24.41% 115.7 19.69%
9.00 to 9.99% 1,183 12.96% 55.3 9.41%
10.00 to 10.99% 458 5.02% 20.5 3.49%
11.00 and over 1,135 12.43% 24.2 4.12%
----- ------ ------ ------
Total 9,130 100.00% $587.6 100.00%
===== ====== ====== ======
</TABLE>
To lessen the risks associated with geographic concentration, management
seeks to maintain diversification in the composition of its servicing portfolio.
The following table provides certain information regarding the geographic
distribution of the Company's servicing portfolio at September 30, 1996.
GEOGRAPHIC DISTRIBUTION
OF MORTGAGE SERVICING PORTFOLIO
AS OF SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
PERCENT
LOAN PERCENT PRINCIPAL OF PRINCIPAL
STATE COUNT OF LOAN BALANCE BALANCE
- ----- ------ ------- --------- ------------
($000,000)
<S> <C> <C> <C> <C>
California 1,692 18.53% $189.7 32.28%
Maryland 197 2.16% 74.4 12.66%
Virginia 733 8.03% 67.2 11.44%
New York 1,611 17.65% 57.5 9.79%
Washington 528 5.78% 45.1 7.68%
Minnesota 974 10.67% 20.6 3.51%
Texas 409 4.48% 24.7 4.20%
North Dakota 473 5.18% 11.3 1.92%
Illinois 183 2.00% 12.8 2.18%
Florida 218 2.39% 10.7 1.82%
Michigan 748 8.19% 10.2 1.74%
Colorado 70 0.77% 4.1 0.70%
Others 1,294 14.17% 59.3 10.08%
----- ------ ------ ------
Total 9,130 100.00% $587.6 100.00%
===== ====== ====== ======
</TABLE>
- 6 -
<PAGE> 9
The seasoning of a servicing portfolio can be a factor contributing to
prepayment risk. The following table sets forth certain information regarding
the age of the mortgage servicing portfolio at September 30, 1996.
BREAKDOWN BY AVERAGE AGE OF
MORTGAGE SERVICING PORTFOLIO
<TABLE>
<CAPTION>
PERCENT
LOAN PERCENT PRINCIPAL OF PRINCIPAL
ORIGINATION YEAR COUNT OF LOAN BALANCE BALANCE
- ---------------- ----- ------- --------- ------------
($000,000)
<S> <C> <C> <C> <C>
PRE 1986 3,153 34.54% $107.5 18.30%
1986 311 3.41% 12.7 2.16%
1987 261 2.86% 13.6 2.31%
1988 153 1.68% 12.0 2.04%
1989 150 1.64% 8.0 1.36%
1990 188 2.06% 8.7 1.48%
1991 222 2.43% 11.8 2.01%
1992 550 6.02% 50.3 8.56%
1993 2,279 24.96% 251.9 42.87%
1994 1,463 16.02% 93.2 15.86%
1995 315 3.45% 14.2 2.42%
1996 85 0.93% 3.7 0.63%
----- ------ ------ ------
Total 9,130 100.00% $587.6 100.00%
===== ====== ====== ======
</TABLE>
The following table sets forth information regarding the sources of
additions and reductions in the servicing portfolio:
- 7 -
<PAGE> 10
ADDITIONS AND REDUCTIONS TO
MORTGAGE SERVICING PORTFOLIO
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
SEPTEMBER 30,
-------------------------
1996 1995
---------- ----------
($000) ($000)
---------- ----------
<S> <C> <C>
Beginning Balance $ 688,458 $ 64,249
Additions 52,546 773,688
Reductions:
Loans Paid Off (52,279) (35,871)
Foreclosures (1,090) (408)
Sales and Transfers (79,399) (100,565)
Payments (20,632) (12,635)
---------- ----------
Total Reductions (153,400) (149,479)
---------- ----------
Ending Balance $ 587,604 $ 688,458
========== ==========
</TABLE>
MORTGAGE LOAN SERVICING ACQUISITIONS
The Company actively pursues selective acquisitions of mortgage loan
servicing rights through bulk acquisitions. Overall, the Company utilizes
acquisitions as a means to increase the size of its mortgage loan servicing
portfolio in order to take advantage of economies of scale in servicing mortgage
loans, to diversify the risks associated with geographic concentration and to
enhance the revenue generating capacity of the Company's operations. In
considering potential acquisitions, the Company examines each mortgage loan
servicing portfolio's individual characteristics as well as its effect upon the
composition of the Company's overall mortgage loan servicing portfolio. The
Company focuses its acquisition activities on residential mortgage loan
servicing rights, however it might on rare occasions acquire a small volume of
commercial mortgage loan servicing rights in conjunction with the purchase of a
larger mortgage loan servicing portfolio.
The Company bases the prices it pays for mortgage loan servicing rights on
the net present value of the estimated future cash flows of the mortgage loan
servicing assets being acquired. The Company employs a computer simulation model
to project and value cash flow streams after management has evaluated each
mortgage loan servicing portfolio. Some of the factors that determine mortgage
loan servicing value include servicing portfolio-specific characteristics such
as principal balance, geographic dispersion, weighted average interest rate,
weighted average remaining maturity, custodial balances and weighted average
servicing fee rate. The model also incorporates projections for future
prepayment
- 8 -
<PAGE> 11
rates and delinquency ratios. The Company bases its assumptions for these
factors on historical and expected experience rather than on conditions
prevailing at any one point in time. Management determines an acceptable
discount rate to apply to projected cash flows after considering mortgage loan
servicing portfolio risk, market conditions and the Company's own internal
return requirements.
The Company conducts a due diligence review of each party with whom it
contracts to purchase mortgage loan servicing rights. The procedure includes a
financial review, verification of information regarding the product being
purchased and a review of the seller's origination, marketing and servicing
procedures, as applicable. Purchase contracts require sellers to provide
representations and warranties relative to the mortgage loans and prior
servicing activities at least as comprehensive as those the Company must make to
the applicable Mortgage Investor. In the event such representations or
warranties are breached, the Company requires the seller to repurchase the
affected loan at its current principal balance plus other charges and expenses
or to indemnify the Company against any losses or costs associated with the
breach whichever is applicable under Mortgage Investor or Agency guidelines.
These contractual remedies reduce the Company's exposure to losses on acquired
mortgage loan servicing rights.
Subsequent to entering into a definitive agreement to purchase a specific
portfolio, the Company, together with the seller, usually must request in
accordance with standardized procedures permission from the Mortgage Investor to
transfer the mortgage loan servicing rights from the seller to the Company. Each
Mortgage Investor has its own criteria for evaluation of such transfers,
including the Company's current status as a "Seller/Servicer" for the particular
Mortgage Investor. Such approval must be received prior to effecting the
transfer of mortgage loan servicing rights.
Most of the larger Mortgage Investors grant approval to be a
Seller/Servicer on a national basis, without geographic restrictions. Generally,
for a company to become a Seller/Servicer for a Mortgage Investor that company
must: (i) have as its principal business purpose, the origination and servicing
of mortgage loans; (ii) have demonstrated a proven ability to originate and
service mortgage loans; (iii) be properly licensed or authorized to originate
and service mortgage loans in the jurisdictions in which it does business; and
(iv) meet various net worth requirements as set by Mortgage Investors.
Additionally, a Seller/Servicer must: (v) maintain quality control and
management systems to evaluate and monitor the overall quality of its loan
production and servicing activities; (vi) have in effect a fidelity bond and
errors and omissions coverages that meet certain coverage requirements; and
(vii) agree to maintain, after approval as a Seller/Servicer, certain net worth
standards. Seller/Servicers are required to provide Mortgage Investors with
annual audited financial statements together with, in the case of GNMA, FNMA,
and FHLMC, computations of required net worth and evidence of required insurance
described in (vi) above. The Company is delinquent in filing this information
with the requisite agencies. The Company
- 9 -
<PAGE> 12
has sought extensions from these agencies. FHLMC has granted the Company an
extension through the end of January 1997; however, the Company has not received
any response from the other Agencies. See "Government Regulations." All Mortgage
Investors require written agreements between the Company and the Mortgage
Investor detailing the requirements and duties of the parties. The Agencies,
GNMA, FNMA and FHLMC, generally require a net worth of $250,000 plus additional
net worth that represents a small percentage (for example, .20% for FNMA) of the
outstanding principal balance of the loan portfolio serviced for the particular
Mortgage Investor. As of the date hereof, the Company is in compliance with the
requirements of Mortgage Investors, including those of GNMA, FNMA and FHLMC. No
assurance can be given that the Company will continue to be in compliance with
such minimum requirements or that any Mortgage Investor will not take action
with respect to the Company's failure to timely file requisite financial
statements and other information discussed above with Mortgage Investors.
BULK ACQUISITIONS. The Company makes selective bulk purchases of mortgage
servicing rights from other mortgage bankers and financial institutions.
Management believes the Company can continue to be a successful acquiror of bulk
servicing packages by focusing on mortgage loan servicing portfolios that
complement its servicing expertise. As a nationwide servicer, the Company has an
advantage over smaller, regional mortgage bankers in bidding for geographically
diverse mortgage loan servicing portfolios. The Company also has the systems,
experienced personnel and financial resources needed to close and transfer
mortgage loan servicing portfolios quickly. Finally, the Company's data
processing systems give it the ability to efficiently service a wide variety of
loan types under assorted Mortgage Investor reporting and remittance
requirements. The Company acquired no bulk loan servicing during the fiscal year
ended September 30, 1996.
FLOW ACQUISITIONS. Under flow acquisition agreements, the Company may enter into
contracts to purchase specific volumes of mortgage loans and servicing rights
with certain specified characteristics over a set period of time at a pre-agreed
price. The Company has developed the capacity for automated transfers for flow
deliveries. However, The Company did not make any flow acquisitions during the
fiscal year ended September 30, 1996. Management evaluates the flow market on an
ongoing basis for opportunities and may enter into flow agreements in the
future.
DELINQUENCY MANAGEMENT
The Company collects servicing fees by deducting them from the interest
portion of mortgage payments as they are received. When a loan is delinquent or
foreclosed, such fees are not received and administrative expenses relative to
that loan increase. With respect to loans serviced for Agencies and certain
private Mortgage Investors, the Company generally must advance mortgage payments
to the Mortgage Investor whether or not they are received from borrowers and
advance other expenses relating to the foreclosure and
- 10 -
<PAGE> 13
disposition of the collateral. The Company is reimbursed for such advances out
of foreclosure or liquidation proceeds or by the Agencies or private mortgage
insurers that insure or guarantee the loans. At its option, the Company may
purchase foreclosed loans out of mortgage-backed securities ("MBS") pools prior
to receipt of liquidation proceeds or proceeds of insurance claims which, in
effect, limit the amount of principal and interest advances that must be made.
The Company funds such advances, including foreclosure expenses, not covered by
Mortgage Investors from working capital.
The Company utilizes a non-proprietary automated collection and
delinquency control system and has formulated comprehensive policies and
procedures for the management of loans in default within the parameters set by
Mortgage Investor and insurer guidelines. Collection efforts may begin when a
loan is as few as nine days delinquent. The system maintains status information,
records of mortgagor contacts and loan servicer reports. Historical collection
activity for each loan is retained on-line and is available to all loan
counselors. The system has the ability to automatically generate timely notices,
letters and reports which comply with regulatory requirements on a state by
state basis.
FHA mortgage insurance and VA guarantees typically cover most of the
foreclosure expenses and advances of the servicer for defaulted government
loans. Private mortgage insurance companies provide similar coverage for insured
conventional loans. FHA covers 100% of the principal balance of any insured
loan, but typically does not cover two months of interest advances and
approximately one-third of the legal fees associated with the foreclosure.
Private mortgage insurers generally cover 25% of the original principal balance,
but typically reimburse advances and other foreclosure expenses. A VA loan
guarantee typically covers the lesser of: (i) 25% of the original loan balance
or (ii) $46,000 for loans which exceed $144,000 and were originated since 1989
or $27,500 for loans originated prior to 1989. Notwithstanding this contractual
limit, the VA historically had purchased a foreclosed property that it
guaranteed at 100% of the remaining loan balance plus accrued interest.
Beginning in 1985, however, the VA has occasionally elected to remit the maximum
liability under its guarantee rather than to purchase the foreclosed property
(known as a "VA No-Bid"). Accordingly, the Company is subject to increased
foreclosure risk with regard to the VA loans in its mortgage loan servicing
portfolio. During September 1995, the Company sold virtually all of the VA loans
serviced by it with servicing rights released to the purchaser. When the VA
issues a No-Bid for a defaulted loan in the Company's mortgage loan servicing
portfolio, the Company acquires ownership of that property upon completion of
the foreclosure sale.
Property acquired through the foreclosure process and which is not
conveyed to the FHA, VA or the Mortgage Investor is known as "real estate owned"
or "REO." If the Company is forced to foreclose on a mortgaged property, it then
must liquidate the property at an amount which in many cases results in a loss.
Losses occur with respect to REOs primarily when sale proceeds of the property
underlying the defaulted loan are less than the
- 11 -
<PAGE> 14
outstanding principal balance of the loan and the costs of holding and disposing
of property. VA No-Bids are a common source of REOs. In some cases, however, the
Company is able to avoid a VA No-Bid and the resulting transfer to REO by paying
a portion of the outstanding principal balance of a defaulted VA loan on behalf
of the borrower to the point it qualifies for conveyance to the VA (a "VA
Buydown"). This procedure allows the Company to minimize its losses on such
defaulted loans. By utilizing a VA Buydown, the Company is able to reduce the
loss it might otherwise experience in connection with a VA No-Bid because the
Company is able to avoid taking the property as a REO and incurring the carrying
costs, marketing costs and administration costs associated with selling the
property. The Company executes this procedure in every case where it believes
that it is cost effective to do so.
The Company's losses in connection with VA-Buydowns, or REOs from VA
No-Bids and other sources (primarily comprised of unreimbursed interest
expenses, legal fees and losses from the liquidation of related property) were
as follows for the fiscal year ended September 30, 1996:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30, 1996
-------------------------------------
TOTAL LOSSES NUMBER AVERAGE LOSS
OF VA OF LOANS PER LOAN
------------ -------- ------------
($000) ($000)
<S> <C> <C>
$-0- -0- $-0-
</TABLE>
The Company's mortgage loan servicing portfolio consists primarily of
loans which it services on a non-recourse basis. At September 30, 1996, the
Company had the following recourse and partial recourse loans:
LOANS WITH COMPLETE RECOURSE AS TO PRINCIPAL
<TABLE>
<CAPTION>
TOTAL LOAN NUMBER TOTAL RECOURSE NUMBER PERCENTAGE OF
PORTFOLIO OF LOANS LOANS OF LOAN TOTAL PORTFOLIO
---------- -------- -------------- ------- ---------------
($000,000) ($000,000)
<S> <C> <C> <C> <C>
$587.6 9,130 $.5 69 .09%
</TABLE>
LOANS WITH PARTIAL RECOURSE AS TO PRINCIPAL
<TABLE>
<CAPTION>
PARTIAL
TOTAL LOAN NUMBER RECOURSE NUMBER PERCENTAGE OF
PORTFOLIO OF LOANS LOANS OF LOAN TOTAL PORTFOLIO
---------- -------- -------- ------- ---------------
($000,000) ($000,000)
<S> <C> <C> <C> <C>
$587.6 9,130 $1.1 86 .19
</TABLE>
- 12 -
<PAGE> 15
The remaining loan servicing portfolio is serviced on a non-recourse basis
without risk of loss to the Company other than expenses related to FHA and VA
loans described above. As of September 30, 1996, the Company maintained
allowances for uncollectible advances and other payments made with regard to
servicing such loans as follows:
<TABLE>
<CAPTION>
TOTAL LOAN ALLOWANCES PERCENTAGE OF
PORTFOLIO FOR LOSSES TOTAL PORTFOLIO
---------- ---------- ---------------
($000,000) ($000,000)
<S> <C> <C>
$587.6 $.27 .05%
</TABLE>
Breakdown of Loan Delinquency Rates of
Mortgage Servicing Portfolio
At September 30, 1996
<TABLE>
<CAPTION>
Percent of
Loan Percent of Principal Principal
Delinquency Status Count Total Loans Balance Balance
- ------------------ ----- ----------- --------- ----------
($000)
<S> <C> <C> <C> <C>
30 Day 296 3.24% $14,085.8 2.40%
60 Day 113 1.24% 5,352.0 0.91%
90 Day 57 0.62% 2,442.1 0.42%
120 Day 128 1.40% 2,997.3 0.51%
--- ---- --------- -----
Net Delinquency 594 6.50% $24,877.2 4.24%
=== ==== ========= =====
Foreclosure 76 0.83% $ 4,219.2 0.72%
Delinquent Bankruptcy 30 0.33% $ 1,054.2 0.18%
</TABLE>
The following table sets forth the Company's average delinquency rates
expressed as a percentage of the number of loans in the mortgage loan servicing
portfolio for the time periods indicated:
- 13 -
<PAGE> 16
BREAKDOWN OF LOAN DELINQUENCY RATES OF
MORTGAGE SERVICING PORTFOLIO
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
-------------------
DELINQUENCY STATUS 1996 1995
- ------------------ ---- ----
<S> <C> <C>
30 Day 3.74% 3.33%
60 Day 1.08% 0.76%
90 Day 0.62% 0.32%
120 Day 1.42% 0.88%
---- ----
Net Delinquency 6.86% 5.29%
==== ====
Foreclosure 0.47% 0.26%
Delinquent Bankruptcy 0.28% 0.51%
</TABLE>
The Company maintains a reserve for estimated future foreclosure losses
associated with the Company's responsibilities as servicer for loans. The
required level of reserves is determined by monthly analysis of such factors as
loan delinquencies, anticipated reinstatement rates from the various stages of
delinquency and loss experience on similar loans serviced. The reserve is
increased by provisions charged to earnings and by purchase price adjustments on
certain acquisitions of mortgage loan administration contracts. The reserve is
reduced by charge-offs, net of recoveries. The Company's reserve was $269,000 at
September 30, 1996. While management believes that adequate reserves have been
established, there can be no assurance that such a level of reserves will
continue to be adequate in the future.
REO is recorded at the lower of cost or fair value, less estimated selling
cost, on its acquisition date and at the lower of such initial amount or current
fair value, less estimated selling cost, thereafter. Differences between the
carrying amount and fair value, less estimated selling cost, are charged to
earnings through provision for foreclosure costs.
FUNDING OF THE PURCHASE OF MORTGAGE LOAN SERVICING RIGHTS
The acquisition of $355.0 million in mortgage loan servicing rights during
in the first quarter of fiscal 1995 was funded by a $2.0 million nonrevolving
36-month term loan from Franklin Federal Bankcorp ("Franklin"), from proceeds
from the sale of manufactured housing servicing rights and funds on hand
(primarily from the proceeds of FIS' private offering of preferred stock, common
stock and warrants). The Franklin term loan was refinanced with part of the
proceeds from a term loan from First Bank (the "First Term Loan"). See "Part II,
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations--Liquidity and Capital Resources."
The Company funded the acquisition of the ASC-PMSR from three loans - a
$695,489 loan from Barnett Bank, a $675,000 loan from ISB and the First Term
Loan (see "Part II, Item 6. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources").
- 14 -
<PAGE> 17
The Company filed a registration statement with the Securities and
Exchange Commission to sell to the public ("IPO") its Common Stock and Common
Stock purchase warrants. The Company has allocated approximately $227,500
(minimum)/$3.525 million (maximum) from the net proceeds of its IPO to expand
its mortgage loan servicing portfolio. Management anticipates that such funds
will enable the Company to purchase servicing rights to mortgage loans with
between $22.7 million (minimum) and $352.5 million (maximum) in principal
balances. Management believes that it will be able to purchase additional
mortgage loan servicing rights with approximately $75 million of outstanding
principal balances using working capital of approximately $748,000 that will
become available if and when the Company closes the minimum portion of its IPO.
See "Part III, Item 12. Certain Relationships and Related Transactions."
MORTGAGE LOAN ORIGINATION
The Company originates residential loans on a retail and wholesale basis,
which, during the fiscal year ended September 30, 1996, consisted of $19.1
million in originations. The Company's originations primarily occurred in
Minnesota ($14.3 million).
Loan origination volume has been as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
------------------------
1996 LOANS 1995 LOANS
---------- ----------
($000,000) ($000,000)
<S> <C>
$19.1 $12.4
</TABLE>
During the fiscal year ended September 30, 1996, mortgage loans originated
by the Company consisted of:
<TABLE>
<CAPTION>
TOTAL LOANS MANUFACTURED MULTI- 1-4 SINGLE
ORIGINATIONS HOUSING FAMILY FAMILY HOUSING
------------ ------------ ---------- --------------
($000,000) ($000,000) ($000,000) ($000,000)
<S> <C> <C> <C>
$19.1 $-0- $-0- $19.1
</TABLE>
During the fiscal year ended September 30, 1995, mortgage loans originated
by the Company consisted of:
<TABLE>
<CAPTION>
TOTAL LOANS MANUFACTURED MULTI- 1-4 SINGLE
ORIGINATIONS HOUSING FAMILY FAMILY HOUSING
------------ ------------ ---------- --------------
($000,000) ($000,000) ($000,000) ($000,000)
<S> <C> <C> <C>
$12.4 $-0- $-0- $12.4
</TABLE>
- 15 -
<PAGE> 18
The Company offers a broad menu of mortgage loan programs to borrowers.
The staff maintains pricing matrices which include various product, rate and
lock period combinations and has safeguards to ensure adherence to the Company's
pricing standards and its underwriting guidelines. Loan origination personnel
cannot commit to a loan that falls outside the parameters set on the pricing
matrix. The Company's senior management can add, delete or adjust any program,
rate, lock period or price at any time and has the sole authority to approve
loans that do not conform to prevailing parameters.
In addition, senior management is actively involved in the monitoring and
setting of the various loan programs offered and related pricing structures.
At present, the Company maintains one retail origination office located in
Minnesota.
SALES OF LOANS - SECONDARY MARKETING; RISK MANAGEMENT
The Company sells the mortgage loans it originates through its retail
operation in the Secondary Market in the form of whole loans and MBS. The
Secondary Market consists of all mortgage transactions that occur after the
original lender closes a loan. The Secondary Market matches excess demand for
mortgage funds in one area with an excess supply in another and is a vehicle for
linking the mortgage market with the broader capital market. Secondary Market
transactions can involve two private lenders, a private lender and an Agency or
a private lender and a private conduit company.
The Company employs several methods of selling loans in the Secondary
Market. FHA, VA and conventional conforming loans are typically pooled to form
MBS issued or guaranteed by the Agencies. The Company then sells the securities
it receives for the loans to investment banking firms that are primary dealers
in government securities. The Company also sells conventional conforming whole
loans to either FNMA or FHLMC for cash or to private Mortgage Investors when
pricing conditions are favorable. Non-conforming conventional loans are sold
directly to private Mortgage Investors, often servicing released.
The Company's express policy is to hedge against, rather than speculate
on, fluctuations in interest rates. The Company manages the interest rate risk
associated with the origination of mortgage loans using hedging strategies,
primarily forward sales of mortgage loans.
The Company has identified fluctuations in interest rates as one of the
most significant risks affecting the income potential of its mortgage loan
origination activities.
Interest risk management is putting into place hedging methodologies to
budget and manage loss on the sale of loan production. The success of this risk
management function rests on the ability to identify and monitor exposure as
loans move through the origination process. The origination process is divided
into two stages: the production stage - the time between the taking of the loan
application from the borrower through the time of the loan closing; and the
inventory stage - the time between the loan closing and the sale of the loan
into the Secondary Market.
- 16 -
<PAGE> 19
The risk on loans which are already closed and warehoused is different
than that of loans which have not closed or may not close. A determination of
the precise amount of interest rate risk is made through the monitoring of the
production stages of each loan and is based on such factors as whether the
interest rate is locked, floating, fixed or adjustable; the maturity date; and
the type of transaction (purchase/refinance). The estimated closing date as well
as the scheduled delivery requirements of a particular product type and/or
Mortgage Investor are additional determinants in this process. The Company's
inventory control system tracks the loans in process and provides detailed
information about the Company's loan production and loan status. This breakdown
allows the Company to monitor both fallout and rate risk.
Fallout risk is the risk of a borrower withdrawing the loan or having the
loan rejected during the underwriting stage. During the production stage,
fallout will manifest itself as the percentage of loans which fail to close. The
primary reason applications are withdrawn is unexpected movements in interest
rates. The loans in process will experience other fallout due to credit,
appraisals, employment and deposit reasons. Fallout is monitored monthly through
an inventory control system to compare rate lock-in and closing percentages.
Currently, in order to minimize interest rate risk and manage loan pipeline
fallout, the Company sells its loan production using individual loan-by-loan
forward sale commitments under which the terms of the sale to the Mortgage
Investor are determined prior to funding of the various loans.
The following tables represent the information relative to loan fallout
for the calendar years ended 1995 and 1994 for the Company:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 YEAR ENDED DECEMBER 31, 1994*
---------------------------- -----------------------------
(NUMBERS OF LOANS)
TOTAL TOTAL TOTAL
TOTAL LOANS FALLOUT PERCENTAGE LOANS FALLOUT PERCENTAGE
PROCESSED ALL REASONS FALLOUT PROCESSED ALL REASONS FALLOUT
----------- ----------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C>
355 7 2.0% 3,461 20 0.6%
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995 YEAR ENDED DECEMBER 31, 1994
---------------------------- ----------------------------
($000,000)
TOTAL TOTAL TOTAL
TOTAL LOANS FALLOUT PERCENTAGE LOANS FALLOUT PERCENTAGE
PROCESSED ALL REASONS FALLOUT PROCESSED ALL REASONS FALLOUT
----------- ----------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C>
$35.4 $.5 1.4% $144.0 $1.6 1.1%
</TABLE>
* Consists of activity during the calendar year by HOFCA prior to the
Company's acquisition of HOFCA.
- 17 -
<PAGE> 20
Price risk, the risk of declining prices, is the most familiar type of
risk because it accurately reflects the exposure of the Company in a rising
interest rate environment. This risk is created in the application stage of the
loan, during loan origination, based on the terms of the lock-in agreements
offered to the borrowers. The period of time that "un-locked" loans spend
between the time loan documents are drawn and the loan is closed and is ready to
ship to the Secondary Market, is also where rate risk must be estimated and
hedged. The Company has established a delivery date system that allows it to
match precise delivery dates of the loan to the settlement securities, Secondary
Market or Mortgage Investors. Management believes that the production function;
processing, underwriting, closing and disbursement activities of the Company,
can play a major role in the control, management and the timing of loan
closings.
There are several pricing factors that are considered on a daily basis
such as the type of loans, e.g. conventional or government, fixed rate or ARM,
15 year or 30 year terms. Loan lock-ins are closely monitored by the Company to
insure the lock-in rates are in line with daily rates in the Secondary Market.
In the event that the interest rate market experiences significant price and/or
rate movement during the day, the Company reserves the right to change posted
daily rates as required by market conditions. The Company may also limit
lock-ins during periods of severe rate increases.
The sale of mortgage loans may generate a gain or loss to the Company
primarily as a result of two factors. First, the Company may make a loan to a
borrower at a price (interest rate plus discount points) which is higher or
lower than the Company would receive if it immediately sold the loan in the
Secondary Market. These pricing differences occur most often as a result of
competitive conditions in a market area. Second, gains or losses may result from
changes in interest rates which affect the market value of the loan from the
time a price commitment is given to a borrower until than loan is committed to
an Mortgage Investor, which typically is a period of 7 to 90 days.
To limit losses associated with borrower default, it is the Company's
policy to sell all loans without recourse. As is customary in the industry, the
Company makes representations and warranties relating to compliance with laws,
regulations and program standards and to accuracy of information in the
origination process. The Company may be required to repurchase a loan or
indemnify the Mortgage Investor in the event of a material, incurable breach of
such a representation or warranty. The Company historically has repurchased only
a nominal number of loans and is often successful in correcting any deficiencies
associated with a repurchased loan to enable remarketing and sale. During the
year ended September 30, 1996, the Company repurchased eight loans with
aggregate unpaid principal balances of approximately $189,000. During the year
ended September 30, 1995, the Company did not repurchase any loans.
To assure salability in the Secondary Market of loans that the Company
plans to originate, the Company reviews retail loan documentation for credit
worthiness and adequate security before funding or purchase. The Company has
developed its own underwriting guidelines, which conform to or exceed the
requirements set forth by the FHA, VA, FNMA, FHLMC, GNMA or private Mortgage
Investors, as applicable.
- 18 -
<PAGE> 21
The Company uses a non-proprietary software program known as Mortgage Flex
to manage many of the mortgage loan origination functions. The pipeline system
monitors the loan pipeline and warehouse, maintaining an inventory of pertinent
data on each loan. The commitment control system tracks master forward sale
commitments and individual trades with Mortgage Investors.
UNDERWRITING
All mortgage loan applications must be approved by the Company in
accordance with its underwriting criteria, including loan-to-value ratios,
borrower income qualifications, Mortgage Investor requirements, necessary
insurance coverage and property appraisal requirements. Because a substantial
majority of the individual mortgage loans originated by the Company may be sold
directly to the FNMA or FHLMC, or pooled and exchanged for FNMA or FHLMC MBS,
the Company's underwriting criteria for conventional conforming mortgage loans
follow FNMA and FHLMC guidelines. The Company's underwriting standards for
conventional mortgage loans that exceed the mortgage loan size limit established
by FNMA and FHLMC (commonly referred to as "conventional nonconforming mortgage
loans" or "Jumbo Loans") are designed to meet criteria established by private
Mortgage Investors and the standards employed by the private mortgage insurers
that the Company uses to insure those mortgage loans. Where conventional
mortgage loans originated by the Company have a loan-to-value ratio greater than
80% at origination, that portion in excess of 80% is covered by private mortgage
insurance.
QUALITY CONTROL
The Company's quality control is performed by contract with Commonwealth
Mortgage Assurance Corporation ("CMAC"), an unaffiliated company. The objective
of quality control is to monitor overall mortgage loan quality to ensure that
mortgage loan originations comply with the Company's quality standards as well
as those of Mortgage Investors and mortgage insurers. CMAC re-underwrites and
independently reverifies pertinent information and documentation used in the
underwriting decision, reviews documentation for adequacy and accuracy and
performs a desk review of the appraisal for each mortgage loan selected for
review. CMAC reviews approximately 10% of the mortgage loans originated by the
Company. Mortgage loans are selected for review based on a number of criteria,
including loan-to-value ratios, self-employment, non-owner occupancy and
cash-out refinancing. The quality review includes a full underwriting and
regulatory compliance review as well as a reverification of credit, employment,
income and source of funds. All material findings are submitted to the Company
for response. A monthly summary report of quality control findings and trends is
prepared for the Board of Directors and senior management. Quality control
reports from CMAC since May 1995, when CMAC commenced quality control functions
for the Company, revealed no material or reportable exceptions in the mortgage
loan origination operations of the Company.
Notwithstanding the foregoing, there can be no assurance that the
Company's quality control procedures will prevent losses on the mortgage loans
originated by the Company.
- 19 -
<PAGE> 22
MORTGAGE LOAN ORIGINATION REVENUES AND EXPENSES
The Company receives fees from borrowers for the origination of retail
mortgage loans, generally in the range of one to two percent of the principal
amount of the mortgage loans. The Company receives smaller fees in connection
with the origination of wholesale mortgage loans because the originating
institutions retain the majority of fees collected from mortgage loan applicants
as compensation for their origination efforts. The Company may charge additional
fees depending upon market conditions or the Company's objectives concerning
mortgage loan origination volume and pricing ("points"). The Company incurs
certain costs in originating mortgage loans, including commissions, overhead,
out-of-pocket costs and, where the mortgage loans are subject to a purchase
commitment from private Mortgage Investors, related commitment fees.
FUNDING OF MORTGAGE ORIGINATIONS AND PURCHASES
The Company's warehousing facility with First Bank (the "First Warehousing
Facility") permits the Company to finance mortgage loan acquisitions and
originations up to an aggregate of $5.0 million. Advances under the Facility may
not exceed 100% of the "Warehouse Collateral Value" of the eligible mortgage
loans (see "Part II, Item 6. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources"). Interest
is charged based upon one of the following three methods: "Fixed Rate,"
"Reference Rate" or "Floating Eurodollar Rate." The applicable method of
interest calculation is at the option of the Company (see "Management's
Discussion and Analysis of Financial Condition and Results of
Operation-Liquidity and Capital Resources"). The Company also pays a monthly
facility fee of approximately $1,000. All principal and accrued interest is
payable on or before May 29, 1997 or sooner in the event of a default. Events of
default include failure to make required payments, breaches of the terms,
representations or warranties under the Company's credit agreement with First
Bank (the "First Credit Agreement") and related documents, insolvency and
material judgments. The Company must also maintain the following minimum
financial criteria (as defined in the First Credit Agreement): "Adjusted
Tangible Net Worth" ("ATNW") must be at least $2.7 million; the "Adjusted
Leverage Ratio" must be no greater than 4.0-to-1.0; the "Debt Service Coverage
Ratio" ("DSCR") must be at least 1.2-to-1.0; the aggregate principal balance of
mortgage loans serviced must be at least $500 million; and the report by an
independent auditor in the Company's audited consolidated financial statements
cannot contain a "going concern" explanatory paragraph.
The Company was in default of the minimum ATNW, ALR and DSCR financial
criteria as of September 30, 1996. See "Part II, Item 6. Management's Discussion
and Analysis of Financial Condition and Results of Operation-Liquidity and
Capital Resources." Payment under the First Warehousing Facility is secured by
all of the assets of the Company.
DMC funded its loan origination activities primarily through its former
parent, ISB, until April 28, 1995, the date DMC was sold to the Company. Since
then, DMC established tablefunding arrangements with its primary Mortgage
Investors whereby these investors provide the funds at the mortgage closing and
thereby substantially eliminate the concern over the liquidity requirements of
loan fundings. The Company, with one exception, has
- 20 -
<PAGE> 23
phased out DMC's tablefunding arrangements. As a subsidiary of the Company, DMC
now uses the First Warehousing Facility and, in addition, on June 26, 1996, the
Company entered into a "repo" transaction to provide for an interim period
additional loan funding capacity (see "Management's Discussion and Analysis of
Financial Condition and Results of Operation-Liquidity and Capital Resources").
MANAGEMENT INFORMATION SYSTEMS
The Company maintains an in-house data processing system and uses
non-proprietary software. The Mortgage System and Problem Loan Servicer are all
on-line, real-time, integrated systems which give the Company control over work
flow and the flexibility to respond to changing operating and market conditions.
On June 1, 1995, DMC converted to the Company's data processing system.
The Company operates a Data General Aviion 5225 computer complex running
under the UNIX-VIS operating systems and the CICS teleprocessing monitor for
mortgage banking applications. The high reliability and growth potential of this
computer are key factors in management's future plans for expansion of the
mortgage loan servicing portfolio and origination activities. Management
believes that its MIS are capable of supporting a mortgage loan servicing
portfolio of approximately 90,000 loans without a significant increase in
capital expenditures. Currently, the Company services approximately 9,100 loans.
The Company has a Disaster Recovery Plan pursuant to which it stores
back-up materials and files on a daily basis. The Company routinely tests the
plan to ensure that it can restore its data systems within minimal time periods
if events so require.
COMPETITION
The mortgage banking business is highly competitive. The Company competes
with financial intermediaries, such as other mortgage bankers, commercial banks,
savings associations, credit unions, loan brokers and insurance companies in the
origination of mortgage loans. The Company competes primarily by offering a
broad menu of mortgage loan programs with competitive features, by emphasizing
the quality of its service and by pricing its range of programs at competitive
rates. Competition for mortgage loan servicing is equally diverse. Mortgage
bankers, commercial banks and savings associations all engage in mortgage loan
servicing activities, either for themselves or in subservicing arrangements for
others, and each participates in the competitive bidding process associated with
acquisitions of mortgage loan servicing portfolios. To the extent that market
pricing becomes more aggressive, the Company may be unable to achieve its
planned level of acquisitions at the desired cost. The Company plans to address
this risk by expanding its origination activities as a source of additions to
the mortgage loan servicing portfolio.
GOVERNMENT REGULATIONS
The Company is subject to the rules and regulations of, and examinations
by, FNMA, FHLMC, GNMA, FHA and VA (collectively for this discussion, the
"Agencies"). The Company must obtain Agency and Mortgage Investor approvals to
originate and/or service
- 21 -
<PAGE> 24
mortgage loans, and it is subject to various state licensing requirements. The
Company is currently eligible and expects to remain eligible to participate in
such programs; however, any significant impairment of its eligibility could have
a material adverse impact on its operations. The Company is delinquent in filing
financial statements and certain other information with the requisite Agencies.
The Company has sought extensions from these Agencies. FHLMC has granted the
Company an extension through the end of January 1997; however, the Company has
not received any response from the other Agencies.
The Company also is subject to regulation at the state and federal level
with respect to specific origination, selling and servicing practices. Failure
to comply, or to cure non-compliance, with these requirements can lead to loss
of approved status to originate and/or service, termination of servicing
contracts without or with limited compensation to the servicer, demands for
indemnification or loan repurchase and class action suits by borrowers and
administrative enforcement actions, including punitive damages.
The Company maintains current records of regulatory requirements,
disseminates such requirements to appropriate parties and reviews the procedures
and controls implemented by the Company in response to regulatory requirements.
Although the Company has systems, personnel and procedures to insure compliance
with these requirements and believes that currently it is in compliance in all
material respects with applicable requirements, significant and incurable
noncompliance could have a material adverse effect on the financial condition
and operating results of the Company. In addition, there can be no assurance
that laws, rules and regulations will not be adopted or interpreted or cases
decided in the future which could make regulatory compliance more difficult
and/or more expensive.
A material failure to service mortgage loans in accordance with
contractual requirements may lead to termination of servicing rights without the
payment of any compensation. Since the incorporation of HOFCA in October 1984
and DMC in 1976, to current management's knowledge, with one possible exception
(see "Part I, Item 3. Legal Proceedings") there have been no terminations of
servicing rights by Mortgage Investors because of a material failure to service
according to contractual obligations.
The payment of interest to borrowers on escrow balances is regulated at
the state level, with most states not requiring the mortgage servicer to make
any such payment. Federal legislation has been proposed that would establish
uniform requirements with respect to payment of interest to borrowers on escrow
balances and would otherwise regulate escrow accounts. Similar legislation was
proposed in 1991 but was not enacted. If this or similar federal legislation is
enacted in the future, it could have a material adverse effect on the Company's
results of operations.
The continuation of programs administered by FNMA, FHLMC and GNMA that
facilitate the issuance of MBS materially impacts the Company's ability to
generate funds by sale of mortgage loans or MBS. A significant portion of the
Company's business is also dependant upon the continuation of various programs
administered by FHA and VA. Although the Company is not aware of any proposed
discontinuation of, or significant reduction in, the operation of such programs,
any such action could have a material adverse effect on the Company's results of
operations.
- 22 -
<PAGE> 25
SEASONALITY
The mortgage banking business is generally subject to seasonal trends
which reflect the pattern of home sales. These sales typically peak during the
spring and summer and decline to lower levels from November through February. As
a result, management anticipates that the Company's mortgage origination
revenues and earnings typically will be higher in the second and third quarters
of each calendar year than in the first and fourth quarters. Other aspects of
the Company's business, such as servicing and acquisitions, are less affected by
seasonality, except to the extent that the growth of the servicing portfolio is
generally higher in periods of higher production.
EMPLOYEES
The Company currently has 31 employees consisting of three executive
officers, 21 mortgage loan servicing personnel, five loan origination personnel
and two administrative assistants. The Company presently leases its employees
from a professional employer organization. There are no unions and management
believes that employee relations are good. The Company anticipates that its
current staff level is sufficient for its needs for the near future.
INTER SAVINGS BANK, FSB
On April 10, 1995, the Company executed an agreement to purchase all of
the issued and outstanding shares of Common Stock of Inter Savings Bank, fsb, a
Federal Savings Bank organized under the laws of the United States, from Aurora
Service Corp., formerly, Developers Service Corp. In November 1995, the Company
terminated that agreement. While the Company may acquire ISB or another bank in
the future, the Company has decided to concentrate on its mortgage banking
activities. The Company had advanced $50,000 towards the ISB purchase price.
Item 2. Properties.
The Company's executive offices are located at the facilities of DMC, 2075
West Big Beaver Road, Suite 550, Troy, Michigan 48084, and consist of
approximately 4,600 square feet of office space and approximately 938 square
feet of storage space. The facilities are leased from an unaffiliated party
pursuant to a lease that expires on October 31, 1998. The Company maintains an
origination office at 7825 Washington Ave. South, Bloomington Minnesota 55439.
The Bloomington office consists of approximately 3,700 square feet and is leased
from an unaffiliated party pursuant to a lease that expires on November 30,
1999.
The Company had offices in Waltham, Massachusetts, Charlotte, North
Carolina, and Boca Raton, Florida. However, as part of the Company's
restructuring, these offices were closed, respectively, in September 1994,
October 1994 and June 1995. The Massachusetts lease termination was settled for
$12,000. The North Carolina lease expired in March 1995
- 23 -
<PAGE> 26
and the Florida lease was on a month-to-month basis (the Company has opened a
new office in Boca Raton). In addition, the Company closed its former principal
office in Dallas, Texas in August 1995. The Company had negotiated a partial
termination of the Dallas lease (which expires in August 1997); however, the
landlord recently commenced suit against HOFCA for the remaining rent due under
the lease (see "Part I, Item 3. Legal Proceedings").
Item 3. Legal Proceedings.
Except as described below, the Company is not presently a party to any
material litigation.
In October 1994, HOFCA commenced an action in Texas District Court, Dallas
County, for declaratory judgment against Messrs. Stouder, Wilson, Wyant,
Dressler and Alderman (collectively "Former Principals"), the five former
principals of HOFCA. The action was for a declaratory judgment relieving HOFCA
of its obligations under employment agreements between HOFCA and the Former
Principals due to breach of the employment agreements. In December 1994, three
of the Former Principals answered the complaint; counterclaimed for declaratory
judgment to the effect that HOFCA breached the employment agreements; and
demanded damages as a result thereof. The other two Former Principals denied
jurisdiction of the Texas Court and commenced actions against HOFCA in North
Carolina Superior Court for damages for breach of the employment agreements. The
Texas counterclaims did not specify the amount of damages sought. The North
Carolina complaints each sought approximately $31,000 in damages plus "bonus
compensation" under the agreements and liquidated damages in an amount equal to
all of the foregoing damages. In February 1996, the parties settled all of the
law suits. See Note 13 to the Company's Consolidated Financial Statements.
In June 1996, Crescent Real Estate Fund, HOFCA's former landlord in
Dallas, Texas, commenced an action in Texas District Court, Dallas County, for
past due rent. The amount sought is not determinable from the complaint, but may
be in excess of $200,000. HOFCA filed an answer denying the allegations and had
the action removed to the U.S. Federal Court for the Northern District of Texas,
Dallas Division. HOFCA disputes the amount owed and intends to vigorously defend
the action. Management believes that there are a number of valid set offs and
does not expect this action to have a material adverse impact on the financial
position or operations of the Company. The Company has accrued $30,000 to settle
this action, which amount represents its estimate of the balance due to the
former landlord at the time that the lease was terminated.
The Company has been informed by GNMA of a potential claim wherein the
Company, under its former ownership and management, allegedly overcharged GNMA
under the terms of certain sub-servicing Agreements. The claim alleges
approximately $3.1 million in potential liability; however, the potential
liability was projected based upon a review of only about one percent of the
records of transactions performed by HOFCA under its agreements with GNMA.
Management believes that these claims are essentially without merit and special
counsel to the Company has reviewed the claim and the relevant transactions and
has informed the Company of its belief that there are reasonable defenses to
GNMA's claims in any amount which might be material to the Company. As of
January
- 24 -
<PAGE> 27
20, 1997, GNMA has made no formal claim or demand for payment or reimbursement
under these terminated sub-service agreements. In the event that GNMA makes
formal demand and the Company is required to pay a substantial amount, the
Company's business may be materially adversely affected.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of Security Holders in the last
quarter of the Company's fiscal year ended September 30, 1996.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
(a) Marketing Information -- The principal U.S. market in which the
Company's Common Stock ($.01 par value, all of which are one class) is traded is
in the over-the-counter market (Bulletin Board Symbol: "HOFC"). The Company's
Common Stock and A Warrants have been conditionally approved for listing on the
NASDAQ SmallCap Market upon the closing of the minimum portion of the Company's
IPO (see "Part III, Item 12. Certain Relationships and Related Transactions").
Such listing is conditioned upon the Company demonstrating full compliance with
all NASDAQ SmallCap criteria for initial listing at the closing of at least the
minimum offering, the Company providing NASDAQ with information related to the
IPO closing and the Company continuing to file with NASDAQ copies of all reports
required to be filed with the Securities and Exchange Commission.
The following table sets forth the range of high and low bid prices for
the Company's Common Stock on a quarterly basis for the last ten quarters ended
September 30, 1996, as reported by the National Quotation Bureau (which reflect
inter-dealer prices, without retail mark-up, markdown, or commission and may not
necessarily represent actual transactions). As of January 16, 1997, the last
sale price for the Company's Common Stock was $3.00 per share. The foregoing and
following information should not be taken as an indication of the existence of
an established public trading market for the Company's Common Stock.
<TABLE>
<CAPTION>
BID PRICES
-------------------
HIGH LOW
------ ------
<S> <C> <C>
Quarter ended September 30, 1994* $ 1/16 $ 1/16
October 3, 1994 - October 17, 1994* $ 3/8 $ 1/16
October 18, 1994 - December 30, 1994 $ 3.50 $ 3.00
Quarter ended March 31, 1995 $4 1/8 $ 1.00
Quarter ended June 30, 1995 $ 3.50 $ 1.00
Quarter ended September 30, 1995 $ 4.25 $ 2.00
Quarter ended December 31, 1995 $ 6.00 $ 2.00
Quarter ended March 31, 1996 $ 6.00 $ 3/4
Quarter ended June 30, 1996 $ 6.50 $4 7/8
Quarter ended September 30, 1996 $5 5/8 $ 4.75
Quarter ended December 31, 1996 $4 7/8 $ 2.50
</TABLE>
- 25 -
<PAGE> 28
* Does not take into account the reverse split of the Company's Common Stock
on a one-for-seven basis effected on October 14, 1994.
(b) Holders -- There were approximately 236 holders of record of the
Company's Common Stock as of January 16, 1997 inclusive of those brokerage firms
and/or clearing houses holding the Company's common shares for their clientele
(with each such brokerage house and/or clearing house being considered as one
holder).
(c) Dividends -- The Company has not paid or declared any dividends upon
its Common Stock since its inception and, by reason of its present financial
status, its contemplated financial requirements and cumulative dividends payable
on the Company's outstanding preferred stock, does not contemplate or anticipate
paying any dividends upon its Common Stock in the foreseeable future.
For information on the sale of equity securities by the Company during the
fiscal year ended September 30, 1996 see "Item 12. Certain Relationships and
Related Transactions."
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion of the results of operations and financial
condition should be read in conjunction with the audited consolidated financial
statements and related notes included herein.
DMC and HOFCA are the Company's principal operating entities. The Company
utilizes Homeowner's Financial Structured Finance Corporation, a wholly-owned
subsidiary, solely for issuing certain mortgage pass-through securities. FIS, a
wholly-owned subsidiary of the Company, also has no substantive operations other
than those of HOFCA.
GENERAL
Effect Of Interest Rate Fluctuations. Long-term interest rates declined
throughout the period from 1991 into 1993 and reached historically low levels in
1993. That interest rate environment generally favored loan origination
activities. Such low interest rates normally expand the market demand for new
loan financing, and increase mortgage loan activity and revenue associated with
such operations. However, partly because of competition, the net interest margin
earned on a given loan held for sale usually decreases in such an environment.
Commencing in late 1993, interest rates increased until approximately mid-1995
and then generally declined until late February 1996. Since February 1996,
long-term interest rates have increased approximately 100 basis points. While
current interest rates are not high by historical standards, the increase in
interest rates had a materially negative effect on loan origination volume
throughout the industry during 1994 and early 1995. If interest rates increase,
it is uncertain whether the Company will be able to maintain it's origination
volume. If interest rates decrease, the Company's origination volume should
increase.
- 26 -
<PAGE> 29
Lower interest rates generally have the effect of increasing prepayments
in the Company's servicing portfolio because they tend to stimulate a higher
level of home purchases and refinancing of existing mortgage debt. However, with
the expansion of it's mortgage loan servicing rights acquisition activities, the
Company has been able to add a significant volume of servicing rights to it's
servicing portfolio. These acquisitions have served to offset the sale of
manufactured housing loan servicing. If origination and acquisition activity
cannot continue to replace prepayments, future loan servicing revenues will
decline. Higher levels of loan prepayments also increase the Company's
amortization of purchased mortgage servicing rights to reflect a shorter
expected life of loans serviced. The Company's servicing portfolio carries a
weighted average interest rate of approximately 7.89% resulting in stable and
expected prepayment levels for the Company.
Higher interest rates historically slow prepayments in the Company's
servicing portfolio because they tend to decrease the level of home purchases
and refinancing of existing mortgage debt. Although interest rates had until
recently dropped, management believes that the decline was not sufficient, in
light of the recent historically low interest rates, to affect levels of loan
prepayments. See "Amortization of Mortgage Loan Servicing Contracts."
Variations in interest rates may also impact revenue from the sale of
servicing rights. To the extent that it's origination volume varies, the Company
may have more or less servicing rights available for sale or retention. Market
expectations regarding future mortgage loan prepayments and other supply and
demand factors may influence the price the Company receives for servicing
rights. At September 30, 1996, the principal balance of mortgage loans in the
Company's servicing portfolio were primarily located in the states of California
(32.3%), Maryland (12.7%), Virginia (11.4%), New York (9.8%) and Washington
(7.7%) (see the "Geographic Distribution of Mortgage Loan Servicing Portfolio"
table in "Part I, Item 1. Business-Mortgage Loan Servicing"). Economic slow
downs in the states in which the Company's business is conducted, may result in
a decline in the Company's results of operations in the future to the extent
such decline affects loan origination volumes or levels of loan delinquency and
defaults.
Effect of Inflation. The Company's mortgage banking operations are affected by
inflation primarily through its impact on interest rates. See above.
Accounting for Mortgage Banking Activities. For the year ended September 30,
1995 and all prior years, the cost of purchased mortgage servicing rights
("PMSR") is capitalized and amortized over the estimated remaining life of the
related loans proportionate to the estimated discounted net servicing income on
a disaggregated basis. The Company monitors changes in interest rates,
prepayment and default experience on the mortgage loans underlying its PMSR's
and, to the extent unanticipated mortgage prepayments and/or defaults occur,
adjusts the amortization on a prospective basis. To the extent that
unanticipated mortgage prepayments result in the carrying value of purchased
servicing rights exceeding estimated discounted future net servicing income, a
write-down of the PMSRs would be made through a charge to current earnings. The
PMSR portfolio is disaggregated by (i) investor type; (ii) remittance type;
(iii) term of loans; (iv) average loan balance; (v) weighted average interest
rate; (vi) weighted average servicing fee; (vii) average custodial account
balances; and (viii) credit worthiness, to include delinquencies,
- 27 -
<PAGE> 30
foreclosures and bankruptcies. From November 1994, when the Company made its
first bulk purchase of PMSRs, through December 1996, the Company's PMSR
portfolio has not experienced any impairment from higher than anticipated
prepayments or defaults. See "Effect Of Interest Rate Fluctuations" above and
Note 2 to the Company's Consolidated Financial Statements.
In May 1995, FASB issued SFAS No. 122 "Accounting for Mortgage Servicing
Rights, an amendment of FASB Statement No. 65" issued for fiscal years beginning
after December 15, 1995. The Company has adopted SFAS No. 122 for the year ended
September 30, 1996. The adoption of SFAS No. 122 resulted in an increase in MSRs
and the recognition of an additional $220,000 gain on the sale of mortgage loans
held for sale.
Under SFAS No. 122, when an enterprise purchases or originates mortgage
loans, and the enterprise sells or securitizes the loans and retains the
servicing rights ("MSR"), the enterprise should allocate the cost of the
mortgage loans to the MSRs and the loans based upon their relative fair values.
SFAS No. 122 also requires establishment of a valuation allowance for the excess
of the carrying amount of capitalized MSRs over estimated fair value. On a
periodic basis for purposes of measuring impairment, MSRs are disaggregated and
stratified on predominant risk characteristics, primarily loan type, interest
rate and investor type. Currently, because of the small volume of mortgage loan
originations, the majority of the Company's originations are sold with mortgage
loan servicing released to the purchasers. However, as the Company increases its
origination activity in the future, management anticipates that a
proportionately larger share of the mortgage loan servicing rights will be
retained and not sold. At such time, the application of SFAS No. 122 as it
related to loan originations may have an impact on the Company's financial
condition and statement of operations. As these effects are directly related to
future interest rates and future expenses, as well as management's internal
decisions regarding retention of such rights, it is currently impossible to
quantify the impact of such events.
Organization. In December 1993, FIS was incorporated for the purpose of
acquiring and operating a mortgage/financial services company. Shortly
thereafter, FIS raised $1.75 million through a private offering of securities
for the purpose of acquiring all of the outstanding shares of HOFCA.
On April 29, 1994, FIS purchased all the capital stock of HOFCA from
unrelated individuals. The acquisition was accounted for as a purchase and
accordingly, the basis of the assets and liabilities of HOFCA were restated to
fair value.
On September 30, 1994, the Company (then known as BW Group, Inc.) acquired
FIS, in a reverse acquisition stock exchange. The transaction was accounted for
as a recapitalization of FIS because the stockholders of FIS received a majority
interest (approximately 97%) in the Company in the transaction. Immediately
after the acquisition, the Company changed its name to Homeowners Financial
Corp.
On April 28, 1995, the Company acquired 100% of the outstanding stock of
DMC, the ASC-PMSR and related assets. The financial statements for the year
ended September 30, 1996 include the results of operations of DMC for the entire
period. However, the financial statements for the year ended September 30, 1995
include the results
- 28 -
<PAGE> 31
of operations of DMC only for the period from May 1, 1995 through September 30,
1995. Accordingly, the results of operations of the Company for the fiscal years
ended September 30, 1995 and 1996 are not directly comparable to prior periods.
RESULTS OF OPERATIONS
The Company is a diversified residential mortgage banker which services,
originates and, in most cases, sells mortgage loans secured by one-to-four
family residences. The Company provides a range of mortgage loan products
including, but not limited to fixed rate and adjustable rate loans with a
variety of terms.
The Company's current loan originations are financed through a warehouse
facility from First Bank. Advances under the Facility may not exceed 100% of the
"Warehouse Collateral Value" of the eligible mortgage loans. The maximum amount
of such borrowing under the current revolving facility is $5.0 million. Interest
is charged based upon one of the following three methods: "Fixed Rate,"
"Reference Rate" or "Floating Eurodollar Rate." The applicable method of
interest calculation is at the option of the Company. See "Liquidity and Capital
Resources" below and "Part I, Item 1. Business-Mortgage Loan Origination-Funding
of Mortgage Originations and Purchases."
During the fiscal year ended September 30, 1994, the Company entered into
definitive agreements to acquire approximately $355.0 million of single family
mortgage loan servicing rights. These rights were acquired to replace
manufactured housing rights sold during the year. All servicing acquisitions
contemplated under these definitive agreements were completed in the first
quarter of fiscal 1995. On April 28, 1995, the Company acquired DMC and the
ASC-PMSR, which increased the single family mortgage loan servicing portfolio by
approximately $363 million.
FISCAL YEAR ENDED SEPTEMBER 30, 1996 COMPARED WITH FISCAL YEAR ENDED
SEPTEMBER 30, 1995.
Overview. The Company's net loss for the fiscal year ended September 30, 1996
was $650,000 before cumulative preferred dividends of $233,000 as compared with
a net loss of $899,000 for the fiscal year ended September 30, 1995 before
preferred dividends of $192,000. The decrease in net loss before preferred
dividends of $249,000, approximately 27.7%, resulted primarily from an increase
in mortgage servicing and subservicing income to $2.9 million from 2.3 million,
approximately $619,000, a 27.3% increase. The increase in mortgage servicing and
subservicing was partially offset by an increase in amortization of purchased
mortgage servicing rights to 780,000 for the fiscal year ended September 30,
1996 from $504,000 for the fiscal year ended September 30, 1995, an increase of
276,000 or 54.8%. Cumulative preferred stock dividends increased $41,000 to
$233,000 for the fiscal year ended September 30, 1996 from $192,000 for the
fiscal year ended September 30, 1995. This increase of approximately 21.4%
resulted from the issuance by the Company of Class B and Class C Preferred
shares during the fiscal year ended September 30, 1996. The Company paid
approximately $96,000 in preferred dividends during the fiscal year ended
September 30, 1996 and will not be able to pay additional cumulative accrued
preferred dividends until the Company is in compliance with all provisions of
the First Credit Agreement. See "Liquidity and Capital Resources" below.
- 29 -
<PAGE> 32
Loan Servicing. Mortgage loan servicing and subservicing revenue increased from
$2.3 million for the fiscal year ended September 30, 1995 to $2.9 million for
the fiscal year ended September 30, 1996. This increase in mortgage loan
servicing revenue of $619,000, approximately 27.3%, was primarily the result of
additional servicing fee income from the DMC and ASC-PMSR portfolios.
During the fiscal year ended September 30, 1996, loans paid in full were
$52.3 million which represents an annualized prepayment rate of approximately
7.6%. During the fiscal year ended September 30, 1995, loans paid in full were
$35.9 million which represents an annualized prepayment rate of approximately
5.9%. The higher prepayment rate for the year ended September 30, 1996 was due
to an increase in prepayments relative to the increase in the size of the loan
servicing portfolio resulting from the acquisition of $355.0 million in bulk
PMSRs and the DMC and ASC-PMSR portfolios during the year ended September 30,
1995.
Regular principal reductions, transfers, bulk sales, other reductions and
foreclosures during fiscal 1996 were $101.1 million as compared to $113.6
million during fiscal 1995, a decrease of $12.5 million, approximately 11.0%.
The decrease is primarily attributable to a decline in sales and transfers of
approximately $21.2 million, partially offset by an increase in regular
principal reductions of approximately $8.0 million.
At September 30, 1996, mortgage loans serviced were $587.6 million as
compared to $688.5 million at September 30, 1995, a decrease of $100.9 million,
approximately 14.7%. The decrease results from the fact that the Company was
unable to replace servicing sales and transfers without additional capital.
Management anticipated that it will obtain funding to purchase additional
mortgage loan servicing rights from the proceeds of the Company's IPO (see "Part
III, Item 12. Certain Relationships and Related Transactions").
For the fiscal years ended September 30, 1996 and 1995, foreclosures were
$1.1 million and $.4 million, an increase of $.7 million, approximately 175.0%.
The increase is primarily attributable to the significant increase in the
Company's servicing portfolio during the year ended September 30, 1995,
approximately 202.5%, a dollar volume increase of $461.1 million.
Loan Origination. Loan origination revenue, which includes the fees associated
with the origination process and the net gains or losses on the sale of loans,
was $240,000 for the fiscal year ended September 30, 1996 compared with $261,000
for the same period in 1995. This decrease of $21,000, approximately 8.0%,
reflects a net marketing loss of $57,000 for the fiscal year ended September 30,
1996 as compared to net marketing gains of approximately $178,000 for the year
ended September 30, 1995, substantially offset by an increase in loan
origination fees to $297,000 for the fiscal year ended September 30, 1996 as
compared to loan origination fees of approximately $83,000 for the fiscal year
ended September 30, 1995.
- 30 -
<PAGE> 33
ANALYSIS OF LOAN ORIGINATION REVENUES
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
SEPTEMBER 30,
-------------------
1996 1995
---- ----
($000)
<S> <C> <C>
Loan origination fees $297 $ 83
Net marketing gains (losses) (57) $178
---- ----
Loan origination revenues 240 $261
==== ====
</TABLE>
Net Interest. The Company's net interest cost before interest expense for the
fiscal year ended September 30, 1996 was $74,000 compared with a net interest
cost of 98,000 for the fiscal year ended September 30, 1995. The decrease of
$24,000, approximately 24.5%, was due to an increase in interest income to
approximately $196,000 for the fiscal year ended September 30, 1996 from $93,000
for the fiscal year ended September 30, 1995, an increase of $103,000,
approximately 110.8%. The increase in interest income was partially offset by an
increase in interest expense to $270,000 for the fiscal year ended September 30,
1996 from $191,000 for the fiscal year ended September 30, 1995, an increase of
$79,000, approximately 41.4%. The increases in interest income and interest
expense resulted from greater loan origination activity.
Interest spread on loans held for sale average 5.9% and 6.1% for the
fiscal year ended September 30, 1996 and 1995, respectively. Because the Company
generally holds loans in inventory for less than 90 days, the rate of interest
earned by the Company generally trends up or down with changes in prevailing
mortgage interest rates. The cost of the related debt used to fund mortgage
loans generally trends with movements in short term interest rates, but is less
sensitive to these changes due to the level of compensating balances maintained
by the Company at its creditor banks.
<TABLE>
<CAPTION>
BREAKDOWN OF NET
INTEREST COST
----------------
YEAR ENDED
SEPTEMBER 30,
----------------
1996 1995
----- ----
($000)
<S> <C> <C>
Net Interest cost:
Interest income $ 196 $ 93
Interest expense on warehouse and
other debt $(270) (191)
----- ----
Net interest (cost) $( 74) $(98)
===== ====
</TABLE>
Personnel Costs. Personnel costs for the fiscal year ended September 30, 1996
were $1.4 million compared to $1.3 million for fiscal 1995, an increase of
$80,000, approximately 6.3%. This increase resulted primarily from an increase
in commissions to $88,000 for the fiscal year ended September 30, 1996 from
$18,000 for the fiscal year ended September 30, 1995. The increase of $70,000,
approximately 388.9%, resulted from an increase in loan origination
- 31 -
<PAGE> 34
income to $293,000 for the fiscal year ended September 30, 1996 from $83,000 for
the fiscal year ended September 30, 1995. Commissions are generally calculated
as a percentage of the loan origination fee, and, the percentage is based upon
the volume of business produced monthly by the loan officer. This allows the
Company to match more closely the origination fee income with the related
commission expense. The Company does not anticipate that the amount of
commissions to be paid in future periods will be material to either its
financial condition or its results of operations.
Occupancy, Office and Professional Expenses. Occupancy, office and
professional expenses decreased $115,000, or approximately 11.0%, from $1.0
million during fiscal 1995 to $932,000 during fiscal 1996, primarily due to
efficiencies effected by consolidating servicing operations.
Provision for Loan Losses. Provisions for loan losses net of recovery for
the fiscal year ended September 30, 1996 were $4,000 compared with $53,000 for
fiscal 1995. The decrease of $49,000 represented approximately 92.5%. The
provision is determined by analysis of such factors as the prevailing level of
loan delinquencies, anticipated reinstatement rates from the various stages of
delinquency, and loss experience on similar loans serviced. The Company acts as
the agent for the Mortgage Investor in filing the foreclosure action, and is
indemnified for all costs, losses and claims resulting from the foreclosure
process. Management believes that the reserve remaining on the Company's books
is sufficient to cover the limited amount of recourse exposure in the loan
servicing portfolio. Essentially all of the Company's loan originations were
sold with servicing released to the purchaser. The Company does not require a
loan loss reserve for origination activities because it retained neither the
loans nor the servicing rights of the loans originated during 1995 and 1996. The
Company's purchase of $355.0 million in loan servicing rights resulted in the
Company acquiring from a private, non-RTC seller servicing rights to a
residential mortgage loan portfolio with no delinquency or foreclosure recourse
to the Company. The DMC and ASC-PMSR portfolios were essentially without
recourse to the Company. The investors for whom the portfolios are serviced by
the Company are responsible for all costs, losses and claims resulting from the
servicing of the loans, including loan delinquencies and foreclosure actions.
Therefore no additional provision for loan losses is required. In the future, as
the Company increases originations with servicing rights retained, the Company
will review and adjust its provision for loan losses.
Amortization of Mortgage Loan Servicing Contracts. Amortization of
mortgage loan servicing contracts was $780,000 for the fiscal year ended
September 30, 1996 compared with $504,000 for the fiscal year ended September
30, 1995. The difference is due to the acquisition of $355.0 million of mortgage
loan servicing rights during the first quarter of the fiscal year ended
September 30, 1995 and the acquisition of DMC and the ASC-PMSR on April 28,
1995, which amortization is included for the entire fiscal year ended September
30, 1996.
Management expects that prepayment rates for servicing rights will remain
constant or increase slightly. The effect of lower interest rates, resulting in
potentially greater prepayment risk, is counterbalanced by the economic threat
posed by inflation, which stabilizes or increases interest rates, thereby
reducing prepayment risk. The Company anticipates that the long-term interest
rates will range between 7.50% and 8.50%. The
- 32 -
<PAGE> 35
overall weighted average interest rate for the Company's portfolio is
approximately 7.89%, therefore, management believes that any material increase
in prepayments would not take place until mortgage interest rates reach and
remain below 7.00% for a sustained period.
Nationwide, prepayment speeds for interest rates of 9.00% or more have
increased more than 40% during calendar years 1995 and 1996, prepayment speeds
on interest rates of 8.00% or less have remained constant or decreased. Results
of operations and liquidity for the Company are not likely to be affected
materially by changes in prepayment speeds unless mortgage interest rates
decline to or below the 7.00% level for a sustained period. Management believes
that, if interest rates were to fall to the level where prepayment speeds
increase to the level where results of operations and liquidity are affected,
increased fee income from loan origination volume from the Company's Minnesota
office would significantly offset the impact on results of operations and
liquidity. The Company would seek to refinance that portion of its servicing
portfolio that was most susceptible to prepayment, retaining the loan servicing
rights on the refinanced loans.
The $355.0 million servicing rights acquisition and the DMC and ASC-PMSR
portfolios were not directly purchased from RTC. The Company has not experienced
and does not anticipate any significant or extraordinary servicing costs or
problems including delinquencies from these portfolios.
Other Operating Expenses. Other operating expenses were $549,000 during
fiscal 1996 compared with $567,000 during fiscal 1995, a decrease of $18,000, or
approximately 3.2%.
Income Taxes. There was no income tax provision or benefit for the fiscal
year ended September 30, 1996. Income tax expense reflected a tax benefit of
$61,000 for the fiscal year ended September 30, 1995. The difference between the
effective tax rate and the statutory rate is principally due to the application
of net operating losses.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary short-term liquidity requirements are for its
mortgage loan fundings and advances that it is required to make related to its
obligations as a servicer of loans. These requirements are generally met through
short-term warehouse borrowings, other short-term borrowings and from cash flow
from operations. The Company also has longer term liquidity requirements,
principally related to acquired mortgage loan servicing contracts, which are
funded with longer term debt.
During the fiscal year ended September 30, 1995, the Company had a net
decrease in cash and cash equivalents of $1.7 million. During the fiscal year
ended September 30, 1996, the Company had a net increase in cash and cash
equivalents of $159,000. Net cash used in operating activities of $3.0 million
for the year ended September 30, 1996 and net cash provided by operating
activities of $37,000 during the year ended September 30, 1995, reflected net
losses of $650,000 and $889,000, respectively, plus adjustments to the net
losses of $2.4 million and $936,000, respectively, which consisted of noncash
amortization of mortgage loan servicing contracts, an increase in accrued income
and servicing receivables and purchase and sale of mortgage loans held for sale
and the proceeds from such sales.
- 33 -
<PAGE> 36
Net cash used in investing activities was $193,000 for the year ended September
30, 1996 and net cash used in investing activities was $2.3 million for the year
ended September 30, 1995. Net cash provided by financing activities of $3.4
million and $602,000 for the fiscal years ended September 30, 1996 and September
30, 1995, respectively, was primarily due to a repurchase agreement financing
transaction and an increase in term debt, respectively.
Changes in the level of mortgage loans held for sale and the related
warehouse debt reflect, among other factors, the general level of, and trends
in, mortgage interest rates, the seasonality of home purchase activity and the
discontinuance of manufactured home lending activities and the shift to
one-to-four family residential mortgage lending.
In order to finance a portion of the acquisition of the $355.0 million in
mortgage loan servicing rights, on November 18, 1994, the Company entered into a
nonrevolving 36-month term loan agreement with Franklin Federal Bancorp
("Franklin") in the amount of $2.0 million which enabled the Company to finance
the purchase of the mortgage loan servicing rights. The Franklin term loan was
refinanced with part of the proceeds from a term loan from First Bank (see
below). The remainder of the $3.3 million purchase price for the $355.0 million
in mortgage loan servicing rights was funded from proceeds from the sale of
manufactured housing servicing rights and funds on hand (primarily from the
proceeds of FIS' private offering of preferred stock, common stock and
warrants).
On April 28, 1995, the Company acquired all of the issued and outstanding
stock of DMC, the ASC-PMSR and related assets for approximately $2.89 million.
The Company had the right, within one year, to require the repurchase or
correction of any loans acquired in the transaction that do not meet certain
Agency eligibility standards. The Company has filed a timely repurchase notice
with ASC. As of the date hereof, management believes that approximately $500,000
of the loans acquired do not meet such standards; however, no assurance can be
given as to whether any or all of the loans in question will be repurchased.
The Company obtained a portion of the funds used to purchase DMC and the
other assets discussed above from two loans - a $695,489 loan from Barnett Bank
("Barnett") and a $675,000 loan from ISB. The Barnett loan accrues interest at
.75% over Barnett's prime rate; interest only is payable monthly and the
principal was due and payable on or before April 27, 1996. In April 1996, August
1996 and September 1996, the Company obtained extensions of the Barnett loan due
date in consideration of the payment of fees by the Company equal to .25% of the
loan amount on each extension date ($5,217 in the aggregate). The Barnett loan
expired on December 27, 1996; however, the Company intends to pay off the loan
with a portion of the proceeds of the IPO (see "Part III, Item 12. Certain
Relationships and Related Transactions"). The Barnett loan is principally
secured by specific assets (bonds, certificates of deposit, treasury notes and
shares of stock) of certain stockholders of the Company. The ISB loan accrued
interest at the rate of 10% per annum. All of the principal and accrued interest
under the ISB loan were repaid on August 30, 1995. Management paid the balance
of the purchase price and repaid the ISB loan from the proceeds of a $4.0
million term loan from First Bank (see below).
On August 30, 1995, the Company entered into a credit agreement with First
Bank, pursuant to which First Bank committed to loan the Company up to $4.0
million ("First
- 34 -
<PAGE> 37
Term Loan") and provide a warehousing facility to the Company of up to $5.0
million ("First Warehousing Facility").
As of September 30, 1996, and January 16, 1997, the Company's outstanding
principal balance under the First Term Loan was $3.2 million and $3.0 million,
respectively. The Company used the proceeds from this loan to pay the balance of
the purchase price for DMC, the ASC-PMSR and related assets, to repay the ISB
loan and repay the Franklin term loan. Principal under the First Term Loan
accrues interest at the fixed rate of 2.75%. Interest is payable monthly and
five percent of the original principal balance ($200,000) is payable quarterly.
All remaining principal and accrued interest is payable on or before August 30,
2000 or sooner in the event of a default. Events of default include failure to
make required payments, breaches of the terms, representations or warranties
under the First Credit Agreement and related documents, insolvency and material
judgments. The Company must also maintain the following minimum financial
criteria (as defined in the First Credit Agreement as amended): "Adjusted
Tangible Net Worth" ("ATNW") must be at least $2.7 million; the "Adjusted
Leverage Ratio" ("ALR") must be no greater than 4.0-to-1.0; the "Debt Service
Coverage Ratio" ("DSCR") must be at least 1.2-to-1.0; the aggregate principal
balance of mortgage loans serviced must be at least $500 million; and the report
of independent auditor in the Company's audited consolidated financial
statements cannot contain a "going concern" explanatory paragraph.
The Company was in default of the following three minimum financial
requirements under the First Credit Agreement concerning the First Term Loan and
the First Warehousing Facility as of September 30, 1996: ATNW, ALR and DSCR. As
of September 30, 1995, the Company was in default of the ATNW criteria.
The Company's ATNW (as defined in the First Credit Agreement) was $2.8
million at September 30, 1995. The minimum ATNW required under the First Credit
Agreement at that time was $3.0 million. The maximum ALR allowed under the First
Credit Agreement was 3.25 to 1.00. At February 29, 1996, the Company's ALR was
3.41 to 1.00. The minimum DSCR (as defined in the First Credit Agreement) was
required to be 1.20 to 1.00. The Company's DSCR at June 30, 1996 was 1.07 to
1.00. In March 1996, the Company converted $503,000 of debt to equity in the
form of Series B Preferred Stock (see "Part III, Item 12. Certain Relationships
and Related Transactions"). As a result of this conversion, as of March 31, 1996
and June 30, 1996, the Company was in compliance with the minimum ATNW and ALR
requirements. In May 1996, the Company received a waiver of the conditions of
default until September 30, 1996 and First Bank amended the First Credit
Agreement in which it lowered the minimum ATNW from $3.0 million to $2.7 million
and increased the maximum ALR from 3.25 to 1.00 to 4.0 to 1.00. As a condition
to granting the waiver, First Bank required the Company to suspend payments of
all preferred stock dividends, approximately $69,000 on a quarterly basis, until
the Company is in full compliance with all terms and provisions of the First
Credit Agreement. The Company's management has reviewed with First Bank
different cost reduction measures and additional sources of revenue to bring the
DSCR condition of default in to compliance, including consolidation of offices,
staffing adjustments and cash management changes to reduce bank charges and
increase interest income.
- 35 -
<PAGE> 38
At September 30, 1996, the Company's ATNW was $1.5 million, the Company's
ALR was 5.83 to 1.00, the Company's DSCR was 0.57 to 1.00. Management
anticipates that the minimum portion of the Company's IPO will close immediately
after the filing of this Annual Report with the Securities and Exchange
Commission. Upon receipt of the net proceeds from the minimum portion of the
IPO, the Company will be in compliance with the ATNW and the ALR requirements,
but will not be in compliance under the minimum DSCR requirement. However,
management believes, but cannot assure that the purchase of sufficient
additional mortgage loan servicing rights with the proceeds of the IPO and
working capital that will become available if and when the minimum IPO closes
will enable most likely will enable the Company to comply with the DSCR
requirement.
On December 4, 1996, First Bank waived compliance with the DSCR
requirement until March 30, 1997. No assurance can be given that the Company
will be able to effect sufficient cost savings and find additional sources of
revenue to cure the DSCR condition of default. Management believes that First
Bank will continue to work with the Company. If the Company is unable to cure
the DSCR condition of default and First Bank refuses to grant an additional
waiver or if First Bank does not acquiesce to the other current defaults, First
Bank may elect to demand full payment of the outstanding balances of the First
Term Loan and the First Warehouse Facility, $3.0 million and $.3 million,
respectively, at January 16, 1997. If First Bank elects to demand full payment
under the Credit Agreement, and the Company is unable to refinance its debt to
First Bank, the Company's business would be materially adversely affected.
Payment under the First Term Loan is secured by all of the assets of the
Company, including all servicing rights owned by the Company and securities
owned by the Company and FIS. The Company is required to make additional
payments of principal when the outstanding principal balance on the First Term
Loan exceeds the "Qualified Servicing Portfolio Collateral Value" (the lesser of
65% of the value of qualified servicing rights or one percent of the aggregate
principal amount of Mortgage Loans serviced).
The First Warehousing Facility permits the Company to finance mortgage
loan acquisitions and originations up to an aggregate of $5.0 million. Advances
under the Facility may not exceed 100% of the "Warehouse Collateral Value" of
the eligible mortgage loans ("WCV"). The WCV is the lesser of: (a) 98% of the
lesser of the origination or acquisition price of the mortgage loan; the
weighted average purchase price under a Firm or Standby Take-Out Commitment (a
commitment from an investor to purchase a mortgage loan within a specific time
period, under which commitment, respectively, the Company is obligated or has
the right to sell the mortgage loan); or the fair market value of the mortgage
loan; and (b) 100% of the remaining unpaid principal balance of the pledged
mortgage loan. A mortgage loan will be deemed to have no value WCV if: (i) more
than 90 days elapse from the date the mortgage loan was pledged; (ii) more than
45 days elapse from the date the mortgage loan was delivered to an investor for
examination and purchase; (iii) more than 21 days elapse from the date certain
Collateral documents were delivered to an investor for correction or completion;
(iv) a delinquency of at least 60 days has occurred on the mortgage loan; (v)
the mortgage loan ceases to be an eligible mortgage loan (i.e., it is not
entirely owned by the Company, it does not qualify as an Agency eligible
mortgage loan or it does not qualify for purchase under an existing Take-Out
Commitment); or (vi) First Bank notifies the Company that, in its reasonable
opinion, the mortgage loan is not marketable.
- 36 -
<PAGE> 39
Interest is charged based upon one of the following three methods: "Fixed Rate,"
"Reference Rate" or "Floating Eurodollar Rate." The applicable method of
interest calculation is at the option of the Company. The Fixed Rate is a rate
equal to 2.75% for the Term Loan and 1.875% for the Warehouse Loan. The Company
must maintain at First Bank unencumbered deposit balances equal to one hundred
percent (100%) of the loan balances outstanding, plus, regulatory reserve
requirements, in order to obtain the Fixed Rate. The Company maintains
sufficient balances as of the date hereof to obtain the Fixed Rate. In the event
that deposit balances drop below one hundred percent (100%) of the loan balances
outstanding, the Company will pay a fee on the deficiency at a floating per
annum rate which is tied to the "Libor rate." The Reference Rate is equal to the
bank's published rate for its customers, more commonly known as the "prime
rate." The Floating Eurodollar Rate, more commonly known as the "Libor rate," is
based on the daily London Interbank Bank Offered Rates as published in the Wall
Street Journal, plus 1.875% for borrowings against the Warehouse Loan and 2.75%
for borrowings against the Term Loan. The Company also pays a monthly facility
fee of approximately $1,000. All principal and accrued interest is payable on or
before May 29, 1997 or sooner in the event of a default (as discussed above).
The Company must also maintain the above discussed minimum financial criteria.
Payment under the First Warehousing Facility is secured by all of the assets of
the Company. On May 29, 1997, the Company's credit facility is scheduled for
review and renewal by First Bank. Management anticipates, but cannot assure,
that the First Credit Agreement will be renewed. In the event that the First
Credit Agreement is not renewed, the Company will have to seek credit
arrangements from one or more alternative sources. If the Company is unable to
secure such credit arrangements at acceptable rates and terms, the Company's
business will be materially and adversely affected.
Immediately upon acquisition of DMC and the assets and operations of ASC,
the Company effected significant cost reductions, including the following: (i)
reducing staff by approximately 80% in the Minnesota office of DMC without
affecting origination income; (ii) closing the Dallas, Texas servicing center
and consolidating servicing operations in Troy, Michigan, effective June 1,
1995; and (iii) replacing the Company's mainframe servicing software with a less
expensive and more efficient computer network system, as a result of which, the
system support staff for the mainframe based system was no longer needed and
these positions were eliminated. The effect of these cost savings has reduced
expenses to a level at which the Company's management believes that the Company
can operate profitably if the Company is able to close the IPO and use some of
the proceeds therefrom to expand its mortgage loan servicing business.
In addition to the cost cutting activities mentioned above and in "Results
of Operations" above, the Company's refinancing of the Franklin debt with First
Bank resulted in additional savings. Interest on the First Bank debt is
calculated at 2.75% on a fixed rate basis, resulting in an annual savings of
approximately $35,000. The term of the loan has been extended to sixty (60)
months, resulting in annual cash savings of approximately $225,000. The First
Term Loan also provided funding for the balance of the purchase price due DMC
and refinanced the ISB loan. Annual cash savings resulting from refinancing the
Franklin debt is equal to approximately fifty (50) percent of the annual debt
service for the balance of the term loan, which was used to refinance the ISB
loan and to fund the balance due on the DMC acquisition.
- 37 -
<PAGE> 40
In September 1995, the Company sold mortgage loan servicing rights on
outstanding principal balances of approximately $37.1 million of residential
mortgage loans. The sale generated approximately $300,000 of working capital for
the Company. The Company recognized a gain of approximately $51,000 on the sale.
In November 1995, the Company sold mortgage loan servicing rights on
outstanding principal balances of approximately $21.6 million representing land
contract loans. The Company recognized a gain of approximately $10,000 on the
sale.
In April 1996, DMC acquired the servicing rights to residential mortgage
loans with an aggregate outstanding principal balance of approximately $23.6
million pursuant to a pooling and servicing agreement between Homeowner's
Financial Structured Finance Corporation ("HFSFC"), DMC and the Bank of New
York, as Trustee. HFSFC is a special purpose corporation, incorporated in
Delaware by the Company solely for the purpose of issuing mortgage pass-through
securities. The Company is receiving approximately $100,000 annually in
additional servicing fee revenue from the servicing of mortgages under the
pooling and servicing agreement.
In April 1996, the Company released mortgage loan servicing rights on
outstanding principal balances of approximately $9.9 million under the terms of
contractual agreements with mortgage investors. The Company recognized a loss of
approximately $120,000.
In April 1996, the Company released mortgage loan subservicing rights on
outstanding principal balances of approximately $34.0 million under the terms of
contractual agreements with ISB. There was no gain or loss on the transaction.
On June 26, 1996, the Company entered into an agreement to sell
approximately $2.6 million of residential mortgage loans to another mortgage
corporation and to repurchase the residential mortgage loans within one hundred
eighty (180) days. The final repurchase date has been extended to February 28,
1997. This transaction, commonly called a "repurchase" or "repo", is a form of
short-term borrowing permitted under the terms of the First Credit Agreement,
providing, for an interim period of time, additional loan funding capacity in
excess of that allowed under the First Warehousing Facility. The Company
continues to service the residential mortgage loans during the repo period. The
other mortgage company in turn receives a financing fee equal to 10.25% on an
annual basis calculated on the outstanding balance of the residential mortgage
loans purchased. This fee is essentially offset by the interest collected from
the mortgage payments by the Company. In August 1996, the Company repurchased
and sold $1,093,000 of these loans and, to date, has repaid approximately
$481,000. The balance remains a liability of the Company. In January 1997, the
Company repurchased and sold an additional $742,000 of these loans and repaid
all $742,000. See Notes 6 and 15 to the Company's Consolidated Financial
Statements.
In December 1996, mortgage loan servicing rights representing
approximately $31.1 million in unpaid principal were recalled by the owner of
the mortgages in exchange for a termination fee paid to the Company of
approximately $226,000. The Company recognized a loss on the transaction of
approximately $5,000.
- 38 -
<PAGE> 41
The Company has generated sufficient cash flow from operations and
borrowings to cover the principal and interest payments due on the First Term
Loan and the interest payment due on the Barnett loan. If long term interest
rates remain above 7.00% and the Company is able to acquire sufficient mortgage
loan servicing rights with proceeds from the IPO and working capital that will
become available if and when the Company closes the minimum portion of its IPO
(see "Part III, Item 12. Certain Relationships and Related Transactions"), the
Company's management believes, but cannot assure, that net cash flows from
operations will be sufficient to cover principal and interest payments due on
the First Term Loan for a minimum additional twelve month period. If the Company
does not close its IPO and acquire sufficient mortgage loan servicing rights,
the Company would have to find other sources to meet its obligations under the
First Term Loan. The Barnett loan was due by December 27, 1996. A portion of
the proceeds of the IPO will be used to retire the Barnett Loan. Management
anticipates that the minimum portion of the Company's IPO will close
immediately after the filing of this Annual Report with the Securities and
Exchange Commission. If the Company does not close its IPO and repay the loan
with proceeds therefrom or obtain an additional extension, the Company would
have to raise sufficient additional capital to retire the Barnett loan from
other sources (see above).
Pursuant to an agreement between the Company and GNMA that was in effect
prior to February 1992, the Company was required to establish two restricted
cash accounts totaling $1.0 million. Prior to September 30, 1994 and in
accordance with the terms of this agreement, the Company had withdrawn
approximately $300,000. In February 1995, GNMA reduced the restrictions placed
on these Company cash accounts thus releasing approximately $700,000 in funds to
the Company for use in its operations.
The Company continues to maintain a restricted cash account in the amount
of $259,000 which was established as the result of a loan sale and servicing
agreement entered into in July 1992. The Company can only use these funds to
reimburse itself as servicer for expenses it advances in collection, bankruptcy
and collateral protection concerning these loans. Additionally, the purchaser of
the loans has a security interest in these accounts and may make claim to them
to reimburse purchaser for losses attributable to loan defaults. The Company
believes that this restricted cash amount is sufficient to cover any future
collection, bankruptcy and collateral protection losses and expenses related to
these loans.
Potential Liability. HOFCA has received informal notice from GNMA of a potential
claim wherein the Company, under its former ownership and management, allegedly
overcharged GNMA under the terms of certain sub-servicing Agreements. Management
believes that these claims are essentially without merit and special counsel to
the Company has reviewed the claim and the relevant transactions and has
informed the Company of its belief that there are reasonable defenses to GNMA's
claims in any amount which might be material to the Company. However, if this
matter results in substantial liability, the Company's business could be
materially adversely affected. See "Part I, Item 3. Legal Proceedings."
Expansion Plans. The Company's strategy in the mortgage banking area is to
increase the size, diversity and quality of its mortgage loan servicing
portfolio and to expand its origination operations. The Company's acquisition of
DMC is consistent with this strategy. The Company plans to increase the size of
its mortgage loan servicing portfolio by
- 39 -
<PAGE> 42
selectively acquiring mortgage loan servicing rights and by retaining the
servicing rights on a portion of the loans it originates. Management believes
that the Company currently has the loan servicing capacity to increase the size
of its mortgage loan servicing portfolio by an additional 40,000 loans without
incurring significant additional capital expenditures or fixed costs. By
increasing the size of the mortgage loan servicing portfolio and consolidating
the mortgage loan servicing operations of DMC and HOFCA into one facility,
management believes that the Company can enhance its mortgage loan servicing
efficiency and become profitable. Moreover, the Company believes that increasing
the size, diversity, type and quality of its mortgage loan servicing portfolio
will enable it to reduce the effects of unanticipated prepayments resulting from
fluctuations in interest rates and defaults resulting from regional economic
downturns.
The Company has allocated approximately $227,500 (minimum)/up to $3.525
million (maximum) from the net proceeds of the IPO to expand its mortgage loan
servicing portfolio. Management anticipates that such funds will enable the
Company to purchase servicing rights to mortgage loans with between $22.7
million (minimum) and $352.5 million (maximum) in principal balances. Management
believes that it will be able to purchase additional mortgage loan servicing
rights with approximately $75 million of outstanding principal balances using
working capital of approximately $748,000 that will become available if and when
the minimum IPO closes.
The Company has begun the process of expanding its origination activities
by acquiring DMC and by purchasing and reselling whole loan portfolios while
retaining the servicing rights. Through the acquisition and expansion of DMC's
origination operations and whole loan activity, the Company hopes to increase
the volume of new loan originations to a level where originations exceed the
volume of prepayments experienced in its mortgage loan servicing portfolio.
If significantly less than all of the securities offered in the IPO are
sold, the Company most likely will require additional funding to purchase
mortgage loan servicing rights, operate at a profitable level and meet all of
its financial obligations. If such additional funds are needed, the Company
would seek to raise funds through bank financing or one or more additional
equity and/or debt offerings. No assurance can be given that such funding would
be available or, if available, that such funding would be available on terms
acceptable to the Company. If such additional funding were not available, the
Company's operations would most likely be materially and adversely affected.
- 40 -
<PAGE> 43
Item 7. Financial Statements.
The following consolidated financial statements have been prepared in
accordance with the requirements of Item 310(a) of Regulation S-B.
HOMEOWNERS FINANCIAL CORP.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 1996 AND 1995
INDEX
Page No.
--------
Independent Auditors' Report..............................................F-1
Consolidated Balance Sheets As Of
September 30, 1996 and 1995.............................................F-2
Consolidated Statements of Operations For
The Years Ended September 30, 1996 and 1995.............................F-3
Consolidated Statements of Stockholders' Equity
The Years Ended September 30, 1996 and 1995.............................F-4
Consolidated Statements of Cash Flows For
The Years Ended September 30, 1996 and 1995.............................F-5
Notes to Consolidated Financial Statements................................F-7
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures.
There have been no changes in, or disagreements with the Company's
independent accountants with respect to accounting and/or financial disclosure.
- 41 -
<PAGE> 44
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
compliance with Section 16(a) of the Exchange Act.
Name Position(s) Held
---- ----------------
Christian W. Pfluger III(1) President, Chief Executive Officer and Director
Henry B. Leshman Chairman of the Board of Directors
Joseph W. Traxler Treasurer and Chief Financial Officer
Mori A. Schweitzer Secretary and a Director
Leonard Rosen Director
Stephen M. Savage Director
Wayne B. Kight Vice President
- ----------
(1) May be deemed a founder of the Company.
Directors are elected to serve until the next annual meeting of stockholders
and until their successors have been elected and have qualified. Officers are
appointed to serve until the meeting of the Board of Directors following the
next annual meeting of stockholders and until their successors have been elected
and have qualified. The Managing Underwriter of the Company's planned IPO has a
five year right to designate one nominee for election to the Company's Board of
Directors.
A summary of the business experience for each officer and director of the
Company is as follows:
CHRISTIAN W. PFLUGER III, age 43, has been President, Chief Executive
Officer and a Director of the Company since September 1994 and of HOFCA since
April 1994. He has been President and a Director of FIS since inception. Since
June 1991, he has been President and owner of Great Hills Mortgage Co., Inc.
("GHM") in Austin, Texas. GHM was a mortgage loan origination and brokerage
company until April 1994 and is currently inactive. From September 1990 to June
1991, Mr. Pfluger was a consultant to financial institutions, primarily savings
banks and insurance companies. From December 1989 to September 1990, he was
Chief Lending Officer of Bluebonnet Savings Bank, FSB in Dallas, Texas. At
Bluebonnet, Mr. Pfluger was involved in the management of single family
origination and servicing, consumer origination and servicing, construction
lending, wholesale banking operations and commercial lending. From 1976 to 1989,
Mr. Pfluger was President and Chief Executive Officer of Taylorbanc Savings
Association ("Taylorbanc") in Taylor,
- 42 -
<PAGE> 45
Texas. In August 1989, the RTC placed Taylorbanc in conservatorship due to the
insolvency of that institution. Mr. Pfluger received a B.A. in Business Finance
from Southwest Texas State University in 1975.
HENRY LESHMAN, age 66, has been the Chairman of the Board of Directors of
the Company since August 1995, Secretary and a Director of HOFCA since April
1994 and Treasurer and a Director of FIS since April 1994. From September 1994
to August 1995, he was Treasurer a Director of the Company. Mr. Leshman spent 30
years in the aluminum business as an executive with Alside, Inc., a division of
U.S. Steel in sales and marketing. He retired to Boca Raton, Florida in 1984 to
become active as a private investor and as co-owner of a Bubbies Ruggies, Inc.,
a commercial bakery, and Shifco, Inc., a seafood distributor.
JOSEPH W. TRAXLER, age 48, has been Treasurer and Chief Financial Officer of
the Company since August 1995 and is currently the Chief Financial Officer of
DMC. Mr. Traxler has more than twenty-five years of management experience in the
mortgage banking and financial services industries. From July 1993 to May 1995,
Mr. Traxler was employed as a consultant to HUB, Inc., a Minneapolis based
investment banking firm. From September 1990 to July 1993, Mr. Traxler was a
Principal and served as Chief Financial Officer of Sandia Mortgage Corporation
(a public company). From October 1988 to August 1990, Mr. Traxler was a Senior
Vice President and the Chief Financial Officer of Paragon Mortgage Corporation.
From December 1987 to September 1988, Mr. Traxler was a Senior Vice President
and the Chief Financial Officer of Bright Mortgage Company. From 1982 to October
1987, Mr. Traxler was employed by Knutson Mortgage Corporation in a number of
management positions, including Executive Vice President and Chief Financial
Officer. Mr. Traxler is a member of the Minnesota and Illinois Societies of
CPA's. Mr. Traxler received a BS degree in accounting from the University of
Illinois at Chicago in 1970 and a MBA degree in Finance from DePaul University
in 1979.
LEONARD L. ROSEN, age 64, has been a Director of the Company since September
1994, and of HOFCA and FIS since April 1994. Since graduating from City College
of New York in 1954, he has been the owner and operator of J. Rosen Furs, Inc.,
New York, New York. He is also President of nine other companies that sell furs
in the New York area.
MORI A. SCHWEITZER, age 64, has been a Director of the Company since
September 1994, and of HOFCA and FIS since April 1994. He has been Secretary of
FIS since April 1994. Mr. Schweitzer is a retired attorney and an investor.
Since 1990, he also has been a Director of IDM Environmental, Inc., a public
company. Mr. Schweitzer received a Law Degree from Brooklyn Law School in 1956.
STEPHEN M. SAVAGE, age 55, has been a Director of the Company since August
1995. Since 1962, he has been a private investor and manager of real estate.
From 1980 to 1987, Mr. Savage was an Arbitrator for the Better Business Bureau
specializing in HUD cases and automobile "lemon law" disputes. Mr. Savage
received a Law Degree from the University of Baltimore in 1965.
WAYNE B. KIGHT, age 45, has been Vice President for the Company since
September 1994. From 1992 to 1993, he was a Loan Officer for Paine Webber
Mortgage Finance, Inc.
- 43 -
<PAGE> 46
(Mortgage Company) in Columbia, Maryland. From 1982 to 1992, Mr. Kight was
President of Bertram & Daniels, Inc., Financial & leasing consultants, in Coral
Springs, Florida. Mr. Kight received a law degree from Woodrow Wilson College of
Law, Atlanta, Georgia in 1978 and a B.A. in Business Administration, from
Georgia State University of Atlanta, Georgia, in 1974.
Compliance With Section 16(a) of The Securities Exchange Act of 1934
To the Company's knowledge, based solely on a review of such materials as
are required by the Securities and Exchange Commission, no officer, director or
beneficial holder of more than ten percent of the Company's issued and
outstanding shares of Common Stock failed to timely file with the Securities and
Exchange Commission any form or report required to be so filed pursuant to
Section 16(a) of the Securities Exchange Act of 1934 during the fiscal year
ended September 30, 1996, except that: (i) Mori A. Schweitzer failed to file two
Forms 4, relating to an aggregate of two transactions, which transactions were
reported in a Form 5 that was not filed on a timely basis; (ii) Stephen M.
Savage failed to file one Form 4, relating to one transaction, which transaction
was reported in a Form 5 that was not filed on a timely basis; and (iii) the
Company has no record of a Form 5 filing by James A. O'Leary III for the fiscal
year ended September 30, 1996. Mr. Schweitzer's two transactions involved an
aggregate of 8,000 shares and Mr. Savage's transaction involved 5,000 shares.
Item 10. Executive Compensation.
The following table shows all the cash compensation paid or to be paid by
the Company, as well as certain other compensation paid or accrued, during the
fiscal years indicated, to the Chief Executive Officer ("CEO") for such period
in all capacities in which he served. Except for the CFO, no Executive Officer
received total annual salary and bonus in excess of $100,000.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
---------------------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
----------------------------------------- --------------------- --------------------
(a) (b) (c) (d) (e) (f) (g) (h) (i)
- -------------------- ----- -------- ------- --------- ---------- ------- ------- ---------
OTHER RESTRICT- ALL OTHER
ANNUAL ED STOCK LTIP COMPENSA
NAME AND PRINCIPAL BONUS COMPEN- AWARD OPTIONS PAYOUTS -TION
POSITION YEAR* SALARY ($) SATION($) ($) SARs ($) (i)
- -------------------- ----- -------- ------- --------- --------- ------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CHRISTIAN PFLUGER, III 1996 $100,000 $19,200
CEO 1995 $100,000 $12,980
1994 $ 41,667 --
</TABLE>
Directors are not compensated for acting in their capacity as Directors.
Directors are reimbursed for their accountable expenses incurred in attending
meetings and conducting their duties.
- 44 -
<PAGE> 47
1994 Incentive Stock Option Plan
In December 1994, the Company's stockholders authorized the 1994 Incentive
Stock Option Plan (the "ISO Plan") to encourage ownership of shares of Common
Stock by key Employees, non-employee directors and advisors. The ISO Plan covers
an aggregate of 200,000 shares of the Company's stock. Incentive Stock Options
to purchase an aggregate of 24,500 shares at an exercise price of $3.50 per
share have been granted to date. 14,000 of these options have expired due to
employment termination.
Administration
The ISO Plan provides for its administration by the Company's Board of
Directors or a Compensation Committee (the "Committee") appointed by the Board
of Directors. The Committee currently consists of Messrs. Pfluger, Rosen and
Leshman. The Board of Directors or the Committee, as appropriate, has
discretionary authority (subject to certain restrictions) to determine: the
individuals to whom and the time at which incentive stock options ("ISOS") will
be granted; whether the ISOs will be incentive stock options within the meaning
of Section 422 of the Code ("SOS") or non-statutory options ("NSOS"); and the
number of shares subject to such options. The Board of Directors or the
Committee may interpret the ISO Plan and may prescribe, amend and rescind rules
and regulations relating thereto.
Eligibility
Each Participant receiving a SOS must be a key employee (as defined in the
ISO Plan) of the Company or of an affiliate at the time of grant. NSOS may be
granted to key employees, non-key employees, non-employee directors, advisors or
independent contractors.
Option Price
The option price of the common shares subject to an ISO may not be less than
the fair market value of the shares on the date the option is granted. In the
case of an optionee receiving SOS who owns more than 10% of the outstanding
shares of the Company of all classes or any parent or subsidiary thereof (a
"Significant Stockholder"), the option price of the shares may not be less than
110% of the fair market value of the Company's shares on the date the option is
granted. If the common shares are not then quoted on any exchange or quotation
medium at the time the option is granted, then the Board of Directors or the
Committee will use its discretion in selecting a good faith value believed to
represent fair market value.
Termination and Amendment
No ISO's may be granted under the ISO Plan after December 17, 2004. The ISO
Plan may be amended consistent with applicable laws and regulations, suspended
or terminated at any time by the board of Directors. However, stockholder
approval will be necessary to increase the aggregate number of shares covered by
the ISO Plan, and no amendment, suspension or termination may affect any
outstanding option without the written consent of the optionee.
- 45 -
<PAGE> 48
Duration and Exercise of Options
ISO's granted under the ISO Plan may be of such duration as shall be
determined by the Board of Directors or the Committee, but no NSOS may be
exercised more that 11 years after the date of grant and no SOS may be exercised
more that 10 years after the date of grant (which term is limited to 5 years in
the case of any Significant Stockholder).
In the event of the termination of employment of an optionee, all ISO's
previously granted to that employee shall expire within 30 days to six months
after such termination, depending upon the cause of such termination.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
(a) Security Ownership of Certain Beneficial Owners -- The persons listed in
the chart below are known to the Company to be the beneficial owners of more
than 5% of the 4,133,313 Shares of the Company's outstanding Common Stock, $.01
par value, as of January 16, 1997.
(b) Security Ownership of Management -- The number and percentage of Shares
of Common Stock of the Company owned of record and beneficially by each officer
and director of the Company and by all officers and directors of the Company as
a group are set forth on the chart below.
Name and Address Amount of Record
of Beneficial and Beneficial Percent of
Owner Ownership(1) Class (2)
- ---------------- --------------------- ----------
C.W. Pfluger III 1,224,250(3)(4)(5)(7) 29.3%
2075 West Big Beaver Road
Suite 550
Troy, MI 48084
James A. O'Leary III 400,000(6)(8) 9.7%
11811 N. Tatum Blvd.
Phoenix, AZ 85028
Henry B. Leshman 280,000(4)(5)(6)(7) 6.7%
7508 LaPaz Ct.
Boca Raton, FL 33433
Leonard L. Rosen 146,250(4)(5)(6)(7) 3.5%
22659 Esplanada Cir W.
Boca Raton, FL 33433
- 46 -
<PAGE> 49
Mori A. Schweitzer 238,000(3)(4)(5)(6) 5.7%
5300 Longbay Rd.
Red Hook, St. Thomas
U.S. Virgin Islands 00801
Stephen M. Savage 62,500(4)(5)(6)(7) 1.5%
7220 Montrico Drive
Boca Raton, FL 33433
Wayne Kight 23,500(5)(6) *
3279 Clint Moore Rd.
Boca Raton, FL 33496
Joseph W. Traxler -0-(5) *
7825 Washington Ave. South
Suite 650
Bloomington, Minnesota 55439
All officers and
directors as a group
(7 persons) 1,974,500(4)(5)(6)(7) 45.3%
- ----------
* Less than one percent.
(1) All such shares are owned beneficially and of record by the individual or
groups indicated, except as otherwise noted in the footnotes to this
table. See "Part III, Item 12. Certain Relationships and Related
Transactions."
(2) Based upon 4,133,313 shares issued and outstanding as of January 20, 1997.
(3) The voting rights to these shares are subject to a voting trust agreement
("VTA") between Messrs. Pfluger and Schweitzer. Pursuant to the VTA as
amended, the parties thereto agree to vote all shares owned by them for
the election of Messrs. Pfluger and Schweitzer to the Board of Directors
and to vote all shares owned by them as a unit as agreed to by them. In
the event that the parties cannot agree on the desired vote, all parties
agree to vote in accordance with the instructions of the parties holding a
majority of the shares covered by the VTA. See "Part III, Item 12. Certain
Relationships and Related Transactions."
(4) Excludes an aggregate of 350 shares of Series A Preferred Stock owned by
Messrs. Pfluger, Leshman, Rosen and Savage and an aggregate of 328 shares
of Series B Preferred Stock owned by Messrs. Pfluger, Schweitzer and
Savage.
(5) Executive Officer and/or Director. Excludes James A. O'Leary III who
resigned as Chairman of the Board of Directors in June 1995.
- 47 -
<PAGE> 50
(6) For Messrs. O'Leary, Leshman, Rosen, Schweitzer, Savage and Kight,
includes, respectively, 10,000 shares, 20,000 shares, 10,000 shares,
30,000 shares, 17,500 shares and 3,500 shares issuable upon exercise of
options and/or warrants.
(7) For Messrs. Pfluger, Leshman and Rosen includes 40,000 shares each, and
for Mr. Savage includes 20,000 shares, all of which shares are issuable
upon exercise of Class C and Class B warrants.
(8) Includes shares owned by Mr. O'Leary's wife and children.
Item 12. Certain Relationships and Related Transactions.
In December 1994, the Company authorized the issuance of an aggregate of
25,000 shares of Common Stock to GHM, a company owned and controlled by
Christian W. Pfluger, and certain creditors of GHM in cancellation of a $60,000
debt to GHM. The $60,000 represents the last unpaid portion of a May 1994
$220,000 loan from GHM to HOFCA. The shares were issued in March 1995.
In October 1995, Mori A. Schweitzer, a Director of the Company, loaned the
Company $50,000. Interest accrued at the rate of 11% per annum and principal and
all accrued interest were payable on January 9, 1996. As further consideration
for the loan, the Company granted Mr. Schweitzer two year warrants to purchase
up to 20,000 shares of the Company's Common Stock at $2.00 per share. The
proceeds of the loan were used to pay certain of the expenses of the IPO. In
March 1996, Mr. Schweitzer converted the principal and accrued interest on this
loan into Series B Preferred Stock at the rate of $1,000 per share.
In February 1996, Stephen M. Savage, a Director of the Company, loaned the
Company $75,000. Interest accrued at the rate of 10% per annum and principal and
all accrued interest were payable after 90 days. In March 1996, Mr. Savage
converted the principal amount of this loan into Series B Preferred Stock at the
rate of $1,000 per share.
Between January 1996 and March 1996, GHM, a company owned and controlled by
Christian W. Pfluger III, President, Chief Executive Officer and a Director of
the Company, loaned the Company varying amounts of money pursuant to a multiple
advance note ("MA Note"). Interest accrues at the rate of 8% per annum and
principal and all accrued interest were payable on demand or on or before
December 31, 1996, which ever is sooner. The outside loan repayment date was
extended to March 31, 1997. As of March 20, 1996, principal and accrued interest
aggregated approximately $208,000. On March 20, 1996, GHM converted $200,000 of
this loan into Series B Preferred Stock at the rate of $1,000 per share. As of
September 30, 1996, principal and accrued interest aggregated approximately
$12,000.
In March 1996, certain of the Company's creditors, including Messrs Pfluger
(GHM), Schweitzer and Savage (see above) and two stockholders converted an
aggregate of $503,000 of loans into Series B Preferred Stock at the rate of
$1,000 per share. These conversions were effectuated to correct two of the
Company's deficiencies under the First Credit
- 48 -
<PAGE> 51
Agreement. See "Part II, Item 6. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."
The sales of the securities listed above were exempt from registration by
reason of the exemptions provided by Section 4(2) of the Act. In this regard,
the securities were issued to a limited number of investors, all but two of whom
were accredited investors, no general solicitation was used in the offer and
sale of the securities and all investors acquired their securities with
investment intent.
In May 1996, the Company issued 58,608 shares of C Preferred Stock and
warrants to purchase 150,000 shares of Common Stock to a foreign investor for
$200,000. The C Preferred is convertible into shares of Common Stock. The
Company used the proceeds of this offering primarily to pay certain expenses of
the IPO. These securities were sold to an entity that is not a "U.S. person" as
that term is defined under Regulation S and the securities were issued pursuant
to the exemption from U.S. registration provided by Regulation S under the Act.
The Company filed a registration statement with the Securities and Exchange
Commission to sell to the public ("IPO") its Common Stock and Common Stock
purchase warrants ("A" Warrants"). The registration statement was declared
effective on November 12, 1996 and the offering currently is in process. The IPO
is being conducted on a "best efforts, 550,000 share minimum - 1,270,000 share
and 1,270,000 A Warrant maximum" basis. The offering prices are $5.00 per share
and $.15 per A Warrant. Toluca Pacific Securities Corporation is the
underwriter. Cleared funds representing the sale of at least the minimum number
of Shares in the IPO are currently on deposit in the escrow account.
Accordingly, management anticipates that the minimum portion of the Company's
IPO will close immediately after the filing of this Annual Report with the
Securities and Exchange Commission. Notwithstanding the foregoing, no assurance
can be given as to whether or when the Company will complete the IPO.
PART IV
Item 13. Exhibits and Reports on Form 8-K.
Exhibits
3.a Certificate of Incorporation of Company(1)
3.b Amendments to Certificate of Incorporation of Company(1)
3.c Certificate of Designations - Series B Preferred Stock(2)
3.d Certificate of Designations - Series C Preferred Stock(3)
3.e By-Laws of Company(1)
6.a The 1994 Incentive Stock Option Plan(1)
10.a Acquisition Agreement with FIS(1)
10.b Warehouse Credit Agreement with Franklin Federal Bancorp(1)
10.c Servicing Loan Agreement with Franklin Federal Bancorp(1)
10.d Lease Agreement-Dallas(1)
- 49 -
<PAGE> 52
10.e Old ISB Stock Purchase Agreement(3)
10.f DMC Purchase and Sale Agreement(3)
10.g Lease Agreement-Troy(3) 10.h Agreement-FIS acquisition of HOFCA(3)
10.i Barnett Bank Promissory Note(3)
10.j ISB Loan Documents(3)
10.k Voting Trust Agreement and Amendment(3)
10.l Credit Agreement with First Bank National Association(3)
(1) Previously filed as an Exhibit to the Company's Registration Statement on
Form 10-SB, SEC File No. 0-25744, filed with the Commission on or about
March 24, 1995, and incorporated herein by reference.
(2) Previously filed as an Exhibit to the Company's Form 10-KSB for the year
ended September 30, 1995, SEC File No. 0-25744, filed with the Commission
on or about April 26, 1996, and incorporated herein by reference.
(3) Previously filed as an Exhibit to the Company's Registration Statement on
Form SB-2, as amended, SEC File No. 33-94882, initially filed with the
Commission on or about July 20, 1995, and incorporated herein by reference.
Reports of Form 8-K
No reports on Form 8-K were filed during the last quarter of the fiscal
year covered by this report.
Statements contained in this 10-KSB as to the contents of any agreement or
other document referred to are not complete, and where such agreement or other
document is an exhibit to the Company's Registration Statement or is included in
the forms indicated above, each such statement is deemed to be qualified and
amplified in all respects by such provisions.
- 50 -
<PAGE> 53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HOMEOWNERS FINANCIAL CORP.
Dated: January 21, 1997 By: /s/ Christian W. Pfluger III
----------------------------------------
Christian W. Pfluger III, President,
Chief Executive Officer
By: /s/ Joseph W. Traxler
----------------------------------------
Joseph W. Traxler, Treasurer (Principal
Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
- ---------- ----- ----
/s/ Christian W. Pfluger III Director January 21, 1997
- --------------------------
Christian W. Pfluger III
/s/ Henry B. Leshman Director January 21, 1997
- --------------------------
Henry B. Leshman
/s/ Mori A. Schweitzer Director January 21, 1997
- --------------------------
Mori A. Schweitzer
/s/ Leonard L. Rosen Director January 21, 1997
- --------------------------
Leonard L. Rosen
/s/ Stephen M. Savage Director January 21, 1997
- --------------------------
Stephen M. Savage
- 51 -
<PAGE> 54
SUPPLEMENTAL INFORMATION AND EXHIBITS
Supplemental Information to be Furnished With Reports Filed Pursuant to
Section 15(d) of the Act by Registrants Which Have Not Registered Securities
Pursuant to Section 12 of the Act.
NOT APPLICABLE.
- 52 -
<PAGE> 55
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Homeowners Financial Corp.
We have audited the accompanying consolidated balance sheets of Homeowners
Financial Corp. and Subsidiaries ("Successor") as of September 30, 1996 and
1995, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Homeowners Financial
Corp. and Subsidiaries as of September 30, 1996 and 1995, and the results of
their operations and their cash flows for the periods then ended in conformity
with generally accepted accounting principles.
As disclosed in Note 2 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 122, Accounting for
Mortgage Servicing Rights, as of October 1, 1995.
WALLACE SANDERS & COMPANY
Dallas, Texas
January 20, 1997
F-1
<PAGE> 56
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
September 30,
--------------------
1996 1995
-------- -------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 203 $ 44
Cash - restricted 259 255
Mortgage loans held for sale 2,986 478
Mortgage loan held for sale - related party 157 --
Other loans - net of allowance of $75 and $153, respectively 78 --
Mortgage servicing rights - net 5,173 5,825
Accrued income and servicing receivables 557 295
Property, premises and equipment - net 94 181
Deferred stock issuance costs 926 336
Other assets 531 621
-------- -------
$ 10,964 $ 8,035
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Accounts payable and other liabilities $ 1,089 $ 986
Repurchase agreements 1,513 --
Notes payable 6,384 4,989
Notes payable to related parties 18 100
-------- -------
9,004 6,075
Commitments and contingencies -- --
Stockholders' equity
Preferred stock, $.10 par value, 1,000,000 shares authorized
Series A, 1,750 shares issued and outstanding * *
Series B, 503 and no shares issued and outstanding, respectively ** --
Series C, 58,608 and no shares issued and outstanding, respectively 6 --
Common stock, $.01 par value, 10,000,000 shares authorized,
4,131,213 and 4,122,125 shares issued and outstanding,
respectively 41 41
Additional paid-in capital 3,210 2,470
Accumulated deficit (1,297) (551)
-------- -------
1,960 1,960
$ 10,964 $ 8,035
======== =======
</TABLE>
* Preferred stock - series A amount prior to rounding to thousands was $175.
** Preferred stock - series B amount prior to rounding to thousands was $50.
See accompanying notes to consolidated financial statements.
F-2
<PAGE> 57
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Years Ended September 30,
---------------------------
1996 1995
----------- -----------
<S> <C> <C>
INCOME
Mortgage servicing and subservicing income - net $ 2,888 $ 2,269
Interest 196 93
Gain on sale of mortgage loans held for sale 240 261
Gain (loss) on disposition of mortgage servicing rights (87) 51
----------- -----------
3,237 2,674
EXPENSES
Compensation and benefits 1,352 1,272
Office occupancy 330 322
Office supplies and expenses 292 261
Professional services 310 464
Interest 270 191
Provision for estimated losses on loans serviced 4 53
Amortization of mortgage servicing rights 780 504
Other 549 567
----------- -----------
3,887 3,634
NET LOSS BEFORE PROVISION FOR
INCOME TAXES (650) (960)
INCOME TAX (PROVISION) BENEFIT -- 61
----------- -----------
NET LOSS (650) (899)
Less cumulative preferred stock dividends (233) (192)
----------- -----------
Loss attributable to common stock $ (883) $ (1,091)
----------- ===========
Loss per share $ (.21) $ (.27)
=========== ===========
Weighted average shares 4,127,648 4,087,875
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 58
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except shares outstanding)
<TABLE>
<CAPTION>
Shares Outstanding Par Value
----------------------------------- -----------------------------
Preferred Preferred
---------------------- ------------------
A B C Common A B C Common
----- --- ------ --------- ---- ---- -- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1994 1,750 -- -- 4,061,825 $ * $ -- $- $ 41
Stock issued for debt conversion -- -- -- 25,000 -- -- - **
Stock issued for services -- -- -- 35,300 -- -- - ***
Dividends -- -- -- -- -- -- - --
Net loss -- -- -- -- -- -- - --
----- --- ------ --------- ---- ---- -- -------
Balance at September 30, 1995 1,750 -- -- 4,122,125 * -- - 41
Stock issued for cash -- -- 58,608 -- -- -- 6 --
Stock issued for debt conversion -- 503 -- -- -- ** - --
Stock issued for services -- -- -- 9,088 -- -- - ***
Dividends -- -- -- -- -- -- - --
Net loss -- -- -- -- -- -- - --
----- --- ------ --------- ---- ---- -- -------
Balance at September 30, 1996 1,750 503 58,608 4,131,213 $ * $ ** $6 $ 41
===== === ====== ========= ==== ==== == =======
<CAPTION>
Additional
Paid-in Accumulated
Capital Deficit Total
------ ------- -------
<S> <C> <C> <C>
Balance at September 30, 1994 $2,300 $ 540 $ 2,881
Stock issued for debt conversion 60 -- 60
Stock issued for services 110 -- 110
Dividends -- (192) (192)
Net loss -- (899) (899)
------ ------- -------
Balance at September 30, 1995 2,470 (551) 1,960
Stock issued for cash 194 -- 200
Stock issued for debt conversion 503 -- 503
Stock issued for services 43 -- 43
Dividends -- (96) (96)
Net loss -- (650) (650)
------ ------- -------
Balance at September 30, 1996 $3,210 $(1,297) $ 1,960
====== ======= =======
</TABLE>
* Preferred stock amount prior to rounding to thousands was $175.
** Preferred stock amount prior to rounding to thousands was $50.
*** Common stock amount prior to rounding to thousands was $91.
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 59
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1996 1995
-------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (650) $ (899)
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 825 533
Provision for losses 4 53
Interest earned on restricted cash (4) --
Preferred stock issued for interest 3 --
Common stock issued for services 43 110
Gain (loss) on disposal of property, premises
and equipment 28 (9)
Gain on sale of mortgage loans held for sale (240) (261)
Gain (loss) on disposal of purchased mortgage
servicing rights 87 (51)
Purchases of mortgage loans held for sale (19,126) (6,656)
Proceeds from sale of mortgage loans
held for sale 16,701 7,584
Recoveries (losses) on mortgage loans
serviced and held for sale 4 248
Change in assets - (increase) decrease
Accrued income and servicing receivables (262) 319
Other assets 82 (129)
Deferred stock issuance costs (590) (336)
Change in liabilities - increase (decrease)
Accounts payable and other liabilities 92 (469)
-------- -------
Net cash provided by (used in)
operating activities (3,003) 37
-------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 60
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(in thousands)
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1996 1995
------- --------
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Cash - restricted -- 719
Receipts from other loans -- 54
Proceeds from sale of purchased mortgage
servicing rights 10 254
Purchases of purchased mortgage servicing
rights (225) (3,294)
Proceeds from sale of property, premises and
equipment 22 25
Purchases of property, premises and equipment -- (84)
Acquisition of businesses -- 24
------- --------
Net cash used in
investing activities (193) (2,302)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from repurchase agreements 2,606 --
Repayments of repurchase agreements -- (1,488)
Proceeds from borrowings 8,647 13,505
Repayments of borrowings (8,345) (11,223)
Proceeds from affiliate borrowings 575 100
Repayments of affiliate borrowings (232) (100)
Payment of dividends (96) (192)
Net proceeds from issuance of stock 200 --
------- --------
Net cash provided by
financing activities 3,355 602
------- --------
Net increase (decrease) in cash and cash equivalents 159 (1,663)
Cash and cash equivalents at beginning of period 44 1,707
------- --------
Cash and cash equivalents at end of period $ 203 $ 44
======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 61
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND NATURE OF BUSINESS AND SIGNIFICANT DEVELOPMENTS
On December 17, 1993, FIS, Inc. ("FIS") was incorporated for the purpose of
acquiring a business operating in the mortgage banking industry and commenced
business operations on April 30, 1994 after its acquisition of 100% of the
common stock of Home Owners Funding Corp. of America ("HOFCA") at the end of the
business day, April 29, 1994. HOFCA operates in the mortgage banking industry as
an originator and servicer of mortgage loans.
On September 30, 1994, FIS entered into an acquisition agreement with B.W.
Group, Inc. ("BWG"), a dormant shell corporation. Under the terms of the
agreement, BWG acquired 100% of the outstanding shares of FIS common and
preferred stock in exchange for common and preferred stock of BWG. This stock
exchange resulted in the shareholders of FIS owning approximately 97% and 100%
of BWG's common and preferred stock, respectively. Simultaneously with the
acquisition, BWG changed its name to Homeowners Financial Corp. ("HFC").
For accounting purposes, the BWG acquisition has been treated as a
recapitalization of FIS, or a reverse acquisition, that is, as if FIS had
acquired BWG in exchange for 130,325 shares of common stock. Such stock
represents the post-acquisition shares owned by BWG's pre-acquisition
stockholders. The stockholders' equity reflects the capital structure of FIS
recording the acquisition of BWG as an issuance of stock for assets.
On March 31, 1995, HFC entered into an agreement to purchase from Inter Savings
Bank, fsb ("ISB"), 100% of the outstanding stock of Developers Mortgage
Corporation ("DMC") and certain other assets of ISB's parent for approximately
$2,894,000. The acquisition, financed primarily with debt, was consummated on
April 28, 1995.
The purchase price of DMC has been allocated as follows (in thousands):
<TABLE>
<S> <C>
Cash $ 112
Purchased mortgage servicing rights 2,503
Other assets 518
------
3,133
Liabilities assumed (239)
------
$2,894
------
</TABLE>
F-7
<PAGE> 62
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. ORGANIZATION AND NATURE OF BUSINESS AND SIGNIFICANT DEVELOPMENTS
(CONTINUED)
The operating results of the DMC acquisition are included in the Company's
consolidated results of operations from the date of acquisition. The following
unaudited pro forma summary presents the consolidated results of operations as
if the acquisition had occurred on October 1, 1994, after giving effect to
certain adjustments, primarily depreciation. These pro forma results have been
prepared for comparative purposes only and do not purport to be indicative of
what would have occurred had the acquisition been made as of that date or of
results which may occur in the future.
<TABLE>
<CAPTION>
Year Ended
September 30,
1995
-------------
<S> <C>
Revenue $ 3,057
-------
Net loss $(1,869)
-------
Net loss per share $ (.46)
=======
</TABLE>
On March 1, 1996, HFC incorporated a wholly owned subsidiary, Homeowner's
Financial Structured Finance Corporation ("HFSFC"). HFSFC is a special purpose
corporation formed solely for the purpose of issuing mortgage pass-through
securities.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Homeowners
Financial Corp. and its wholly owned subsidiaries, DMC, HFSFC, FIS, and FIS's
wholly owned subsidiary, HOFCA (collectively referred to as the "Company").
All significant intercompany accounts and transactions are eliminated.
Cash and Cash Equivalents
Cash and cash equivalents include unrestricted cash on hand and investments with
original maturities of three months or less. Cash balances having restrictions
as to withdrawals and usage are recorded in the balance sheet as restricted
cash.
F-8
<PAGE> 63
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the lower of cost or market
determined on a net aggregate basis.
Other Loans
Other loans consist of commercial loans carried at their unpaid principal
balance, net of any allowance for loan losses.
Investment in Foreclosures
Manufactured homes acquired through foreclosure are carried at the lower of cost
or fair value at the time of foreclosure. Subsequently, the carrying values of
foreclosed assets are periodically evaluated and adjustments are made to net
realizable value, when appropriate.
Foreclosed real estate is carried at the lower of cost or fair value minus
estimated selling costs.
Allowance for Losses
Possible losses on loan portfolios serviced are provided for based on
management's evaluation of each situation, including the determination of
collectibility and net realizable value of the asset or underlying collateral.
Mortgage Servicing Rights
For the periods prior to October 1, 1995, the Company followed SFAS 65
"Accounting for Certain Mortgage Banking Activities", in which the cost of
mortgage servicing rights ("Mortgage Servicing Rights" or "MSRs") is capitalized
and amortized over the estimated remaining life of the related loans
proportionate to the estimated discounted net servicing income on a
disaggregated basis. The Company monitors changes in interest rates, prepayment
and default experience on the mortgage loans underlying its MSRs and, to the
extent unanticipated mortgage prepayments and defaults occur, adjusts
amortization on a prospective basis. To the extent that unanticipated mortgage
prepayments result in the carrying value of purchased servicing rights exceeding
estimated discounted future net servicing income, a write-down of the MSRs would
be made through a charge to current earnings. The MSR portfolio is disaggregated
by (i) investor type, (ii) remittance type, (iii) term of loans, (iv) average
loan balance, (v) weighted average interest rate; (vi) weighted average
servicing fee, (vii) average custodial account balances; and (viii) credit
worthiness, to include delinquencies, foreclosures and bankruptcies.
F-9
<PAGE> 64
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Effective October 1, 1995, the Company adopted SFAS No. 122 "Accounting for
Mortgage Servicing Rights", an amendment of FASB Statement No. 65. Under SFAS
No. 122, when an enterprise purchases or originates mortgage loans, and the
enterprise sells or securitizes the loans and retains the servicing rights the
enterprise should allocate the cost of the mortgage loans to the MSRs and the
loans based upon their relative fair values. Currently, because of the small
volume of mortgage loan originations, the majority of the Company's originations
are sold with mortgage loan servicing released to the purchasers. However, as
the Company increases its originations activity in the future, management
anticipates that a proportionately larger share of the mortgage loan servicing
rights will be retained and not sold. SFAS No. 122 also requires establishment
of a valuation allowance for the excess of the carrying amount of capitalized
mortgage servicing rights over estimated fair value. On a periodic basis for
purposes of measuring impairment, MSRs are disaggregated and stratified on
predominant risk characteristics, primarily loan type, interest rate and
investor type. The effect of adopting SFAS No. 122 for the year ended September
30, 1996 was to increase MSRs by $220,000 and recognize a gain on the sale of
mortgage loans for a corresponding amount.
In addition, as permitted by SFAS No. 122, the Company has elected to continue
to apply its previous accounting policies for stratifying MSRs to those MSRs
that were capitalized prior to the adoption of SFAS No. 122.
Excess Servicing Rights
Excess servicing rights ("ESR") are recorded when mortgage loans are sold with
servicing retained and represent the approximate present value of the actual
servicing rate in excess of the normal servicing rate. ESRs are amortized over
the estimated remaining life of the related loans. The unamortized cost of the
ESRs and the amortization thereon is periodically evaluated in relation to
estimated future net servicing revenues, taking into consideration changes in
interest rates, current prepayment rates, and expected future cash flows. The
Company evaluates the carrying value of the servicing portfolio by estimating
the discounted future net excess servicing income of the portfolio based on
management's best estimate of remaining loan lives. To the extent that
unanticipated mortgage prepayments result in the carrying value of ESRs
exceeding estimated future excess servicing income, a write-down of the asset
would be made through a charge to current earnings. It is the Company's policy
to sell mortgage loans with a normal servicing fee.
The Company has no ESRs at September 30, 1996 and 1995.
Depreciation and Amortization
Depreciation expense for property, premises and equipment is provided using the
straight-line method over the estimated useful lives of the related assets.
Leasehold improvements are amortized over their estimated useful lives or the
lease term, whichever is shorter.
F-10
<PAGE> 65
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Goodwill acquired in the 1994 acquisition of HOFCA by FIS is amortized over 25
years. The Company assesses the recoverability of this acquired intangible by
determining whether the amortization of the asset balance over its remaining
life can be recovered through the undiscounted future operating cash flows of
the acquired operation. The amount of impairment, if any, is measured based on
projected discounted future operating cash flows. The Company believes that no
impairment has occurred and that no reduction of the estimated useful life is
warranted.
As of September 30, 1996 and 1995, the goodwill resulting from the acquisition
has been included in other assets net of accumulated amortization of
approximately $19,000 and $10,000, respectively.
Deferred Stock Issuance Costs
During 1996 and 1995, the Company has incurred and capitalized accounting,
legal, printing, and other expenses aggregating approximately $926,000 as
deferred stock issuance costs in connection with a proposed public offering of
its common stock. On the date the proposed public offering becomes effective
these deferred stock issuance costs will be charged to additional paid-in
capital. If the public offering were to be abandoned, the deferred stock
issuance costs would be charged to operations.
Sales of Servicing Rights
The Company recognizes gain or loss on the sales of servicing rights when all
risks and rewards have irrevocably passed to the purchasers and there are no
significant unresolved contingencies.
Gains or losses on servicing rights are recognized when the servicing rights are
sold based upon the difference between the selling prices and the carrying
amount of the related servicing rights sold.
Repurchase Agreements
The Company enters into agreements to sell and repurchase certain mortgage loans
held for sale. Due to the agreements to repurchase, the sales of these mortgage
loans are not recorded and the agreements to repurchase are reported as
borrowings collateralized by an approximate equivalent amount of mortgage loans.
F-11
<PAGE> 66
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Mortgage Servicing Revenues
Fees received for servicing mortgage loans owned by investors are generally
based on a stipulated percentage of the outstanding monthly principal balance of
such loans and are payable only out of interest collected from mortgagors.
Servicing fees, late charges and miscellaneous other fees collected from
mortgagors and others are recognized as income when collected. Servicing costs
are charged to expense as incurred.
Escrow, Agency and Fiduciary Funds
The Company maintains certain cash balances on behalf of its servicing customers
and investors as part of its servicing operations. These funds are held in
trust, generally in noninterest bearing bank accounts which are excluded from
the corporate assets and liabilities of the Company.
Income Taxes
Income taxes are provided in accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under SFAS 109,
the deferred tax assets and liabilities are determined based on the difference
between the financial reporting and tax basis of assets and liabilities at
enacted tax rates that will be in effect for the years in which the differences
are expected to reverse.
The Company files state income tax returns in each state in which it operates
and provides for state income tax expense for financial reporting purposes at
the applicable rates. Deferred state income taxes result from timing differences
in the treatment of income and expense items for tax and financial statement
purposes and are insignificant.
Credit Concentrations
As of September 30, 1996, a significant portion of the Company's servicing
portfolio is secured by single-family and manufactured homes located in 48
states with the heaviest loan concentrations (in terms of principal amount) in
the states of California, Maryland, New York and Virginia. The Company's
exposure to credit loss, limited to manufactured housing loans subserviced for
GNMA and serviced for others with limited recourse, may be affected by, among
other things, a downturn in regional local economic conditions.
As of September 30, 1996, the Company's mortgage servicing portfolio is
comprised of a significant amount of mortgage loans that are in the Federal Home
Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage
Association (Fannie Mae) programs. Such concentrations represent approximately
52% and 20%, respectively, of the total principal of the Company's servicing
portfolio.
F-12
<PAGE> 67
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Mortgage Loan Inventory and Origination Pipeline Hedges
In order to offset the risk that a change in interest rates will result in a
decrease in the value of the Company's current mortgage loan inventory or its
commitments to purchase or originate mortgage loans ("Committed Pipeline"), the
Company enters into hedging transactions. The Company's hedging policies
generally require that substantially all of its inventory of conforming and
government loans and the maximum amount of its Committed Pipeline that may close
be hedged with nonmandatory forward delivery contracts. The Company's policy is
to enter into forward delivery contracts on a best efforts basis whereby the
Company is not required to pay any fees for the forward commitment contracts
received from purchasers of the Company's mortgage loans. These contracts are
nonbinding to the Company but obligate the purchasers to take delivery should
the Company desire to complete the transaction.
Financial Instruments with Off-Balance Sheet Risks
At September 30, 1996, the Company's commitments to originate loans approximated
$549,000, substantially all of which had been committed for sale to investors.
The Company is required to make guaranteed principal and interest payments to
investors of the GNMA portfolio subserviced regardless of actual collection from
the mortgagee. In certain instances, the Company is required to buy foreclosed
loans out of a pool and either attempt to have them reinstated or foreclose upon
the manufactured housing collateralizing the loan. A portion of these advances
on GNMA loans are not recoverable and the Company has accrued a liability (see
Note 6) for such losses to be incurred. Loans subjecting the Company to this
kind of risk approximated $525,000 at September 30, 1996.
In addition, the Company is servicing approximately $1,151,000 in limited
recourse loans at September 30, 1996 that relate to servicing purchased from
third parties. The Company is required to absorb certain losses that may be
incurred by these loans up to $259,000.
These financial instruments are collateralized by single-family and manufactured
homes and the Company does not expect losses, if any, in excess of those accrued
to have a material effect upon the Company's financial position.
F-13
<PAGE> 68
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Fair Value of Financial Instruments
Financial instruments consist of cash, mortgage loans and notes payable and have
carrying amounts which approximate their fair values. The following methods and
assumptions were used to estimate those values:
Cash Consists of cash equivalents.
Mortgage loans Marked-to-market based upon estimated
sales prices of similar securities.
Notes payable Estimated based on the current rates
offered on similar terms.
Management Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to prior year's financial statements to
conform to the September 30, 1996 presentation.
NOTE 3. CASH - RESTRICTED
As a result of a loan sale and servicing agreement entered into in July 1992,
HOFCA was required to establish two restricted cash accounts in the original
amounts of $50,000 and $300,000 and grant the purchaser a security interest in
such accounts. These accounts can only be used to reimburse the purchaser for
losses attributable to loan defaults and reimburse the Company as servicer for
expenses it advances in collection, bankruptcy and collateral protection
efforts.
F-14
<PAGE> 69
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. MORTGAGE SERVICING RIGHTS
Changes in MSRs were as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1996 1995
------- -------
<S> <C> <C>
Beginning balance $ 5,825 $ 678
Purchase accounting allocation - 2,559
Additions 248 3,294
Sale of MSR's (120) (202)
Amortization - scheduled (780) (504)
------- -------
$ 5,173 $ 5,825
======= =======
Estimated fair value $ 6,651 $ 6,553
======= =======
</TABLE>
In September 1995, the Company sold MSRs with outstanding principal amounts of
approximately $37,100,000 representing the GNMA residential mortgage loan
servicing that was acquired in the DMC acquisition. The Company recognized a
gain of approximately $51,000 on the sale.
In November 1995, the Company sold MSRs with outstanding principal amounts of
approximately $21,600,000 representing the land contract loan servicing that was
acquired in the DMC acquisition. The Company recognized a gain of approximately
$10,000 on the sale.
In April and June of 1996, the Company released MSRs with outstanding principal
amounts of approximately $9,900,000 and $34,000,000, respectively, under the
terms of contractual agreements with the investors. The Company recognized
losses upon release of approximately $120,000.
In April 1996, DMC acquired the MSRs to residential mortgage loans with an
aggregate outstanding principal balance of approximately $23,600,000 pursuant to
a pooling and servicing agreement between HFSFC, DMC and the Bank of New York,
as Trustee. In accordance with SFAS No. 122, the Company capitalized
approximately $220,000 of MSRs and recognized a gain from the sale of the pass
through securities of approximately $220,000.
F-15
<PAGE> 70
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4. MORTGAGE SERVICING RIGHTS (CONTINUED)
The Company's servicing portfolio is comprised of the following (in thousands):
<TABLE>
<CAPTION>
September 30, September 30,
1996 1995
------------- -------------
<S> <C> <C>
Manufactured housing loans:
Serviced for GNMA 525 $ 720
Serviced with limited recourse 1,149 1,408
Serviced - FHA insured 3,910 3,303
Serviced with no recourse 1,329 4,014
-------- --------
Subtotal 6,913 9,445
Residential mortgage loans with no recourse 526,976 619,704
Residential mortgage loans - FHA insured 53,715 59,309
-------- --------
$587,604 $688,458
-------- --------
</TABLE>
For GNMA loans and other loans with recourse, upon foreclosure the property is
conveyed to the Company and the Company assumes the market risk of disposing of
the property.
Escrow, agency and fiduciary funds maintained in connection with the foregoing
loan servicing were approximately $9,300,000 and $9,300,000 at September 30,
1996 and 1995, respectively.
In certain instances, the Company will buy foreclosed loans out of a pool and
either attempt to have them reinstated or foreclose upon the secured properties.
A portion of these advances on GNMA loans may not be recoverable and estimated
losses have been recognized in accrued loan servicing losses.
F-16
<PAGE> 71
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. PROPERTY, PREMISES AND EQUIPMENT
Property, premises and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
Estimated September 30, September 30,
Useful Lives 1996 1995
------------ ------------- -------------
<S> <C> <C> <C>
Land - $ - $ 50
Furniture, fixtures and equipment 3 - 5 years 173 173
Leasehold improvements 3 - 7 years 9 9
------ ------
182 232
Less: Accumulated depreciation
and amortization (88) (51)
------ ------
$ 94 $ 181
====== ======
</TABLE>
Depreciation expense approximated $37,000 and $29,000 for the years ended
September 30, 1996 and 1995, respectively.
NOTE 6. REPURCHASE AGREEMENT
In June 1996, the Company entered into an agreement with an unrelated mortgage
company ("Lender") to sell and repurchase certain mortgage loans held for sale
approximating $2,606,000. The Company is required by the agreement to make
monthly remittances to the Lender equal to the principal and interest collected
during the servicing of the mortgages. On or before December 24, 1996, the
Company is required to repurchase the mortgages at an amount that will yield a
10.25% return to the Lender.
In August 1996, the Company repurchased and sold approximately $1,093,000 of the
mortgages. The Company delayed the remittance of the $1,093,000 plus accrued
interest to the Lender and, accordingly, that amount is recorded as an unsecured
note payable. (See Notes 7 and 15)
F-17
<PAGE> 72
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. NOTES PAYABLE
The following is a summary of notes payable (in thousands):
<TABLE>
<CAPTION>
September 30,
----------------
1996 1995
------ ------
<S> <C> <C>
Note payable to a bank at prime plus .75%, collateralized by
personal assets of certain shareholders of the Company, and due
on December 27, 1996. $ 695 $ 695
Term note payable to a bank at a variable rate of interest,
collateralized by substantially all of the assets of the Company,
and due at various dates through August 30, 2000. 3,200 3,867
Warehouse credit facility from a bank at a variable rate of
interest, collateralized by substantially all of the assets of the
Company, and due on May 29, 1997. 1,396 427
Borrowing from a mortgage company, bearing interest at 10.25%,
unsecured, and due upon demand. (See Notes 6 and 15) 1,093 --
------ ------
$6,384 $4,989
====== ======
</TABLE>
At September 30, 1996 and 1995, the prime rate was 8.25% and 8.75%,
respectively.
At September 30, 1996, the Company's warehouse credit facility was for an
aggregate $5,000,000 of borrowings of which approximately $3,604,000 was unused.
The credit facility is available to fund origination of mortgage loans and
purchase loans from third party originators. The term note payable and warehouse
credit facility restrict the payment of dividends except for the preferred stock
dividends which were themselves restricted in May 1996.
The term note and warehouse credit facility are charged interest based upon one
of the following three methods, the selection of which is at the option of the
Company:
Fixed Rate: At the per annum rate of 1.875% for the warehousing credit
facility and 2.75% for the term loan. For any interest calculation period
in which the aggregate weighted average daily balances maintained on
deposit with the bank by the Company are less than an amount equal to the
weighted average daily aggregate unpaid principal balance owed to the
bank, then the Company will pay a fee on the deficiency at a floating per
annum rate which is tied to LIBOR.
F-18
<PAGE> 73
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. NOTES PAYABLE (CONTINUED)
Reference Rate: At the per annum rate which is most recently publicly
announced by the bank as its "reference rate", which may be a rate at,
above or below, which the bank lends to other persons plus 0% for
warehousing credit facility advances and 1% for term loan borrowings.
Floating Eurodollar Rate: At a per annum floating rate which is tied to
LIBOR plus 1.875% for warehousing credit facility advances and 2.75% for
term loan borrowings.
The Company was not in compliance with certain provisions of the term note and
warehouse credit facility as of September 30, 1995 through March 31, 1996 at
which time the credit facility was amended. The amendment extended the Warehouse
Termination Date, as defined to May 29, 1997. In addition, the Company was not
in compliance with certain provisions of the term note and amended credit
facility as of September 30, 1996 and the months subsequent thereto. The Company
has received a waiver of one such compliance provision, but as of January 20,
1997, no such waiver has been granted by the bank for the remaining compliance
provisions.
At September 30, 1996, future maturities of notes payable after giving effect to
the non-compliance with certain provisions of the term note and warehouse credit
facility are (in thousands):
<TABLE>
<CAPTION>
Year Ending
September 30,
-------------
<S> <C>
1997 $6,384
1998 -
1999 -
2000 -
2001 -
------
$6,384
------
</TABLE>
F-19
<PAGE> 74
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8. ALLOWANCE FOR LOSSES
Activity in the allowance account was as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1996 1995
---- -----
<S> <C> <C>
Beginning balance $183 $ 100
Purchase accounting allocation -- 55
Provision (benefit) for losses 82 (100)
Net recoveries (charge-offs) 4 128
---- -----
$269 $ 183
==== =====
</TABLE>
The allowances for losses were allocated as follows (in thousands):
<TABLE>
<CAPTION>
September 30,
----------------------
1996 1995
--------- ---------
<S> <C> <C>
Accrued loan servicing losses $ 120 $ 100
Servicing receivables 63 -
--------- ---------
$ 183 $ 100
========= =========
</TABLE>
NOTE 9. BENEFIT PLAN
In March 1996, the Company terminated its 401(k) savings plan in connection with
the shifting of its workforce from company employees to leased employees. Upon
termination of the plan, all participants became fully vested and all of the
plan's assets were distributed to the participants.
F-20
<PAGE> 75
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. INCOME TAXES
The provision for income taxes consists of the following components (in
thousands):
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1996 1995
----- -----
<S> <C> <C>
Current benefit $(204) $(200)
Provision for valuation allowance 204 139
----- -----
$ -- $ (61)
===== =====
</TABLE>
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and liabilities are presented below (in thousands):
<TABLE>
<CAPTION>
September 30,
----------------------
1996 1995
--------- ---------
<S> <C> <C>
Tax loss carryforwards $ 2,984 $ 2,780
Less valuation allowance (2,984) (2,780)
--------- ---------
$ -- $ --
========= =========
</TABLE>
The increase in the valuation allowance was approximately $204,000 and $869,000
for the years ended September 30, 1996 and 1995, respectively.
As of September 30, 1996, the Company has loss carryforwards as follows (in
thousands):
<TABLE>
<CAPTION>
Available
Through
------------
<S> <C> <C>
HOFCA pre-acquisition net operating loss $3,061 2009
HOFCA pre-acquisition built-in losses 2,445 Indefinitely
DMC pre-acquisition net operating loss 1,966 2010
HFC and post-acquisition net operating losses 1,304 2011
------
$8,776
------
</TABLE>
As a result of the changes in control resulting from the HOFCA and DMC
acquisitions, the pre-acquisition tax loss carryforwards are subject to annual
utilization limits of approximately $130,000 for HOFCA and $188,000 for DMC.
F-21
<PAGE> 76
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. INCOME TAXES (CONTINUED)
As of January 20, 1997, the Company is in the process of filing its Federal
income tax returns for fiscal years 1994, 1995 and 1996.
NOTE 11. RELATED PARTY TRANSACTIONS
Activity with respect to related party loans was as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1996 1995
----- -----
<S> <C> <C>
Beginning balance $ 100 $ 60
Advances 650 200
Repayments (232) (100)
Interest added to principal of loans 3 --
Related party loans converted to stock (503) (60)
----- -----
$ 18 $ 100
===== =====
Interest expense $ 3 $ 1
===== =====
</TABLE>
During the year ended September 30, 1996, certain directors and shareholders
made loans to the Company. With one exception which bore an effective interest
rate of 13.3%, these loans were noninterest bearing. The loans are unsecured and
due upon demand. In consideration for a portion of these advances, a director
received stock warrants expiring on October 9, 1997 for 20,000 shares of common
exercisable at $2.00 per share.
During the year ended September 30, 1995, the related party loans were unsecured
and were primarily noninterest bearing.
In February 1996, the Company funded a thirty year mortgage for the wife of the
Company's principal shareholder and chief executive officer in the amount of
$157,500. The mortgage has a seven year balloon term, is secured by a single
family residence, and bears interest at 6.375%. The Company was forced to fund
and then remarket the loan when two wholesale investors failed to honor their
commitments to fund the loan. As a result of the failure of the wholesale
investors to honor their commitments, in January 1997, the mortgage was sold to
Fannie Mae at an approximate loss of $3,800.
F-22
<PAGE> 77
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12. STOCKHOLDERS' EQUITY
Preferred Stock
The preferred stock is redeemable at the Company's option upon 30 days notice,
payment of all cumulative dividends and at 102% of cost. The preferred stock
pays cumulative dividends at the following rates:
Series A 11.00%
Series B 12.00%
Series C 12.00%
At September 30, 1996 and 1995, dividends in arrears on the preferred stock were
$153,245 and $16,042, respectively.
In March 1996, $503,000 of related party debt was converted into 503 shares of
Series B preferred stock.
In May 1996, the Company issued 58,608 shares of Series C preferred stock with
warrants to purchase 150,000 shares of common stock to a foreign investor for
$200,000.
Payment of dividends on preferred stock has been suspended as a requirement to
obtain the amendment to the term note and warehouse credit facility and for the
bank's forbearance with respect to the non-compliance issues.
Common Stock
In December 1994, 25,000 shares of common stock were issued as repayment of
related party debt totaling $60,000.
In March 1995 and August 1995, 1,000 and 94,300 shares, respectively, of common
stock were issued in payment of legal and consulting fees aggregating $110,048.
In November 1995 and May 1996, 3,700 and 5,388 shares, respectively, of common
stock were issued in payment of legal fees aggregating $43,070.
Stock Options
In December 1994, the Company instituted an incentive stock option plan ("ISO
Plan") covering key employees, nonemployee directors and advisors. The ISO Plan
has authority to issue an aggregate of 200,000 shares of the Company's stock.
F-23
<PAGE> 78
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12. STOCKHOLDERS' EQUITY (CONTINUED)
Stock option transactions (incentive and nonincentive) were:
<TABLE>
<CAPTION>
Expiration Exercise Number
Month Price of Shares
-------------- ---------- ---------
<S> <C> <C> <C>
Granted in connection with the BWG acquisition July 1997 $ 1.75 21,429
September 1997 $ 3.00 15,000
December 1997 $ 3.50 27,500
--------
Options outstanding at September 30, 1994 $1.75-3.50 63,929
Granted to
Shareholder for services December 1997 $ 3.50 10,000
Employees under the ISO Plan December 1999 $ 3.50 24,500
Directors for services May 1999 $ 3.00 40,000
Shareholders in exchange for the their
providing collateral on borrowings May 1998 $ 3.00 80,000
Exercised --
Expired or canceled due to separation $ 3.50 (10,500)
--------
Options outstanding at September 30, 1995 $1.75-3.50 207,929
Granted --
Exercised --
Expired or canceled due to separation $ 3.50 (3,500)
--------
Options outstanding at September 30, 1996 $1.75-3.50 $204,429
========
</TABLE>
The estimated fair market values of the Company's stock on the effective
issuance dates of the options were less than the option exercise prices.
Consequently, no compensation expense has been recognized with respect to
options granted.
At September 30, 1996, 189,500 shares were available for future grants under the
ISO Plan.
Warrants
In connection with the issuance of the Series A preferred stock, the Company
issued Class A and Class B warrants to its preferred stockholders. The Class A
warrants were for an aggregate 350,000 shares of common stock, exercisable at
$2.00 per share and were to expire on September 30, 1995. The Class B warrants
were for an aggregate 350,000 shares of common stock, exercisable at $3.00 per
share and expire on September 30, 1997.
F-24
<PAGE> 79
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 12. STOCKHOLDERS' EQUITY (CONTINUED)
In September 1995, 20,000 of the Class A warrants were retired and the remaining
330,000 Class A warrants were redesignated as Class C warrants with their
expiration date extended to September 30, 1997. At the same time, 330,000 of the
Class B warrants had their exercise price reduced to $2.00 per share.
In October 1996, as consideration for making advances to the Company, a director
received 20,000 warrants expiring on October 9, 1997. Each warrant is
exercisable for one share of common stock at $2.00 per share.
In May 1996, in connection with the issuance of the Series C preferred stock,
150,000 Class D warrants were issued. Each Class D warrant expires on May 31,
2001 and is exercisable for one share of common stock at $2.00 per share. These
warrants are callable for redemption by the Company commencing on May 31, 1997
upon 30 days notice at a price of $.15 per warrant. Such redemption is
predicated upon the price of the Company's common stock exceeding $7.50 per
share over a defined period of time. The Class D warrants are non-transferable.
Rescission Offer
In April 1995, the Company made a rescission offer to its Series A preferred
stockholders. A possible effect of such offer would have been the repayment to
any electing stockholders of their original investment plus accrued cumulative
dividends through the offer date. The repayment was to be 10% in cash with the
balance in the form of a 36-month note bearing interest at 11%. The amount of
stockholders' equity subject to the rescission offer was $1,750,000 and all
affected stockholders elected not to accept the offer.
NOTE 13. COMMITMENTS AND CONTINGENCIES
GNMA Claims
In March 1995, the Company was informed by GNMA of a potential claim wherein the
Company, under its former ownership and management, allegedly overcharged GNMA
under the terms of certain sub-servicing agreements. The claim alleges an
approximate $3,100,000 projected liability based upon a review of only about one
percent of the transactions performed by HOFCA under its agreements with GNMA.
Management believes that this claim is essentially without merit and special
counsel to the Company has reviewed the claim and the relevant transactions and
has informed the Company of its belief that there are reasonable defenses to
GNMA's claim in any amount which might be material to the Company. GNMA has made
no formal claim or demand for payment or reimbursement under these terminated
sub-service agreements. Management believes that there will be no material
impact from the uncertainty pursuant to SFAS No. 5.
F-25
<PAGE> 80
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Legal Proceedings
In 1994, the Company commenced legal actions against five of the seven former
owners of HOFCA in order to seek relief from its obligations under employment
agreements with the individuals due to their alleged breach of such agreements.
The former owners filed countersuits seeking damages and "bonus compensation."
The Company had accrued the remaining payments due under the employment
agreements at September 30, 1995. The litigation went to mediation during
November 1995. On February 22, 1996, the Company and the seven former owners
entered into a Settlement Agreement and Release. This Settlement Agreement and
Release constitutes full settlement of and release from all claims of both the
former owners and the Company. Upon settlement, the Company paid the former
owners an aggregate amount approximating $46,000 which was expensed in the
accompanying financial statements.
In June 1996, Crescent Real Estate Fund, the Company's former landlord in
Dallas, Texas, commenced an action in Texas District Court, Dallas County, for
past due rent from August 1995 forward. The amount sought is not determinable
from the complaint, but may be in excess of $200,000. The Company disputes the
amount owed, has responded to the complaint and has had the action removed to
the U.S. Federal District Court for the Northern District of Texas, Dallas
Division. The Company intends to vigorously contest the action. The Company's
management does not expect this action to have a material adverse impact on the
financial position or operations of the Company. The Company has accrued $30,000
to settle this action, which amount represents its estimate of the balance due
to the former landlord at the time that the lease was terminated.
Servicing
At September 30, 1996, the Company owed approximately $218,000 to an escrow cash
account that it maintains on behalf of the borrowers of certain of the loans the
Company services. As of January 20, 1997, the escrow account had not been
funded.
Leases
The Company is obligated under non-cancelable leases for office space, all of
which are accounted for as operating leases. The leases expire at various dates
with options for renewals. The leases contain escalation clauses which provide
for increased rental expense, primarily based upon increases in the consumer
price index and real estate taxes. Rent expense approximated $164,000 and
$214,000 for the years ended September 30, 1996 and 1995, respectively.
F-26
<PAGE> 81
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Minimum annual rental commitments on non-cancelable operating leases for
premises are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ending
September 30,
-------------
<S> <C>
1997 $ 99
1998 98
1999 8
2000 -
2001 and thereafter -
------
$ 205
</TABLE>
NOTE 14. SUPPLEMENTAL CASH FLOW INFORMATION
The following is a presentation of supplemental cash flow information and
noncash investing and financing activities (in thousands):
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------
1996 1995
---- ----
<S> <C> <C>
Cash paid for interest $221 $177
---- ----
Cash paid for taxes $ -- $ --
---- ----
Conversion of borrowings to capital $503 $ 60
==== ====
</TABLE>
In connection with the acquisition of DMC during the year ended September 30,
1995, the Company had the following transaction (in thousands):
<TABLE>
<S> <C>
Assets acquired $ 3,133
Liabilities assumed (239)
Debt financing (2,806)
-------
Cash paid 88
Less cash acquired (112)
-------
Net cash paid (received) $ (24)
=======
</TABLE>
In connection with the acquisition of DMC, the Company incurred debt of
$2,806,000.
F-27
<PAGE> 82
HOMEOWNERS FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 15. SUBSEQUENT EVENTS
Issuance of Common Stock for Services Rendered
In November 1996, the Company issued 2,100 shares of common stock to an attorney
in exchange for legal services provided in the approximate amount of $10,500.
Proposed Stock Offering
On November 12, 1996, the Company's registration statement was declared
effective by the Securities and Exchange Commission. The proposed offering is
for a minimum of 550,000 shares and a maximum of 1,270,000 shares of common
stock at an offering price of $5.00 per share. In addition, there is a maximum
of 1,270,000 warrants offered at $.15 per warrant. There is no assurance as to
whether or when the Company will complete the offering.
Disposition of Mortgage Servicing Rights
In December 1996, mortgage servicing rights representing approximately
$31,104,000 of unpaid principal were recalled by the owner of the mortgages in
exchange for a termination fee paid to the Company of approximately $226,000.
The Company recognized a loss on the transaction of approximately $5,000.
Notes Payable
On December 27, 1996, the $695,000 note payable matured and was not paid. No
extension of the due date has been requested.
In October 1996, the Company repaid approximately $481,000 of the unsecured note
payable due to a mortgage company in partial settlement of the reduction in the
repurchase agreement.
Repurchase Agreement
In January 1997, the Company repurchased and sold approximately $742,000 of the
repurchase agreement mortgage loans and remitted the repurchase price plus
accrued interest to the lender.
In January 1997, the lender extended the maturity date of the repurchase
agreement until February 28, 1997. All other terms and conditions remained the
same.
F-28
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> OCT-01-1995
<PERIOD-END> SEP-30-1996
<CASH> 462,000
<SECURITIES> 0
<RECEIVABLES> 979,000
<ALLOWANCES> 344,000
<INVENTORY> 3,143,000
<CURRENT-ASSETS> 4,240,000
<PP&E> 182,000
<DEPRECIATION> 88,000
<TOTAL-ASSETS> 10,964,000
<CURRENT-LIABILITIES> 5,804,000
<BONDS> 0
0
6,000
<COMMON> 41,000
<OTHER-SE> 1,913,000
<TOTAL-LIABILITY-AND-EQUITY> 10,964,000
<SALES> 0
<TOTAL-REVENUES> 3,237,000
<CGS> 0
<TOTAL-COSTS> 3,887,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,000
<INTEREST-EXPENSE> 270,000
<INCOME-PRETAX> (650,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (650,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (650,000)
<EPS-PRIMARY> (.21)
<EPS-DILUTED> (.21)
</TABLE>
