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As filed with the Securities and Exchange Commission on September 16, 1996.
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO __________
COMMISSION FILE NUMBER 0-19604
AAMES FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 95-4340340
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3731 WILSHIRE BOULEVARD, 10TH FLOOR
LOS ANGELES, CALIFORNIA 90010
(Address of principal executive offices, including ZIP Code)
(213) 351-6100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class
COMMON STOCK, PAR VALUE $0.001
PREFERRED STOCK PURCHASE RIGHTS
10.50% SENIOR NOTES DUE 2002
Securities registered pursuant to Section 12(g) of the Act:
Title of each Class
None
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
Indicated by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.[ ]
At August 30, 1996, there were outstanding 15,829,824 shares of
the Common Stock of Registrant, and the aggregate market value of the shares
held on that date by non-affiliates of the Registrant, based on the closing
price ($47.25 per share) of the Registrant's Common Stock on the New York Stock
Exchange was $747,959,184. For purposes of this computation, it has been assumed
that the shares beneficially held by directors and officers of Registrant were
"held by affiliates"; this assumption is not to be deemed to be an admission by
such persons that they are affiliates of Registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement relating to its
1996 Annual Meeting of Stockholders are incorporated by
reference in Items 10, 11, 12 and 13 of Part III of this
Annual Report.
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PART I
ITEM 1. BUSINESS
GENERAL
Aames Financial Corporation (the "Company"), founded in 1954, is
a consumer finance company engaged in the business of originating, purchasing,
selling and servicing home equity mortgage loans secured by single family
residences. The Company's principal market is credit-impaired borrowers who have
significant equity in their homes but whose borrowing needs are not being met by
traditional financial institutions due to credit exceptions or other factors.
The Company focuses its efforts on collateral lending and believes that it
originates and purchases a greater proportion of lower credit grade loans ("C-"
and "D" loans) than most other lenders to credit-impaired borrowers. These lower
credit grade loans are characterized by lower combined loan-to-value ratios and
higher average interest rates than higher credit grade loans ("A-," "B" and "C"
loans). The Company believes lower credit-quality borrowers represent an
underserved niche of the home equity loan market and present an opportunity to
earn a superior return for the risks assumed. Although the Company has
historically experienced delinquency rates that are higher than those prevailing
in its industry, management believes the Company's historical loan losses are
generally lower than those experienced by most other lenders to credit-impaired
borrowers because of the lower combined loan-to-value ratios on the Company's
lower credit grade loans. The mortgage loans originated and purchased by the
Company are generally used by borrowers to consolidate indebtedness or to
finance other consumer needs rather than to purchase homes. Consequently, the
Company believes that it is not as dependent as traditional mortgage bankers on
levels of home sales or refinancing activity prevailing in its markets.
The Company originates and purchases loans through three
production channels. The Company has historically originated its loans through
its retail loan office network. In 1994, the Company diversified its production
channels to include a wholesale correspondent program which consisted initially
of purchasing loans from other mortgage bankers and financial institutions
underwritten in accordance with the Company's guidelines. In fiscal 1996, this
program was expanded to include the purchase of loans in bulk from other
mortgage bankers and financial institutions. On August 28, 1996, the Company
acquired One Stop Mortgage, Inc. ("One Stop"), which further diversified the
Company's production channels to include the originations and purchase of
mortgage loans from a network of independent mortgage brokers. While the Company
intends to continue focusing on its traditional niche in the "C-" and "D" credit
grade loans, the Company also intends to continue to diversify the loans it
originates and purchases through its three production channels to include more
"A-," "B" and "C" credit grade loans. The Company underwrites every loan it
originates and re-underwrites and reviews appraisals on all loans it purchases.
See "-- Mortgage Loan Production -- Underwriting."
Substantially all of the mortgage loans originated and purchased
by the Company are sold in the secondary market through public securitizations
in order to enhance profitability, maximize liquidity and reduce the Company's
exposure to fluctuations in interest rates. In a securitization, the Company
recognizes a gain on the sale of loans securitized upon the closing of the
securitization, but does not receive the excess servicing, which is payable over
the actual life of the loans securitized. The excess servicing represents, over
the estimated life of the loans, the excess of the weighted average interest
rate on the pool of loans sold over the sum of the investor pass-through rate,
normal servicing fee and the monoline insurance fee. The net present value of
that excess (determined based on certain prepayment and loss assumptions) less
transaction expenses is recorded as excess servicing gain or loss at the time of
the closing of the securitization. The Company securitized and sold in the
secondary market $107 million, $317 million and $791 million of loans in the
years ended June 30, 1994, 1995 and 1996, respectively. Each of the Company's
securitizations has been credit-enhanced by insurance provided by a monoline
insurance company to receive ratings of "Aaa" by Moody's Investors Service and
"AAA" from Standard & Poor's.
The Company retains the servicing rights (collecting loan
payments and handling borrower defaults) to substantially all of the loans it
originates or purchases. At June 30, 1996, the Company had a servicing portfolio
of $1.25 billion, 27% of which was serviced by subservicers. In fiscal 1996, the
Company serviced directly all
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loans in its servicing portfolio which were secured by mortgaged properties
located in Arizona, California, Colorado, Nevada, Oregon, Utah and Washington.
Loans secured by properties located in other states were serviced through one or
more subservicers which were paid a fee per loan and a participation in certain
other fees paid by the borrowers. The Company will implement in fiscal 1997 a
new servicing system which will provide the Company the capability to service in
house all loans originated or purchased by it regardless of the state in which
the mortgaged property is located. See "-- Loan Servicing."
BUSINESS STRATEGY
The Company's strategy is to continue to build on its position as
a leading lender to credit-impaired borrowers. The expansion of the Company's
business over the last three years has been driven by the growth in the volume
of loans originated and purchased by the Company and by the Company's ability to
continue to access the capital markets to facilitate the sale of these loans
through securitizations. The Company intends to pursue its growth strategy by
(i) continuing to expand its retail loan office network, wholesale correspondent
program, and independent broker network, (ii) increasing its servicing portfolio
and servicing capabilities; (iii) continuing to enhance its corporate and
operating infrastructure and (iv) diversifying its funding sources. An important
long-term goal of the Company's business strategy is to continue to build its
excess servicing receivable, mortgage servicing rights and residual assets
("Excess Spread Receivables"). The Company believes that its investments in
these assets yield attractive cash on cash returns. In addition, the Company
believes its cash flow profile will change over time as the rate of loan
production growth moderates and as the size of its servicing portfolio and its
Excess Spread Receivables increases. In particular, the Company intends to
employ the following strategies:
Geographic Diversification. The Company plans to continue the
geographic expansion of its loan production. During fiscal 1996, the Company
expanded its retail loan office network into the Midwest and East and continued
to expand its wholesale correspondent network. The Company intends to continue
focusing on its expansion in the Midwest and East and to expand its loan
purchasing capabilities by building new relationships with loan correspondents
and, with the acquisition of One Stop, independent mortgage brokers nationwide
with the goal of increasing market share in these areas.
Diversification of Loan Production Channels. At the beginning of
fiscal 1994, the Company originated virtually all of its mortgage loans through
its retail loan office network. Since that time, the Company has been pursuing a
strategy of diversifying its loan production. The Company has developed a
wholesale correspondent program and has recently added a network of independent
brokers as a production source when it acquired One Stop. The Company intends to
increase production through each of these channels and to diversify the loans it
originates and purchases to include more "A-," "B" and "C" credit grade loans.
Increase Servicing Portfolio; Increase Margins and Develop
Subservicing Capabilities. The Company plans to build the size of its servicing
portfolio to provide a stable, and ultimately a significant, source of recurring
revenue. On June 30, 1996, the Company's servicing portfolio was $1.25 billion,
up 105% from $609 million at the end of the prior year. The Company expects to
increase the size of its loan servicing portfolio by continuing to increase loan
originations and purchases and completing new securitizations. To service this
greater volume and to provide the Company with the capability of servicing its
entire portfolio, the Company is investing in a new servicing system which is
expected to be on line prior to the end of fiscal 1997. This new operation is
expected to increase margins in the Company's servicing operations and to
provide the Company with the capability of subservicing for other mortgage
bankers, a potential new revenue source.
Continue to Enhance Corporate and Operational Management and
Infrastructure. From June 30, 1994 to June 30, 1996, the Company's revenues and
net income grew 255% and 485%, respectively, and its employee base grew from 303
employees at June 30, 1994 to 672 employees at June 30, 1996. To support this
significantly larger operation, the Company has invested in additional corporate
and operating management and infrastructure. The Company has also expanded its
telemarketing operations, including a predictive dialer system which is expected
to be fully operational in fall 1996.
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Continue to Diversify Funding Sources. The Company intends to
continue to expand and diversify its funding sources by adding additional
warehouse and residual financing facilities and seeking to increase the advance
rates on existing and new facilities. In addition, the Company intends to obtain
higher credit ratings by improving its financial condition and operating
results. The Company believes that higher credit ratings, as well as obtaining
higher advance rates on warehouse and residual facilities, should improve the
Company's cash flow over time. In particular, higher credit ratings could
facilitate the Company's use of letters of credit in lieu of cash in
overcollateralization accounts, and the Company's obtaining debt financing at a
lower cost. In addition, the Company intends to improve its liquidity by
exploring alternatives, including: (i) whole loan sales, (ii) monetization of
the excess servicing receivable asset (including sale of interest-only strips),
and (iii) use of senior/subordinated securitization structures which may be more
cash flow efficient than buying monoline insurance. The Company also believes it
will improve its cash flow by improving the efficiency of its servicing
operations and realizing overall operating leverage over time as cash expenses
grow at a slower rate than cash receipts.
RECENT DEVELOPMENTS
One Stop Acquisition. On August 28, 1996, the Company acquired
One Stop, a residential mortgage lender specializing in originating and
purchasing home equity mortgage loans made to credit-impaired borrowers from a
network of independent mortgage brokers. At August 31, 1996, One Stop operated
in 26 states out of 24 offices. The acquisition is part of the Company's
strategy to diversify its mortgage loan production sources and to expand the
geographic scope of its operations. The acquisition was accomplished through the
merger of a wholly-owned subsidiary of the Company into One Stop, in a tax-free
exchange accounted for as a pooling-of-interests.
Under the terms of the acquisition, each outstanding share of One
Stop Common Stock was converted into the right to receive 16,479.4 shares of the
Company's Common Stock. The Company issued 2.3 million shares of its Common
Stock, representing approximately 14.7% of its issued and outstanding shares
(after giving effect to the acquisition), 102,750 shares of which have been
placed in escrow pursuant to an escrow agreement as security for the
indemnification obligations of One Stop and its principal stockholder, to be
released on August 28, 1997. The Company has agreed to use its best efforts to
file certain registration statements under the Securities Act covering
approximately 1.0 million of the shares of its Common Stock issued in connection
with the acquisition. Additionally, the Company assumed options granted to key
employees to purchase approximately 375,000 shares.
For the three month period ended July 31, 1996, One Stop's loan
originations and purchases totaled approximately $126 million. Neil Kornswiet,
the founder of One Stop, will continue as President, Chief Executive Officer and
Chairman of the Board of Directors of One Stop (which will be operated as a
separate subsidiary under the name, "One Stop Mortgage, Inc.") under a five year
employment contract. Mr. Kornswiet will also serve as Executive Vice President
of the Company and will serve on its Board of Directors.
Recent Financings. Since June 30, 1996, the Company has entered
into or renewed warehouse financing facilities, bringing its aggregate
warehousing capacity under all of its warehouse credit facilities at September
10, 1996 to $675 million, and has entered into a $50.0 million credit facility
secured by certain excess servicing receivables.
MORTGAGE LOAN PRODUCTION
The Company's principal loan product is a non-conforming home
equity loan with a fixed principal amount and term to maturity which is
typically secured by a first mortgage on the borrower's residence with either a
fixed or adjustable rate. Non-conforming home equity loans are loans made to
homeowners whose borrowing needs may not be met by traditional financial
institutions due to credit exceptions or other factors and that cannot be
marketed to agencies such as Ginnie Mae, Fannie Mae and Freddie Mac. In
addition, the Company offers junior mortgages and other products in order to
meet a wide variety of borrower needs. In fiscal 1996, the Company obtained its
loans through two primary channels: its retail loan office network, through
which loans are originated by the Company out of its 50 retail loan offices
located in 17 states, and its wholesale correspondent program, through which
loans are purchased from mortgage bankers and other financial institutions. With
the acquisition of One Stop
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on August 28, 1996, the Company expanded its loan production channels to include
a network of independent mortgage brokers, from which loans are submitted to One
Stop for funding or purchase.
The following table illustrates the sources of the Company's loan
production, excluding loans originated or purchased by One Stop during fiscal
1996 in the aggregate amount of $320 million:
FISCAL YEARS ENDED JUNE 30,
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1994 1995 1996
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(IN THOUSANDS)
Retail loans:
Total dollar amount $130,200 $148,200 $220,900
Number of loans 3,373 3,734 4,792
Average loan amount $ 36.6 $ 39.7 $ 46.0
Average initial combined loan to value 52% 55% 60%
Weighted average interest rate 10.3% 11.8% 11.0%
Wholesale correspondent program:
Total dollar amount $ 19,700 $206,800 $628,200
Number of loans 265 2,314 7,166
Average loan amount $ 74.3 $ 89.4 $ 87.7
Average initial combined loan to value NM 65% 66%
Weighted average interest rate NM 11.4% 11.7%
Total loans:
Total dollar amount $149,900 $355,000 $849,100
Number of loans 3,638 6,048 11,958
Average loan amount $ 41.2 $ 58.7 $ 71.0
Average initial combined loan to value 52% 61% 64%
Weighted average interest rate 10.3% 11.6% 11.5%
Retail Loan Office Network. The Company originates home equity
mortgage loans through its network of retail loan offices which, at August 31,
1996, consisted of 50 retail loan offices located in 17 states. The Company is
aggressively pursuing a strategy of expanding its retail loan office network
beyond the 36 offices located in California and the other Western states. Of the
Company's 50 retail loan offices, seven are located in the Midwest and seven are
located along the East Coast. The Company believes that it has significant
additional expansion opportunities in these and other areas.
The Company selects areas in which to introduce or expand its
retail presence on the basis of selected demographic statistics, marketing
analyses and other criteria developed by the Company. Typically, new office
locations have become profitable within 90 days of opening.
The Company's expansion of its retail loan office network has
resulted in significant increases in retail loan production over the last three
fiscal years. The Company originated $130 million, $148 million and $221 million
of mortgage loans through this network in fiscal 1994, 1995 and 1996,
respectively.
The Company generates applications for loans through its retail
loan office network principally through a multimedia advertising program, which
includes the use of direct mailings to homeowners, radio and television
advertising, yellow-page listings, and telemarketing. The Company believes that
its advertising campaigns establish
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name recognition and serve to distinguish the Company from its competitors. The
Company continually monitors the sources of its applications to determine the
most effective methods and manner of advertising.
The Company's advertising invites prospective borrowers to call
its headquarters office through the Company's toll-free telephone numbers. On
the basis of an initial screening conducted at the time of the call, the
Company's customer service representative makes a preliminary determination of
whether the customer and the property meet the Company's lending criteria,
schedules an appointment with an appraiser and refers the customer to the most
conveniently located retail loan office.
The Company's loan officer at the local retail loan office
assists the applicant in completing the loan application, orders a credit report
from an independent, nationally recognized credit reporting agency and performs
various other tasks in connection with the completion of the loan package. The
loan package is then forwarded to the Company's headquarters office for review
by underwriters and for loan approval. If the loan package is approved, the loan
is funded by the Company. The Company's loan officers are trained to structure
loans that meet the applicant's needs, while satisfying the Company's lending
guidelines. If an applicant does not meet the guidelines for the loan applied
for, a different loan that may also serve the applicant's needs is usually
suggested.
Through its retail loan office network, the Company also takes
applications from prospective borrowers who respond to the Company's advertising
but fall outside the Company's target market. These loans may be brokered to
other institutional lenders or to private investors. In these cases, the Company
receives brokerage commissions on loans actually funded.
Wholesale Correspondent Program. The Company purchases closed
loans from mortgage bankers and other financial institutions on a continuous or
"flow" basis, and through bulk purchases. In fiscal 1996, 74% of the Company's
loan production came from these sources. The Company believes that its wholesale
correspondent program represents a cost effective means to increasing loan
production. Although the Company purchases mortgage loans from a variety of
sources, one correspondent represented approximately 32% of total mortgage loans
purchased in fiscal 1996.
Independent Broker Network. On August 28, 1996, the Company
acquired One Stop, and thereby expanded its mortgage loan production sources to
include a network of independent mortgage brokers. Under this program, the
independent mortgage broker identifies the potential applicant, assists the
applicant in completing the loan application and submits the application with
the other documents constituting the completed loan package to One Stop for
underwriting and loan approval. Prior to its acquisition by the Company, a
substantial portion of the loans originated or purchased by One Stop were "A-,"
"B," or "C" loans. Beginning in September 1996, One Stop intends to increase the
percentage of "C-" and "D" loans originated and purchased by it. All loans
originated by One Stop will be underwritten in accordance with the Company's
underwriting guidelines. Once approved, the loan is funded or purchased by One
Stop directly.
Consistent underwriting, quick response times and personal
service are critical to successfully producing loans through independent
mortgage brokers. To meet these requirements, One Stop operates out of 24
offices to service the needs of the independent brokers and loan applicants. One
Stop strives to provide quick response time to the loan application (generally
within 24 hours). In addition, loan consultants and loan processors are
available in the offices to answer questions, assist in the loan application
process and facilitate ultimate funding of the loan.
Underwriting. The Company underwrites every loan it originates
and re-underwrites each loan it purchases, in each case, either utilizing its
staff consisting at August 31, 1996 of 157 full-time appraisers, or a Company-
qualified contract appraiser. The Company's underwriting guidelines are designed
to assess the adequacy of the real property as collateral for the loan and the
borrower's creditworthiness. An assessment of the adequacy of the real property
as collateral for the loan is primarily based upon an appraisal of the property
and a calculation of the ratio (the "combined loan-to-value ratio") of all
mortgages existing on the property (including the loan applied for) bear to the
appraised value of the property at the time of origination. As a lender that
specializes in loans made to credit-impaired borrowers, the Company ordinarily
makes home equity mortgage loans to borrowers with credit histories
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or other factors that would typically disqualify them from consideration for a
loan from traditional financial institutions. Consequently, the Company's
underwriting guidelines generally require substantially lower combined
loan-to-value ratios than would typically be the case if the borrower could
qualify for a loan from a traditional financial institution. Creditworthiness is
assessed by examination of a number of factors, including calculation of
debt-to-income ratios, which is the sum of the borrower's normal monthly
expenses divided by the borrowers's monthly income before taxes and other
payroll deductions, an examination of the borrower's credit history through
standard credit reporting bureaus, and by evaluating the borrower's payment
history with respect to existing mortgages, if any, on the property.
The underwriting of a mortgage loan to be originated or purchased
by the Company includes a review of the completed loan package, which includes
the loan application, a current appraisal, a preliminary title report and a
credit report. All loan applications and all closed loans offered to the Company
for purchase must be approved by the Company in accordance with its underwriting
criteria. On an exception basis, and approval of the Company's underwriters,
home equity mortgage loans may be made that do not conform to the Company's
guidelines but only with the approval of a senior underwriter or by an executive
officer of the Company. The Company regularly reviews its underwriting
guidelines and makes changes when appropriate to respond to market conditions,
because of the poor performance of loans representing a particular loan product
or to respond to changes in laws or regulations. In September 1996, the Company
changed its underwriting guidelines to eliminate one loan purchase product known
as the "no documentation - salaried employee" loan product in the "C-" and "D"
credit grades because of what management believed to be the higher than average
delinquency rates experienced on such loans, raised the combined loan-to-value
ratios of its "A-" credit grade loans to conform to market conditions and
lowered the combined loan-to-value ratios for its "C-" and "D" credit grade
loans made in certain judicial foreclosure states in recognition of the greater
length of time it takes in such states to complete the foreclosure process.
All appraisals in connection with loans originated by the Company
through its retail loan office network are performed by Company appraisers. The
Company's appraisers determine a property's value by reference to the sales
prices of comparable properties recently sold, adjusted to reflect the condition
of the property as determined through inspection. Loans purchased as part of the
Company's wholesale correspondent program are reviewed by Company appraisers or
Company-qualified contract appraisers, to assure that they meet the Company's
standards. All of the Company's appraisers are full-time employees of the
Company and compensated by salary and a bonus that is not dependent on
completion of loan transactions.
The Company requires title insurance coverage issued on an ALTA
form of title insurance on all properties securing mortgage loans it originates
or purchases. The loan originator and its assignees are generally named as the
insured. Title insurance policies indicate the lien position of the mortgage
loan and protect the Company against loss if the title or lien position is not
as indicated. The applicant is also required to maintain hazard and, in certain
instances, flood insurance, in an amount sufficient to cover the new loan and
any senior mortgage, subject to the maximum amount available under the National
Flood Insurance Program.
Quality Control. The Company's quality control program is
intended to (i) monitor and improve the overall quality of loan production
generated by the Company's retail loan office network and its wholesale
correspondent program or loans presented or purchased from its independent
broker network and (ii) identify and communicate to management existing or
potential underwriting and loan packaging problems or areas of concern. The
quality control file review examines compliance with the Company's underwriting
guidelines and federal and state regulations. This is accomplished by focusing
on: (i) the accuracy of all credit and legal information; (ii) a collateral
analysis which may include a desk or field re-appraisal of the property and
review of the original appraisal; (iii) employment and/or income verification;
and (iv) legal document review to ensure that the necessary documents are in
place.
Credit Grades. The Company believes that it originates a greater
proportion of lower credit quality loans ("C-" and "D" loans) than other lenders
who lend to credit-impaired borrowers and as a result has historically
experienced delinquency rates that are higher than those generally prevailing in
its industry. However, the Company has not historically experienced significant
loan losses because its loan portfolio has been characterized by relatively low
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combined loan-to-value ratios. The weighted average initial combined
loan-to-value ratio of loans in its servicing portfolio at June 30, 1994, 1995
and 1996 was 56%, 59% and 63%, respectively. The increase in weighted average
combined loan-to-value ratios at June 30, 1996 reflected a changing mix in the
mortgage loans in the servicing portfolio to include a greater proportion of
first mortgages and higher credit grade loans.
The following chart generally outlines certain parameters of the
credit grades of the Company's underwriting guidelines at September 10, 1996:
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"A-" CREDIT "B" CREDIT "C" CREDIT "C-" CREDIT "D" CREDIT
GRADE GRADE GRADE GRADE GRADE
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GENERAL Has good Pays the Marginal credit Marginal credit Designed to
REPAYMENT credit but majority of history which history not provide a
might have accounts on is offset by offset by other borrower with
some minor time but has other positive positive poor credit
delinquency. some 30- attributes. attributes. history an
and/or 60-day opportunity to
delinquency. correct past
credit
problems
through lower
monthly
payments.
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EXISTING Current at Current at Cannot exceed Must be paid Must be paid
MORTGAGE application application four 30-day in full from from loan
LOANS time and a time and a delinquencies loan proceeds proceeds.
maximum of maximum of or one 60-day and no more Rating not a
two 30-day four 30-day or multiple 30- than 119 days factor.
delinquencies delinquencies day delinquent.
in the past 12 in the past 12 delinquencies
months. months. in the past 12
months.
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NON-MORTGAGE Major credit Major credit Major credit Major and Major credit
CREDIT and installment and installment and installment minor credit delinquency is
debt should be debt can debt can delinquency is acceptable.
current but exhibit some exhibit some acceptable, but
may exhibit minor 30- minor 60- must
some minor and/or 60-day and/or 90-day demonstrate
30-day delinquency. delinquency. some payment
delinquency. regularity.
Minor credit Minor credit
Minor credit may exhibit up may exhibit
may exhibit to 90-day more serious
some minor delinquency. delinquency.
delinquency.
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BANKRUPTCY Charge-offs, Discharged Discharged Discharged Current
FILINGS judgments, more than two more than two prior to bankruptcy
liens, and years with years with closing. must be paid
former reestablished reestablished through loan.
bankruptcies credit. credit.
are
unacceptable.
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DEBT SERVICE- Generally not Generally not Generally not Generally not Generally not
TO-INCOME to exceed to exceed to exceed to exceed to exceed
RATIO 45%. 50%. 50%. 55%. 60%.
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MAXIMUM Generally 85% Generally 80% Generally 70% Generally 65% Generally 65%
LOAN-TO- for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4 for a 1 to 4
VALUE RATIO: family family family family family
dwelling dwelling dwelling dwelling. dwelling.
NON- residence; 70% residence; 65% residence; 65%
OWNER for a for a for a
OCCUPIED condominium. condominium. condominium.
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NON- Generally 70% Generally 65% Generally 65% N/A N/A
OWNER for a 1 to 2 for a 1 to 2 for a 1 to 2
OCCUPIED family family family
dwelling; 65% dwelling; 60% dwelling; 60%
for a 3 to 4 for a 3 to 4 for a 3 to 4
family. family. family.
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The following tables present certain information on the Company's
loan originations through its retail loan office network and loan purchases
through its wholesale correspondent program during fiscal 1995 and fiscal 1996:
Loan Originations and Purchases in Fiscal 1995
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Weighted
Average
Dollar Amount of % of Weighted Average Interest
Credit Grade Loan Total Loan-to-Value Rate
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A- 111,808,000 31% 63% 10.6%
B 55,338,000 16% 65% 11.1%
C 70,515,000 20% 59% 11.7%
C- 53,635,000 15% 62% 12.2%
D 63,629,000 18% 58% 13.3%
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TOTAL $ 354,925,000 100%
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Loan Originations and Purchases in Fiscal 1996
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Weighted
Average
Dollar Amount of % of Weighted Average Interest
Credit Grade Loan Total Loan-to-Value Rate
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A- $ 224,943,000 26% 68% 10.2%
B 143,700,000 17% 68% 10.6%
C 139,329,000 16% 63% 11.5%
C- 106,067,000 12% 63% 12.1%
D 235,018,000 27% 61% 13.1%
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TOTAL $ 849,057,000 100%
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SECURITIZATION OF LOANS
The primary funding strategy of the Company is to securitize and
sell mortgage loans originated or purchased by the Company. Securitization is a
cost competitive source of capital compared to other debt financing sources
available to the Company. Through June 30, 1996, the Company had completed 17
securitizations totaling $1.3 billion. The Company's operations have been
restructured in recent years specifically for the purpose of efficiently
originating, purchasing, underwriting and servicing loans for securitization in
order to meet the requirements of rating agencies, credit enhancers and
investors. The Company generally seeks to complete a securitization once each
quarter. The Company applies the net proceeds of the securitization to pay down
its warehouse facilities in order to make these facilities available for future
funding of mortgage loans.
In a securitization, the Company sells the loans that it has
purchased or originated to a real estate mortgage investment conduit ("REMIC")
for a cash purchase price and an interest in the loans securitized (in the form
of "excess servicing"). The cash purchase price is raised through an offering of
senior pass-through certificates by the trust. Following the securitization, the
purchasers of the senior certificates receive the principal collected and the
investor pass-through interest rate on the certificate balance, while the
Company receives the excess servicing. The excess servicing is typically a
certificated security in the form of a residual certificate, which generally
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represents the excess servicing on the loans. The excess servicing represents,
over the estimated life of the loans, the excess of the weighted average
interest rate on the pool of loans sold over the sum of the investor pass
through rate, normal servicing fee and the monoline insurance fee. The net
present value of that excess (determined based on certain prepayment and loss
assumptions) less transaction expenses is recorded as excess servicing gain or
loss at the time of the closing of the securitization.
The purchasers of the senior certificates receive a
credit-enhanced security. The Company's securitizations have been enhanced
generally through two sources: (i) subordination of an amount of excess
servicing retained by the Company and (ii) an insurance policy provided by an
AAA/Aaa-rated monoline insurance company. As a result, each offering of senior
certificates receives ratings of AAA from Standard & Poor's and Aaa from Moody's
Investors Service.
Each pooling and servicing agreement that the Company has entered
into in connection with its securitizations requires either the establishment of
a reserve account that may initially be funded by cash deposited by the Company
or the overcollateralization of the REMIC trust. The Company's interest in each
overcollateralization amount and reserve account is reflected on the Company's
Consolidated Financial Statements as "residual assets." If payment defaults
exceed the amount of the overcollateralization or the reserve account, as
applicable, the monoline insurance company policy will pay any further losses
experienced by holders of the senior interests in the related REMIC trust. To
date, there have been no claims on any monoline insurance company policy
obtained in any of the Company's securitizations.
In connection with its securitizations, the Company typically
enters into an agreement pursuant to which it agrees to sell loans to the trust
in the future at an agreed-upon price (the "pre-funding"). The pre-funding locks
in the price agreed upon with investors on the pricing date (typically five
business days prior to the closing date of the securitization) for a period of
generally 30 days. In a pre-funding arrangement, the Company typically delivers
approximately 75% of the loans sold at the closing and the remainder generally
within 30 days after the closing.
LOAN SERVICING
Servicing includes collecting and remitting loan payments,
accounting for principal and interest, contacting delinquent borrowers, handling
borrower defaults and liquidating foreclosed properties. The Company retains the
servicing rights to substantially all of the loans it originates or purchases.
The following table sets forth certain information regarding the Company's
servicing portfolio for the periods indicated:
FISCAL YEARS ENDED JUNE 30,
----------------------------------------------------------------------
1994 1995 1996
--------------------- -------------------- ------------------
(IN THOUSANDS)
Loans added to the servicing portfolio........... $ 213,900 $ 354,900 $ 849,100
Servicing portfolio (period end)................. 381,800 608,700 1,250,400
Loan service revenue (1)......................... 6,099 8,246 18,185
- -------------------------
(1) For a description of loan service revenue, see Note 1 of Notes to
Consolidated Financial Statements.
In fiscal 1996 the Company directly serviced all loans in its
servicing portfolio which were secured by mortgaged properties located in
Arizona, California, Colorado, Nevada, Oregon, Utah and Washington. Loans
secured by properties located in other states were serviced through one or more
subservicers which were paid a fee per loan and a participation in certain other
fees paid by the borrowers. The Company is in the process of implementing a new
servicing system which will provide the Company the capability to service
in-house all loans originated or purchased by it regardless of the state in
which the mortgaged property is located. This new servicing system is expected
to be implemented in fiscal 1997. The Company's new servicing system will also
provide the Company the capability of subservicing on behalf of other mortgage
lenders. The Company intends to offer this service in fiscal 1998. The Company
believes that the successful implementation of its new servicing system will
provide it with improved margins on its servicing and potentially a new source
of servicing revenue.
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The pooling and servicing agreements between the Company and the
REMIC trusts established in connection with securitizations typically require
the Company advance interest (but not principal) on delinquent loans to the
holders of the senior interests in the related REMIC trust to the extent the
Company deems such advances of interest to be ultimately recoverable. No
advances are made for interest if the Company deems that the advances are not
ultimately recoverable and no advances are made for payments of principal.
Realized losses on the loans are paid out of the related reserve account or paid
out of principal and interest payments on overcollateralized amounts as
applicable, and if necessary, from the related monoline insurance company
policy.
The pooling and servicing agreements also typically provide that
the Company may be terminated as servicer by the monoline insurance company
which insures the senior interests in the related REMIC trust (or by the trustee
with the consent of the monoline insurance company) upon certain events of
default, including the Company's failure to perform its obligations under the
pooling and servicing agreement, the rate of over 90-day delinquency (including
properties acquired on foreclosure and not sold) exceeding specified limits,
losses on foreclosure exceeding certain limits, any payment being made by the
monoline insurance company under its policy, and certain events of bankruptcy or
insolvency. Serviced loans subject to such agreements represented approximately
84% (by dollar volume) of the Company's servicing portfolio at June 30, 1996. At
June 30, 1996, four REMIC trusts representing approximately 23% (by dollar
volume) of the Company's servicing portfolio exceeded the foregoing delinquency
rate, although the servicing rights of the Company have not been terminated. See
"Item 7. Management's Discussion and Analysis of Financial Condition -- Risk
Factors -- Delinquencies; Negative Impact on Cash Flow; Right to Terminate
Normal Servicing."
The Company receives a servicing fee based on a percentage of the
declining principal balance of each loan serviced. Servicing fees are collected
by the Company out of the borrower's monthly payments. In addition, the Company,
as servicer, generally receives all late and assumption charges paid by the
borrower, as well as other miscellaneous fees for performing various loan
servicing functions. The Company also generally receives any prepayment fees
paid by borrowers.
The Company's servicing portfolio is subject to reduction by
normal monthly payments, by prepayment and by foreclosure. It is the Company's
strategy to build and retain its servicing portfolio. In general, revenue from
the Company's loan servicing portfolio may be adversely affected as interest
rates decline and loan prepayments increase. This effect has historically been
partially offset by increases in prepayment fee income received from borrowers.
In some states in which the Company currently operates, prepayment fees may be
limited or prohibited by applicable law. In addition, the Company's ability to
collect prepayment fees under certain circumstances will be restricted in future
periods under federal regulations which went into effect in 1995. See
"--Regulation."
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The following table illustrates the mix of credit grades in the
Company's servicing portfolio as of June 30, 1996:
- ---------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted
Dollar Amount of Average Average
Credit Grade Loan % of Total Loan-to-Value Interest Rate
- ---------------------------------------------------------------------------------------------------------------------------------
A- $ 308,901,000 25 % 66 % 10.4 %
B 185,892,000 15 % 67 % 10.8 %
C 192,051,000 15 % 62 % 11.6 %
C- 144,565,000 12 % 62 % 12.1 %
D 291,592,000 23 % 60 % 12.9 %
Other 127,406,000 10 % 55 % 12.2 %
-----
---------------------------
Total $ 1,250,407,000 100 %
- ---------------------------------------------------------------------------------------------------------------------------------
COLLECTIONS, DELINQUENCIES AND FORECLOSURES
The Company sends borrowers a monthly billing statement ten days
prior to the monthly payment due date. Although borrowers generally make loan
payments within ten to fifteen days after the due date (the "grace period"), if
a borrower fails to pay the monthly payment within the grace period, the Company
commences collection efforts by notifying the borrower of the delinquency. (In
the case of borrowers in the "C-" and "D" credit grades, collection efforts
begin approximately six days after the due date.) If the loan remains unpaid,
the Company will contact the borrower to determine the cause of the delinquency
and to obtain a commitment to cure the delinquency at the earliest possible
time.
As a general matter, if efforts to obtain payment have not been
successful, a pre-foreclosure notice will be sent to the borrower shortly after
the due date of the next subsequently scheduled installment, providing 30 days'
notice of impending foreclosure action. During the 30-day notice period,
collection efforts continue. However, if no substantial progress has been made
in collecting delinquent payments from the borrower, foreclosure proceedings
will begin. Generally, the Company will have commenced foreclosure proceedings
when a loan is 45 to 60 days delinquent.
Servicing and collection practices change over time in accordance
with, among other things, the Company's business judgment, changes in portfolio
performance and applicable laws and regulations.
Loans originated or purchased by the Company are secured by
mortgages, deeds of trust, security deeds or deeds to secure debt, depending
upon the prevailing practice in the state in which the property securing the
loan is located. Depending on local law, foreclosure is effected by judicial
action or nonjudicial sale, and is subject to various notice and filing
requirements. In general, the borrower, or any person having a junior
encumbrance on the real estate, may cure a monetary default by paying the entire
amount in arrears plus other designated costs and expenses incurred in enforcing
the obligation during a statutorily prescribed reinstatement period. Generally,
state law controls the amount of foreclosure expenses and costs, including
attorneys' fees, which may be recovered by a lender. After the reinstatement
period has expired without the default having been cured, the borrower or junior
lienholder no longer has the right to reinstate the loan and must pay the loan
in full to prevent the scheduled foreclosure sale.
Although foreclosure sales are typically public sales, frequently
no third-party purchaser bids in excess of the lender's lien because of the
difficulty of determining the exact status of title to the property, the
possible
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deterioration of the property during the foreclosure proceedings and a
requirement that the purchaser pay for the property in cash or by cashier's
check. Thus, the Company often purchases the property from the
trustee or referee for an amount equal to the principal amount outstanding under
the loan, accrued and unpaid interest and the expenses of foreclosure. Depending
upon market conditions, the ultimate proceeds of the sale may not equal the
Company's investment in the property.
The following table sets forth delinquency and foreclosure
experience of loans originated and/or purchased included in the Company's
servicing portfolio for the periods indicated:
FISCAL YEARS ENDED JUNE 30,
------------------------------------------------------
1994 1995 1996
---------------- ---------------- --------------
Percentage of dollar amount of delinquent loans to loans
serviced (period end) (1) (2) (3)
One Month................................................... 3.8% 3.9% 4.9%
Two Months.................................................. 1.6% 1.5% 1.8%
Three or More Months:
Not foreclosed (3) (4).................................... 6.7% 5.0% 8.0%
Foreclosed ............................................... 3.6% 1.5% 1.0%
---------------- ---------------- --------------
Total............................................. 15.7% 11.9% 15.7%
================ ================ ==============
Percentage of dollar amount of loans foreclosed to loans
serviced (period end) (2)........................................................ 3.0% 1.2% 1.2%
Number of loans foreclosed......................................................... 215 159 221
Principal amount at time of foreclosure of foreclosed loans (in thousands)......... $ 11,528 $ 6,675 $ 14,349
Net losses on foreclosed loans included in pools (in thousands).................... $ 0 $ 92 $ 922
- ----------------------
(1) Delinquent loans are loans for which more than one payment is due.
(2) The delinquency and foreclosure percentages are calculated on the basis
of the total dollar amount of mortgage loans originated or purchased by
the Company and, in each case, serviced by the Company, or the Company
and any subservicers, as applicable, as of the end of the periods
indicated.
(3) At June 30, 1996, the dollar volume of loans delinquent more than 90
days in the Company's four REMIC trusts formed during the period from
December 1994 to September 1995 exceeded the permitted limit in the
related pooling and servicing agreements. The higher delinquency rates
could result in the termination of the Company's normal servicing
rights with respect to the loans in these trusts, although to date no
servicing rights have been terminated, negatively affect the Company's
cash flows and adversely influence the Company's assumptions underlying
the excess servicing gain (see "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Delinquencies; Negative Impact on Cash Flow; Right to
Terminate Normal Servicing").
(4) Represents loans which are in foreclosure but as to which foreclosure
proceedings have not concluded.
The Company's servicing portfolio has grown over the periods
presented. However, because foreclosures and losses typically occur months or
years after a loan is originated, data relating to delinquencies, foreclosures
and losses as a percentage of the current portfolio can understate the risk of
future delinquencies, losses or foreclosures.
COMPETITION
In addition to competing with other consumer finance lenders,
mortgage bankers and mortgage brokers, the Company competes with financial
institutions that have substantially greater financial resources than the
Company. Although some traditional financial institutions are aggressively
promoting and pricing home equity loans and attempting to increase the
percentage of their portfolios consisting of consumer real estate loans, the
Company does not believe that these trends have had a material impact on its
competitive position. The Company competes by emphasizing customer service on a
timely basis to attract borrowers whose needs are not generally met by
traditional financial institutions and by placing a greater emphasis on the
equity value of the property securing the loan. Nevertheless, there can be no
assurance that the Company will not face increased competition from such
institutions.
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Further, a number of the Company's competitors have recently increased their
access to the capital markets, which helps foster their growth and therefore
increases competition.
REGULATION
The operations of the Company are subject to extensive
regulation, supervision and licensing by federal, state and local government
authorities. Regulated matters include, without limitation, loan origination,
credit activities, maximum interest rates and finance and other charges,
disclosure to customers, the terms of secured transactions, the collection,
repossession and claims-handling procedures utilized by the Company, multiple
qualification and licensing requirements for doing business in various
jurisdictions and other trade practices.
The Company's loan origination activities are subject to the laws
and regulations in each of the states in which those activities are conducted.
The Company's activities as a lender are also subject to various federal laws
including, among others, the Truth in Lending Act ("TILA"), the Real Estate
Settlement Procedures Act, the Equal Credit Opportunity Act of 1974, as amended
("ECOA"), the Home Mortgage Disclosure Act and the Fair Credit Reporting Act of
1970, as amended ("FCRA").
The TILA and Regulation Z promulgated thereunder contain
disclosure requirements designed to provide consumers with uniform,
understandable information with respect to the terms and conditions of loans and
credit transactions in order to give them the ability to compare credit terms.
TILA also guarantees consumers a three-day right to cancel certain credit
transactions including loans of the type originated by the Company. Management
of the Company believes that it is in compliance with TILA in all material
respects.
In September 1994, the Riegle Community Development and
Regulatory Improvement Act of 1994 (the "Riegle Act") was enacted. Among other
things, the Riegle Act made certain amendments to TILA. The TILA Amendments,
which became effective in October 1995, generally apply to mortgage loans with
(i) total points and fees upon origination in excess of the greater of eight
percent of the loan amount or $400 or (ii) an annual percentage rate of more
than ten percentage points higher than comparably maturing U.S. treasury
securities. Loans covered by the TILA Amendments are known as "Section 32
loans."
The TILA Amendments impose additional disclosure requirements on
lenders originating Section 32 loans and prohibit lenders from originating
Section 32 loans that are underwritten solely on the basis of the borrower's
home equity without regard to the borrower's ability to repay the loan. In
accordance with TILA Amendments, the Company applies underwriting criteria that
take into consideration the borrower's ability to repay to all Section 32 loans.
The TILA Amendments also prohibit lenders from including
prepayment fee clauses in Section 32 loans to borrowers with a debt-to-income
ratio in excess of 50%. In addition, a lender that refinances a Section 32 loan
previously made by such lender will not be able to enforce any prepayment
penalty clause contained in such refinanced loan. The Company reported $1.9
million, $2.0 million and $3.2 million in prepayment fee revenue in fiscal 1994,
1995 and 1996, respectively. The Company will continue to collect prepayment
fees on loans originated prior to the effectiveness of the TILA Amendments and
on non-Section 32 loans as well as on Section 32 loans in permitted
circumstances following the effectiveness of the TILA Amendments. The TILA
Amendments impose other restrictions on Section 32 loans, including restrictions
on balloon payments and negative amortization features, which the Company does
not believe will have a material impact on its operations.
The Company is also required to comply with the ECOA, which
prohibits creditors from discriminating against applicants on the basis of race,
color, sex, age or marital status. Regulation B promulgated under ECOA restricts
creditors from obtaining certain types of information from loan applicants. It
also requires certain disclosures by the lender regarding consumer rights and
requires lenders to advise applicants of the reasons for any credit denial. In
instances where the applicant is denied credit or the rate or charge for a loan
increases as a result of information obtained from a consumer credit agency,
another statute, the FRCA requires the lender to supply the applicant with a
name and address of the reporting agency. The Company is also subject to the
Real Estate
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Settlement Procedures Act and is required to file an annual report with the
Department of Housing and Urban Development pursuant to the Home Mortgage
Disclosure Act.
In the course of its business, the Company may acquire properties
as a result of foreclosure. There is a risk that hazardous or toxic waste could
be found on such properties. In such event, the Company could be held
responsible for the cost of cleaning up or removing such waste, and such cost
could exceed the value of the underlying properties.
The Company is also subject to various other federal and state
laws regulating the issuance and sale of securities, relationships with entities
regulated by the Employee Retirement Income Security Act of 1974, as amended,
and other aspects of its business.
The laws, rules and regulations applicable to the Company are
subject to regular modification and change. There are currently proposed various
laws, rules and regulations which, if adopted, could impact the Company. There
can be no assurance that these proposed laws, rules and regulations, or other
such laws, rules or regulations, will not be adopted in the future which could
make compliance much more difficult or expensive, restrict the Company's ability
to originate, purchase, broker or sell loans, further limit or restrict the
amount of commissions, interest and other charges earned on loans originated or
sold by the Company, or otherwise adversely affect the business or prospects of
the Company.
EMPLOYEES
At June 30, 1996, the Company employed 672 persons. The Company
has satisfactory relations with its employees.
ITEM 2. PROPERTIES
The executive and administrative offices of the Company are
located at 3731 Wilshire Boulevard, Los Angeles, California, and consist of
approximately 101,000 square feet. The lease on these premises extends through
July 31, 2000. The Company intends to relocate its corporate executive offices
to Downtown Los Angeles in May 1997 under a lease that will expire in May 2007
and intends to sublease its current facility for the remainder of the term of
its lease. The executive and administrative offices of One Stop are located at
200 Baker Street, Costa Mesa, California, and consist of approximately 19,544
square feet. The lease on these premises extends through November 8, 1998.
The Company and One Stop also lease space for their loan offices.
These facilities aggregate approximately 135,000 square feet and are leased
under terms which vary as to duration. In general, the leases expire between
1996 and 2001, and provide for rent escalations tied to either increases in the
lessor's operating expenses or fluctuations in the consumer price index in the
relevant geographical area.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in litigation arising in the normal
course of business. The Company believes that any liability with respect to such
legal actions, individually or in the aggregate, is not likely to be material to
the Company's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of fiscal 1996
to a vote of the security holders of the Company.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
In November 1995, the Company's Common Stock began trading under
the symbol "AAM" on the New York Stock Exchange (NYSE). Prior to that time, the
Company's Common Stock was quoted on the NASDAQ National Market System. The
following table sets forth the range of high and low sale prices per share for
the periods indicated.
CASH
HIGH LOW DIVIDEND
------------------- ----------------- -------------------
FISCAL 1996
Fourth Quarter 37 24 1/8 $ .05
Third Quarter 25 1/8 16 1/4 .05
Second Quarter 24 1/2 16 1/8 .05
First Quarter 19 1/2 11 1/2 .05
FISCAL 1995
Fourth Quarter 12.5 7.25 $ .05
Third Quarter 8.75 5.25 .05
Second Quarter 6 5.25 .05
First Quarter $ 6.25 $ 5.25 .05
At September 15, 1996, the Company had 68 stockholders of record,
and the Company believes that it had in excess of 2,000 beneficial owners of its
Common Stock. Since its initial public offering on December 3, 1991, the Company
has consistently paid quarterly cash dividends on its Common Stock. The Company
declared and subsequently paid an aggregate of $.20 per share in dividends for
the year ended June 30, 1996, representing approximately 8.7% of its net income
for the period. The Board of Directors of the Company periodically reviews the
Company's dividend policy in light of the earnings, cash position and capital
needs of the Company, general business conditions and other relevant factors. In
addition, the Company's ability to pay dividends is limited under various bank
and other credit agreements.
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ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data for the Company for the
five year period ended June 30, 1996 have been derived from the Consolidated
Financial Statements of the Company which have been audited by Price Waterhouse
LLP, independent accountants. The selected consolidated financial data should be
read in conjunction with the Consolidated Financial Statements and Notes thereto
and other financial information included herein. Results of operations of the
Company for the year ended June 30, 1996, reflect the Company's adoption of SFAS
No. 122. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations." The selected consolidated financial data
for the Company for the year ended June 30, 1996 does not give pro forma effect
to the acquisition of One Stop. See "Item 1. Business--Recent Developments."
Fiscal Year Ended June 30,
-----------------------------------------------------------------------
1992 1993 1994 1995 1996
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
STATEMENT OF INCOME DATA:
Revenue:
Excess servicing gain ................................. $ 1,583 $ 3,486 $ 8,101 $ 22,954 $ 78,274
Commissions ........................................... 13,166 18,686 16,432 15,799 19,880
Loan service .......................................... 3,346 4,377 6,099 8,246 18,185
Fees and other ........................................ 3,397 4,762 5,595 7,940 12,069
----------- ----------- ----------- ----------- -----------
Total revenue ....................................... 21,492 31,311 36,227 54,939 128,408
Total expenses ........................................ 17,466 22,955 27,244 37,788 74,877
----------- ----------- ----------- ----------- -----------
Income before income taxes ............................ 4,026 8,356 8,983 17,151 53,531
Provision for income taxes (1) ........................ 1,112 3,353 3,684 7,117 22,483
----------- ----------- ----------- ----------- -----------
Net income ............................................ $ 2,914 $ 5,003 $ 5,299 $ 10,034 $ 31,048
=========== =========== =========== =========== ===========
Net income per share (fully diluted) .................. $ 0.51 $ 0.75 $ 0.61 $ 1.11 $ 2.09
=========== =========== =========== =========== ===========
Weighted average number of shares outstanding
(in thousands) (fully diluted) ...................... 5,717 6,623 8,751 9,021 15,465
CASH FLOW DATA:
(Used in) provided by operating activities ............ $ 3,115 $ (1,490) $ (13,857) $ (43,375) $ (122,233)
(Used in) investing activities ........................ (568) (489) (870) (988 (4,597)
Provided by (used in) financing activities ............ 7,515 (1,522) 22,855 48,209 124,687
Net increase (decrease) in cash and cash equivalents .. 10,062 (3,501) 8,128 3,846 (2,143)
RATIOS AND OTHER DATA:
Return on average common equity ....................... NM 36% 18% 27% 33%
Return on average managed receivables (2) ............. 1.5% 2.1% 1.6% 2.0% 3.3%
Loans originated or purchased:
Retail loans ...................................... $ 90,600 $ 122,200 $ 130,200 $ 148,200 $ 220,900
Wholesale loan correspondent ...................... 0 0 19,700 206,800 628,200
----------- ----------- ----------- ----------- -----------
Total (3) ..................................... 90,600 122,200 149,900 355,000 849,100
=========== =========== =========== =========== ===========
Loans pooled and sold in the secondary market ......... $ 11,000 $ 52,500 $ 106,800 $ 316,600 $ 791,300
Loans serviced (period end) ........................... $ 204,600 $ 262,100 $ 381,800 $ 608,700 1,250,400
Weighted average commission rate on retail loan
origination (4) ..................................... 13.0% 14.0% 12.0% 9.4% 7.7%
Weighted average interest rate (4) .................... 12.7% 11.2% 10.2% 11.6% 11.0%
Weighted average initial combined loan-to-value
ratio (4)(5):
Retail loans ........................................ 53% 51% 52% 55% 60%
Wholesale loan correspondents ....................... NM NM NM 65.0% 66.0%
Number of retail loan offices (period end) ............ 21 24 27 32 48
ASSET QUALITY DATA:
Delinquent loans to loans serviced
(period end) (6)(7) ................................... 18% 16% 16% 12% 16%
Number of loans foreclosed ............................ 69 137 215 159 221
Dollar amount of loans foreclosed as a percentage of
average loans serviced .............................. 1.2% 2.4% 3.0% 1.2% 1.2%
Net losses as a percentage of average amount
outstanding ......................................... NM NM NM .02% .10%
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At June 30,
--------------------------------------------------------------
1992 1993 1994 1995 1996
--------- ---------- ---------- ---------- ---------
BALANCE SHEET DATA:
Cash and cash equivalents...............................$ 11,886 $ 8,385 $ 16,513 $ 20,359 $ 18,216
Excess Spread Receivable (8)............................ 2,544 7,555 18,780 56,960 184,691
Total assets............................................ 18,927 21,307 53,344 114,623 293,997
--------- ---------- ---------- ---------- ---------
10.5% Senior Notes due 2002............................. -- -- -- 23,000 23,000
5.5% Convertible Subordinated Debentures due 2006....... -- -- -- -- 115,000
Other long-term debt.................................... 1,177 944 1,104 144 45
Total long-term debt................................ 1,177 944 1,104 23,144 138,045
Stockholders' equity.................................... 12,136 15,850 31,669 80,047 110,170
(1) Prior to December 1991, the Company was operated as an S
Corporation for federal tax purposes and consequently was not
responsible for federal income taxes.
(2) Represents net income divided by the average servicing
portfolio for the fiscal year.
(3) Does not include loans originated or purchased by One Stop during
fiscal 1996 in the aggregate amount of $320 million.
(4) Computed on loans originated or purchased, as the case may be,
during the period.
(5) The weighted average combined loan-to-value ratio of a loan
secured by a first mortgage is determined by dividing the amount
of the loan by the appraised value of the mortgaged property at
origination. The weighted average combined loan-to-value ratio of
loans secured by a junior mortgage is determined by taking the
sum of the loans secured by the junior and all senior mortgages
and dividing by the appraised value of the mortgaged property at
origination.
(6) Does not include loans for which only the servicing rights were
purchased by the Company. Delinquent loans are loans for which
more than one payment is past due.
(7) At June 30, 1996, the dollar volume of loans delinquent more than
90 days in the Company's four real estate mortgage investment
conduit ("REMIC") trusts formed during the period from December
1994 to September 1995 exceeded the permitted limit in the
related pooling and servicing agreements. The higher delinquency
rates could result in the termination of the Company's normal
servicing rights with respect to the loans in these trusts,
although to date no servicing rights have been terminated,
negatively affects the Company's cash flows and influence the
Company's assumptions underlying the excess servicing gain (see
"Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors --
Delinquencies; Negative Impact on Cash Flow; Termination of
Normal Servicing").
(8) Represents the sum of excess servicing receivable and residual
assets, and at June 30, 1996, mortgage servicing rights. See Note
1 of Notes to Consolidated Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with
Item 6. Selected Financial Data and Item 8. Financial Statements and
Supplementary Data.
OVERVIEW
The Company, founded in 1954, is a consumer finance company
engaged in the business of originating, purchasing, selling and servicing home
equity mortgage loans secured by single family residences. The Company's
principal market is credit-impaired borrowers who have significant equity in
their homes but whose borrowing needs are not being met by traditional financial
institutions due to credit exceptions or other factors. The Company focuses its
efforts on collateral lending and believes that it originates a greater
proportion of lower credit grade loans ("C-" and "D" loans) than most other
lenders to credit-impaired borrowers. These lower credit grade loans are
characterized by lower combined loan-to-value ratios and higher average interest
rates than the higher credit grade loans ("A-," "B" and "C" loans). The Company
believes lower credit-quality borrowers represent an underserved niche of the
home equity loan market and present an opportunity to earn a superior return for
the risks assumed. Although the Company has historically experienced delinquency
rates that are higher than those prevailing in its industry, management believes
the Company's historical loan losses are generally lower than those experienced
by most other lenders to credit-impaired borrowers because of the lower combined
loan-to-value ratios on the Company's lower credit grade loans. The mortgage
loans originated and purchased by the Company are generally used by borrowers to
consolidate indebtedness or to finance other consumer needs rather than to
purchase homes.
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20
Consequently, the Company believes that it is not as dependent as traditional
mortgage bankers on levels of home sales or refinancing activity prevailing in
its markets.
The Company originates and purchases loans through three
production channels. The Company has historically originated its loans through
its retail loan office network. In 1994, the Company diversified its production
channels to include a wholesale correspondent program which consisted initially
of purchasing loans from other mortgage bankers and financial institutions
underwritten in accordance with the Company's guidelines. In fiscal 1996, this
program was expanded to include the purchase of loans in bulk from mortgage
bankers and other financial institutions. On August 28, 1996, the Company
acquired One Stop which further diversified the Company's production channels to
include the origination and purchase of mortgage loans from a network of
independent mortgage brokers. While the Company intends to continue focusing on
its traditional niche in the "C-" and "D" credit grade loans, the Company also
intends to continue to diversify loan originations and purchases through its
three production channels to include more "A-," "B" and "C" credit grade loans.
The Company underwrites every loan it originates and re-underwrites and reviews
appraisals on all loans it purchases. See "Item 1. Business - - Mortgage Loan
Production -- Underwriting."
The Company has experienced significant growth in the last
three years. Management believes that this growth is primarily attributable to
(i) the Company's geographic expansion of its retail loan office network from 21
offices in California at July 1, 1993 to 50 offices located in 17 states at
August 31, 1996, (ii) the commencement of the Company's wholesale correspondent
program in fiscal 1994, which was expanded in fiscal 1996 to include purchases
of loans in bulk, (iii) the Company's ability to complete increasingly large
mortgage loan securitizations on a quarterly basis, (iv) the Company's increased
access to warehouse and other credit facilities over this period, and (v) the
Company's ability to effect additional debt and equity financings over this
period, which in the aggregate raised net proceeds of approximately $134 million
and $52.4 million, respectively. The Company has managed its growth by employing
experienced senior management, regularly monitoring its underwriting guidelines
and strengthening quality control procedures.
The acquisition of One Stop was accomplished through the
merger of a wholly-owned subsidiary of the Company into One Stop, in a tax-free
exchange accounted for as a pooling-of-interests, in which the Company issued
approximately 2.3 million shares of its Common Stock and assumed options granted
to key employees to purchase approximately 375,000 shares of its Common Stock.
Under the pooling rules, the historical financial results of the Company will be
restated to reflect the combination and will reflect the historical losses of
One Stop. Further, under the pooling rules, the costs incurred by the Company
and One Stop in consummating the acquisition will be expensed during the first
quarter of fiscal 1997. See "-- One-time Charges."
ONE-TIME CHARGES
Because of several one-time charges, the Company expects to
incur a net loss for the quarter ended September 30, 1996. As a result of, and
subsequent to, the acquisition of One Stop, One Stop's credit facilities with an
investment bank were terminated and, as a consequence, the Company will accrue a
pre-tax write-off of approximately $23 million (approximately $15 million on an
after-tax basis) in prepaid financing costs capitalized by One Stop,
representing the fair market value of a warrant for 25% of the equity of One
Stop granted to an investment bank in connection with entering into those credit
facilities. However, the $15 million charge will be less than the additions to
the Company's consolidated stockholders' equity of $23.3 million resulting from
the acquisition of One Stop. Further, because the acquisition of One Stop is to
be accounted for as a pooling-of-interests, all merger costs, which are expected
to aggregate approximately $2 million, will be expensed in the first quarter of
fiscal 1997. In addition, in August 1996, the Company entered into a lease for
new corporate offices, prior to the expiration of the lease for its existing
headquarters. As a consequence, the Company will incur a pre-tax charge of
approximately $2 million in the first quarter of fiscal 1997.
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RESULTS OF OPERATIONS -- FISCAL YEARS 1994, 1995, AND 1996
The following table sets forth information regarding the
components of the Company's revenue in fiscal 1994, 1995 and 1996:
-------------------------------------------------------------------------------
1994 1995 1996
----------------------- ---------------------- -----------------------
Revenue:
Excess servicing gain $ 8,101 22.3% $ 22,954 41.7% $ 78,274 61.0%
Commissions 16,432 45.3% 15,799 28.8% 19,880 15.4%
Loan Service:
Servicing spread 2,778 7.7% 4,399 8.0% 12,666 9.9%
Prepayment fees 1,866 5.2% 1,974 3.6% 3,228 2.5%
Late charges and other servicing fees 1,455 4.0% 1,873 3.4% 2,291 1.8%
Fees and other:
Closing 1,626 4.5% 2,077 3.8% 2,512 2.0%
Appraisal 893 2.5% 988 1.8% 1,167 0.9%
Underwriting 833 2.3% 1,091 2.0% 1,600 1.2%
Interest income 771 2.1% 2,339 4.3% 5,850 4.6%
Other 1,472 4.1% 1,445 2.6% 940 0.7%
-------- ----- -------- ----- -------- -----
Total revenue $ 36,227 100% $ 54,939 100% $128,408 100%
======== ===== ======== ===== ======== =====
Expenses:
Compensation and related expenses 13,616 37.5% 17,610 32.2% 33,241 25.8%
Sales and advertising costs 7,891 21.7% 9,906 18.1% 18,362 14.2%
General and administrative expenses 5,415 14.9% 7,067 12.9% 13,926 10.7%
Interest expense 322 0.9% 3,205 5.8% 9,348 7.3%
-------- ----- -------- ----- -------- -----
Total expenses 27,244 75% 37,788 69% 74,877 58%
-------- ----- -------- ----- -------- -----
Income before income taxes 8,983 24.8% 17,151 31.2% 53,531 41.7%
Income taxes 3,684 10.2% 7,117 12.9% 22,483 17.5%
-------- ----- -------- ----- -------- -----
Net income $ 5,299 14.6% $ 10,034 18.3% $ 31,048 24.2%
======== ===== ======== ===== ======== =====
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REVENUE
Total revenue for fiscal 1996 increased $73.5 million, or
134%, over total revenue for fiscal 1995 which, in turn, increased $18.7
million, or 52%, over total revenue in fiscal 1994. These increases in total
revenue were primarily the result of higher excess servicing gain and loan
service revenue resulting from increased volumes of mortgage loans originated
and purchased by the Company and securitized and sold. The Company originated
and purchased $150 million, $355 million and $849 million of mortgage loans
during fiscal 1994, 1995 and 1996, respectively.
In a securitization, the Company recognizes a gain on the sale
of loans securitized upon the closing of the securitization, but does not
receive the excess servicing, which is payable over the actual life of the loans
securitized. The excess servicing represents, over the estimated life of the
loans, the excess of the weighted average interest rate on the pool of loans
sold over the sum of the investor pass-through rate, normal servicing fee and
the monoline insurance fee. The net present value of that excess (determined
based on certain prepayment and loss assumptions) less transaction expenses is
recorded as excess servicing gain or loss at the time of the closing of the
securitization. Excess servicing gain increased by $55.3 million, or 241%, in
fiscal 1996 compared to fiscal 1995 and $14.9 million, or 183%, in fiscal 1995
compared to fiscal 1994. These increases resulted primarily from the greater
size of the mortgage loan pools securitized and sold by the Company in the
secondary market and, in fiscal 1996, increased servicing spreads and the
recognition of mortgage servicing rights pursuant to SFAS 122 in the amount of
$11.8 million (see "--Certain Accounting Considerations"). The Company
securitized and sold $107 million, $317 million and $791 million of loans in the
secondary market during fiscal 1994, 1995, and 1996, respectively. The weighted
average servicing spread on loans securitized and sold during these periods was
3.91%, 3.91% and 4.93% for fiscal 1994, 1995 and 1996, respectively. The higher
weighted average servicing spread in 1996 reflected a decrease in pass-through
rates to investors and a change in product mix. In the future, the Company
expects to realize a lower percentage of excess servicing gain on the sale of
loans as a result of changes in assumptions to reflect the changing composition
of the Company's loan product mix and other factors.
Commissions earned on loan originations continue to be a
significant component of total revenue, although to a lesser degree than in
prior years, comprising 45%, 29% and 15% of total revenue in fiscal 1994, 1995
and 1996 respectively. Commissions increased $4.1 million, or 26%, in fiscal
1996 compared to fiscal 1995, and decreased $633,000, or 3.9%, in fiscal year
1995 compared to fiscal 1994. Commission revenue is primarily a function of the
volume of mortgage loans originated by the Company through its retail loan
office network and the weighted average commission rate charged on such loans.
The increase in commissions in fiscal year 1996 was a result of increased
origination volume, offsetting a decline in weighted average commission rate.
The decrease in commissions in fiscal year 1995 was due to a reduction in the
weighted average commission rate, partially offset by an increase in the dollar
amount of loans originated. The weighted average commission rate was 11.6 %,
9.4% and 7.7% during fiscal 1994, 1995 and 1996, respectively. The lower
weighted average commission rate in 1996 reflected competitive factors, and
the increase of higher credit grade loans originated through the Company's
retail loan office network. Commissions do not include $722,000 and $1.0
million of commissions on loans which were held for sale as of June 30, 1995
and 1996, respectively.
Loan service revenue increased $9.9 million, or 121%, in
fiscal 1996 compared to fiscal 1995 and $2.1 million, or 35%, in fiscal 1995
compared to fiscal 1994. Loan service revenue consists of net servicing spread
earned on the principal balances of the loans in the Company's loan servicing
portfolio, prepayment fees, late charges and other fees retained by the Company
in connection with the servicing of loans. The increases in fiscal 1996 and 1995
were due primarily to the greater size of the portfolio of loans serviced in
each of these periods. The Company's loan servicing portfolio increased to $1.25
billion at June 30, 1996, up 105% from the June 30, 1995 balance of $609 million
which, in turn, increased 59% over the June 30, 1994 balance.
Fees and other revenue increased by $4.1 million, or 52%, in
fiscal 1996 compared to fiscal 1995 and increased $2.3 million, or 42%, in
fiscal 1995 compared to fiscal 1994. Fees and other revenue consist of fees
received by the Company through its retail loan office network in the form of
closing, appraisal, underwriting and other fees, plus interest income. The
dollar amount of these fees increased in each of the years presented due to the
22
23
larger number of mortgage loans originated through the Company's retail loan
office network during the respective periods. Interest income increased in
fiscal 1996 and 1995 due to interest earned on larger amounts of loans held by
the Company during the period from origination or purchase of the loans until
the date sold by the Company.
EXPENSES
Compensation and related expenses increased $15.6 million, or
89%, in fiscal 1996 compared to fiscal 1995 as a result of increased
compensation paid to senior management ($4.2 million) as well as the addition of
new personnel. For primarily the same reasons, compensation and related expenses
increased by $4.0 million, or 29%, in fiscal 1995 as compared to fiscal 1994.
Compensation and related expenses as a percentage of total revenues were 38%,
32% and 26% for fiscal 1994, 1995 and 1996, respectively. The Company
anticipates that compensation expense will increase in fiscal 1997 as a result
of a full year's compensation to be paid to members of senior management who
joined the Company in the latter half of fiscal 1996, as well as the addition in
fiscal 1997 of One Stop's senior management and other personnel.
Sales and advertising costs increased $8.5 million, or 85%, in
fiscal 1996 compared to fiscal 1995 and $2.0 million, or 26%, in fiscal 1995
compared to fiscal 1994, due primarily to the Company's nationwide expansion of
its retail loan office network. Sales and advertising costs as a percentage of
total revenue were 22%, 18% and 14% for fiscal 1994, 1995, and 1996,
respectively.
General and administrative expenses increased $6.9 million, or
97%, in fiscal 1996 compared to fiscal 1995 and decreased to 11% from 13% of
revenue for the same periods. General and administrative expenses increased by
$1.7 million, or 31%, in fiscal 1995 compared to fiscal 1994, a decrease to 13%
from 15% of revenue for the same periods. The dollar increases were primarily
the result of occupancy and communications costs related to the expansion of the
Company's retail loan office network (an increase of $3.7 million in 1996 when
compared to 1995 and $592,000 in 1995 when compared with 1994), and equipment
rental expense (an increase of $956,000 in 1996 when compared to 1995 and
$10,000 in 1995 when compared with 1994). The increase in equipment rental
expense in 1996 was primarily attributable to an airplane lease entered into in
February 1996.
Interest expense increased to $9.3 million in fiscal 1996
compared to $3.2 million in fiscal 1995 and $322,000 in fiscal 1994 primarily as
a result of increased borrowings under various financing arrangements used to
fund the origination and purchase of mortgage loans prior to their
securitization and sale in the secondary market. Interest expense is expected to
increase in future periods due to the Company's continued reliance on
warehousing arrangements to fund increased originations and purchases of loans
pending their securitization, and as a result of the Company's sale in the third
quarter of fiscal 1996 of $115 million of its 5.5% Convertible Subordinated
Debentures due 2006.
INCOME TAXES
The Company's provision for income taxes increased to $22.5
million in fiscal 1996 from $7.1 million in fiscal 1995 and $3.7 million in
fiscal 1994 primarily as a result of increased pre-tax income.
FINANCIAL CONDITION
Loans held for sale. Prior to securitization, the Company
holds mortgage loans in its portfolio. Due to the increased volume of loan
originations and purchases, the Company's portfolio of loans held for sale
increased to $67.3 million at June 30, 1996 from $24.1 million at June 30, 1995.
Accounts receivable. Accounts receivable representing
servicing fees and advances, increased by $2.5 million from $6.1 million at June
30, 1995 to $8.6 million at June 30, 1996. This increase was primarily due to
the increased size of the servicing portfolio.
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24
Excess servicing receivable. Excess servicing receivable,
increased $87.0 million from $42.0 million at June 30, 1995 to $129 million at
June 30, 1996 reflecting the increased size of the Company's securitizations
during 1996.
Mortgage servicing rights. The June 30, 1996 balance includes
$10.9 million of mortgage servicing rights capitalized in accordance with SFAS
No. 122. This balance reflects the capitalization under SFAS No. 122 of $11.8
million of servicing rights partially offset by amortization of $857,000 during
fiscal 1996. See "--Certain Accounting Considerations."
Residual assets. Residual assets represent the reserve
accounts and overcollateralization amounts required to be maintained in
connection with the securitization of loans. Residual assets include cash and
mortgage loans in excess of the principal amounts of the senior certificates of
the REMIC trusts. Residual assets increased $29.8 million from $14.9 million at
June 30, 1995 to $44.7 million at June 30, 1996.
Equipment and improvements. Primarily as a result of the
expansion of the Company's retail loan office network and the associated
investment in technology, equipment and improvements, net increased $3.5 million
from $2.1 million at June 30, 1995 to $5.6 million at June 30, 1996.
Prepaid and other assets. Prepaid and other assets increased
$4.6 million from $5.0 million at June 30, 1995 to $9.6 million at June 30,
1996. The increase was primarily related to prepaid financing costs incurred in
connection with the issuance of $115 million of 5.5% Convertible Subordinated
Debentures due 2006 in the third quarter of fiscal 1996 and, to a lesser extent,
to prepaid advertising costs.
Revolving warehouse arrangements. Amounts outstanding under
warehouse arrangements increased by $11.0 million from a zero balance at
June 30, 1995 to an $11.0 million balance at June 30, 1996 primarily as a
result of the larger amount of loans held for sale at such dates.
Borrowings. Notes payable increased by $115 million from $23.1
million at June 30, 1995 to $138 million at June 30, 1996 primarily as a result
of the issuance in the third quarter of fiscal 1996 of $115 million of 5.5%
Convertible Subordinated Debentures due 2006.
24
25
LIQUIDITY
The table below summarizes cash flow generated by operating
activities:
FISCAL YEARS ENDED JUNE 30,
-----------------------------------------------
1994 1995 1996
-------------- ------------ -------------
(IN THOUSANDS)
OPERATING CASH INCOME:
Excess cash flows generated by securitization trusts.................. $ 3,482 $ 7,984 $ 29,932
Less cash required to be invested in residual assets (1).......... (4,228) (8,691) (29,794)
-------------- ------------ -------------
Net excess cash flow from securitization trusts................... (746) (707) 138
Other servicing fees.............................................. 5,310 4,664 6,049
Interest received................................................. 771 2,339 6,397
Commission income................................................. 16,432 15,799 19,880
Other cash income................................................. 4,825 5,601 5,372
-------------- ------------ -------------
Total Operating Cash Income....................................... 26,592 27,696 37,836
OPERATING CASH EXPENSES:
Securitization and loan acquisition costs......................... (1,589) (10,937) (37,317)
Cash operating expenses........................................... (26,779) (36,377) (69,304)
Taxes paid........................................................ (2,991) (5,196) (4,240)
Interest paid..................................................... 0 (805) (2,415)
Total Operating Cash Expenses..................................... (31,359) (53,315) (113,276)
Net Operating Cash Flow........................................... (4,767) (25,619) (75,440)
Cash (used in) provided by other payables and receivables......... 875 (3,765) (3,598)
Cash used in loans held for sale.................................. (9,965) (13,991) (43,195)
-------------- ------------ -------------
Net Cash used in Operating Activities............................. ($13,857) ($43,375) ($122,233)
============== ============ =============
CHANGE IN EXCESS SPREAD RECEIVABLES (2)............................... $ 11,225 $ 38,180 $ 127,731
NET CASH PROVIDED BY FINANCING ACTIVITIES............................. $ 22,855 $ 48,209 $ 124,687
- --------------------
(1) Cash required to fund initial and required overcollateralization
account balances.
(2) Represents the sum of excess servicing receivables and residual
assets, and at June 30, 1996, mortgage servicing rights. See
Note 1 to Notes to Consolidated Financial Statements.
The Company's operations require continued access to short-term
and long-term sources of cash. The Company's operating cash requirements include
the funding of: (i) mortgage loan originations and purchases prior to their
securitization and sale, (ii) fees and expenses incurred in connection with the
securitization and sale of loans, (iii) cash reserve account or
overcollateralization requirements in connection with the securitization and
sale of mortgage loans, (iv) tax payments due on recognition of excess servicing
gain, and (v) ongoing administrative and other operating expenses.
The Company has operated on a negative operating cash flow basis
and expects to continue to do so for as long as the Company's cash requirements
necessitated by the growth in volume of its securitization program continue to
grow at rates in excess of the cash generated by the Company from its
operations, including its servicing activities. Historically, the Company has
funded, and expects to continue to fund, these negative operating cash flows,
subject to limitations under the Company's existing credit facilities,
principally through borrowings from financial institutions, sales of equity
securities and sales of senior and subordinated notes, among other sources.
There can be no assurance that the Company will have access to the capital
markets in the future or that financing will be available to satisfy the
Company's operating and debt service requirements or to fund its future growth.
See "--Capital Resources" and "Item 1. Business--Business Strategy."
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26
New loan originations and purchases represent the Company's most
significant cash flow requirement. The Company pays a premium on loans purchased
through its wholesale correspondent program and on loans purchased from
independent mortgage brokers. The amount of cash used to pay premiums
approximated $33.7 million in 1996.
The Company securitized and sold in the secondary market $107 million, $317
million and $791 million of loans in fiscal 1994, 1995 and 1996, respectively.
In connection with securitization transactions completed during these periods,
the Company was required to provide credit enhancements in the form of reserve
accounts or overcollateralization amounts. In addition, during the life of the
related REMIC trusts, the Company subordinates a portion of the excess servicing
otherwise due it to the rights of holders of senior interests as a credit
enhancement to support the sale of the senior interests. In connection with
securitizations effected in fiscal 1994, 1995, and 1996, initial reserve
accounts or overcollateralization requirements were set at $2.2 million, $3.5
million, and $7.5 million, respectively. The terms of the REMIC trusts generally
require that all excess servicing otherwise payable to the Company during the
early months of the trusts be used to increase the cash reserve accounts, or to
repay the senior interests in order to increase overcollateralization to
specified maximums. The accumulated amounts of such cash reserve accounts and
overcollateralization amounts are reflected on the Company's balance sheet as
"residual assets." At June 30, 1996, the residual assets balance was $44.7
million.
In addition, the increasing use of securitization transactions as a funding
source by the Company has resulted in a significant increase in the amount of
excess servicing gain recognized by the Company. During fiscal 1994, 1995, and
1996, the Company recognized excess servicing gain in the amounts of $8.1
million, $23.0 million, and $78.3 million, respectively. The recognition of
excess servicing gain has a negative impact on the cash flow of the Company
since the Company is required to pay federal and state taxes on a portion of
these amounts in the period recognized although it does not receive the cash
representing the gain until later periods as the related service fees are
collected and applicable reserve or overcollateralization requirements are met.
The Company also incurs certain expenses in connection with
securitizations, including underwriting fees, credit enhancement fees, trustee
fees, hedging and other costs, which in fiscal 1996 approximated 1.0% of the
principal amount of the securitized mortgage loans.
CAPITAL RESOURCES
The Company finances it operating cash requirements primarily through (i)
warehouse and other credit facilities, (ii) the securitization and sale of
mortgage loans, and (iii) the issuance of debt and equity securities.
Warehouse and Other Credit Facilities. At August 31, 1996, the Company had
four warehouse and one other credit facility in place. There is a $150 million
warehouse and working capital line of credit from a syndicate of six commercial
banks that is secured by loans originated and purchased by the Company as well
as certain servicing receivables, which bears interest at the rate of 0.875%
over one-month LIBOR. This line currently expires on December 26, 1996 and is
subject to renewal. There are two additional warehouse lines of credit from two
investment banks that are secured by loans originated and purchased by the
Company. These lines of $150 million and $125 million bear interest at the rate
of 0.875% over one-month LIBOR and are subject to renewal periodically. The $150
million line expires on January 1, 1997 and the $125 million line expires on
September 30, 1996. The Company also has a $250 million warehouse line of credit
with another investment bank that is secured by loans originated and purchased
by One Stop. This line bears interest at the rate of 1.1% over one-month LIBOR
and expires on September 27, 1996. Finally, the Company has a $50.0 million
credit facility from an investment bank that is secured by certain excess
servicing receivables in certificated form. Until February 1997 this is a
revolving facility that bears interest at the rate of 2.5% over one-month LIBOR;
during the amortizing term thereafter until August 1999, it bears interest at
the rate of 4.5% over one-month LIBOR. Management expects, although there can be
no assurance, that the Company will be able to maintain these or similar
facilities in the future. See "-- Risk Factors -- Dependence on Funding Sources
- -- Dependence on Warehouse and Other Credit Facilities."
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27
Securitization Program. The Company's most important capital resource has
been its ability to sell loans originated and purchased by it in the secondary
market in order to generate cash proceeds to pay down its warehouse facilities
and fund new originations and purchases. The value of and market for the
Company's loans are dependent upon a number of factors, including general
economic conditions, interest rates and governmental regulations. Adverse
changes in such factors may affect the Company's ability to securitize and sell
loans for acceptable prices within a reasonable period of time. The ability of
the Company to sell loans in the secondary market on acceptable terms is
essential for the continuation of the Company's loan origination and purchase
operations. A reduction in the size of the secondary market for loans of the
types originated or purchased by the Company may adversely affect the Company's
ability to sell loans in the secondary market with a consequent adverse impact
on the Company's profitability and ability to fund future originations and
purchases. See "-- Risk Factors--Dependence on Funding Sources--Dependence on
Securitization Program."
In addition, in order to gain access to the secondary market, the Company
has relied on monoline insurance companies to provide financial guarantee
insurance on senior interests in the REMIC trusts established by the Company.
The Company has not structured a pool for securitization and sale in the
secondary market based solely on the internal credit enhancements of the pool or
the Company's guarantees. Any substantial reduction in the size or availability
of the secondary market for the Company's loans or the unwillingness of monoline
insurance companies to provide financial guarantee insurance for the senior
interests in the REMIC trusts could have a material adverse effect on the
Company's financial position and results of operations. At June 30, 1996, the
dollar volume of loans delinquent more than 90 days on the Company's four REMIC
trusts formed during the period from December 1994 to September 1995 exceeded
the permitted limit in the related pooling and servicing agreements. The higher
delinquency rates could result in the termination of the Company's normal
servicing rights with respect to the loans in these trusts, although to date no
servicing rights have been terminated, negatively affect the Company's cash
flows and adversely influence the Company's assumptions underlying the excess
servicing gain. See "-- Risk Factors - Delinquencies; Negative Impact on Cash
Flow; Right to Terminate Normal Servicing."
Other Capital Resources. The Company has funded negative cash flows
primarily from the sale of its equity and debt securities. In December 1991,
July 1993, and June 1995, the Company effected offerings of its Common Stock
with net proceeds to the Company aggregating $61.1 million. In March 1995, the
Company completed an offering of its 10.5% Senior Notes due 2002 with net
proceeds to the Company of $22.2 million. In February 1996, the Company
completed an offering of its 5.5% Convertible Subordinated Debentures due 2006
with net proceeds to the Company of $112 million.
The Company had cash and cash equivalents of approximately $18.2 million
(of which $2.2 million was restricted) at June 30, 1996. However, the Company
expects to continue its growth strategies. Consequently, the Company anticipates
that it will need to arrange for additional cash resources prior to the third
quarter of fiscal 1997 through additional debt or equity financing, additional
bank borrowings or restructuring its securitization program. The Company has no
commitments for additional bank borrowings or additional debt or equity
financing and there can be no assurance that the Company will be successful in
consummating any such financing transaction in the future on terms the Company
would consider to be favorable. See "-- Risk Factors - Negative Cash Flows and
Capital Needs."
RISK MANAGEMENT
The Company employs a variety of strategies in order to manage the risk
that mortgage loans held for sale pending securitization will fluctuate in value
as a result of changing interest rates prevailing in the market. The Company
hedges against interest rate fluctuations by selling United States Treasury
securities not yet purchased. The amount and timing of hedging
transactions are determined by members of the Company's senior management.
Management assesses factors including the interest rate environment, loan
production levels and open positions of current hedging positions. The Company
has also mitigated its interest rate exposure by effecting securitizations once
each quarter resulting in a holding period for most of the mortgage loans
originated and purchased by it of less than one quarter.
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28
The Company also mitigates its exposure to interest rate risk through a
pre-funding strategy in which it agrees to sell loans to the REMIC trust in the
future at an agreed-upon price. The pre-funding locks in the price agreed upon
with investors on the pricing date (typically five business days prior to the
closing date of the securitization) for a period of generally 30 days. In a
pre-funding arrangement, the Company typically delivers approximately 75% of the
loans sold at the closing and the remainder generally within 30 days after the
closing.
CERTAIN ACCOUNTING CONSIDERATIONS
As a fundamental part of its business and financing strategy, the Company
sells substantially all of its mortgage loans through securitizations. In a
securitization, the Company recognizes a gain on the sale of loans securitized
upon the closing of the securitization, but does not receive the cash
representing such gain until it receives the excess servicing, which is payable
over the actual life of the loans securitized. The cash purchase price is raised
through an offering of pass-through certificates by the trust. Following the
securitization, the purchasers of the pass-through certificates receive the
principal collected. The excess servicing represents, over the estimated life of
the loans, the excess of the weighted average interest rate on each pool of
loans sold over the sum of the pass-through interest rate, a normal servicing
fee and the fees of the monoline insurance carrier. The net present value of
that excess (based on certain prepayment and loss assumptions) less transaction
expenses is recorded as excess servicing gain or loss when the loan is
securitized and sold. The excess servicing receivable included in the
Consolidated Financial Statements represents these amounts reduced by direct
transaction costs. The excess servicing receivable is amortized in proportion to
and over the expected lives of the related loans.
The Company's excess servicing receivable is amortized over the estimated
remaining life of the underlying loans as an offset against the excess servicing
component of servicing income actually received in connection with such loans.
If actual prepayments with respect to sold loans occur faster or credit
experience is worse than projected at the time such loans were sold, the
carrying value of the excess servicing receivable may have to be written down
through a charge to earnings in the period of adjustment. For the three years
ended June 30, 1996, there were no material adjustments to the Company's
carrying value of the excess servicing receivable as a result of actual
prepayment experience. However, there can be no assurance of the accuracy of
management's prepayment estimates. If actual prepayments with respect to sold
loans in the secondary market or funded by private investors were to exceed
management's estimates materially, the carrying value of the excess servicing
receivable would be written down through a charge to earnings in the period of
adjustment.
Effective fiscal 1996, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 122, "Accounting for Mortgage Servicing
Rights" ("SFAS 122") which requires that upon sale or securitization of
servicing retained mortgages, companies capitalize the cost associated with the
right to service mortgage loans based on their relative fair value. The Company
determines fair value based on the present value of estimated net future cash
flows related to servicing income. The cost allocated to the servicing rights is
amortized in proportion to and over the period of estimated net future servicing
fee income. The Company periodically reviews capitalized servicing fees
receivable for valuation impairment. This review is performed on a disaggregated
basis for the predominant risk characteristics of the underlying loans which are
loan type, term and credit quality. The Company generally makes loans to
credit-impaired borrowers whose borrowing needs may not be met by traditional
financial institutions due to credit exceptions and other factors. Impairment is
recognized in valuation allowance for each disaggregated stratum in the period
of impairment. The effect of adopting SFAS 122 was to increase the net income of
the Company as reported in the Company's Consolidated Financial Statements for
fiscal 1996 by $5.7 million or $0.37 per weighted average share.
In May 1993, the FASB released SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan" ("SFAS 114"). SFAS 114 was amended by SFAS No. 118
"Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures," ("SFAS 118") released in October 1994. The Company adopted SFAS
114 in fiscal 1996. As the Company generally sells its loans within a relatively
short period, the adoption of SFAS 114, as amended by SFAS 118, did not have a
material impact on the Company's financial position or results of operations.
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In October 1995, the FASB released SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"). This statement establishes methods of
accounting for stock-based compensation plans. SFAS 123 is effective for fiscal
years beginning after December 15, 1995. The Company expects to continue to
apply Accounting Principles Board Opinion 25 for measurement of stock
compensation and will provide the disclosure required by SFAS 123 beginning in
fiscal year 1997. The adoption of SFAS 123 is not expected to have a material
effect on the financial position of the Company.
RISK FACTORS
This Report contains certain forward looking statements. Actual results
could differ materially from those projected in the forward-looking statements
as a result of the risk factors set forth below.
NEGATIVE CASH FLOWS AND CAPITAL NEEDS
In a securitization, the Company recognizes a gain on sale of the loans
securitized upon the closing of the securitization, but does not receive the
cash representing such gain until it receives the excess servicing, which in
general is payable over the actual life of the loans securitized. The Company
incurs significant expense in connection with a securitization and incurs both
current and deferred tax liabilities as a result of the gain on sale. Net cash
used in operating activities for fiscal 1994, 1995 and 1996 was $13.9 million,
$43.4 million and $122 million, respectively. Therefore, the Company requires
continued access to short- and long-term external sources of cash to fund its
operations. The Company expects to continue to operate on a negative cash flow
basis as the volume of the Company's loan purchases and originations increases
and its securitization program grows. The Company's primary cash requirements
include the funding of: (i) mortgage loan originations and purchases pending
their securitization and sale; (ii) fees and expenses incurred in connection
with the securitization of loans; (iii) reserve account or overcollateralization
requirements in connection with the securitization and sale of the loans; (iv)
tax payments due on recognition of excess servicing gain; (v) ongoing
administrative and other operating expenses; and (vi) interest and principal
payments under the Company's warehouse credit facilities and other existing
indebtedness.
The Company's primary sources of liquidity in the future are expected to be
existing cash, fundings under its warehouse and other credit facilities, sales
of mortgage loans through securitization, and further issuances of debt or
equity. See "--Liquidity" and "--Capital Resources."
The Company's primary sources of liquidity as described in the paragraph
above are expected to be sufficient to fund the Company's liquidity requirements
through at least the second quarter of fiscal 1997 if the Company's future
operations are consistent with management's current growth expectations.
However, because the Company expects to continue to operate on a negative cash
flow basis for the foreseeable future, it anticipates that it will need to
effect debt or equity financings regularly. The type, timing and terms of
financing selected by the Company will be dependent upon the Company's cash
needs, the availability of other financing sources and the prevailing conditions
in the financial markets. There can be no assurance that any such sources will
be available to the Company at any given time or as to the favorableness of the
terms on which such sources may be available.
As a result of the limitations describe above, the Company may be
restricted in the amount and type of future debt it may issue.
DELINQUENCIES; NEGATIVE IMPACT ON CASH FLOW; RIGHT TO TERMINATE NORMAL SERVICING
A substantial majority of the Company's servicing portfolio consists of
loans securitized by the Company and sold to REMIC trusts. Generally, the form
of pooling and servicing agreement entered into in connection with these
securitizations contains specified limits on the 90-day delinquency rate
(including properties acquired upon foreclosure and not sold) prevailing on the
loans included in each REMIC trust. If, at any measuring date, the 90-day
delinquency rate with respect to any REMIC trust were to exceed the specified
limit applicable to such trust, provisions of the pooling and servicing
agreements permit the monoline insurance company to terminate the
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Company's servicing rights to the pool as more fully described below. In
addition, high delinquency rates have a negative impact on cash flow.
At June 30, 1996, four of the Company's REMIC trusts (representing 23% of
the dollar volume of the Company's servicing portfolio) exceeded the applicable
90-day delinquency standard. These four trusts were formed in the last quarter
of calendar 1994 and each of the first three quarters of calendar 1995. At June
30, 1996, the 90-day delinquency rate on these four trusts ranged from 13.8% to
22.7%. The Company believes that the high delinquency rates it has experienced
are primarily due to the higher proportion of lower credit grade loans ("C-" and
"D" loans) originated and purchased by it compared to most other lenders to
credit-impaired borrowers (which generally have a greater focus on A- through C
loans). However, the Company believes its historical loan losses have been below
those experienced by most other lenders to credit-impaired borrowers as a result
of the higher combined loan-to-value ratios which it requires on its lower
credit grade loans. At June 30, 1996, the initial combined loan-to-value ratio
on loans in the four REMIC trusts was 64%.
The Company has recently implemented a variety of measures designed to
reduce delinquency rates on loans included in REMIC trusts to be formed by the
Company in future periods, including the implementation of new procedures
designed to shorten the time required to transfer servicing on loans purchased
through the Company's wholesale correspondent program and the elimination of its
loan program which has experienced the highest delinquency rates. In addition,
as a result of the expansion of the Company's loan production capacity,
including the acquisition of One Stop, the proportion of higher credit grade
loans originated or purchased by the Company is increasing. The Company expects
that the combined effect of these developments will have a positive impact on
90-day delinquency rates experienced in REMIC trusts formed by the Company in
future periods, although average combined loan-to-value ratios are likely to
increase. However, there can be no assurance that this will in fact occur.
Further, delinquency rates and losses on the Company's existing REMIC trusts and
future REMIC trusts could increase. The Company is also in discussions with a
monoline insurance company regarding possible changes to the structure of future
REMIC trusts that would result in delinquency standards that more accurately
reflect the composition of the Company's business. Although the four REMIC
trusts formed by the Company after September 1995 had delinquency rates at June
30, 1996 within expectations and below the applicable 90-day delinquency
standard (which were raised to 13% with respect to the June 1996 REMIC trust),
the loans included in these latter four trusts were originated or purchased
prior to these developments and have been outstanding for a relatively short
period of time and there can be no assurance that delinquency rates on these
trusts will not increase in future periods.
Under the form of pooling and servicing agreement entered into in
connection with the Company's securitizations, the monoline insurance company
insuring the senior interests in the related REMIC trust may terminate the
Company's normal servicing rights if the 90-day delinquency rate exceeds the
applicable specified limit. Although the monoline insurance company has the
right to terminate servicing with respect to the four REMIC trusts referred to
above, no servicing rights have been terminated. There can be no assurance that
the Company's servicing rights with respect to the mortgage loans in such
trusts, or any other trust which exceeds the specified limits in future periods,
will not be terminated. The monoline insurance company has other rights to
terminate servicing if the Company were to breach its obligations under the
agreement, losses on foreclosure were to exceed specified limits, the insurance
company were required to make payments under its policy or certain bankruptcy or
insolvency events were to occur. None of these events have occurred with respect
to any of the trusts formed by the Company.
The Company's cash flow is also adversely impacted by high delinquency
rates in REMIC trusts. Generally, provisions in the pooling and servicing
agreement have the effect of requiring the overcollateralization account, which
is funded primarily by the excess spread on the loans held in the trust, to be
increased up to about twice the level otherwise required when the delinquency
rates exceed the specified limit. As of June 30, 1996, the Company was required
to maintain an additional $16.5 million in overcollateralization accounts as a
result of the level of its delinquency rates above that which would have been
required to be maintained if the applicable delinquency rates had been below the
specified limit. Of this amount, at June 30, 1996, $12.5 million remains to be
added to the overcollateralization accounts from future spread income on the
loans held by these trusts.
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Delinquency and loss rates also affect the assumptions used by the Company
in computing excess servicing gain and could affect the Company's ability to
effect securitizations in the capital markets.
RISKS OF CONTRACTED SERVICING
The Company currently contracts with subservicers for the servicing of all
loans it originates or purchases which are secured by properties located in
states other than Arizona, California, Colorado, Nevada, Oregon, Utah and
Washington. These subservicing arrangements accounted for approximately 27% of
the Company's $1.25 billion servicing portfolio at June 30, 1996. The Company is
subject to risks associated with inadequate or untimely service rendered by
subservicers. Many of the Company's borrowers require notices and reminders to
keep their loans current and to prevent delinquencies and foreclosures. Any
failure by a subservicer to provide adequate or timely service could result in
higher delinquency rates and foreclosure losses on the portfolio of loans.
Although the Company intends to service all loans it originates or purchases
commencing in calendar 1997 (regardless of the location of the mortgaged
property) the Company does not currently intend to transfer the subservicing
previously contracted and would be required to pay a termination fee if it were
to decide to do so.
DEPENDENCE ON FUNDING SOURCES
Dependence on Warehouse and Other Credit Facilities. The Company is
dependent upon its access to warehouse and other credit facilities in order to
fund new originations and purchases of mortgage loans pending securitization.
The Company currently has warehouse and other credit facilities with certain
financial institutions with aggregate commitment of $725 million. The Company's
warehouse and other credit facilities expire between September 30, 1996 and
February 1997. In addition, the Company's growth strategies will require
significant increases in the amount of the Company's warehouse and other credit
facilities. There can be no assurance that the Company will be able to secure
such financing on affordable terms, or at all. The Company expects to be able to
maintain existing warehouse and other credit facilities (or to obtain
replacement or additional financing) as current arrangements expire or become
fully utilized; however, there can be no assurance that such financing will be
obtainable on favorable terms. To the extent that the Company is unable to
extend or replace existing facilities, and arrange new warehouse or other credit
facilities, the Company may have to curtail loan origination and purchasing
activities, which would have a material adverse effect on the Company's
financial position and results of operations.
Dependence on Securitization Program. The Company relies on its ability to
securitize and sell its mortgage loans in the secondary market in order to
generate cash proceeds for repayment of its warehouse facilities. Accordingly,
adverse changes in the Company's securitization program or in the secondary
mortgage market could impair the Company's ability to originate, purchase and
sell mortgage loans on a favorable or timely basis. Any such impairment could
have a material adverse effect upon the Company's financial position and results
of operations. In addition, in order to gain access to the secondary market, the
Company has relied upon monoline insurance companies to provide financial
guarantee insurance on the senior interests in loans sold in the secondary
market in order to obtain ratings for such interests. To date, the Company has
not structured a pool of loans for securitization and sale in the secondary
market based solely on the internal credit enhancements of the pool of loans or
the Company's credit. Any substantial reduction in the size or availability of
the secondary market of the Company's loans, or the unwillingness of the
monoline insurance companies to provide financial guarantee insurance for the
senior interests in loans sold in the secondary market, or other accounting, tax
or regulatory changes adversely affecting the Company's securitization program,
could have a material adverse effect on the Company's financial position and
results of operations.
CAPITALIZED EXCESS SERVICING RECEIVABLE; MORTGAGE SERVICING RIGHTS
The majority of the Company's revenue is recognized as excess servicing
gain, which represents the present value of the excess servicing, less
transaction expenses, on mortgage loans sold servicing retained by the Company.
The Company recognizes excess servicing gain in the fiscal year in which such
loans are sold, although cash (representing the excess servicing and normal
servicing fees) is received by the Company over the life of the loans.
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Concurrent with recognizing excess servicing gain, the Company records an excess
servicing receivable as an asset on its consolidated balance sheet.
The amount of the excess servicing receivable is computed using prepayment,
loss and discount rate assumptions that the Company believes market participants
would use for similar instruments at the time of sale. Because of changes in the
markets in which the Company competes and the mix of loans included in any
particular pool, the prepayment, default and interest rate assumptions
applicable to the Company's pools may differ. Consequently, the performance of
prior securitizations effected by the Company may not constitute an accurate
predictor of future performance. In particular, the Company expects to realize a
lower percentage of excess servicing gain on the sale of loans than was the case
in prior securitizations completed by the Company as a result of changes in the
composition of the Company's loan product mix and other factors. The Company is
not aware of an active market for its excess servicing receivable. No assurance
can be given that excess servicing receivable could in fact be sold or monetized
at its stated value on the balance sheet, if at all.
The Company's capitalized excess servicing receivable is amortized over the
estimated remaining life of the underlying mortgage loans as an offset against
the excess servicing component of servicing income actually received in
connection with such loans. Although management of the Company believes that it
has made reasonable estimates, on a pool-by-pool basis, of the excess servicing
likely to be realized over the life of each pool, the rates of prepayment and
loss assumptions utilized by the Company are estimated and actual experience may
vary from these estimates. The Company reviews quarterly, on a pool-by-pool
basis, its prepayment and loss assumptions in relation to then current pool
performance and market conditions and, if necessary, would write down the
remaining asset to the net present value of the revised estimated remaining
future excess servicing receivable.
An increase in losses from those initially assumed in valuing excess
servicing could result in capitalized excess servicing amortization expense
exceeding realized excess servicing, thereby adversely affecting the Company's
servicing income and resulting in a reduction in cash flow and a charge to
earnings in the period of adjustment. Likewise, if liquidations with respect to
such mortgage loans were to occur sooner and/or with greater frequency than
initially assumed, capitalized excess servicing amortization would occur more
quickly than originally anticipated, which would have an adverse effect on
servicing income in the period of such adjustment. The rates of foreclosures
experienced by credit-impaired borrowers in certain economic conditions may
exceed those experienced by other mortgage borrowers.
In complying with SFAS No. 122, beginning in fiscal 1996, the Company
records mortgage servicing rights as assets in the period of the Company's sale
or securitization of the related mortgage loans, which include the Company's
estimates of future servicing fees, prepayment fees and other ancillary income
with respect to the underlying mortgage loan, whereas, under the prior standard,
the Company recorded such amounts as received. This accounting method has
resulted in and may, in future periods in which the Company originates or
purchases mortgage loans the terms of which provide for significant prepayment
penalties or other ancillary income, result in earlier recognition of excess
servicing gain than did the Company's reporting under the prior standard.
Furthermore, insofar as the Company's ability to originate or purchase mortgage
loans with such terms may be adversely affected by federal or state regulations
(see "--Government Regulation") or market conditions, the Company's revenue in
future periods may be negatively affected. There can be no assurance as to the
Company's ability in any future period to originate or purchase loans providing
for the same prepayment penalties or other ancillary income to the servicer.
In addition, SFAS No. 122 requires recognition of impairment of capitalized
mortgage servicing rights, including the Company's excess servicing receivable,
on a disaggregated basis in terms of differentiated groups of mortgage loans
identified by the predominant risk characteristics of such mortgage loans (e.g.
seasoning of the mortgage loans or whether the related interest rates are fixed
or adjustable). Compliance with SFAS No. 122 may, depending on market conditions
in future periods, require the Company to recognize greater levels of impairment
(and corresponding write-downs of its Company's excess servicing receivable)
than the Company might have recognized in its reporting under the prior
standard.
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RECENT ADDITION OF WHOLESALE CORRESPONDENT PROGRAM
Until 1994, the Company originated substantially all of the loans it
serviced and sold through its retail loan office network. In 1994, the Company
commenced its wholesale correspondent program and in 1995 expanded it to include
purchases of loans in bulk resulting in substantial growth in the number of
loans purchased. The extent of credit or other problems associated with loans
purchased pursuant to this recent expansion into a new channel of loan
production will not become apparent until sometime in the future.
The Company's significant growth and expansion have placed substantial new
and increased pressures on the Company's personnel and systems. In order to
support the growth of its business, the Company has added a significant number
of new operating procedures, facilities and personnel. Although the Company
believes the addition of new operating procedures and personnel will be
sufficient to enable it to meet its growing operating needs, there can be no
assurance that this will be the case. Failure by the Company to manage its
growth effectively, or to sustain its historical levels of performance in credit
analysis, property appraisal and transaction structuring with respect to the
increased loan origination and purchase volume, could have a material adverse
effect on the Company's results of operations and financial condition.
RECENT ACQUISITION OF ONE STOP
On August 28, 1996, the Company acquired One Stop in a merger transaction.
One Stop will be operated as a wholly-owned subsidiary of the Company. The
Company acquired One Stop with the expectation that the acquisition will result
in beneficial synergies for the combined business. The Company's ability to
achieve these beneficial synergies will depend in part on whether the operations
of One Stop can be integrated into the Company's in an efficient, effective and
timely manner. Integral to this process is the integration of the two companies'
management teams and operating procedures. There is no assurance that this
integration will be accomplished smoothly or successfully, and the difficulties
of such integration may be increased by the necessity of coordinating
geographically separated organizations with different cultures. The integration
of operations of One Stop's business will require the dedication of management
resources, which may temporarily distract attention from the day-to-day business
of each of the companies' businesses. The inability of management to integrate
successfully the operations of One Stop's business in a timely manner may have
an adverse effect on the business, results of operations and financial condition
of the Company's business on a consolidated basis.
One Stop commenced operations in October 1995. One Stop had net income of
$547,000 for the period ended December 31, 1995 and a $1.8 million loss for the
six months ended June 30, 1996. One Stop had total stockholders equity of $23.2
million as of June 30, 1996. There can be no assurance that One Stop will
achieve profitability or successfully implement its business strategy.
Since commencement of operations in October 1995, One Stop's rate of growth
in originating and purchasing loans has been significant. Further, One Stop has
generally sold its loans on a whole-loan basis or retained them in its
portfolio. The Company intends to include One Stop's loans in the Company's
securitizations. It is not known what impact, if any, the inclusion of these
loans will have on the structure or pricing of the Company's securitizations. In
light of One Stop's growth and the expected changes in its operations, the
historical financial performance of One Stop is of limited relevance in
predicting future performance. Also, the loans originated and purchased by One
Stop and to be included in the Company's securitization in September 1996 have
been outstanding for a relatively short period of time. Consequently, the
delinquency and loss experience of One Stop's loans to date may not be
indicative of that to be achieved in future periods, and One Stop may not be
able to maintain delinquency and loan loss ratios at their present levels as One
Stop's loan portfolio becomes more seasoned.
Further, there can be no assurance that the present and potential brokers
doing business with One Stop will continue their current utilization patterns
without regard to the acquisition. Prior to its acquisition by the Company, a
substantial portion of the loans originated or purchased by One Stop were "A-,"
"B," or "C" loans. Beginning in September 1996, One Stop intends to increase the
percentage of "C-" and "D" loans originated and purchased
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by it. All loans originated by One Stop will be underwritten in accordance with
the Company's underwriting guidelines. Once approved, the loan is funded or
purchased by One Stop directly. This change in underwriting guidelines could
also have a negative impact on relations with One Stop's brokers. Any
significant reduction in utilization patterns by brokers doing business with One
Stop could have an adverse effect on the near-term business and results of
operations of One Stop, and on the Company on a consolidated basis.
The One Stop acquisition is intended to be accounted for on a
pooling-of-interests basis. Under the pooling rules, the historical financial
results of the Company will be restated to reflect the combination. Following
the consummation of the acquisition, the historical results of the Company will
be restated to reflect the historical losses of One Stop. Further, under the
pooling rules, the costs incurred by the Company and One Stop in consummating
the acquisition will be expensed during the first quarter of fiscal 1997.
CONCENTRATION OF WHOLESALE CORRESPONDENT PROGRAM
The Company has implemented a program for purchasing mortgage loans in bulk
as well as on an ongoing or "flow" basis from mortgage bankers and financial
institutions. This program accounted for 74% of all mortgage loans originated or
purchased by the Company in fiscal 1996. Although the Company acquires mortgage
loans from a variety of sources, a significant portion of the volume of mortgage
loans acquired by the Company has been concentrated among a relatively small
number of correspondents and bulk purchase transactions, with one such
correspondent representing approximately 32% of total mortgage loans purchased
in fiscal 1996. Any significant reduction in the amount of mortgage loans
available for sale from this source or the failure to effect purchases or a
delay of a significant number of such purchases beyond the end of a quarter,
could have a material adverse impact on total loan purchases by the Company
during a quarter with a consequent material adverse impact on the Company's
revenue and results of operations.
COMPETITION
As a marketer of home equity mortgage loans, the Company faces intense
competition. Traditional competitors in the financial services business include
other mortgage banking companies, commercial banks, credit unions, thrift
institutions and finance companies. Many of these competitors in the financial
services business are substantially larger and have more capital and other
resources than the Company. Competition can take many forms, including
convenience in obtaining a loan, customer service, marketing and distribution
channels and interest rates. In addition, the current level of gains realized by
the Company and its competitors on the sale of their sub-prime mortgage loans is
attracting additional competitors into this market with the possible effect of
lowering gains that may be realized on the Company's future loan sales.
Competition may be affected by fluctuations in interest rates and general
economic conditions. During periods of rising rates, competitors which have
locked in lower borrowing costs may have a competitive advantage. During periods
of declining rates, competitors may solicit the Company's customers to refinance
their loans. During economic slowdowns or recessions, credit-impaired borrowers
may have new financial difficulties and may be receptive to offers by the
Company's competitors.
The Company's wholesale correspondent program depends largely on
independent mortgage bankers and other financial institutions for the purchases
of new loans. The Company's competitors also seek to establish relationships
with the same mortgage bankers and other financial institutions. In addition,
the Company expects the volume of loans purchased by the Company to increase and
the relative proportion of purchased loans when compared with retail loans will
continue to expand. The Company's future results may become more exposed to
fluctuations in the volume and cost of the Company's wholesale correspondent
program resulting from competition from other purchasers of such loans, market
conditions and other factors. In addition, a number of the Company's competitors
have recently increased their access to the capital markets, which fosters their
growth and therefore competition.
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CONCENTRATION OF OPERATIONS IN CALIFORNIA
At June 30, 1996, a significant majority of the loans serviced by the
Company were secured by properties located in California. Because the Company's
servicing portfolio is currently concentrated in California, the Company's
financial position and results of operations have been and are expected to
continue to be influenced by general trends in the California economy and its
residential real estate market. The California economy has experienced a
slowdown or recession over the last several years which has been accompanied by
a sustained decline in the values of California real estate. Residential real
estate market declines may adversely affect the values of the properties
securing loans such that the principal balances of such loans, together with any
primary financing on the mortgaged properties, will equal or exceed the value of
the mortgaged properties. In addition, California historically has been
vulnerable to certain natural disaster risks, such as earthquakes and
erosion-caused mudslides, which are not typically covered by the standard hazard
insurance policies maintained by borrowers. Uninsured disasters may adversely
impact borrowers' ability to repay loans made by the Company and adversely
impact the Company's results of operations.
TIMING OF LOAN SALES
The Company endeavors to effect the securitization and sale of a loan pool
each quarter. However, market and other considerations, including the conformity
of loan pools to monoline insurance company and rating agency requirements,
could affect the timing of such transactions. Any delay in the sale of a loan
pool beyond a quarter-end would postpone the recognition of excess servicing
gain related to such loans until their sale and would likely result in losses
for such quarter being reported by the Company.
DEPENDENCE ON MANAGEMENT; EMPLOYMENT AGREEMENTS
The Company's success will continue to depend to a significant extent on
its executive officers and other key management, particularly its Chief
Executive Officer, Gary K. Judis; its Chief Operating Officer, Cary H. Thompson;
and its Executive Vice President and President of One Stop, Neil B. Kornswiet.
The Company's Chief Executive Officer, Chief Operating Officer and the Chief
Executive Officer of One Stop are each parties to employment agreements with the
Company which provide for bonus payments based upon the net income or return on
equity of the Company or One Stop, as applicable. In the case of the Chief
Executive Officer of the Company, he is entitled to receive a base salary of
$850,000 per annum and, for each quarter ended December 31, 1996, a bonus equal
to 7.5% of the Company's pre-tax income (prior to bonuses and prior to any
extraordinary charges). Commencing in January 1997, the Chief Executive Officer
of the Company will receive a bonus measured by the Company's return on equity.
The Company's Chief Operating Officer is entitled to a base salary of $500,000
per annum and a quarterly bonus measured by the Company's return on equity. The
Chief Executive Officer of One Stop is entitled to a base salary of $750,000 per
annum and a quarterly bonus equal to 7.5% of One Stop's pre-tax income. Other
members of senior management are participants in a management bonus plan which
awards bonuses measured by the Company's return on equity.
ECONOMIC CONDITIONS
General. The risks associated with the Company's business become more acute
in any economic slowdown or recession. Periods of economic slowdown or recession
may be accompanied by decreased demand for consumer credit and declining real
estate values. Any material decline in real estate values reduces the ability of
borrowers to use home equity to support borrowings and increases the current
combined loan-to-value ratios of loans previously made by the Company, thereby
weakening collateral coverage and increasing the possibility of a loss in the
event of default. Further, delinquencies, foreclosures and losses generally
increase during economic slowdowns or recessions. Because of the Company's focus
on credit-impaired borrowers, the actual rates of delinquencies, foreclosures
and losses on such loans could be higher than those generally experienced in the
mortgage lending industry. In addition, in an economic slowdown or recession,
the Company's servicing costs may increase. Any sustained period of increased
delinquencies, foreclosure, losses or increased costs could adversely affect the
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Company's ability to securitize or sell loans in the secondary market and could
increase the cost of securitizing and selling loans in the secondary market.
The Company's principal market is credit-impaired borrowers who have
significant equity in their homes and whose borrowing needs are not being met by
traditional financial institutions. Loans made to such borrowers may entail a
higher risk of delinquency and higher losses than loans made to more
creditworthy borrowers. While the Company believes that the underwriting
criteria and collection methods it employs enable it to reduce the higher risks
inherent in loans made to credit-impaired borrowers, no assurance can be given
that such criteria or methods will afford adequate protection against such
risks. In the event that pools of loans sold and serviced by the Company
experience higher delinquencies, foreclosures or losses than anticipated, the
Company's financial condition or results of operations could be adversely
affected.
Interest rates. The Company's earnings may be directly affected by the
level of and fluctuations in interest rates which affect the Company's ability
to earn a spread between interest received on its loans and the costs of its
liabilities. While the Company monitors the interest rate environment and
employs a hedging strategy designed to mitigate the impact of changes in
interest rates, there can be no assurance that the earnings of the Company would
not be adversely affected during any period of unexpected changes in interest
rates. During periods of increasing interest rates, the Company generally
experiences market pressure to reduce its servicing spread or commissions on
originations. A substantial and sustained increase in interest rates could
adversely affect the ability of the Company to originate loans and could reduce
the gains recognized by the Company upon their securitization and sale. A
significant decline in interest rates could decrease the size of the Company's
loan servicing portfolio by increasing the level of loan prepayments, thereby
shortening the life and impairing the value of the excess servicing receivables
and mortgage servicing rights. Fluctuating interest rates also may affect the
net interest income earned by the Company resulting from the difference between
the yield to the Company on mortgage loans held pending sale and the interest
paid by the Company for funds borrowed under the Company's warehouse credit
facilities or otherwise. In addition, inverse or flattened interest yield curves
could have an adverse impact on the earnings of the Company because the loans
pooled and sold by the Company have long-term rates while the senior interests
in the related REMIC trusts are priced on the basis of intermediate rates.
The Company introduced adjustable rate mortgages as a new product in
January 1994. Adjustable rate loans account for a substantial portion of the
mortgage loans originated or purchased by the Company. Substantially all such
adjustable rate mortgages include a "teaser" rate, i.e., an initial interest
rate significantly below the fully indexed interest rate at origination.
Although these loans are underwritten at the fully indexed rate at origination,
credit-impaired borrowers may encounter financial difficulties as a result of
increases in the interest rate over the life of the loan.
CONTINGENT RISKS
Although the Company sells substantially all the mortgage loans which it
originates or purchases, the Company retains some degree of credit risk on
substantially all loans sold. During the period of time that loans are held
pending sale, the Company is subject to the various business risks associated
with the lending business including the risk of borrower default, the risk of
foreclosure and the risk that a rapid increase in interest rates would result in
a decline in the value of loans to potential purchasers. The documents governing
the Company's securitization program require the Company to establish deposit
accounts or build overcollateralization levels through retention of excess
servicing distributions in such accounts or application of excess servicing
distributions to reduce the principal balances of the senior interests issued by
the related REMIC trust, respectively. Such amounts serve as credit enhancement
for the related REMIC trust and are therefore available to fund losses realized
on loans held by such trust. The Company continues to be subject to the risks of
default and foreclosure following securitization and the sale of loans to the
extent of excess servicing distributions required to be retained or applied to
reduce principal from time to time. Such amounts are determined by the monoline
insurance company issuing the guarantee of the related interests in each REMIC
trust and are a condition to obtaining the requisite rating thereon. In
addition, documents governing the Company's securitization program require the
Company to commit to repurchase or replace loans which do not conform to the
representations and warranties made by the Company at the time of sale.
36
37
When borrowers are delinquent in making monthly payments on loans included in a
REMIC trust, the Company is required to advance interest payments with respect
to such delinquent loans to the extent that the Company deems such advances
ultimately recoverable. These advances require funding from the Company's
capital resources but have priority of repayment from collections or recoveries
on the loans in the related pool in the succeeding month.
In the ordinary course of its business, the Company is subject to claims
made against it by borrowers and private investors arising from, among other
things, losses that are claimed to have been incurred as a result of alleged
breaches of fiduciary obligations, misrepresentations, errors and omissions of
employees and officers of the Company (including its appraisers), incomplete
documentation and failures by the Company to comply with various laws and
regulations applicable to its business. The Company believes that liability with
respect to any currently asserted claims or legal actions is not likely to be
material to the Company's financial position or results of operations; however,
any claims asserted in the future may result in legal expenses or liabilities
which could have a material adverse effect on the Company's financial position
and results of operations.
GOVERNMENT REGULATION
Members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of the Company's loans are made to borrowers
for the purpose of consolidating consumer debt or financing other consumer
needs, the competitive advantages of tax deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. Accordingly, the reduction or elimination of these tax
benefits could have a material adverse effect on the demand for loans of the
kind offered by the Company.
The operations of the Company are subject to regulation by federal, state
and local government authorities, as well as to various laws and judicial and
administrative decisions, that impose requirements and restrictions affecting,
among other things, the Company's loan originations, credit activities, maximum
interest rates, finance and other charges, disclosures to customers, the terms
of secured transactions, collection, repossession and claims-handling
procedures, multiple qualification and licensing requirements for doing business
in various jurisdictions, and other trade practices. Although the Company
believes that it is in compliance in all material respects with applicable
local, state and federal laws, rules and regulations, there can be no assurance
that more restrictive laws, rules or regulations will not be adopted in the
future that could make compliance more difficult or expensive, restrict the
Company's ability to originate, purchase or sell loans, further limit or
restrict the amount of interest and other charges earned on loans originated or
purchased by the Company, further limit or restrict the terms of loan
agreements, or otherwise adversely affect the business or prospects of the
Company.
In October 1995, certain amendments to the Truth in Lending Act (the "TILA
Amendments") went into effect. The TILA Amendments provide in general that
lenders may not include prepayment fee clauses in loans regulated by those
amendments ("Section 32 Loans") if the borrower has a debt-to-income ratio in
excess of 50%. In addition, a lender that refinances a Section 32 Loan
previously made by such lender will not be able to enforce any prepayment
penalty clause contained in such refinanced loan. A majority of the loans
originated or purchased by the Company prior to October 1995 would have been
Section 32 Loans if they had been originated after that date. The Company has
modified its loan programs to significantly reduce the number of Section 32
Loans it originates and purchases.
37
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are attached to this
report:
Report of Independent Accountants
Consolidated Balance Sheets at June 30, 1995 and 1996
Consolidated Statements of Income for Fiscal Years Ended
June 30, 1994, 1995 and 1996
Consolidated Statements of Stockholders' Equity for Fiscal
Years Ended June 30, 1994, 1995 and 1996
Consolidated Statements of Cash Flows for Fiscal Years Ended
June 30, 1994, 1995 and 1996
Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Information regarding Directors and Executive Officers of
Registrant will appear in the proxy statement for the 1996 Annual Meeting of
Stockholders, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will appear in
the proxy statement for the 1996 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding executive compensation will appear in the
proxy statement for the 1996 Annual Meeting of Stockholders, and is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related
transactions will appear in the proxy statement for the 1996 Annual Meeting of
Stockholders, and is incorporated by this reference.
38
39
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements:
See Financial Statements listed as part of Item 8.
Financial Statements and Supplementary Data.
(b) Financial Statement Schedules:
Schedule 6 Property, Plant and Equipment.
Schedule 7 Accumulated Depreciation, Depletion
and Amortization of Property, Plant
and Equipment.
(c) Exhibits - Management Contracts and Compensatory
Plans:
10.1 Form of Director and Officer
Indemnification Agreement.(1)
10.2 Amended and Restated Employment
Agreement between Registrant and
Gary K. Judis.
10.3 Amended and Restated Employment
Agreement between Registrant and
Cary H. Thompson.
10.4 Stock Option Agreement between the
Registrant and Cary H. Thompson.
10.5 1991 Stock Incentive Plan, as
amended.(2)
10.6 1995 Stock Incentive Plan.
10.7 1995 Employee Stock Purchase
Plan(3)
(d) Other Exhibits:
3.1 Certificate of Incorporation of
Registrant, as amended.
3.3 Bylaws of Registrant as currently in
effect.(1)
4.1 Specimen certificate evidencing
Common Stock of Registrant.
4.2 Form of Representative Warrant.(1)
4.3 Form of Rights Agreement, dated as
of June 21, 1996, between Registrant
and Wells Fargo Bank, as rights
agent.(4)
10.8 Office Lease, dated December 13,
1989, between State Street Bank and
Trust Company of California, N.A.
and Registrant's wholly owned
subsidiary, Aames Home Loan, for the
premises located at 3731 at Wilshire
Boulevard, Los Angeles, California
90010.(1)
10.9 Amendments dated August 1,1991,
March 15, 1992, June 30, 1993 and
September 7, 1993 to Office Lease
filed as Exhibit 10.2.(5)
10.10 Indenture of Trust, dated February
1, 1995, between Registrant and
Bankers Trust Company of California,
N.A., relating to Registrant's
10.50% Senior Notes due 2002.(5)
10.11 Supplemental Indenture of Trust,
dated as of April 25, 1995 to
Exhibit 10.8.(6)
10.12 Indenture, dated as of February 26,
1996, between Registrant and The
Chase Manhattan Bank, N.A., relating
to Registrant's $115,000,000 of 5.5%
Convertible Subordinated Debentures
due 2006.(7)
10.13 Interim Loan and Security Agreement,
dated as of April 21, 1995, between
National Westminster Bank Plc, New
York Branch and Registrant's wholly
owned subsidiary, Aames Capital
Corporation.(8)
39
40
10.14 Notice of Extension Agreement No. 5,
dated as of June 28, 1996, with
respect to Exhibit 10.13
10.15 Amendment No. 4, dated as of June
28, 1996, with respect to Exhibit
10.13
10.16 Guarantee by Registrant with respect
to Exhibit 10.13.(8)
10.17 Mortgage Loan Warehousing Agreement,
dated as of December 27, 1995, among
Registrant's wholly owned
subsidiary, Aames Capital
Corporation; Registrant; the lenders
from time to time a party thereto;
Nations Bank of Texas, N.A., as
administrative agent for the lenders
and a lender; and First Interstate
Bank of California, as co-agent for
the lenders and a lender.(9)
10.18 First Amendment to Mortgage Loan
Warehousing Agreement, dated as of
February 20, 1996, with respect to
Exhibit 10.17
10.19 Second Amendment to Mortgage Loan
Warehousing Agreement and Related
Documents, dated June 28, 1996, with
respect to Exhibit 10.(17)
10.20 Aircraft Lease Agreement, dated as
of March 8, 1996, between C.I.T.
Leasing Corporation, as lessor, and
Registrant's wholly owned
subsidiary, Oxford Aviation
Corporation, Inc., as lessee.(7)
10.21 Corporate Guaranty Agreement, dated
as of March 8, 1996, between
Registrant, as guarantor, and C.I.T.
Leasing Corporation with respect to
Exhibit 10.20(7)
11.1 Statement Re. Computation of Per
Share Earnings.
21.0 Subsidiaries of the Registrant
23.1 Consent of Price Waterhouse LLP
27.0 Financial Data Schedule
- ---------------------
1 Incorporated by reference from Registrant's Registration Statement on
Form S-1, File No. 33-43237.
2 Incorporated by reference from Registrant's Registration Statement on
Form S-1, File No. 33-62400.
3 Incorporated by reference from Registrant's Registration Statement, File
No. 333-01312.
4 Incorporated by reference from Registrant's Registration Statement on
Form 8-A, File No. 33-13660.
5 Incorporated by reference from Registrant's Registration Statement on
Form S-2, File No. 33-88516.
6 Incorporated by reference from Registrant's Annual Report on Form 10-K
for the Year Ended June 30, 1995.
7 Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
for the Three Months Ended March 31, 1996.
8 Incorporated by reference from Registrant's Registration Statement on
Form S-2, File No. 33-91640.
9 Incorporated by reference from Registrant's Quarterly Report on Form 10-Q
for the Three Months Ended December 31, 1995.
(e) Reports on Form 8-K:
Current Report on Form 8-K dated April 23, 1996 --
Item 5.
40
41
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.
AAMES FINANCIAL CORPORATION
(Registrant)
By: /s/ Gary K. Judis
------------------------------------
Gary K. Judis
Chairman of the Board and
Chief Executive Officer
September 12, 1996
------------------
Date
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.
Signature Title Date
--------- ----- ----
/s/ Gary K. Judis Chairman, Chief Executive Officer, September 12, 1996
- --------------------------------------- President
Gary K. Judis
/s/ Cary H. Thompson Chief Operating Officer, Director September 12, 1996
- ---------------------------------------
Cary H. Thompson
/s/ Gregory J. Witherspoon Executive Vice President - Finance, September 12, 1996
- --------------------------------------- Chief Financial Officer, Director
Gregory J. Witherspoon
/s/ Bobbie J. Burroughs Executive Vice President - Administration, September 12, 1996
- --------------------------------------- Secretary, Director
Bobbie J. Burroughs
/s/ Neil B. Kornswiet Executive Vice President, Director September 12, 1996
- ---------------------------------------
Neil B. Kornswiet
/s/ Mark E. Elbaum Senior Vice President - Finance, September 12, 1996
- --------------------------------------- Principal Accounting Officer
Mark E. Elbaum
/s/ Joseph R. Cerrell Director September 12, 1996
- ---------------------------------------
Joseph R. Cerrell
/s/ Dennis F. Holt Director September 12, 1996
- ---------------------------------------
Dennis F. Holt
/s/ Melvyn Kinder Director September 12, 1996
- ---------------------------------------
Melvyn Kinder
41
42
AAMES FINANCIAL
CORPORATION
RULE12-06 Property, Plant and Equipment
Fiscal Years 1994, 1995 and 1996
Column A Column B Column C Column D Column E Column F
- -------- -------- -------- -------- -------- --------
Classification Balance at Additions Retirements Other changes- Balance
beginning at cost add (deduct)- at end of
of period period
- ------------------------------------------------------------------------------------------------------
1994
Automobile 191,000 34,000 23,000 202,000
Furniture &
Fixtures 841,000 396,000 1,237,000
Leasehold
Improvements
Data
Processing Eq 679,000 437,000 1,116,000
Capital Leases 797,000 797,000
-------------------------------------------------------------------------------
Total 2,618,000 870,000 23,000 3,465,000
===============================================================================
1995
Automobile 202,000 69,000 76,000 195,000
Furniture &
Fixtures 1,237,000 349,000 125,000 1,461,000
Leasehold
Improvements
Data
Processing Eq 1,116,000 538,000 1,654,000
Capital Leases 797,000 797,000
-------------------------------------------------------------------------------
Total 3,456,000 976,000 201,000 4,240,000
===============================================================================
1996
Automobile 195,000 154,000 93,000 256,000
Furniture &
Fixtures 1,461,000 1,400,000 70,000 2,791,000
Leasehold
Improvements 133,000 35,000 168,000
Data
Processing Eq 1,654,000 2,933,000 58,000 4,529,000
Data
Processing SFTW
Capital Leases 797,000 9,000 806,000
-------------------------------------------------------------------------------
Total 4,240,000 4,729,000 221,000 8,748,000
===============================================================================
43
AAMES FINANCIAL
CORPORATION
RULE12-07 Accumulated Depreciation,
Depletion and Amortization of Property
Plant and Equipment
Fiscal Years 1994, 1995 and 1996
Column A Column B Column C Column D Column E Column F
- -------- -------- -------- -------- -------- --------
Description Balance at Additions Retirements Other changes- Balance
beginning Charged to add (deduct)- at end of
of period Costs describe period
& Expenses
- -----------------------------------------------------------------------------------
1994
Automobile 70,000 25,000 7,000 88,000
Furniture &
Fixtures 534,000 112,000 646,000
Leasehold
Improvements 92,000 8,000 100,000
Data
Processing Eq. 220,000 175,000 395,000
Capital Leases 424,000 131,000 555,000
-----------------------------------------------------------------
Total 1,340,000 451,000 7,000 1,784,000
=================================================================
1995
Automobile 88,000 9,000 76,000 21,000
Furniture &
Fixtures 646,000 175,000 125,000 696,000
Leasehold
Improvements 100,000 12,000 112,000
Data
Processing Eq. 395,000 263,000 658,000
Capital Leases 555,000 130,000 685,000
-----------------------------------------------------------------
Total 1,784,000 589,000 201,000 2,172,000
=================================================================
1996
Automobile 21,000 102,000 72,000 51,000
Furniture &
Fixtures 696,000 292,000 988,000
Leasehold
Improvements 112,000 10,000 122,000
Data
Processing Eq. 658,000 548,000 1,206,000
Data
Processing SFTW. 685,000 73,000 758,000
Capital Leases 797,000 9,000 806,000
-----------------------------------------------------------------
Total 2,172,000 1,037,000 72,000 3,137,000
=================================================================
44
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
Aames Financial Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of stockholders' equity and of cash flows
represent fairly, in all material respects, the financial position of Aames
Financial Corporation and its Subsidiaries (the "Company") at June 30, 1996 and
1995, and the results of their operations and their cash flows for each of the
three years in the period ended June 30, 1996, in conformity with generally
accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1 to the Consolidated Financial Statements, the Company
adopted an accounting standard that changed its method of accounting for
mortgage servicing rights for the year ended June 30, 1996.
The audits referred to above also included an audit of the financial statement
schedules listed in Item 14. In our opinion, these financial statement
schedules present fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial
statements.
Price Waterhouse LLP
Los Angeles, California
August 12, 1996
45
CONSOLIDATED BALANCE SHEETS
June 30, June 30,
1996 1995
-------------------------------
ASSETS
Cash and cash equivalents $ 18,216,000 $ 20,359,000
Loans held for sale, at cost
which approximates market 67,327,000 24,132,000
Accounts receivable, less allowance for doubtful
accounts of $473,000 and $360,000 8,600,000 6,090,000
Excess servicing receivable (Note 2) 129,113,000 42,078,000
Mortgage servicing rights 10,902,000
Residual assets 44,676,000 14,882,000
Equipment and improvements, net (Note 3) 5,612,000 2,063,000
Prepaid and other 9,551,000 5,019,000
-------------------------------
TOTAL ASSETS $293,997,000 $114,623,000
===============================
Liabilities and Stockholders' Equity
Borrowings (Note 4) $138,045,000 $ 23,144,000
Revolving warehouse facilities (Note 4) 11,026,000
Accounts payable and accrued exprenses 8,976,000 6,141,000
Accrued compensation and related expenses 3,949,000 1,703,000
Income taxes payable (Note 5) 21,831,000 3,588,000
-------------------------------
TOTAL LIABILITIES 183,827,000 34,576,000
Commitments and Contingencies (Note 6)
Stockholders' equity
Preferred stock, par value $.001 per share 1,000,000 shares
authorized; none outstanding
Common Stock, par value $.001 per share 50,000,000 and
10,000,000 shares authorized; 13,501,900 and
13,221,000 shares outstanding (Note 9) 14,000 14,000
Additional paid-in capital 63,628,000 61,864,000
Retained earnings 46,528,000 18,169,000
-------------------------------
Total Stockholders' equity 110,170,000 80,047,000
-------------------------------
Total liabilities and stockholders' equity $293,997,000 $114,623,000
===============================
46
CONSOLIDATED STATEMENTS OF INCOME
Fiscal Years Ended June 30,
1996 1995 1994
---------------------------------------------
REVENUE:
Excess servicing gain (Note 2) $ 78,274,000 $ 22,954,000 $ 8,101,000
Commissions 19,880,000 15,799,000 16,432,000
Loan Service 18,185,000 8,246,000 6,099,000
Fees and other 12,069,000 7,940,000 5,595,000
---------------------------------------------
TOTAL REVENUE 128,408,000 54,939,000 36,227,000
---------------------------------------------
EXPENSES:
Compensation and related expenses (Note 6) 33,241,000 17,610,000 13,616,000
Sales and advertising costs 18,362,000 9,906,000 7,891,000
General and administrative expenses 13,926,000 7,067,000 5,415,000
Interest expense (Note 4) 9,348,000 3,205,000 322,000
---------------------------------------------
TOTAL EXPENSES 74,877,000 37,788,000 27,244,000
---------------------------------------------
INCOME BEFORE INCOME TAXES 53,531,000 17,151,000 8,983,000
PROVISION FOR INCOME TAXES (NOTE 5) 22,483,000 7,117,000 3,684,000
---------------------------------------------
NET INCOME $ 31,048,000 $ 10,034,000 $ 5,299,000
---------------------------------------------
NET INCOME PER SHARE
Primary $ 2.20 $ 1.11 $ 0.61
---------------------------------------------
Fully diluted 2.09 1.11 0.61
---------------------------------------------
WEIGHTED AVERAGE NUMBER
OF OUTSTANDING SHARES
Primary 14,096,000 9,021,000 8,751,000
---------------------------------------------
Fully diluted 15,465,000 9,021,000 8,751,000
---------------------------------------------
47
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Years Ended June 30,
1996 1995 1994
-------------------------------------------------------
OPERATING ACTIVITIES
Net income 31,048,000 10,034,000 5,299,000
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Depreciation and amortization 1,048,000 606,000 466,000
Deferred income taxes 15,369,000 3,972,000 (69,000)
Excess servicing gain (103,975,000) (33,891,000) (9,690,000)
Excess servicing amortization 16,940,000 4,402,000 2,693,000
Mortgage servicing rights originated (11,759,000)
Mortgage servicing rights amortization 857,000
Loans originated or purchased (895,834,000) (387,600,000) (190,200,000)
Proceeds from sale of loans 852,639,000 373,609,000 180,235,000
Changes in assets, and liabilities:
(increase) decrease in:
Accounts receivable (2,510,000) (2,663,000) (1,415,000)
Prepaid and other (4,532,000) (2,217,000) (900,000)
Residual assets (29,794,000) (8,691,000) (4,228,000)
Increase (decrease) in:
Accounts payable and
accrued expenses 3,150,000 534,000 2,755,000
Accrued compensation and
related expenses 2,246,000 581,000 435,000
Income taxes payable 2,874,000 (2,051,000) 762,000
Net cash used in operating activities (122,233,000) (43,375,000) (13,857,000)
Investing activities:
Purchases of property and equipment (4,597,000) (988,000) (870,000)
Net cash used in investing activities (4,597,000) (988,000) (870,000)
Financing activities
Proceeds from sale of stock
or exercise of options 1,764,000 40,087,000 12,263,000
Proceeds from borrowing 115,000,000 23,000,000 2,900,000
Amounts outstanding under
warehouse arrangements 11,026,000 (9,675,000) 9,675,000
Dividends paid (2,689,000) (1,743,000) (1,743,000)
Payments on bank notes and long-term debt (414,000) (3,460,000) (240,000)
Net cash provided by financing activities 124,687,000 48,209,000 22,855,000
Net increase (decrease) in cash (2,143,000) 38,460,000 8,128,000
Cash and cash equivalents at beginning of period 20,359,000 16,513,000 8,385,000
Cash and cash equivalents at end of period $ 18,216,000 20,359,000 16,513,000
Supplemental disclosures:
Interest paid $ 6,633,000 3,225,000 333,000
Taxes paid 4,354,000 4,843,000 2,991,000
48
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK ADDITIONAL PAID-IN RETAINED TOTAL
CAPITAL EARNINGS
AS OF JUNE 30, 1993 $ 6,000 $ 9,522,00 $ 6,322,000 $ 15,850,000
Issuance of common stock 3,000 12,260,000 12,263,000
Dividends $ (1,743,000) $ (1,743,000)
Net income 5,299,000 5,299,000
AS OF JUNE 30, 1994 9,000 21,782,000 9,878,000 31,669,000
Issuance of common stock 5,000 40,082,000 40,087,000
Dividends $ (1,743,000) $(1,743,000)
Net income 10,034,000 10,034,000
AS OF JUNE 30, 1995 14,000 61,864,000 18,169,000 80,047,000
Proceeds from sale of stock
or exercise of options 1,764,000 1,764,000
Dividends $ (2,689,000) $ (2,689,000)
Net income 31,048,000 31,048,000
AS OF JUNE 30, 1996 $14,000 $63,628,000 $46,528,000 $110,170,000
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Summary of Significant Accounting Policies
OPERATIONS
Aames Financial Corporation, a Delaware corporation ("Aames"), and its
subsidiaries (collectively, the "Company") engage in the consumer finance
business by offering mortgage loans to homeowners through 47 offices located in
16 states at year end. The Company also functions as an insurance agent and
mortgage trustee through certain of its subsidiaries. The Company's market is
borrowers who have significant equity in their homes but whose borrowing needs
are not being met by traditional financial institutions. The Company's business
includes originating (funding and brokering), purchasing, selling and servicing
mortgage loans primarily secured by single family residences (i.e., one-to
four-family). Loans originated by the Company are primarily extended on the
basis of the equity in the borrower's property and, to a lesser extent, the
creditworthiness of the borrower. The aggregate outstanding balances of loans
serviced by the Company was $1.25 billion and $609 million at June 30, 1996 and
June 30, 1995, respectively (which include $337 million and $152 million of
loans at June 30, 1996 and June 30, 1995, respectively, serviced for the
Company by unaffiliated subservicers under subservicing agreements).
The Company's ability to continue to originate and purchase loans is dependent,
in part, upon its ability to securitize and sell loans in the secondary market
in order to generate cash proceeds for new originations and purchases. The
value of and market for the Company's loans are dependent upon a number of
factors, including general economic conditions, interest rates and governmental
regulations. Adverse changes in such factors may affect the Company's ability
to purchase or sell loans for acceptable prices within reasonable periods of
time.
A prolonged, substantial reduction in the size of the secondary market for
loans of the types originated and purchased by the Company may adversely affect
the Company's ability to securitize and sell loans with a consequent adverse
impact on the Company's profitability and ability to fund future originations
and purchases which could have a material adverse effect on the Company's
financial position and results of operations.
In addition, in order to gain access to the secondary market, the Company has
relied on monoline insurance companies to provide financial guarantee insurance
on the senior interests in the real estate mortgage investment conduit
("REMIC") trusts established by the Company. Any substantial reduction in the
size or availability of the secondary market for the Company's loans or the
unwillingness of monoline insurance companies to provide financial guarantee
insurance for the senior interests in REMIC trusts could have a material
adverse effect on the Company's financial position and results of operations.
PRINCIPLES OF ACCOUNTING AND CONSOLIDATION
The consolidated financial statements of the Company include the accounts of
Aames and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with 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.
CASH IN TRUST
The Company services loans on behalf of customers. In such capacity, certain
monies are collected and placed in segregated trust accounts, which totaled
$26.8 million and $10.9 million at June 30, 1996 and June 30, 1995,
respectively. These accounts and corresponding liabilities are not included in
the accompanying balance sheet.
EQUIPMENT AND IMPROVEMENTS
Equipment and improvements are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are being recorded utilizing
straight-line and accelerated methods over the following estimated useful
lives:
FURNITURE Five to seven years
LEASEHOLD IMPROVEMENTS Shorter of five years or lease term
EQUIPMENT UNDER CAPITAL LEASES Five years
AUTOMOBILES Five years
DATA PROCESSING EQUIPMENT Five years
50
REVENUE RECOGNITION
The Company derives its revenue principally from servicing spreads, commissions
from the origination of the loans, insurance commissions, closing fees,
prepayment fees and fees charged for services such as appraisals and
underwriting. Loans originated through the Company's retail branch network or
purchased from correspondents are funded by the Company for pooling and sale in
the secondary market and placed with private investors or brokered to other
financial institutions. Revenue from loans pooled and sold in the secondary
market is recognized when such loan pools are sold. Revenue from loans funded
by private investors is recognized as income when escrow closes on the loan and
the funds are disbursed. The Company retains the right to service all loans
funded by the Company or placed with private investors. The Company receives a
fee for servicing such loans based on a fixed percentage of the declining
principal balance. A servicing spread is retained by the Company from the
monthly payments received from borrowers, a portion of which is accounted for
as a normal servicing fee. Loans brokered to other financial institutions are
sold on a servicing-released basis.
During the loan origination process, the Company negotiates fees, commissions
and payment terms to accommodate the borrower's immediate and long-term cash
flow needs. To the extent negotiation of the commission rate leads to a higher
or lower interest rate on the loan, this will generally have an inverse effect
on the servicing spread retained by the Company. Such negotiations result in a
wide range of loan servicing spreads retained by the Company.
Commission revenue on loan originations and related direct origination costs
are deferred until the related loan is sold. Upon sale of the loan, the
deferred commissions are recognized as commission revenue in the Consolidated
Statement of Income and deferred origination costs are recognized in the
applicable expense classification.
The accounting practice employed by the Company, whereby it accounts for a
portion of the servicing spread as a normal servicing fee, has the effect of
normalizing the loan servicing revenues recognized by the Company derived from
the long-term servicing of loans originated or purchased by the Company and
pooled and sold in the secondary market on a servicing-retained basis, or
placed with private investors. An excess loan servicing gain or loss is
recorded to account for the difference between the servicing spread retained by
the Company and the normal servicing fee that is determined by the Company
taking into account several factors including industry practices. The net
present value of that difference (based on certain prepayment and other
assumptions to determine an expected life of the loan) is recorded as an excess
servicing gain or loss when the loan is sold in a pool or funded by private
investors. The excess servicing gain included in the Consolidated Statements of
Income includes these amounts reduced by direct transaction costs. For loans
sold in the secondary market, the excess servicing gain includes provisions for
credit risk obligations retained by the Company. The excess servicing
receivable included in the Consolidated Balance Sheets results from the
recordation of such initial gains on an aggregate basis adjusted for
amortization.
As the Company receives cash in the form of the servicing spread it retains
(including the normal servicing fee), the excess servicing receivable is
reduced in proportion to and over the expected lives of the related loans
giving effect to the prepayment assumption utilized in its determination. On a
quarterly basis, the Company reviews its prepayment and other assumptions in
relation to its actual experience and current rates of prepayment prevalent in
the industry. The excess servicing receivable is written down when a shortfall
in the net present value of the estimated remaining future excess servicing fee
revenue becomes apparent. The excess servicing receivable is not increased as a
result of slower than estimated prepayment experience. The Company receives
prepayment fees on certain loans if they are paid off before maturity.
MORTGAGE SERVICING RIGHTS
The Company elected to adopt Statement of Financial Accounting Standard No.
122, "Accounting for Mortgage Servicing Rights" ("SFAS No. 122"), which amends
the prior mortgage banking standard for fiscal 1996. SFAS No. 122 prohibits
retroactive application to fiscal years prior to adoption. Accordingly, certain
information appearing in the Company's financial statements for fiscal 1995 and
before are based on the prior standard and such results are not directly
comparable to the results for fiscal 1996. Under SFAS No. 122 the Company
recognizes mortgage servicing rights ("MSR's") as assets separate from the
mortgage loans to which the MSR's relate based on their respective fair values.
In the past, the Company had allocated the entire cost of originating or
purchasing a mortgage loan to the carrying value of such mortgage loans. MSR's
are amortized over the lives of the loans to which the MSR's relate, reducing
servicing income in future periods.
To the extent that a portion of the total cost of originating or purchasing
mortgage loans has been allocated to the MSR's, relatively greater gains were
recognized on the securitization and sale of mortgage loans because of the
reduction of the Company's basis in such loans. The effect of adopting SFAS No.
122 was to increase the net income of the Company for the fiscal year ended
June 30, 1996 by $5.7 million or $.37 per fully diluted weighted average share.
In order to determine the fair value of the MSR's, the Company estimates the
expected future net servicing revenue based on common industry assumptions
(since market prices for MSR's under comparable servicing sales contracts are
not available to the Company), as well as on the Company's historical
experience.
51
INCOME TAXES
Taxes are provided on substantially all income and expense items included in
earnings, regardless of the period in which such items are recognized for tax
purposes. The Company uses an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Company's financial
statements or tax returns. In estimating future tax consequences, the Company
generally considers all expected future events other than enactments of changes
in the tax law or rates.
RISK MANAGEMENT
The Company employs certain risk management strategies to minimize its risk
from interest rate fluctuations during the period between the time it
originates or purchases loans and the time such loans are sold in the secondary
market. The Company sells its loans in the secondary market on a quarterly
basis, thus limiting the period of its interest rate risk exposure. These
securitzations are structured to allow the Company to sell a specified amount
of certain loans for a limited time in the future at an agreed upon price. In
addition, the Company regularly reviews the interest rates on its loan products
and makes adjustments to rates to reflect market conditions. Additionally, the
Company employs a hedging strategy whereby it enters into agreements to sell
securities not yet purchased that correlate to securities that are used to
index sales of the Company's loans in the secondary market. Gains or losses on
these transactions are included in the excess servicing gain at the time the
underlying loans are sold. At June 30, 1996, the Company had open hedging
positions with a notional balance of $40.0 million.
CASH AND CASH EQUIVALENTS
Cash equivalents, consisting primarily of short-term investments, are
considered cash equivalents if they were purchased with an original maturity of
three months or less. At June 30, 1996, the Company had $2.2 million held in a
restricted account in connection with the sale of a loan pool. These funds were
released to the Company in July 1996.
LOANS HELD FOR SALE
Loans held for sale are carried at the lower of aggregate cost or market value.
Market value is determined by current investor yield requirements.
RESIDUAL ASSETS
In connection with its securitization transactions, the Company initially
deposits with a trustee cash or the required over collateralization amount of
loans, and subsequently deposits a portion of the servicing spread collected on
the related loans. The amounts set aside ($44.7 million at June 30, 1996 and
$14.9 million at June 30, 1995) are available for distribution to investors in
the event of certain shortfalls in amounts due to investors. These amounts are
subject to increase up to maximum subordination amounts as specified in the
related securitization documents. Cash amounts on deposit are invested in
certain instruments as permitted by the related securitization documents. To
the extent amounts on deposit exceed specified levels, distributions are made
to the Company and, at the termination of the related REMIC trust, any
remaining amounts on deposit are distributed to the Company.
DEBT ISSUANCE
At June 30, 1996, the Company had an unamortized balance of debt issuance costs
of $3.8 million related to the issuance of $23.0 million of 10.5% Senior Notes
due 2002 and the issuance of $115 million of 5.5% Convertible Subordinated
Debentures due 2006. This balance is included in "Prepaid and other" on the
Consolidated Balance Sheets and is amortized into interest expense over the
life of the related debt.
EARNINGS PER SHARE
Earnings per share of common stock is computed using the weighted average
number of shares of common stock outstanding during each period, after giving
effect to the assumed exercise of certain stock options and warrants, and in
addition, for fully diluted earnings per share, the conversion of shares
related to the Company's 5.5% Convertible Subordinated Debentures due 2006.
In May 1996, the Company's $.001 par value common stock was split
three-for-two. All references in the accompanying Consolidated Balance Sheets,
Consolidated Statements of Earnings and Notes to Consolidated Financial
Statements to the number of common shares and share amounts have been restated
to reflect the stock split.
RECLASSIFICATIONS
Certain amounts related to 1994 and 1995 have been reclassified to conform to
the 1996 presentation.
52
Note 2 Excess Servicing Receivable
The excess servicing receivable represents the net present value of the
difference between the servicing spread retained by the Company and the normal
servicing fee determined by the Company taking into account several factors
including industry practices. The amount is amortized over the estimated lives
of the loans to which the excess servicing receivable relates.
The activity in the excess servicing receivable is summarized as follows:
Fiscal Years Ended June 30,
1996 1995 1994
------------ ------------ ------------
Balance, beginning of year $ 42,078,000 $12,589,000 $ 5,592,000
Excess servicing gain 103,975,000 33,891,000 9,690,000
Amortization of receivable (16,940,000) (4,402,000) (2,693,000)
============ =========== ===========
Balance, end of year $129,113,000 $42,078,000 $12,589,000
The Company discounts the cash flows on the related loans sold based upon the
rates charged to borrowers on such loans adjusted for credit risk obligations
retained by the Company. The Company had reserves of $10.2 million, $3.4
million and $959,000 at June 30, 1996, 1995 and 1994, respectively, related to
these credit risk obligations, which are netted against the excess servicing
receivable. The weighted average rates used to discount the cash flows were
14.7%, 14.5% and 13.7% for the years ended June 30, 1996, 1995 and 1994,
respectively. The excess servicing receivable is amortized using the same
discount rate used to determine the original excess servicing gain recorded.
On a quarterly basis, the Company analyzes its prepayment assumptions in
relation to actual prepayment experience on a disaggregated basis, based on
loan origination date and type of loan (fixed or adjustable), to determine
whether actual prepayment experience has had any impact on the carrying value
of the excess servicing receivable.
Note 3 Equipment and Improvements
Equipment and improvements comprise the following:
Fiscal Years Ended June 30,
1996 1995
------------ -----------
Data processing equipment 4,727,000 1,654,000
Furniture and fixtures 2,791,000 1,460,000
Leashold improvements 169,000 133,000
Equipment under capital leases 806,000 796,000
Automobiles 256,000 195,000
---------- ----------
Total 8,749,000 4,238,000
Accumulated depreciation and amortization (6,137,000) (2,175,000)
========== ==========
Net $5,612,000 $2,063,000
53
Note 4 Borrowing and Revolving Warehouse Facilities
Borrowings consist of the following:
Fiscal Years Ended June 30,
1996 1995
------------ -----------
5.5% Subordinated Convertible Debentures
due 2006 convertible to 4.1 million
shares of $.001 par value common stock
at $28 per share. The Subordinated
Convertible Debentures are subordinated
to all existing and future senior debt
of the Company (as defined in the
indenture Agreement). $115,000,000
10.5% Senior Notes due 2002,
collateralized by certain residual
certificates. Principal payments of
$5,750,000 in each of calendar years
1999 through 2002 23,000,000 23,000,000
Obligations under capital leases 45,000 144,000
============ ===========
TOTAL BORROWINGS $138,045,000 $23,144,000
Amounts outstanding under revolving warehouse facilities:
Fiscal Years Ended June 30,
1996 1995
------------ -----------
Warehouse facility with investment bank
collateralized by mortgages/deeds of
trust; expires January 1, 1997 with
interest at 0.0875% over applicable
LIBOR rate; total credit available
$150 million. Applicable LIBOR rate
was 5.5% at June 30, 1996 $11,026,000
Revolving warehouse facility with
commercial banks collateralized by
mortgages/deeds of trust; due in
December 1996 with interest at .875%
over applicable LIBOR rate; total
credit available $100 million.
Applicable LIBOR rate was 5.5% at
June 30, 1996.
============ ===========
Total amounts outstanding under
revolving warehouse facilities $11,026,000
54
Maturities on borrowings are as follows:
OBLIGATIONS
OBLIGATIONS UNDER CAPITAL
UNDER CAPITAL LEASES - NET
Fiscal Years Ended June 30, LEASES OF INTEREST BORROWINGS TOTAL - NET
1997 $47,000 $45,000 $ 45,000
1998
1999 $ 5,750,000 5,750,000
------------ ------------
2000 5,750,000 5,750,000
------------ -----------
2001 5,750,000 5,750,000
------------ -----------
Thereafter 120,750,000 120,750,000
------- ------- ------------ ------------
TOTAL $47,000 $45,000 $138,000,000 $138,045,000
EQUIPMENT UNDER LEASES
Equipment under capital leases is comprised of various computer and equipment
items. Accumulated amortization of $758,000 and $685,000 relating to this
equipment has been recorded as of June 30, 1996 and 1995, respectively.
Note 5 Income Taxes
The provision for income taxes consisted of the following:
For 1996, 1995 and 1994, the Company's effective income tax rate is computed
using the appropriate statutory rates with no significant differences.
Fiscal Years Ended June 30,
1996 1995 1994
----------- ---------- ----------
CURRENT:
Federal $6,344,000 $2,154,000 $2,939,000
State 2,187,000 992,000 814,000
----------- ---------- ----------
8,531,000 3,146,000 3,753,000
DEFERRED:
Federal 10,212,000 2,891,000 (86,000)
State 3,740,000 ,1,080,000 17,000
----------- ---------- ----------
Total 13,952,000 ,3,971,000 (69,000)
=========== ========== ==========
$22,483,000 $7,117,000 $3,684,000
For 1996, 1995 and 1994, the Company's effective income tax rate is computed
using the appropriate statutory rates with no significant differences.
55
The financial statement balances at June 30, 1996 and 1995 are as follows:
Fiscal Years Ended June 30,
1996 1995
----------- ----------
Current taxes payable (receivable)
Federal $2,668,000 $ (596,000)
State 706,000 (321,000)
----------- ----------
Total 3,374,000 (917,000)
=========== ==========
Deferred taxes payable
Federal 13,451,000 3,240,000
State 5,006,000 1,265,000
----------- ----------
Total 18,457,000 4,505,000
----------- ----------
Total tax liabilities $21,831,000 $3,588,000
=========== ==========
Deferred tax liabilities (assets) are comprised of the following:
Fiscal Years Ended June 30,
1996 1995
----------- -----------
Deferred tax liabilities:
Excess servicing $16,851,000 $5,891,000
Depreciation 412,000 216,000
Mortgage servicing rights 5,015,000
----------- ----------
Total deferred tax liabilities 22,278,000 6,107,000
----------- ----------
Deferred tax assets:
State taxes (2,471,000) (790,000)
Vacation accrual (298,000) (233,000)
Allowance for doubtful accounts (218,000) (212,000)
Other accruals (834,000) (367,000)
----------- ----------
Total deferred tax assets (3,821,000) (1,602,000)
----------- ----------
Valuation allowance
Net deferred tax liabilities $18,457,000 $4,505,000
=========== ==========
56
Note 6 Commitments and Contingencies
The Company leases office space under operating leases expiring at various
dates through July 2001. In addition, in February 1996, the Company entered
into an operating lease for an airplane, which expires February 2006. Total
rent expense related to operating leases amounted to $2.8 million, $1.5 million
and $1.4 million, for the years ended June 30, 1996, 1995 and 1994,
respectively. Certain leases have provisions for renewal options and/or rental
increases at specified increments or in relation to increases in the Consumer
Price Index (as defined). As of June 30, 1996, listed below are future minimum
rental payments required under non-cancelable operating leases that have
initial or remaining terms in excess of one year:
Fiscal Years Ended June 30,
1997 $ 3,560,000
1998 3,144,000
1999 2,893,000
2000 2,658,000
2001 1,427,000
Thereafter 4,158,000
$17,840,000
LITIGATION
The Company is involved in certain litigation arising in the normal course of
its business. The Company believes that any liability with respect to such
legal actions, individually or in the aggregate, is not likely to be material
to the Company's consolidated financial position or results of operations.
EMPLOYMENT AGREEMENTS
The Chief Executive Officer has an employment agreement with the Company
expiring on December 31, 1996, which provides for a base salary plus a bonus
equal to 7.5% of the Company's adjusted pre-tax income. The Chief Executive
Officer entered into a new employment agreement with the Company which expires
on June 30, 2001. The new agreement provides for, commencing January 1, 1997, a
base salary, a performance bonus measured against a target return on equity and
a discretionary bonus. In addition, certain options were granted thereunder.
(See "Note 9 -- Notes to Consolidated Financial Statements.") Under the new
agreement, in the event of a termination without cause or in the event of
certain changes in control, the Company shall pay three years base salary, plus
an amount equal to his performance bonuses over the preceding twelve quarters
provided, however, if the termination occurs after January 1, 2000, then he
shall receive three years base salary plus an amount equal to his performance
bonus over the previous eight quarters.
The Chief Operating Officer has an employment agreement with the Company
expiring on June 30, 2001, which provides for a base salary and a performance
bonus measured against a target return on equity. In addition, certain options
were granted thereunder. (See "Note 9 -- Notes to Consolidated Financial
Statements.") The agreement also provides that, in the event of a termination
without cause or in the event of certain changes in control, the Company shall
pay two years base salary plus an amount equal to his performance bonus over
the previous eight quarters.
Note 7 Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial instruments
as of June 30, 1996 is made by the Company using available market information
and appropriate valuation methodologies. However, considerable judgment is
necessarily required to interpret market data to develop the estimates of fair
value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Estimated
Carrying Amount Fair Value
--------------- ------------
Cash and cash equivalents $ 18,216,000 $ 18,216,000
Loans held for sale 67,327,000 71,434,000
Excess servicing receivable 129,113,000 129,113,000
Mortgage servicing rights 10,902,000 10,902,000
Amounts outstanding under
revolving warehouse facilities 11,026,000 11,026,000
Borrowings 138,045,000 139,035,000
57
The fair value estimates as of June 30, 1996 are based on pertinent information
available to management as of the respective dates. Although management is not
aware of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively revalued for purposes of
these financial statements since those dates and, therefore, current estimates
of fair value may differ significantly from the amounts presented herein.
The following describes the methods and assumptions used by the Company in
estimating fair values:
Cash and cash equivalents are based on the carrying amount which is a
reasonable estimate of the fair value.
Loans held for sale are based on current investor yield requirements.
Amounts outstanding under revolving warehouse facilities and borrowings
are short-term in nature and generally bear market rates of interest.
Excess servicing receivable and mortgage servicing rights are based on the
expected future cashflows using common industry assumptions as well as the
Company's historical experience.
The fair value of the Company's borrowings are estimated based on the
quoted market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities.
Note 8 401 (k) Retirement Savings Plan
The Company sponsors a 401 (k) Retirement Savings Plan, a defined contribution
plan. Substantially all employees are eligible to participate in the plan after
reaching the age of 21 and completion of six months of service. Contributions
are made from employees' elected salary deferrals. Employer contributions are
determined at the beginning of the plan year at the option of the employer. For
fiscal years 1996, 1995 and 1994, the Company's contribution to the plan
aggregated $252,000, $46,000 and $39,000, respectively.
Note 9 Stockholders' Equity
Under the Company's 1991 Stock Incentive Plan (the 1991 Plan) a total of 750,000
shares have been reserved for issuance. At June 30, 1996, options to exercise
694,499 have been granted at prices ranging from $4.50 to $11.92 per share;
303,550 of these shares have been granted to the Company's Chief Executive
Officer at prices ranging from $5.50 to $11.92 per share. Additionally, the
Chief Operating Officer was granted a non-qualifying stock option of 10,000
shares at $5.50.
Under the Company's 1995 Stock Incentive Plan (the 1995 Plan), a total of 1.1
million shares have been reserved for issuance. At June 30, 1996, options to
exercise 979,451 shares have been granted at prices ranging from $11.92 to
$41.87 per share. Of these shares, 141,188 have been granted to the Company's
Chief Executive Officer at $30.00 per share and 767,250 have been granted to the
Company's Chief Operating Officer at prices ranging from $11.92 to $21.50 per
share. Additionally, the Chief Operating Officer was granted a non-qualified
stock option of 447,300 shares at $30.00. These 447,300 shares are not
exercisable while he is an officer of the Company.
During the fiscal year ended June 30, 1996, 159,730 shares have been exercised
at prices ranging from $5.00 to $11.92 per share.
Options to exercise 40,084 shares were granted to outside directors at prices
ranging from $5.50 to $21.50 per share. The Company has outstanding 20,055
warrants to purchase common stock at $6.00 per share. These are exercisable and
have certain registration rights. During the fiscal year ended June 30, 1996, a
total of 4,333 shares granted to a director were exercised at a price of $5.50
per share. In addition, 129,945 warrants were exercised during the fiscal year
ended June 30, 1996 at a price of $6.00 per share.
On May 6, 1996 the Company declared a three-for-two split of the Company's
common stock, payable May 17, 1996 to stockholders of record on May 6, 1996.
The split was affected as a dividend of one share of common stock on every
three shares of common stock. After giving effect to this stock split, the
Company has 13.5 million shares outstanding at June 30, 1996. All share and
per share data in the accompanying financial statements are presented to give
retroactive effect to the stock split.
On June 13, 1995, the Company completed the sale of 3.0 million shares of
common stock in a public offering. The proceeds to the Company from the
offering, net of expenses, were $40.0 million. On July 1, 1993, the Company
completed the sale of 1.7 million shares of common stock (including 325,000
shares owned by the Chief Executive Officer) in a public offering. The proceeds
to the Company from the offering, net of expenses, were $12.3 million.
58
The Company's bank agreements generally limit the Company's ability to pay
dividends. In addition, the Company's $23.0 million of 10.5% Senior Notes due
2002 places certain restrictions on additional indebtedness based on the
Company's net worth.
RIGHTS AGREEMENT
In June 1996, the Board of Directors of the Company declared a dividend
distribution of one preferred stock purchase right ("Right") on each share of
the Company's common stock outstanding on July 12, 1996. Each Right, when
exercisable, entitles the holder to purchase from the Company one one-hundredth
of a share of Preferred Stock, par value $0.001 per share, of the Company at a
price of $100.00, subject to adjustments in certain cases to prevent dilution.
The Rights will become exercisable (with certain limited exceptions provided in
the Rights agreement) following the 10th day after (a) a person or group
announces acquisition of 15 percent or more of the Company's Common Stock, (b)
a person or group announces commencement of a tender offer, the consummation of
which would result in ownership by the person or group of 15 percent or more of
the Company's common stock, (c) the filing of a registration statement for any
such exchange offer under the Securities Act of 1933, as amended, or (d) the
Company's board of continuing directors determines that a person is an "adverse
person," as defined in the Rights agreement.
Note 10 Quarterly Financial Data (unaudited)
Three Months Ended
(In thousands, except per share amounts)
Sep-30 Dec-31 Mar-31 Jun-30
FISCAL 1996
Revenue $22,832 $28,263 $33,215 $44,098
Income before income taxes 9,758 11,623 13,667 18,483
Net Income 5,658 6,741 7,935 10,714
Earnings per share - Fully diluted $0.41 $0.49 $0.53 $0.63
FISCAL 1995
Revenue 12,427 12,654 143,633 15,495
Income before income taxes 3,686 3,957 4,130 5,378
Net income 2,172 2,315 2,400 3,147
Earnings per share - fully diluted 0.25 0.27 0.27 0.32
Note 11 Subsequent Event
On August 12, 1996, the Company entered into an agreement to acquire One Stop
Mortgage, Inc., in a transaction to be accounted for as a pooling of interests.
Aames will issue 2.3 million shares of its common stock in exchange for all of
the outstanding common stock of One Stop Mortgage, Inc. and will assume stock
options granted to key employees of One Stop Mortgage, Inc. covering 375,000
shares of One Stop Mortgage, Inc. At June 30, 1996, One Stop Mortgage, Inc. had
total assets of approximately $127 million and an accumulated deficit of
approximately $1.3 million. The transaction is projected to close on August 28,
1996.
59
Stock Price and Dividend Information (unaudited)
In November 1995, the Company's common stock began trading under the symbol
"AAM" on the New York Stock Exchange (NYSE). The following table sets forth the
range of high and low sale prices and per share for the periods indicated.
Cash
High Low Dividend**
------- ------- ----------
FISCAL 1996*
First Quarter $19 1/2 $11 1/2 $.05
Second Quarter 24 1/2 16 1/8 .05
Third Quarter 25 1/8 16 1/4 .05
Fourth Quarter 37 24 1/8 .05
FISCAL 1995 $ 9 1/2 $ 7 3/4 $.05
First Quarter 9 7 3/4 .05
Second Quarter 13 1/4 7 7/8 .05
Third Quarter 18 1/8 11 3/4 .05
* Quarterly Financial Data as reported by Bloomberg.
As of September 15, 1996, the Company had 68 stockholders of record, and the
Company believes that it had in excess of 2,000 beneficial owners of its common
stock. Since its initial public offering on December 3, 1991, the Company has
consistently paid quarterly cash dividends on its common stock. The Company
declared and subsequently paid an aggregate of $.20 per share in dividends for
the year ended June 30, 1996, representing approximately 17.4% of its net income
for the period. The Board of Directors of the Company reviews the Company's
dividend policy at least annually in light of the earnings, cash position and
capital needs of the Company, general business conditions and other relevant
factors. In addition, the Company's ability to pay dividends is limited to an
amount equal to its net income in any given calendar quarter.