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UNITED
STATES
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 December 31, 2004
or
o 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 001-32447
_____________________
SAXON
CAPITAL, INC.
(Exact
Name of Registrant as Specified in Its Charter)
|
Maryland |
30-0228584 |
|
(State
or Other Jurisdiction of Incorporation) |
(I.R.S.
Employer Identification No.) |
| |
|
|
4860
Cox Road
Suite
300
Glen
Allen, Virginia 23060 |
23060 |
|
(Address
of Principal Executive Offices) |
(Zip
Code) |
Registrant’s
Telephone Number, Including Area Code: (804) 967-7400.
_____________________
Securities
registered pursuant to Section 12(b) of the Securities Exchange Act of
1934:
None
Securities
registered pursuant to Section 12(g) of the Securities Exchange Act of 1934:
Common
Stock, $0.01 par value
(Title of
class)
Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. Yes [ X ] No [ ]
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of 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. [ ]
Indicate
by check mark whether the registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). Yes [X] No [ ]
The
number of shares of common stock of the registrant outstanding as of March 3,
2005 was 49,849,386. The aggregate market value of the voting and non-voting
common stock held by non-affiliates of the registrant's precedessor ("Old
Saxon") as of June 30, 2004 was $423,121,335.*
* Calculated
by excluding all shares held by executive officers and directors of Old Saxon
and all shareholders reporting beneficial ownership of more than 5% of Old
Saxon’s common stock without conceding that all such persons were
“affiliates” of Old Saxon for purposes of federal securities laws.
Documents
Incorporated by Reference
The
registrant intends to file a definitive proxy statement pursuant to Regulation
14A for use in connection with its 2005 annual meeting of shareholders within
120 days of the end of the fiscal year ended December 31, 2004. Portions of such
proxy statement are incorporated by reference into Part III of this Form
10-K.
TABLE
OF CONTENTS
Page
Certain
information contained in this annual report on Form 10-K, including certain
information incorporated by reference into this document, constitutes
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Generally,
forward-looking statements can be identified by the use of forward-looking
terminology including, but not limited to, “may,” “will,” “expect,” “intend,”
“should,” “anticipate,” “estimate,” “is likely to,” “could,” “are confident
that,” or “believe” or comparable terminology. All statements contained in this
item as well as those discussed elsewhere in this Report addressing our
operating performance, events, or developments that we expect or anticipate will
occur in the future, including statements relating to net interest income
growth, earnings or earnings per share growth, and market share, as well as
statements expressing optimism or pessimism about future operating results, are
forward-looking statements. The forward-looking statements are based upon
management’s views and assumptions as of the date of this Report, regarding
future events and operating performance and are applicable only as of the dates
of such statements. By their nature, all forward-looking statements involve risk
and uncertainties. Actual results may differ materially from those contemplated
by the forward-looking statements for a number of reasons, including those
addressed in “Risk Factors” and the following risks and uncertainties, but not
limited to:
| |
· |
changes
in overall economic conditions or unanticipated changes in interest
rates; |
| |
· |
our
ability to successfully implement our growth
strategy; |
| |
· |
greater
than expected declines in consumer demand for residential mortgages,
particularly non-conforming loans. |
| |
· |
our
ability to sustain loan origination growth at levels sufficient to absorb
costs of production and operational costs; |
| |
· |
continued
availability of financing facilities and access to the securitization
markets or other funding sources; |
| |
· |
deterioration
in the credit quality of our loan portfolio and those of others serviced
by us; |
| |
· |
lack
of access to the capital markets for additional
funding; |
| |
· |
challenges
in successfully expanding our servicing platform and technological
capabilities; |
| |
· |
changes
to the rating of our servicing operation; |
| |
· |
difficulty
in satisfying complex rules in order for us to qualify as a real estate
investment trust, or REIT, for federal income tax
purposes; |
| |
· |
the
ability of certain of our subsidiaries to qualify as qualified REIT
subsidiaries for federal income tax
purposes; |
| |
· |
our
ability and the ability of our subsidiaries to operate effectively within
the limitations imposed by the federal income tax laws and regulations
applicable to REITs; |
| |
· |
changes
in federal income tax laws and regulations applicable to
REITs; |
| |
· |
increased
servicing termination trigger events; |
| |
· |
future
litigation developments or regulatory or enforcement actions;
and |
| |
· |
increased
competitive conditions or changes in the legal and regulatory environment
in our industry. |
These
risks and uncertainties should be considered in evaluating forward-looking
statements, and undue reliance should not be placed on such statements. We
undertake no obligation to update publicly any of these statements in light of
future events except as required in subsequent periodic reports we file with the
Securities and Exchange Commission.
Saxon
Capital, Inc., a Delaware corporation, which we refer to as Old Saxon, was
formed on April 23, 2001 and acquired all of the issued and outstanding capital
stock of SCI Services, Inc. (referred to as our predecessor) from Dominion
Capital, Inc., a wholly-owned subsidiary of Dominion Resources, Inc., on July 6,
2001. Saxon Capital, Inc., a Maryland corporation (formerly known as Saxon REIT,
Inc.), which we refer to as New Saxon, was formed on February 5, 2004 for the
purpose of effecting Old Saxon’s conversion to a real estate investment trust,
or REIT, under the Internal Revenue Code of 1986, as amended (the “Internal
Revenue Code”). A merger agreement effecting the REIT conversion was approved by
the boards of directors and shareholders of the constituent entities and the
merger was completed on September 24, 2004. The merger had no effect on our
consolidated financial statements, as this was a merger of companies under
common control.
Pursuant
to the merger agreement, Old Saxon merged with and into Saxon Capital Holdings,
Inc., a wholly-owned subsidiary of New Saxon, and New Saxon succeeded to and
continued the operations of Old Saxon, changing its name to “Saxon Capital,
Inc.” At the effective
time of the merger, each outstanding share of Old Saxon common stock was
converted into the right to receive one share of New Saxon common stock and a
cash payment of $4.00. New Saxon simultaneously issued an additional 17.0
million shares of its common stock in a public offering, which resulted in
$386.8 million in gross proceeds, which was partly used to pay the cash portion
of the merger consideration.
We
maintain our principal executive offices at 4860 Cox Road, Suite 300, Glen
Allen, Virginia 23060, and our telephone number is (804) 967-7400. Our common
stock currently trades on Nasdaq under the symbol “SAXN.” We are expecting to
transfer our common stock from the Nasdaq National Market to the New York Stock
Exchange on Friday, March 18, 2005 under the symbol “SAX.”
Available
Information
This
annual report on Form 10-K, as well as our quarterly reports on Form 10-Q,
current reports on Form 8-K, and amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are
made available as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange
Commission, free of charge, through our website. Our website address is
www.saxoncapitalinc.com.
We have
adopted a code of conduct that applies to all of our employees, officers and
directors. Our code of conduct is also available, free of charge, on our
website, along with our Audit Committee Charter, our Governance and Nominating
Committee Charter, and our Compensation Committee Charter. We will post on our
website any amendments to the code, or waivers from, our code of conduct, if
any, applicable to any of our directors or executive officers.
General
Since
effecting our conversion to a REIT in September 2004, we have structured our
business to facilitate compliance with REIT qualification rules. We have
continued to conduct our business operations substantially as they were
conducted prior to the REIT conversion. Our primary business strategy is to
manage and grow on our balance sheet our portfolio of non-conforming mortgage
loans to produce stable net interest and fee income. We hold our loans in our
portfolio segment after they have been sold to our qualified REIT subsidiary.
Our primary means of growing our portfolio is our three loan production business
channels, which we call our retail, our wholesale, and our correspondent
business channels. We refer to our retail, wholesale, and correspondent channels
collectively as our “mortgage loan production segment.” We service the loans in
our portfolio, as well as loans owned by third parties, in our servicing
segment. We conduct our wholesale and our correspondent business channels, as
well as secondary marketing, master servicing, and other administrative
functions through Saxon Mortgage, Inc., which we refer to as Saxon Mortgage, and
our retail business channel through America’s MoneyLine, Inc., which we refer to
as America’s MoneyLine. We conduct our servicing segment through Saxon Mortgage
Services, Inc., which we refer to as Saxon Mortgage Services. See “Item 7 -
Management’s Discussion and Analysis of Financial Condition and Results of
Operations” for a complete
discussion of our consolidated results of operations and segment results, as
well as production data for our business channels. Our segment information for
the years ended December 31, 2003 and 2002 has been restated to reflect a change
in the composition of our reportable segments. Throughout our discussion of our
business operations, words such as “we” and “our” are intended to include our
operating subsidiaries.
In our
mortgage loan production segment, we originate, purchase and securitize
primarily non-conforming residential mortgage loans. These loans are secured
primarily by first mortgages. We believe we deliver superior value and service
through our disciplined credit, pricing, and servicing processes throughout the
lives of these loans. Our borrowers typically have limited credit histories,
have high levels of consumer debt, or have experienced credit difficulties in
the past. Mortgage loans to such borrowers are generally classified as
“non-conforming” because they generally do not conform to or meet the
underwriting guidelines of conventional mortgage lenders, such as government
sponsored entities, or GSEs, like Fannie Mae or the Federal Home Loan Mortgage
Corporation, or Freddie Mac. We originate and purchase loans on the basis of the
borrower’s ability to repay the mortgage loan, the borrower’s historical pattern
of debt repayment, and the appropriateness of the loan collateral including the
amount of equity in the borrower’s property (as measured by the borrower’s
loan-to-value ratio, or LTV). The interest rate and maximum loan amount are
determined based upon our underwriting and risk-based pricing matrices. We have
been originating and purchasing non-conforming mortgage loans since 1996, and
believe the proprietary data that we have accumulated in our data warehouse is
key to our ability to analyze the characteristics that drive loan performance.
At Saxon
Mortgage, our wholesale channel originates or purchases loans through its
network of approximately 4,000 independent brokers throughout the country and
our correspondent channel purchases mortgage loans from approximately 350
correspondent lenders following a complete re-underwriting of each mortgage
loan. At America’s MoneyLine, our retail channel originates mortgage loans
directly to borrowers through its retail branch network, which consisted of 25
branches as of December 31, 2004 and currently consists of 21 branches, and also
uses direct mail and the Internet to originate loans. For the years ended
December 31, 2004 and 2003 we originated, purchased, or called approximately
$3.8 billion and $2.8 billion, respectively, and securitized approximately $3.2
billion and $2.7 billion of residential mortgage loans, respectively. Called
loans occur upon exercise of the clean-up call option by our taxable REIT
subsidiaries, as servicer or master servicer, of the securitized pools of our
predecessor for which Dominion Capital, Inc. retained residual interests. A
clean-up call option is an option to acquire all remaining mortgage loans, and
any real estate owned, referred to as REO, in a securitized pool that arises at
the time the aggregate unpaid scheduled principal balance of the loans declines
to an amount that is less than 10% of the aggregate unpaid scheduled principal
balance of the total pool at the time of securitization. In some cases, the
rights to exercise the call option, as well as the pool of called loans, may be
owned by an unaffiliated third party.
We earn
revenues primarily from the interest income from the mortgage loans originated
or purchased in our mortgage loan production segment that are held in our
portfolio segment and from mortgage loan servicing. For the years ended December
31, 2004, 2003 and 2002, revenues from our mortgage loan portfolio were 84%,
77%, and 75%, respectively, of our total revenues
and revenues from servicing were 11%, 12%, and 11%, respectively, of our total
revenues. Our business is impacted by seasonality with our production and
delinquency levels typically being higher in the second, third, and fourth
quarters of the year.
We intend
to continue accessing the asset-backed securitization market to provide
long-term financing for our mortgage loans. We finance the loans initially under
one of several different secured and committed warehouse financing facilities on
a recourse basis. These loans are subsequently financed using asset-backed
securities issued through securitization trusts. From May 1996 to December 31,
2004, we securitized approximately $19.0 billion in mortgage loans. Since July
6, 2001, we have structured our securitizations as financing transactions for
financial reporting purposes under accounting principles generally accepted in
the United States of America, or GAAP. Accordingly, following a securitization,
(1) the mortgage loans we originate or purchase remain on our consolidated
balance sheet; (2) the securitization indebtedness replaces the warehouse debt
associated with the securitized mortgage loans; and (3) we record interest
income on the mortgage loans and interest expense on the securities issued in
the securitization over the life of the securitization, instead of recognizing a
gain or loss upon completion of the securitization. This accounting treatment
more closely matches the recognition of income with the receipt of cash payments
on the individual loans than does gain on sale accounting, which we used prior
to July 6, 2001.
Our
Industry
The
residential mortgage market is the largest consumer finance market in the United
States. According to the Mortgage Bankers Association of America, or MBAA,
website as of January 21, 2005, lenders in the United States originated over
$2.9 trillion in single-family mortgage loans in 2004 compared to $3.4 trillion
in 2003. A substantial portion of the loan originations in 2003 and 2004 was
attributable to mortgage loan refinancing by customers taking advantage of the
decline in interest rates during 2003 and 2004. According to the MBAA website as
of January 21, 2005, lenders in the United States are expected to originate $2.5
trillion in single-family mortgage loans in 2005. Because we believe that,
historically, non-conforming mortgage loan originations have been less
susceptible to interest rate fluctuations than have conforming mortgage loan
originations, we believe that the projected decline is largely attributable to a
reduction in refinancing of conforming loans as interest rates rise. Thus, we do
not expect the same level of decline in the non-conforming market and expect
that our 2005 production levels will increase over 2004 production levels.
Generally,
the mortgage loan industry is segmented by the size of the mortgage loans and
the credit characteristics of the borrowers. Mortgage loans that conform to the
guidelines of GSEs, such as Fannie Mae or Freddie Mac, which have guidelines for
both size and credit characteristics, are called conforming mortgages. Our
mortgage loans are considered non-conforming mortgages because of the size of
the loans (generally referred to as jumbo mortgages), or the credit profiles of
the borrowers (generally referred to as sub-prime mortgages), or both. We
believe the non-conforming segment of the mortgage industry provides credit to a
broad range of consumers who are underserved by the conforming mortgage market.
Our
Strategy
Our goal
is to maximize shareholder value by building a high-quality non-conforming
mortgage loan portfolio that produces stable net interest income and fee income
from the loans we originate, purchase, and service. We intend to execute our
strategy by:
| |
· |
increasing
production volume across our origination platform by using our targeted
marketing strategy, which involves direct mail and telemarketing, to
increase our profitability by focusing on higher yielding, lower credit
grade mortgage loan products and by offering more credit score-based
products in the future; |
| |
· |
utilizing
aggregated historical loan performance information accumulated in our data
warehouse to refine our risk based pricing strategies to help minimize our
credit exposure while maximizing our expected return on
investment; |
| |
· |
increasing
the consistency of our loan performance by emphasizing high levels of
borrower contact through our Life of the Loan Credit Risk Management
strategy; and |
| |
· |
continuing
to invest in technology to support consistent credit decisions, loss
mitigation efforts, and operating efficiencies, and to increase customer
satisfaction by providing quick underwriting decisions and delivery of
services. |
Mortgage
Loan Production Segment
Wholesale
Channel
Our
wholesale channel purchases and originates non-conforming residential mortgage
loans through non-exclusive relationships with various mortgage companies and
mortgage brokers. We provide a variety of mortgage products to our brokers to
allow them to better service their customers. Mortgage brokers identify
applicants, help them complete loan application paperwork, gather required
information and documents, and act as our liaison with the borrower during the
lending process. We review and underwrite an application submitted by a broker,
accept or reject the application, determine the range of interest rates and
other loan terms, and fund the loan upon acceptance by the borrower and
satisfaction of all conditions to the loan. In some instances, brokers will
close a loan using their sources of funds, and then sell us the closed loan
after we underwrite it. By relying on brokers to market our products and assist
the borrower throughout the loan application process, we can increase loan
volume through the wholesale channel without increasing marketing, labor, and
other overhead costs incurred in connection with retail loan production.
New
brokers join our wholesale network from various sources. Our account executives
and our website are the main sources for new brokers. Brokers must meet various
requirements and must complete the broker application package, provide evidence
of a state license, articles of incorporation, financial statements, resumes of
key personnel, and other information as needed. The wholesale channel’s
management reviews this information to determine if the broker should be
approved. When appropriate, the application may be reviewed and investigated by
our Quality Control, or QC, Department before final approval.
Our
on-going investment in technology has allowed us to provide our broker network
with the ability to obtain on-line loan approvals and pricing in seconds. We
believe the power and convenience of on-line loan approvals is a value added
service that has and will continue to solidify our business relationships. In
addition, our website provides our brokers with loan status reports, product
guidelines, loan pricing, interest rate locks, and many other added features. We
expect to continue to adapt web-based technologies to enhance our one-on-one
relationships with our customers.
During
2004, our wholesale channel implemented several initiatives focused on
developing a solid sales organization, enhancing operational performance,
increasing profitability and improving the technology-related components of our
business. Specifically, we:
| |
· |
continued
our emphasis on training efforts for our sales division to increase
production levels per account executive and to decrease employee turnover,
resulting in enhanced customer relationships and increased market
penetration; |
| |
· |
increased
our investment in customer service
training; |
| |
· |
completed
several loan process enhancements to improve credit cycle times and reduce
broker compliance and regulatory compliance-related issues;
and |
| |
· |
made
additions to our website to increase customer utilization and improve
operational efficiencies. |
In 2005,
our wholesale channel will continue to implement our core initiatives to grow
production, improve operating efficiencies and increase profitability. In 2005,
management established the following initiatives for our wholesale business
channel:
| |
· |
expand
our internal sales group, by adding positions in the western and central
regions; |
| |
· |
add
sales specific tools to our website to enable our sales staff to access
point of sale literature, such as marketing
materials; |
| |
· |
refine
our sales compensation plans to focus on those loans that present us with
the greatest opportunity for
profitablility; |
| |
· |
open
a third processing center in Texas to add additional service support for
the central, mountain, and western time zone
states; |
| |
· |
implement
initiatives to replace our current origination system, enabling a
reduction of keystrokes, improved process flows, as well as enhanced
workflow management tools. |
Correspondent
Channel
We enter
into loan purchase and sale agreements with mortgage bankers, banks, thrifts,
and credit unions to sell non-conforming residential mortgage loans to us
through our correspondent channel. Our correspondent lenders close their loans
through their own financing. After the loans are closed, the correspondent sells
them to us through either “flow” or “bulk” delivery.
We make
most of our purchases of loans using the “flow-delivery” method. That is, we
purchase individual loans and re-underwrite and review the collateral for each
loan that we purchase. We seek to buy most of the loans we purchase from
correspondent lenders on an individual basis. We also make bulk purchases of
loans in which our correspondent lenders close the loans and hold them until
they have a pool of loans ready to be sold at one time. The pool of loans is put
up for bid by the correspondent and typically sold to the purchaser offering the
highest price for the pool. In the case of “bulk-delivery”, we still
re-underwrite each loan and review all collateral before purchasing. We prefer
the flow-delivery method to bulk-delivery because the flow-delivery method has
had lower acquisition costs, and as a result has been more profitable than
bulk-delivery. Acquisition costs in our correspondent channel consist primarily
of the following:
| |
· |
the
premiums that we pay to our correspondent customers for each loan;
and |
| |
· |
general
and administrative costs, net of any fees that we receive from our
correspondent customers. |
Although
our general and administrative costs are higher for flow-delivery loans than
they are for bulk loans, the premiums we pay for flow-delivery are lower because
we negotiate directly with each correspondent with respect to each loan rather
than bidding against other purchasers for a pool of loans. In addition, the fees
that we receive on flow-delivery loans are higher. The profitability of
flow-delivery loans has been further enhanced by the lower relative levels of
delinquency that we have experienced compared with bulk-delivery loans. We
believe this is because we have a greater degree of control over loan product
mix, credit grade mix, loan origination process, and the servicing transfer
process for flow-delivery loans compared to bulk-delivery loans.
For the
years ended December 31, 2004, 2003, and 2002, our correspondent flow loan
volume accounted for 82%, 77%, and 62%, respectively, of our total correspondent
channel loan production. Our 2004 flow volume exceeded our 2003 and 2002 volume
by 21% and 122%, respectively, which was mainly attributable to the continued
growth in our customer base and the strong refinance market that existed during
the first three quarters of 2004. We continue to focus our efforts on the more
profitable flow portion of the business. We maintain the capacity to underwrite,
perform a funding/compliance review, and purchase loans using the bulk method in
volumes well in excess of our 2004 production.
We had
approximately 350 approved correspondent lenders as of December 31, 2004. New
correspondent lenders become our customers from leads generated by our
correspondent sales force. Our account executives and our website are the main
sources for new correspondent lenders. Generally, to become one of our approved
correspondent lenders, a correspondent must meet various requirements and must
complete the seller application package, provide evidence of a state license,
bank or thrift charter, financial statements, evidence of insurance and
regulatory compliance, a copy of quality control procedures, resumes of key
personnel, and other information as needed. Our QC Department reviews this
information for final approval.
In 2004,
our correspondent channel implemented the following initiatives that assisted in
improving our overall financial performance:
| |
· |
increased
our online automated underwriting system usage by over
235%; |
| |
· |
continued
to streamline our manual underwriting, automated underwriting, and quality
control processes to improve turn-around times and customer service; and
|
| |
· |
increased
our average monthly funding customer base by 10% through enhanced
processes that created customer retention and through the continuous
prospecting of new customers. |
For 2005,
management established the following key initiatives for our correspondent
business channel:
| |
· |
attract
more small to medium sized flow mortgage banking
customers; |
| |
· |
create
training materials for our customers; |
| |
· |
create
a private labeling product for our automated underwriting system that
allows our customers to use this system on their own
websites; |
| |
· |
automate
and enhance compliance testing; |
| |
· |
create
an on-line web based system that allows customer pipeline
management. |
Retail
Channel
Our
retail channel is operated by our wholly-owned subsidiary, America’s MoneyLine.
As of March 15, 2005, we originate non-conforming mortgage loans directly to
borrowers through America’s MoneyLine’s 21 branch offices. These branches are
located in the following metropolitan areas: Phoenix, AZ; Foothill Ranch, CA;
Denver, CO; Milford, CT; Ft. Lauderdale, FL; Tampa, FL; Atlanta, GA; Oakbrook
Terrace, IL; New Orleans, LA; Greenbelt, MD; Livonia, MI; Raleigh, NC; Cherry
Hill, NJ; Hauppauge, NY; Las Vegas, NV; Portland, OR; Pittsburgh, PA; Dallas,
TX; Ft. Worth, TX (Retention Unit); Glen Allen, VA (Internet/Direct Unit); and
Richmond, VA.
We
interact with our borrowers through loan officers in our branch locations and
direct-to-the-borrower tools such as the Internet, telemarketing, and direct
mailings. As part of our efforts to manage credit risk, all loan underwriting,
closing, funding, and shipping is managed centrally out of our headquarters in
Glen Allen, VA. A typical retail branch consists of approximately eleven
employees: a branch manager, eight loan officers, and two loan processors. We
seek to ensure that all of our loans officers are properly licensed where such
licensing is required.
In 2004,
our retail channel implemented the following initiatives:
| |
· |
implemented
applications to better catalogue lead development from the application
through the funding process to enable us to reduce costs relative to lead
selection and distribution; |
| |
· |
completed
integration with select national title and appraisal vendors to allow
processing staff to more efficiently order services, reducing total
processing times; |
| |
· |
reallocated
human capital based on geographic
demographics; |
| |
· |
opened
a processing center in Texas to enhance our ability to service central,
mountain, and western time zone customers as well as to take advantage of
the lower overhead cost available to us in
Texas. |
For 2005, management established
the following key initiatives for our retail business channel:
| |
· |
increase
usage of our automated underwriting system to reduce origination costs by
enabling the system to make decisions with regard to a greater percentage
of mortgage loans; |
| |
· |
implement
additional automation of our underwriting program for our customers and
staff; |
| |
· |
continue
to diversify our marketing capabilities beyond the Internet-based lead
sources that have traditionally comprised the majority of our lead
sources. This will be accomplished through increased telemarketing and
direct mail-generated marketing as well as enhancement to the
website; |
| |
· |
continue
to diversify our marketing capabilities beyond the Internet-based lead
sources that have traditionally comprised the majority of our lead
sources. This will be accomplished through increased telemarketing and
direct mail-generated marketing as well as enhancement to the
website; |
| |
· |
continue
to diversify our production by marketing our traditional sub-prime lending
products; |
| |
· |
continue
to diversify our production by marketing our traditional sub-prime lending
products; |
| |
· |
reduce
employee turnover; and |
| |
· |
implement
initiatives to upgrade our current origination system, enabling a
reduction of keystrokes and improved process flows, as well as
implementing enhanced workflow management
tools. |
We have
no plans to open additional branch offices in 2005. In July 2004, we closed two
branch offices, reducing the number of our retail branches from 27 to 25, and
during February and March of 2005, we closed four additional branch offices in
order to reduce our fixed costs associated with our branch network, while
continuing an analysis of potential opportunities for additional cost savings
through additional branch and/or operational consolidation. We review quarterly
the top 40 metropolitan statistical areas to identify our target markets based
on the following initial statistics:
| |
· |
median
household income; and |
In addition,
we review competitors’ performance in those markets to identify strategic
opportunities for growth. We also review certain monthly financial metrics to
monitor the performance of each branch.
Servicing
Segment
Once we
originate or purchase a mortgage loan, our wholly-owned subsidiary, Saxon
Mortgage Services, begins the process of servicing the loan, seeking to ensure
that the loan is repaid in accordance with its terms. In addition to servicing
mortgage loans that we originate or purchase, we also service mortgage loans for
other lenders and investors. For the year ended December 31, 2004, we purchased
the rights to service $11.5 billion in mortgage loans, which represented 57% of
our total servicing portfolio at December 31, 2004. Our Life of the Loan Credit
Risk Management strategy is applied to every loan in our servicing portfolio.
The inherent risk of delinquency and loss associated with non-conforming loans
requires active communication with our borrowers. Beginning with an introductory
call made as soon as seven days following the origination or purchase of a
mortgage loan, we attempt to establish a consistent payment relationship with
the borrower. Contact with the borrower is initiated through outbound telephone
campaigns, monthly billing statements, and direct mail, and is tailored to
reflect the borrower’s payment habits, loan risk profile, and loan status. In
addition, our call center uses a predictive dialer to create calling campaigns
for delinquent loans based upon the borrower’s historical payment patterns and
the borrower’s risk profile. Our technology delivers extensive data regarding
the loan and the borrower to the desktop of the individual servicing the loan.
Our website also provides borrowers with access to account information and
online payment alternatives.
For 2004,
the following key initiatives were implemented for our servicing segment. We:
| |
· |
continued
to reinforce the business structure and training of our growing
staff; |
| |
· |
established
a “Best Practices” plan to continue our high customer service
levels; |
| |
· |
continued
to focus on productivity gains through process improvement and outsourcing
non-essential areas. |
For 2005,
management established the following key initiatives for the servicing
segment:
| |
· |
open
a new servicing center in Virginia to support the growth of our servicing
segment and serve as a secondary site for disaster recovery
purposes; |
| |
· |
maximize
the effectiveness of our human capital by reinforcing management training
and development to assist with internal promotion of our
employees; |
| |
· |
continue
process improvement; |
| |
· |
maximize
the effectiveness of our technology assets; |
| |
· |
improve
strategic awareness of our servicing business plan;
and |
| |
· |
continue to focus on servicing portfolio growth and
performance. |
Our goal is to provide the
most efficient and economical solutions to the workflow processes we manage in
the servicing area. Outsourcing has allowed us to maintain our high quality of
performance while reducing our costs. We have in the past successfully
outsourced areas including tax tracking, insurance tracking and foreclosure and
bankruptcy tracking. In 2004, we began outsourcing document management
functions, which has improved our timelines and document exception
rates.
We
continue to develop our website to improve customer service and expand
business-to-business initiatives, as well as to enhance our performance in
default and timeline management. We are able to deliver online access to
selected loan documents and an online interview guiding our borrower through
alternatives to foreclosure.
Once an
account becomes thirty days delinquent, the borrower receives a breach notice
allowing thirty days, or more if required by applicable state law, to cure the
default before the account is referred for foreclosure. The call center
continues active collection campaigns and may offer the borrower relief through
a forbearance plan designed to resolve the delinquency in ninety days or less.
Accounts
that are more than sixty days delinquent are transferred to our Loss Mitigation
department, which continues to actively attempt to resolve the delinquency while
our Foreclosure department refers the file to local counsel to begin the
foreclosure process. The Loss Mitigation department is supported by our
predictive dialer as well as the Fiserv system. Fiserv is our core servicing
platform and provides all loan level detail and interacts with our supplemental
products such as the dialer, pay-by-phone and website activity.
Delinquent
accounts not resolved through collection and loss mitigation activities are
foreclosed in accordance with state and local laws. Foreclosure timelines are
managed through an outsourcing partner that uploads data into the loan servicing
system. The Fiserv system schedules key dates throughout the foreclosure
process, enhancing the outsourcer’s ability to monitor and manage foreclosure
counsel. Properties acquired through foreclosure are transferred to the REO
department to manage eviction and marketing of the properties.
Once the
properties are vacant, they are listed with one of three national asset
management firms that develop a marketing strategy designed to ensure the
highest net recovery upon liquidation. The REO department monitors these asset
managers. Property listings are reviewed monthly to ensure the properties are
properly maintained and actively marketed.
See
“Management’s Discussion and Analysis of Results of Operations and Financial
Condition—Business Segment Results” for a further discussion of the financial
results of our segments. See Note 21 to our audited consolidated financial
statements for information about the revenues, income and assets of each of our
business segments.
We
underwrite each loan that we originate or purchase on an individual basis, even
in instances where we purchase a group of mortgage loans in bulk. This means we
thoroughly review the borrower’s credit history, appraisal of property securing
the loan, and income documents (except to the extent our stated income and
limited documentation programs do not require income documentation) for accuracy
and completeness. Our underwriting guidelines are designed to help us evaluate a
borrower’s credit history and capacity to repay the loan. In addition, we review
credit scores derived from the application of one or more nationally recognized
credit-scoring models. We have established seven classifications with respect to
the credit profile of potential borrowers, and we assign a rating to each loan
based on these classifications. Based on our analysis of these factors, we
determine loan terms, including the interest rate and maximum LTV. As an
example, we generally offer loans with higher interest rates to borrowers that
have less favorable credit histories than borrowers with more favorable credit
histories, based upon our assessment of the loan’s appraisal or fraud risk and
probability of default.
Our
underwriting philosophy also requires that we analyze the overall situation of
the borrower and takes into account compensating factors that may be used to
offset certain areas of weakness. Specific compensating factors may include
mortgage payment history, disposable income, employment stability, number of
years at current residence, LTV, income documentation type, and property type.
We may, from time to time, apply underwriting criteria that are either more
stringent or more flexible depending on the economic conditions of a particular
market.
We also
use our automated credit decision system to provide pre-qualification decisions
over the Internet. When this system is used, the loan is still underwritten by
one of our underwriters before funding. While we intend to continue to expand
the functionality of our automated decision system to enhance efficiencies, we
will continue to use our staff to review income, transaction details, and
appraisal documentation to ensure that each loan is underwritten in accordance
with our guidelines.
Our
underwriting guidelines are determined by our credit committee, which is
composed of senior executives as well as members of senior management of each
business channel. Our credit committee meets frequently to review proposed
changes to our underwriting guidelines. To the extent an individual loan does
not qualify for a loan program or credit grade, our underwriters can and will
make recommendations for an approval of the loan by “underwriting exception.”
Our business channels’ underwriting managers have final approval of underwriting
exceptions, which are tracked in our data warehouse. Performance of loans with
or without exceptions is monitored and reported monthly to appropriate company
officers.
Our
senior underwriting managers generally have a minimum of ten years of industry
experience and report directly to the Executive Vice President in charge of the
respective business channel, and directly to our Chief Credit Officer for credit
policy matters. Reporting to each senior underwriting manager are supervisory
underwriting managers who have substantial industry
experience. Our underwriting managers conduct regular training sessions on
emerging trends in production, as well as provide feedback from the monthly
default resolution plan, or DRP, and risk management meetings, which are held
quarterly.
The loans
we originate and purchase generally do not meet conventional underwriting
standards, such as the standards used by GSEs like Fannie Mae or Freddie Mac. As
a result, our loan portfolios are likely to have higher delinquency and
foreclosure rates than loan portfolios based on conventional underwriting
criteria.
Our
underwriting standards are applied in accordance with applicable federal and
state laws and regulations, and require a qualified appraisal of the mortgaged
property conforming to Fannie Mae and Freddie Mac standards or in some cases an
insured automated valuation. Each appraisal includes a market data analysis
based on recent sales of comparable homes in the area and a replacement cost
analysis based on the current cost of building a similar home. The appraisal may
not be more than 180 days old on the day the loan is originated. In most
instances, we require a second full appraisal or an Insured Automated Valuation
Model, when qualified, for properties that have a value of more than $500,000.
We have
three loan documentation programs:
| |
· |
Full
Documentation—requires
the borrower’s credit report, loan application, property appraisal, and
documents that verify employment and bank deposits, such as W-2s, pay
stubs, and/or signed tax returns for the past two years. As of December
31, 2004, the full documentation program covered 73% of our
loans. |
| |
· |
Limited
Documentation—requires
six months of personal and/or business bank statements as documentation of
the borrower’s stated cash flow. All limited documentation loans require
personal bank statements from the borrower -- six months of bank
statements are required for LTVs below 80% and 12 months of bank
statements are required for LTVs in excess of 80%. As of December 31,
2004, the limited documentation program covered 4% of our
loans. |
| |
· |
Stated
Income—requires
verification of borrower’s employment and/or existence of business.
Borrower’s income as stated on the loan application is reviewed for
reasonableness for the related occupation but is not independently
verified. A self-employed borrower must have been in business for at least
two years. As of December 31, 2004, the stated income documentation
program covered 23% of our loans. |
Our full
documentation program requires the highest level of credit documentation of all
of our programs and is typically selected by those borrowers that are able to
meet those requirements. Our limited documentation program is typically selected
by self-employed borrowers, who may have encountered difficulty qualifying for
Fannie Mae and Freddie Mac loans due to the requirements for W-2 forms, pay
stubs, and similar employment-related documentation requirements associated with
such loans. Our stated income program is typically selected by borrowers who do
not meet the requirements for independent verification of income associated with
Fannie Mae and Freddie Mac loans. Both limited documentation and stated income
program loans require specialized underwriting and involve higher degrees of
risk; accordingly
these loans generally have higher interest rates and lower LTVs than are
available to borrowers that meet the requirements of our full documentation
program.
As
described below, we have two loan programs for first mortgages, a niche program
for first and second mortgages with 100% combined LTV (referred to as CLTV), and
one program for second mortgages. The key distinguishing features of each
program are the documentation required to obtain a loan, the LTV, and the credit
scores necessary to qualify under a particular program. Each program also uses
maximum LTVs and loan amounts to mitigate risk. We apply our proprietary credit
grading system only to non-conforming and sub-prime loans, many of which
inherently carry greater risk than conforming and prime loans.
In
addition, each of our loan products has a maximum CLTV amount, which is the
maximum encumbrance allowed on a specific mortgaged property. We permit three
general categories of second liens that may be subordinate to a Saxon Capital
first lien. These are:
| |
· |
an
institutional lender’s second lien; or |
| |
· |
a
private second lien (including second liens retained by a seller of a
mortgaged property). |
The
maximum CLTV varies based on occupancy type, documentation type, LTV, and loan
amount. Our “A+” and “A” credit grade second lien programs allow for a maximum
CLTV of 100% for fully documented loans secured by owner-occupied properties to
borrowers with a minimum credit score of 600. The credit scores range from 300
to 900. Subordinate financing is allowed to 100% CLTV where the maximum first
lien held by us is 90% or less. Our first liens in excess of 90% LTV do not
allow subordinate financing. The stated income program and any of our first
liens in excess of $500,000 require that a subordinate lienholder be a lending
institution.
The key
determinants of credit score are payment history, credit usage, credit report
inquiries, the length of time borrowers have been managing credit, the number of
credit accounts borrowers have, and the type of institutions that have extended
credit to such borrowers. For example, borrowers with a 600 credit score
generally have few isolated late payments, usually none more than 30 days. Their
credit usage will normally be moderate to high, and their history will contain
bank references. Inquiries to the credit report will be moderate or limited to
events such as car shopping or major purchase events. Conversely, borrowers with
a 450 credit score generally have many delinquent accounts. Their delinquencies
will be severe, include 90 day delinquent accounts, and charged off accounts in
the last 12 months. These borrowers will have exhibited this type of
payment behavior over an extended period of time. Credit usage will be high or
may have no accounts with available lines open. Inquiries will normally be
excessive since lenders are not as willing to grant credit to borrowers with
lower credit scores.
ScorePlus
Underwriting Program. Our
ScorePlus underwriting program is a product that we developed to provide a
faster and simpler credit qualification process to those customers using our
automated system by limiting the basis for our underwriting decisions to the
following five factors:
| |
· |
credit
score (in place of secondary credit
review); |
| |
· |
foreclosure
history; and |
These
variables fit into parameters for maximum LTV and loan amount by occupancy,
income documentation, and property type to assess rate and risk. This program is
available for mortgage loans secured by properties of all occupancy types and in
all of our loan documentation programs. Because the ScorePlus underwriting
decision is based solely on the five factors listed above, the underwriting
process can be more extensively automated for those customers for whom speed of
decision is the paramount need. The ScorePlus program involves a lesser degree
of individualized examination of traditional underwriting factors (other than
the five factors listed above). For borrowers unable to meet the ScorePlus
requirements, we offer to review the borrower’s specific circumstances and
extend credit where we can do so prudently and at an appropriately risk-adjusted
price, based on reasoned exceptions.
We
believe our ScorePlus program, which was introduced to the marketplace in
January 2001, is one of our most successful products developed to date based on
increased production of the aggregate dollar value of the loans funded under
this program. For the year ended December 31, 2004, we generated $2.0 billion in
loans through our ScorePlus program, or 57% of our total loan volume for 2004,
compared to $1.6 billion, or 55% of total loan volume for the year ended
December 31, 2003. We expect that ScorePlus’ percentage of our total production
will continue to increase throughout 2005.
In
November 2004, we consolidated three existing lending programs into one. The
Traditional and ScorePlus High LTV programs were retired and merged into our
ScorePlus program. The factors listed above in the ScorePlus description are now
considered for all ScorePlus loans. This change allows us to provide less
complex guidelines to our customers and create an ease of use in our automated
underwriting system. LTVs were reduced in the lower credit score bands and were
increased slightly in the less risky higher credit score ranges.
ScoreDirect
Program. We
introduced our ScoreDirect program in December of 2003 using the credit score as
the determining factor in the credit decision. ScoreDirect is only offered as a
full documentation product. In addition to credit score, the following factors
are also considered:
| |
· |
debt-to-income
ratio; and |
| |
· |
current
mortgage delinquency. |
ScoreDirect
does not offer the possibility for allowing certain exceptions. For loans not
meeting our ScoreDirect guidelines, we apply the ScorePlus guidelines for
possible qualification. As of
December 31, 2004, the portion of our mortgage loan portfolio represented by the
ScoreDirect Program was 5%.
Second
Liens. This
credit score driven product, available for loans up to 100% CLTV, is
concentrated on the home equity market and is available for loans secured by
owner-occupied primary residences only and under our full documentation and
stated income documentation programs. We typically sell the loans secured by
second liens that we originate or purchase. As of December 31, 2004, the portion
of our mortgage loan portfolio represented by loans secured by second liens was
less than 1%.
Quality
Control
The
primary focus of our QC Department is to ensure that all loans are underwritten
in accordance with our underwriting guidelines. On a monthly basis, using a
statistically-based sampling system, the QC Department selects certain funded
loans for review, re-underwrites those loans, re-verifies the sources of income
and employment, and reviews the appraisals to ensure collateral values for the
loans are supported by the appraisals. In addition, the QC Department selects
loans before funding for re-underwriting based upon collateral and borrower
characteristics as a further quality control procedure. Any material findings
noted during the QC Department’s monthly review are communicated to senior
management immediately.
Our QC
Department is also responsible for performing a fraud investigation on any loan
which becomes delinquent on its first or second payment due date, as well as
loans that go into default later in the loan’s life and which our Loss
Mitigation department believes may contain borrower or seller
misrepresentations. To the extent the QC Department’s review indicates that a
loan contains material misrepresentations, the QC Department will make
recommendations regarding the exercise of remedies available to us, including,
where appropriate, requiring the originator to repurchase the loan from us and
potentially civil litigation. In addition, the QC Department advises our
business channels on methods to avoid funding loans with similar issues in the
future.
All
findings of the QC Department are reported quarterly to members of senior
management at risk management meetings. At these meetings, management analyzes
the results of the monthly QC Department audits as well as performance trends
and servicing issues. Based upon this meeting, further analysis is undertaken
and recommendations may be made to the Credit Committee to modify underwriting
guidelines or procedures.
Mortgage
Loan Portfolio
Net
mortgage loan portfolio included on our consolidated balance sheet was $6.0
billion as of December 31, 2004. We have generally seen consistent levels on our
combined weighted average LTV, percentage of first mortgage owner occupied and
mix of fixed rate and variable rate mortgage loan characteristics. We saw a
slight increase in our weighted average median credit scores, determined based
on the median of FICO, Empirica, and Beacon credit scores, during 2004. We
expect these changes to the composition of our portfolio credit scores to have a
positive effect on the performance of our portfolio with a lower level of losses
expected. We expect
lower levels of impaired loans and losses in relation to the portfolio as a
whole and this has led to a lower required allowance for loan loss as a
percentage of the mortgage loan portfolio.
During
2004, we also saw a decrease in the weighted average interest rate on our
portfolio. This was primarily due to the liquidation of higher weighted average
coupon loans as well as an increase in the credit quality of our mortgage loan
portfolio because higher credit quality loans generally have lower interest
rates. This decrease in interest rates has caused a decline in the gross yield
that we earn on our mortgage portfolio. To the extent interest rates rise in
2005, we would expect an increase in the interest rates we charge on the
mortgage loans we originate. In addition, because of our intent to focus to some
extent on higher interest rate, lower credit grade products, the credit quality
characteristics of our mortgage loan production may be lower than we experienced
in 2004. If we increase our lower credit grade production in the future, and
thereby increase our percentage of these loans in our portfolio mix, we may
increase the weighted average interest rate on our portfolio and, if managed
properly, this may positively impact net interest income. However, lower credit
grade production will likely lead to increased delinquencies and higher
provisions for mortgage loan losses.
Overview
of Mortgage Loan Portfolio
| |
December
31,
2004
(1) |
December
31,
2003
(1) |
Variance |
| |
($
in thousands) |
|
Average
principal balance per loan |
$138 |
$133 |
3.76% |
|
Combined
weighted average initial LTV |
78.87% |
78.16% |
0.91% |
|
Percentage
of first mortgage loans owner occupied |
96.11% |
95.04% |
1.13% |
|
Percentage
with prepayment penalty |
76.44% |
80.18% |
(4.66)% |
|
Weighted
average median credit score (2) |
617 |
610 |
7
points |
|
Percentage
fixed rate mortgages |
35.85% |
37.75% |
(5.03)% |
|
Percentage
adjustable rate mortgages |
64.15% |
62.25% |
3.05% |
|
Weighted
average interest rate: |
|
|
|
|
Fixed
rate mortgages |
7.76% |
8.22% |
(5.60)% |
|
Adjustable
rate mortgages |
7.47% |
8.24% |
(9.34)% |
|
Gross
margin - adjustable rate mortgages (3) |
5.49% |
5.40% |
1.67% |
_______________
| |
(1) |
Excludes
loans funded but not transmitted to the servicing system as of December
31, 2004 and 2003 of $238.5 million and $78.8 million,
respectively. |
| |
(2) |
The
credit score is determined based on the median of FICO, Empirica, and
Beacon credit scores. |
| |
(3) |
The gross margin is the amount added to the applicable
index rate, subject to any rate caps and limits specified in the mortgage
note, to determine the interest rate. |
Mortgage Loan
Portfolio by Product Type
We
originate and purchase both adjustable rate mortgages, or ARMs, and fixed rate
mortgages, or FRMs. The majority of our FRMs are 30-year mortgages. Our ARM
production consists of floating ARMs and hybrid ARMs. A floating ARM is a loan
on which the interest rate adjusts throughout the life of the loan, either every
six or every 12 -months. A hybrid ARM is a loan on which the interest rate is
fixed for the initial 24 to 60 -month’s of the loan term, and thereafter adjusts
either every six or every 12 -months. All of our ARMs adjust with reference to a
defined index rate.
We offer
fixed rate interest only and adjustable rate interest only loans. FRM interest
only loans require only interest payments to be made for the first 60 months of
the loan. After this interest only period is complete, the loan is then
recalculated to fully amortize the principal over the remaining term of the
loan. The ARM interest only loan is similar in that it also requires only
interest payments to be made for the first 60 months of the loan; however, once
the interest only period is complete, the loan is then recalculated to a fully
amortizing 25-year ARM with variable interest rates.
The
interest rate on ARMs once the initial rate period has lapsed is determined by
adding the “gross margin” amount to the “index” rate. The index most commonly
used in our loan programs is the one-month LIBOR. The gross margin is a
predetermined percentage that, when added to the index, gives the borrower the
rate that will eventually be due. It is common in the beginning stages of an ARM
loan to allow the borrower to pay a rate lower than the rate that would be
determined by adding the margin to the index. Over time, the rate adjusts upward
so that the interest rate the borrower pays eventually takes into account the
index plus the entire margin amount.
In
general, our mix of ARMs and FRMs remained relatively consistent during 2004.
However, we have experienced a decrease in our two-year hybrid loans, our three
to five-year hybrid loans, and our floating ARMs, primarily because of a
significant increase in our interest only adjustable rate product. The same
trend is also seen in our FRMs; we have experienced a decrease in our 15-year,
30-year, balloon, and other FRM products primarily because of a significant
increase in our interest only fixed rate product.
The
following table sets forth information about our mortgage loan portfolio based
on product type as of December 31, 2004 and 2003.
| |
December
31,
2004
(1) |
December
31,
2003
(1) |
Variance |
|
Floating
adjustable rate mortgages |
0.44% |
0.61% |
(27.87)% |
|
Interest
only adjustable rate mortgages |
18.23% |
2.22% |
721.17% |
|
Two
year hybrids (2) |
28.14% |
37.15% |
(24.25)% |
|
Three
- five year hybrids (2) |
17.34% |
22.27% |
(22.14)% |
|
Total
adjustable rate mortgages |
64.15% |
62.25% |
3.05% |
|
Fifteen
year |
3.66% |
3.93% |
(6.87)% |
|
Thirty
year |
23.34% |
23.44% |
(0.43)% |
|
Interest
only fixed rate mortgages |
2.38% |
1.64% |
45.12% |
|
Balloons
and other (3) |
6.47% |
8.74% |
(25.97)% |
|
Total
fixed rate mortgages |
35.85% |
37.75% |
(5.03)% |
_______________
| |
(1) |
Excludes
loans funded but not transmitted to the servicing system as of December
31, 2004 and 2003 of $238.5 million and $78.8 million,
respectively. |
| |
(2) |
Hybrid
loans are loans that have a fixed interest rate for the initial two to
five years and after that specified time period, become adjustable rate
loans. |
| |
(3) |
Balloon
loans are loans with payments calculated according to a 30-year
amortization schedule, but which require the entire unpaid principal and
accrued interest to be paid in full on a specified date that is less than
30 years after origination. |
Mortgage
Loan Portfolio by Borrower Credit Score
The
following table sets forth information about our mortgage loan portfolio by
borrower risk classification as of December 31, 2004 and 2003.
| |
December
31,
2004
(1) |
December
31,
2003
(1) |
Variance |
|
Credit
scores > 650 |
|
|
|
|
Percentage
of portfolio |
29.01% |
25.34% |
14.48% |
|
Combined
weighted average initial LTV |
78.43% |
76.19% |
2.94% |
|
Weighted
average median credit score |
692 |
692 |
— |
|
Weighted
average interest rate: |
|
|
|
|
Fixed
rate mortgages |
7.05% |
7.42% |
(4.99)% |
|
Adjustable
rate mortgages |
6.50% |
7.01% |
(7.28)% |
|
Gross
margin - adjustable rate mortgages (2) |
4.86% |
4.59% |
5.88% |
|
Credit
scores 650 - 601 |
|
|
|
|
Percentage
of portfolio |
30.00% |
28.43% |
5.52% |
|
Combined
weighted average initial LTV |
79.34% |
78.38% |
1.22% |
|
Weighted
average median credit score |
625 |
626 |
(1)
point |
|
Weighted
average interest rate: |
|
|
|
|
Fixed
rate mortgages |
7.56% |
7.96% |
(5.03)% |
|
Adjustable
rate mortgages |
6.95% |
7.60% |
(8.55)% |
|
Gross
margin - adjustable rate mortgages (2) |
5.21% |
4.95% |
5.25% |
|
Credit
scores 600 - 551 |
|
|
|
|
Percentage
of portfolio |
24.08% |
25.07% |
(3.95)% |
|
Combined
weighted average initial LTV |
78.93% |
79.32% |
(0.49)% |
|
Weighted
average median credit score |
578 |
577 |
1
point |
|
Weighted
average interest rate: |
|
|
|
|
Fixed
rate mortgages |
8.24% |
8.75% |
(5.83)% |
|
Adjustable
rate mortgages |
7.74% |
8.42% |
(8.08)% |
|
Gross
margin - adjustable rate mortgages (2) |
5.69% |
5.50% |
3.45% |
|
Credit
scores 550 - 526 |
|
|
|
|
Percentage
of portfolio |
9.00% |
11.15% |
(19.28)% |
|
Combined
weighted average initial LTV |
79.57% |
79.93% |
(0.45)% |
|
Weighted
average median credit score |
539 |
538 |
1
point |
|
Weighted
average interest rate: |
|
|
|
|
Fixed
rate mortgages |
9.41% |
9.92% |
(5.14)% |
|
Adjustable
rate mortgages |
8.70% |
9.20% |
(5.43)% |
|
Gross
margin - adjustable rate mortgages (2) |
6.30% |
6.12% |
2.94% |
|
Credit
scores <=525 |
|
|
|
|
Percentage
of portfolio |
7.24% |
9.20% |
(21.30)% |
|
Combined
weighted average initial LTV |
78.19% |
77.98% |
0.27% |
|
Weighted
average median credit score |
510 |
508 |
2
points |
|
Weighted
average interest rate: |
|
|
|
|
Fixed
rate mortgages |
10.48% |
10.92% |
(4.03)% |
|
Adjustable
rate mortgages |
9.43% |
10.03% |
(5.98)% |
|
Gross
margin - adjustable rate mortgages (2) |
6.60% |
6.64% |
(0.60)% |
|
Unavailable
credit scores |
|
|
|
|
Percentage
of portfolio |
0.67% |
0.81% |
(17.28)% |
|
Combined
weighted average initial LTV |
73.33% |
73.48% |
(0.20)% |
|
Weighted
average median credit score |
— |
— |
— |
|
Weighted
average interest rate: |
|
|
|
|
Fixed
rate mortgages |
10.10% |
10.10% |
— |
|
Adjustable
rate mortgages |
9.44% |
9.49% |
(0.53)% |
|
Gross
margin - adjustable rate mortgages (2) |
5.82% |
5.60% |
3.93% |
___________
| |
(1) |
Excludes
loans funded but not transmitted to the servicing system as of December
31, 2004 and 2003 of $238.5 million and $78.8 million,
respectively. |
| |
(2) |
The
gross margin is the amount added to the applicable index rate, subject to
any rate caps and limits specified in the mortgage note, to determine the
interest rate. |
During
2004, our loan originations continued to include a high percentage of A plus
production, which lowered the weighted average coupon on our portfolio. As a
result, we experienced declines in our weighted average interest rates on our
portfolio during 2004.
Mortgage
Loan Portfolio by Income Documentation
Typically,
we require income documentation that conforms to GSE requirements. We call this
a full documentation mortgage loan. We also originate loans that require less
income documentation through our limited documentation mortgage loan program,
and we originate loans with no verification of income through our stated income
mortgage loan program. In general, the risk of loss on the mortgage loan
increases as less income documentation is required during the origination
process.
Our mortgage loan documentation as of
December 31, 2004 had changed very little compared to December 31, 2003. The
following table sets forth information about our mortgage loan portfolio based
on income documentation as of December 31, 2004 and 2003.
|
|
|
December 31, 2004
(1) |
December
31, 2003 (1) |
|
|
|
|
|
|
|
Income
documentation |
|
|
%
of Portfolio |
|
|
Weighted
Average Median Credit Score |
|
|
%
of Portfolio |
|
|
Weighted
Average Median Credit Score |
|
|
%
of Portfolio Variance |
|
|
Weighted
Average
Median
Credit
Score
Variance |
|
|
Full
documentation |
|
|
72.46 |
% |
|
610 |
|
|
72.25 |
% |
|
602 |
|
|
0.29 |
% |
|
8
points |
|
|
Limited
documentation |
|
|
4.26 |
% |
|
623 |
|
|
5.06 |
% |
|
626 |
|
|
(15.81 |
)% |
|
(3)
points |
|
|
Stated
income |
|
|
23.28 |
% |
|
638 |
|
|
22.69 |
% |
|
632 |
|
|
2.60 |
% |
|
6
points |
|
_______________
| |
(1) |
Excludes
loans funded but not transmitted to the servicing system as of December
31, 2004 and 2003 of $238.5 million and $78.8 million,
respectively. |
Mortgage
Loan Portfolio by Borrower Purpose
We saw
very little change in the mix of borrower purpose within our portfolio during
2004. We anticipate an increase in the future in the percentage of our cash-out
refinance mortgage loan portfolio as a result of rising interest rates and our
marketing efforts. We expect borrowers who have credit card or installment debt
will still be in the market for cash-out refinance loans as they strive to
reduce their monthly payments by extending debt over a longer period of time to
help increase their disposable income. Most of this activity will likely be
within the sub-prime lending sector. The
following table sets forth information about our mortgage loan portfolio based
on borrower purpose as of December 31, 2004 and 2003.
|
Borrower
Purpose |
|
December
31, 2004 (1) |
|
December
31, 2003 (1) |
|
Variance |
|
|
Cash-out
refinance |
|
|
68.38 |
% |
|
69.23 |
% |
|
(1.23 |
)% |
|
Purchase |
|
|
23.00 |
% |
|
21.25 |
% |
|
8.24 |
% |
|
Rate
or term refinance |
|
|
8.62 |
% |
|
9.52 |
% |
|
(9.45 |
)% |
_______________
| |
(1) |
Excludes
loans funded but not transmitted to the servicing system as of December
31, 2004 and 2003 of $238.5 million and $78.8 million, respectively.
|
Mortgage
Loan Portfolio Geographic Distribution
We saw
very little shift in the concentration of our geographic distribution during
2004. We do not expect our geographic portfolio mix to change materially in
2005. We analyze our portfolio for economic trends from both a macro and a micro
level to determine if we have any credit loss exposure within a specific
geographic region. We group the states in the United States by region as
follows:
The
following table sets forth the percentage of our mortgage loan portfolio by
region as of December 31, 2004 and 2003.
| |
December
31,
2004
(1) |
December
31,
2003
(1) |
Variance |
|
South |
29.35% |
28.38% |
3.42% |
|
California |
21.11% |
22.46% |
(6.01)% |
|
Mid
Atlantic |
14.16% |
13.53% |
4.66% |
|
Midwest |
13.16% |
13.61% |
(3.31)% |
|
West |
9.93% |
9.22% |
7.70% |
|
Southwest |
7.78% |
7.94% |
(2.02)% |
|
New
England |
4.51% |
4.86% |
(7.20)% |
|
Total |
100.00% |
100.00% |
|
_______________
| |
(1) |
Excludes
loans funded but not transmitted to the servicing system as of December
31, 2004 and 2003 of $238.5 million and $78.8 million,
respectively. |
Securitized
Mortgage Loan Coupon and Prepayment Penalty Coverage
Our
weighted average coupon, or WAC, on our respective securitizations has declined
since 2001 due to the declining interest rate environment and our originations
of higher credit grade mortgage loans over the period from 2001 to 2004. In
2005, we expect our average credit scores may decline slightly as we head into a
rising rate environment. If this occurs, we expect the WAC on our loans to rise.
The current loan balance as a percentage of original loan balance declined from
December 31, 2003 to December 31, 2004 as our customers have either prepaid or
paid down their mortgage loans by making the regular contractual principal
payments.
The following
tables set forth information about our securitized mortgage loan portfolio as of
December 31, 2004 and 2003.
| |
Issue
Date |
Original
Loan
Principal
Balance |
Current
Loan
Principal
Balance |
Percentage
of Portfolio |
Percentage
of Original Remaining |
Remaining
WAC Fixed |
Remaining
WAC Arm |
| |
|
($
in thousands) |
|
|
|
|
|
December
31, 2004 |
|
|
|
|
|
|
|
|
SAST
2001-2 |
8/2/2001 |
$650,410 |
$144,211 |
3% |
22% |
9.36% |
9.83% |
|
SAST
2001-3 |
10/11/2001 |
$699,999 |
$143,788 |
3% |
21% |
10.01% |
9.60% |
|
SAST
2002-1 |
3/14/2002 |
$899,995 |
$253,942 |
5% |
28% |
8.88% |
8.99% |
|
SAST
2002-2 |
7/10/2002 |
$605,000 |
$196,468 |
4% |
32% |
8.87% |
9.16% |
|
SAST
2002-3 |
11/8/2002 |
$999,999 |
$363,438 |
7% |
36% |
8.35% |
8.31% |
|
SAST
2003-1 |
3/6/2003 |
$749,996 |
$352,543 |
7% |
47% |
7.45% |
8.08% |
|
SAST
2003-2 |
5/29/2003 |
$599,989 |
$323,092 |
6% |
54% |
7.30% |
7.41% |
|
SAST
2003-3 |
9/16/2003 |
$1,000,000 |
$630,271 |
12% |
63% |
7.23% |
7.51% |
|
SAST
2004-1 |
2/19/2004 |
$1,099,999 |
$851,286 |
16% |
77% |
7.85% |
7.40% |
|
SAST
2004-2 |
7/27/2004 |
$1,199,994 |
$1,113,932 |
21% |
93% |
7.02% |
6.74% |
|
SAST
2004-3 |
10/27/2004 |
$899,956 |
$885,484 |
17% |
98% |
7.51% |
6.99% |
|
Total
|
|
$9,405,337 |
$5,258,455 |
|
|
|
|
|
December
31, 2003 |
|
|
|
|
|
|
|
|
SAST
2001-2 |
8/2/2001 |
$650,410 |
$252,627 |
6% |
39% |
9.54% |
9.86% |
|
SAST
2001-3 |
10/11/2001 |
$699,999 |
$275,915 |
7% |
39% |
10.02% |
9.65% |
|
SAST
2002-1 |
3/14/2002 |
$899,995 |
$449,616 |
11% |
50% |
8.93% |
9.21% |
|
SAST
2002-2 |
7/10/2002 |
$605,000 |
$353,607 |
8% |
58% |
8.88% |
9.08% |
|
SAST
2002-3 |
11/8/2002 |
$999,999 |
$698,704 |
17% |
70% |
8.43% |
8.38% |
|
SAST
2003-1 |
3/6/2003 |
$749,996 |
$626,089 |
15% |
83% |
7.57% |
8.06% |
|
SAST
2003-2 |
5/29/2003 |
$599,989 |
$546,274 |
13% |
91% |
7.39% |
7.53% |
|
SAST
2003-3 |
9/16/2003 |
$1,000,000 |
$977,656 |
23% |
98% |
7.33% |
7.59% |
|
Total |
|
$6,205,388 |
$4,180,488 |
|
|
|
|
Borrowers
who accept a prepayment penalty receive a lower interest rate on their mortgage
loan. A number of states restrict our ability to charge prepayment penalties on
mortgage loans made to borrowers in such states. Borrowers always retain the
right to refinance their loan, but may have to pay a fee of up to six-months
interest on 80% of the remaining principal when prepaying their loans. If the
mortgage loan prepays within the prepayment penalty coverage period, we will
record revenue from collection of a prepayment penalty. We report prepayment
penalties when we collect such fees in interest income. In addition, if a loan
prepays we fully expense any related deferred costs for that loan upon
prepayment. We reflect the amortization of deferred costs in interest
income.
We
experienced higher prepayments of our mortgage loans during 2004 compared to
2003. This was primarily due to refinancing activity steadily increasing during
2004 compared to 2003 as we continued to experience a declining interest rate
environment and a strong housing market. We expect slower prepayment speeds in
future periods if market interest rates continue to increase. This would
positively impact interest income. However, we would also anticipate a decrease
in the prepayment penalty income we receive.
| |
|
|
12
Month Constant Prepayment Rate (Annual Percent) |
Life-to-date
Constant Prepayment Rate (Annual Percent) |
|
Issue
Date |
Percent
with Prepayment Penalty |
Fixed |
Arm |
Fixed |
Arm |
|
December
31, 2004 |
|
|
|
|
|
|
|
SAST
2001-2 |
8/2/2001 |
46.19% |
36.11% |
52.36% |
30.75% |
42.96% |
|
SAST
2001-3 |
10/11/2001 |
23.07% |
41.45% |
50.46% |
35.79% |
42.73% |
|
SAST
2002-1 |
3/14/2002 |
64.85% |
34.12% |
49.03% |
31.29% |
40.97% |
|
SAST
2002-2 |
7/10/2002 |
57.27% |
36.03% |
47.77% |
32.90% |
39.90% |
|
SAST
2002-3 |
11/8/2002 |
53.38% |
38.17% |
51.72% |
30.56% |
41.09% |
|
SAST
2003-1 |
3/6/2003 |
69.48% |
34.98% |
49.58% |
26.83% |
40.17% |
|
SAST
2003-2 |
5/29/2003 |
71.64% |
31.87% |
44.93% |
25.88% |
37.15% |
|
SAST
2003-3 |
9/16/2003 |
58.69% |
24.44% |
41.52% |
20.23% |
35.48% |
|
SAST
2004-1 |
2/19/2004 |
50.32% |
— |
— |
18.89% |
30.77% |
|
SAST
2004-2 |
7/27/2004 |
56.27% |
— |
— |
12.37% |
22.62% |
|
SAST
2004-3 |
10/27/2004 |
51.66% |
— |
— |
1.77% |
21.59% |
|
December
31, 2003 |
|
|
|
|
|
|
|
SAST
2001-2 |
8/2/2001 |
69.24% |
38.26% |
49.86% |
28.29% |
38.37% |
|
SAST
2001-3 |
10/11/2001 |
64.44% |
40.07% |
48.25% |
32.74% |
38.42% |
|
SAST
2002-1 |
3/14/2002 |
77.07% |
37.23% |
43.23% |
29.53% |
35.54% |
|
SAST
2002-2 |
7/10/2002 |
75.02% |
35.44% |
38.37% |
30.41% |
33.23% |
|
SAST
2002-3 |
11/8/2002 |
72.83% |
27.58% |
33.32% |
22.68% |
29.20% |
|
SAST
2003-1 |
3/6/2003 |
74.53% |
— |
— |
14.33% |
24.83% |
|
SAST
2003-2 |
5/29/2003 |
71.72% |
— |
— |
12.21% |
18.11% |
|
SAST
2003-3 |
9/16/2003 |
58.57% |
— |
— |
4.79% |
8.84% |
Mortgage
Loan Production
Overview
Our
subsidiaries originate or purchase mortgage loans through our three separate
production channels: wholesale; correspondent; and retail. Having three
production channels allows us to diversify our production without becoming
reliant on any one particular area of the mortgage loan market. Further
discussion of each channel’s mortgage loan production can be found in
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Business Segment Results.”
The
following table sets forth selected information about our total loan production
and purchases for the years ended December 31, 2004, 2003, and
2002.
| |
For
the Year Ended December 31, |
Variance |
| |
2004
(1) |
2003 |
2002
(1) |
2004
- 2002 |
| |
($
in thousands) |
|
|
Loan
production |
$3,764,628 |
$2,842,942 |
$2,484,074 |
51.55% |
|
Average
principal balance per loan |
$143 |
$144 |
$130 |
10.00% |
|
Number
of loans originated |
26,261 |
19,700 |
19,108 |
37.43% |
|
Combined
weighted average initial LTV |
80.18% |
79.57% |
78.59% |
2.02% |
|
Percentage
of first mortgage loans owner occupied |
93.23% |
92.47% |
93.85% |
(0.66)% |
|
Percentage
with prepayment penalty |
65.52% |
73.45% |
77.64% |
(15.61)% |
|
Weighted
average median credit score (2) |
621 |
618 |
606 |
15
points |
|
Percentage
fixed rate mortgages |
31.77% |
35.89% |
36.00% |
(11.75)% |
|
Percentage
adjustable rate mortgages |
68.23% |
64.11% |
64.00% |
6.61% |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
7.90% |
7.86% |
8.78% |
(10.02)% |
|
Adjustable
rate mortgages |
7.04% |
7.65% |
8.80% |
(20.00)% |
|
Gross
margin - adjustable rate mortgages (3) |
5.59% |
5.23% |
5.56% |
0.54% |
|
Number
of funding days |
253 |
252 |
252 |
1
day |
|
Volume
per funding day |
$14,880 |
$11,282 |
$9,857 |
51% |
_______________
| |
(1) |
Amounts
for the years ended December 31, 2004 and 2002 include $270.0 million and
$188.6 million, respectively, in called loans.
|
| |
(2) |
The
credit score is determined based on the median of FICO, Empirica, and
Beacon credit scores. |
| |
(3) |
The gross margin is the amount added to the
applicable index rate, subject to rate caps and limits, to determine the
interest rate. |
Mortgage
loan production was $3.8 billion for the year ended December 31, 2004, which
represents a 36% increase over the year ended December 31, 2003 production of
$2.8 billion and a 52% increase over the year ended December 31, 2002 production
of $2.5 billion. Our production growth during the year ended December 31, 2004
was primarily due to our competitive pricing discipline, positive impacts
relating to our interest-only products and score based underwriting programs, as
well as the marketplace perception that interest rates will rise in the near
future. We also experienced a significant increase in the number of loans
originated for the year ended December 31, 2004 compared to the years ended
December 31, 2003 and December 31, 2002. Of the total mortgage loan production
of $3.8 billion for the year ended December 31, 2004, wholesale comprised 40%,
correspondent comprised 27%, and retail comprised 26%, with the remaining 7%, or
$270 million, representing called loans purchased from previously securitized
off-balance sheet pools during the year. We retain the option as master servicer
to call loans once the balance is below 10% of the original balance of the
securitization. We routinely review the financial consequences of calling loans,
and it is frequently to our advantage to do so since the loans that we place
into our portfolio are performing assets.
We saw a
slight decrease in our average loan balance for the year ended December 31, 2004
compared to the year ended December 31, 2003. This decrease was attributable to
the loans called during 2004 having a lower average balance than new production
since these loans were six to seven years old. No loans were called in 2003. We
saw a significant increase in our average loan balance for the year ended
December 31, 2004 compared to the year ended December
31, 2002, primarily related to the increase in production of interest-only
loans, which typically have higher principal balances than fixed rate and
adjustable rate mortgage loans have.
We saw an
increase in our weighted average median credit scores during 2004 compared to
2003 and 2002 as a result of increased production of higher credit quality
loans. While our weighted average interest rates associated with fixed rate
mortgages remained relatively stable from 2003 to 2004, we saw a 10% decrease in
these rates from 2002 to 2004 and a 20% decrease in the weighted average
interest rates on our adjustable rate mortgage production for 2004 compared to
2002. This was primarily the result of a declining interest rate environment
coupled with our efforts to remain competitive in the marketplace. As stated
earlier, we also experienced an increase in the credit quality of our loans, and
higher credit quality loans generally have lower interest rates.
The
percentage of our production with prepayment penalties decreased to 66% for 2004
from 73% for 2003, primarily as a result of the seasoned portfolio of called
loans discussed above which had minimal prepayment penalties in effect. The
percentage of our production with prepayment penalties was 78% in 2002. The
decline in production of loans with prepayment penalties since 2002 relates to
the Alternative Mortgage Transactions Parity Act, which became effective July 1,
2003, restricting the ability of state-chartered mortgage lenders to charge
prepayment penalties on certain types of mortgage loans.
Loan
Production by Product Type
We
experienced a shift from fixed rate mortgage products to adjustable rate
mortgage products from 2002 to 2004, primarily because borrowers found lower
interest rates offered by our adjustable rate products to be attractive. We saw
an increase in our interest only production for both our adjustable and fixed
rate mortgage production in 2004 compared to 2003 and 2002, reflecting our
marketing efforts to expand the use of this product. The following table shows
the composition of our loan production based on product type for the years ended
December 31, 2004, 2003, and 2002.
|
|
|
For the Year
Ended December 31, |
Variance |
|
|
|
|
2004
(1) |
|
|
2003 |
|
|
2002
(1) |
|
|
2004
- 2002 |
|
|
Interest
only adjustable rate mortgages |
|
|
30.66 |
% |
|
5.42 |
% |
|
— |
|
|
— |
% |
|
Two
year hybrids (2) |
|
|
24.80 |
% |
|
40.01 |
% |
|
35.68 |
% |
|
(30.49 |
)% |
|
Three
-five year hybrids (2) |
|
|
12.46 |
% |
|
18.63 |
% |
|
26.26 |
% |
|
(52.55 |
)% |
|
Floating
adjustable rate mortgages |
|
|
0.31 |
% |
|
0.05 |
% |
|
2.06 |
% |
|
(84.95 |
)% |
|
Total
adjustable rate mortgages |
|
|
68.23 |
% |
|
64.11 |
% |
|
64.00 |
% |
|
6.61 |
% |
|
Interest
only fixed rate mortgages |
|
|
2.57 |
% |
|
2.48 |
% |
|
0.69 |
% |
|
272.46 |
% |
|
Fifteen
year |
|
|
2.78 |
% |
|
3.28 |
% |
|
4.53 |
% |
|
(38.63 |
)% |
|
Thirty
year |
|
|
18.96 |
% |
|
21.69 |
% |
|
22.54 |
% |
|
(15.88 |
)% |
|
Balloons
and other (3) |
|
|
7.46 |
% |
|
8.44 |
% |
|
8.24 |
% |
|
(9.47 |
)% |
|
Total
fixed rate mortgages |
|
|
31.77 |
% |
|
35.89 |
% |
|
36.00 |
% |
|
(11.75 |
)% |
_______________
| |
(1) |
Includes all called loans. |
| |
(2) |
Hybrid
loans are loans that have a fixed interest rate for the initial two to
five years and after that specified time period, become adjustable rate
loans. |
| |
(3) |
Balloon
loans are loans with payments calculated according to a 30-year
amortization schedule, but which require the entire unpaid principal and
accrued interest to be paid in full on a specified date that is less than
30 years after origination. |
Loan
Production by Borrower Credit Score
We
continue to experience a decline in the interest rates on our loans due to a
significant increase in our higher credit quality production from 2002 to 2004.
We intend to focus to some extent on originating higher interest rate, lower
credit grade mortgage loans in the future. If this occurs, we expect the
interest rates on our loans to rise. The following table shows the composition
of our loan production by borrower risk classification for the years ended
December 31, 2004, 2003, and 2002.
| |
For
the Year Ended December 31, |
Variance |
| |
2004
(1) |
2003 |
2002
(1) |
2004
- 2002 |
|
Credit
scores > 650 |
|
|
|
|
|
Percentage
of total purchases and originations |
31.11% |
30.69% |
21.38% |
45.51% |
|
Combined
weighted average initial LTV |
81.56% |
80.92% |
77.43% |
5.33% |
|
Weighted
average median credit score |
689 |
691 |
691 |
(2)
points |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
7.65% |
7.67% |
8.07% |
(5.20)% |
|
Adjustable
rate mortgages |
6.31% |
6.69% |
7.63% |
(17.30)% |
|
Gross
margin - adjustable rate mortgages (2) |
5.06% |
4.49% |
4.76% |
6.30% |
|
Credit
scores 650 - 601 |
|
|
|
|
|
Percentage
of total purchases and originations |
30.94% |
29.05% |
29.28% |
5.67% |
|
Combined
weighted average initial LTV |
80.75% |
79.53% |
78.70% |
2.60% |
|
Weighted
average median credit score |
624 |
626 |
625 |
(1)
point |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
7.76% |
7.70% |
8.54% |
(9.13)% |
|
Adjustable
rate mortgages |
6.66% |
7.13% |
8.11% |
(17.88)% |
|
Gross
margin - adjustable rate mortgages (2) |
5.35% |
4.83% |
5.08% |
5.31% |
|
Credit
Scores 600 - 551 |
|
|
|
|
|
Percentage
of total purchases and originations |
23.35% |
23.06% |
26.42% |
(11.62)% |
|
Combined
weighted average initial LTV |
78.76% |
78.50% |
78.68% |
0.10% |
|
Weighted
average median credit score |
579 |
577 |
577 |
2
points |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
7.96% |
8.02% |
9.16% |
(13.10)% |
|
Adjustable
rate mortgages |
7.32% |
7.91% |
8.88% |
(17.57)% |
|
Gross
margin - adjustable rate mortgages (2) |
5.83% |
5.43% |
5.62% |
3.74% |
|
Credit
Scores 550 - 526 |
|
|
|
|
|
Percentage
of total purchases and originations |
7.84% |
9.61% |
11.32% |
(30.74)% |
|
Combined
weighted average initial LTV |
78.44% |
79.46% |
78.35% |
0.11% |
|
Weighted
average median credit score |
542 |
538 |
538 |
4
points |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
8.88% |
8.81% |
10.31% |
(13.87)% |
|
Adjustable
rate mortgages |
8.18% |
8.73% |
9.60% |
(14.79)% |
|
Gross
margin - adjustable rate mortgages (2) |
6.43% |
6.10% |
6.18% |
4.05% |
|
Credit
Scores <=525 |
|
|
|
|
|
Percentage
of total purchases and originations |
6.40% |
7.47% |
9.18% |
(30.28)% |
|
Combined
weighted average initial LTV |
78.26% |
77.79% |
75.62% |
3.49% |
|
Weighted
average median credit score |
518 |
513 |
504 |
14
points |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
9.72% |
9.76% |
10.73% |
(9.41)% |
|
Adjustable
rate mortgages |
8.81% |
9.41% |
10.43% |
(15.53)% |
|
Gross
margin - adjustable rate mortgages (2) |
6.60% |
6.54% |
6.70% |
(1.49)% |
|
Unavailable
credit scores |
|
|
|
|
|
Percentage
of total purchases and originations |
0.36% |
0.12% |
2.42% |
(85.12)% |
|
Combined
weighted average initial LTV |
75.23% |
66.71% |
45.05% |
66.99% |
|
Weighted
average median credit score |
— |
— |
— |
— |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
10.39% |
8.74% |
10.02% |
3.69% |
|
Adjustable
rate mortgages |
9.46% |
8.97% |
10.12% |
(6.52)% |
|
Gross
margin - adjustable rate mortgages (2) |
6.47% |
5.78% |
5.74% |
12.72% |
___________
| |
(1) |
Includes
all called loans. |
| |
(2) |
The
gross margin is the amount added to the applicable index rate, subject to
any rate caps and limits specified in the mortgage note, to determine the
interest rate. |
Loan
Production by Income Documentation
For the
year ended December 31, 2004, we saw a 24% increase in our stated documentation
loan program compared to the year ended December 31, 2002. Our production in our
limited documentation loan program decreased 45% from 2002 to 2004. The
following table shows the composition of our loan production based on income
documentation for the years ended December 31, 2004, 2003, and
2002.
| |
|
For
the Year Ended December 31, |
|
Variance |
|
|
|
|
2004
(1) |
|
2003 |
|
2002
(1) |
|
2004
- 2002 |
|
|
Income
documentation |
|
|
%
of Production |
|
|
Weighted
Average Median Credit Score |
|
|
%
of Production |
|
|
Weighted
Average Median Credit Score |
|
|
%
of Production |
|
|
Weighted
Average Median Credit Score |
|
|
%
of Production |
|
|
Weighted
Average Median Credit Score |
|
|
Full
documentation |
|
|
70.53 |
% |
|
613 |
|
|
66.69 |
% |
|
606 |
|
|
72.68 |
% |
|
601 |
|
|
(2.96 |
)% |
|
12
points |
|
|
Limited
documentation |
|
|
3.54 |
% |
|
618 |
|
|
3.99 |
% |
|
629 |
|
|
6.47 |
% |
|
621 |
|
|
(45.29 |
)% |
|
(3)
points |
|
|
Stated
income |
|
|
25.93 |
% |
|
642 |
|
|
29.32 |
% |
|
643 |
|
|
20.85 |
% |
|
616 |
|
|
24.36 |
% |
|
26
points |
|
_______________
| |
(1) |
Includes
all called loans. |
Loan
Production by Borrower Purpose
For the
year ended December 31, 2004, we saw a decrease in our rate or term refinance
loan production with an increase in our purchase loan production as compared to
the years ended December 31, 2003 and 2002. We anticipate the percentage of our
purchase mortgage loan production may increase and our rate or term refinancing
may decrease in the future if interest rates should rise. The following table
shows the composition of our loan production based on borrower purpose for the
years ended December 31, 2004, 2003, and 2002.
| |
For
the Year Ended December 31, |
Variance |
|
Borrower
Purpose |
2004
(1) |
2003 |
2002
(1) |
2004
- 2002 |
|
Cash-out
refinance |
66.93% |
68.05% |
69.89% |
(4.24)% |
|
Purchase |
26.57% |
23.34% |
20.32% |
30.76% |
|
Rate
or term refinance |
6.50% |
8.61% |
9.79% |
(33.61)% |
_______________
| |
(1) |
Includes
all called loans. |
Geographic
Distribution
We saw
very little shift in our production levels by region for the year ended December
31, 2004 compared to years ended December 31, 2003 and 2002. The following table
sets forth the percentage of our loans originated or purchased by region for the
years ended December 31, 2004, 2003, and 2002.
| |
For
the Year Ended December 31, |
Variance |
| |
2004
(1) |
2003 |
2002
(1) |
2004
- 2002 |
|
South |
26.68% |
26.14% |
27.19% |
(1.88)% |
|
California |
24.92% |
27.09% |
24.23% |
2.85% |
|
Mid
Atlantic |
15.87% |
14.06% |
13.79% |
15.08% |
|
Midwest |
11.57% |
11.57% |
12.08% |
(4.22)% |
|
West |
10.43% |
9.12% |
8.94% |
16.67% |
|
Southwest |
6.19% |
6.36% |
8.71% |
(28.93)% |
|
New
England |
4.34% |
5.66% |
5.06% |
(14.23)% |
|
Total |
100.00% |
100.00% |
100.00% |
|
_______________
| |
(1) |
Includes
all called loans. |
Securitization
and Financing
As a
fundamental part of our present business and financing strategy, we securitize
almost all of our mortgage loans. From time to time, we may choose to sell loans
rather than securitize them if we believe that market conditions present an
opportunity to achieve a better return through such sales. From July 2001
through December 31, 2004, we sold $570.2 million in mortgage loans. As of
December 31, 2004, we had securitized $19.0 billion and $9.4 billion of the
loans we originated or purchased since 1996 and 2001, respectively, and intend
to continue accessing the asset-backed securitization market to provide
long-term financing for our mortgage loans. We generate earnings primarily from
the net interest income and fees we record on the mortgage loans we originate
and purchase, both before and after securitization.
In one of
our typical securitizations, pools of mortgage loans, together with the right to
receive all payments on the loans, are assembled and transferred to a trust. The
trust pledges the mortgage loans to an indenture trustee to secure payment on
notes that are issued by the trust and represent our indebtedness. Most of the
notes, which are referred to as asset-backed securities, are offered for sale to
the public. The trust also issues a certificate that represents the ownership
interest in the trust, which is retained by a qualified REIT subsidiary of
Saxon. Many of the notes are
assigned ratings by rating agencies such as Moody’s Investors Service, Standard
& Poor’s, and Fitch Ratings Ltd. The indenture pursuant to which the notes
are issued establishes various classes of notes, and assigns an order of rights
to priority of payment to each class. A trust agreement and an administration
agreement also provide for such administrative matters as the appointment of a
trustee of the trust and the monthly distribution of funds and reports to the
holders of the certificates. A sale and servicing agreement provides for the
transfer of the mortgage loans to the trust and the servicing of the mortgage
loans.
We finance
loans initially under one of several different secured and committed warehouse
financing facilities. When the loans are later securitized, we receive proceeds
from the securities issued by the securitization trust, and use some of those
proceeds to pay off the related warehouse financing. Generally, as the company
sponsoring the securitization, we are not legally obligated to make payments on
the securities issued by the securitization trust, although under GAAP
applicable to our current portfolio-based accounting, such obligations are
included as liabilities on our consolidated balance sheet. We do, however, make
certain customary representations and warranties to each securitization trust,
which, if violated, could legally obligate us to repurchase some or all of the
securitized loans from the trust. The asset-backed securities issued by the
securitization trust receive interest out of the interest collected on the
securitized loans and generally pay down as the securitized loans pay off.
The
structure we employ in securitization transactions requires credit enhancement.
Overcollateralization is a method of credit enhancement that we have typically
used; however, we may elect to use different or additional methods of credit
enhancement, such as primary mortgage insurance, bond insurance, reserve funds,
or other methods described in the prospectuses filed with respect to our
subsidiaries’ asset-backed securities. There are no direct financial costs to
the use of overcollateralization. By applying excess cash flow (mortgage
interest income net of interest on the asset-backed securities, losses, and
servicing fees) to pay down the asset-backed securities of the trust faster than
the underlying mortgages are repaid, we are able to create and maintain any
required overcollateralization. Once the overcollateralization meets
predetermined levels, we will begin to receive the excess cash flow from the
mortgage loans in the trust. Depending upon the structure of the asset-backed
securities and the performance of the underlying loans, excess cash flow may not
be distributed to us for five to nine months or more. These excess amounts are
derived from, and are affected by, the interplay of several economic factors:
| |
· |
the
extent to which the interest rates of the mortgage loans exceed the
interest rates of the related asset-backed
securities; |
| |
· |
the
creation of overcollateralization; |
| |
· |
the
level of loss and delinquencies experienced on the securitized mortgage
loans; and |
| |
· |
the
extent to which the loans are prepaid by borrowers in advance of scheduled
maturities. |
Prior to
our conversion to a REIT, we had structured our securitizations as real estate
mortgage investment conduits, or REMICs, which required us to recognize gain for
tax purposes at the time of the securitization. We now intend to structure most
or all of our securitizations as non-REMIC
borrowing transactions for federal income tax purposes, which will facilitate
compliance with the applicable REIT income and asset tests and allow us to defer
recognition of any taxable gain associated with the securitized mortgage loans.
We may recognize excess inclusion income attributable to the interests we retain
in such securitization transactions, which could have negative tax consequences
to us or our shareholders. See “Risk Factors - Federal Income Tax Risks Related
to Our Qualification as a REIT - Recognition
of Excess Inclusion Income by us could have adverse tax consequences to us or
our shareholders.”
Competition
We face
intense competition in the business of originating, purchasing, securitizing,
and servicing mortgage loans. Our competitors include consumer finance companies
and other diversified financial institutions, mortgage banking companies,
commercial banks, investment banks, credit unions, savings and loans, credit
card issuers, Internet-based lending companies, and insurance finance companies.
Many of our largest competitors operate under federal charters and regulations
that preempt state and local rules governing lenders and that facilitate
efficient nationwide mortgage lending operations while we do not benefit from
these federal regulations. Many traditional mortgage lenders have begun to offer
products similar to those we offer to our borrowers. Fannie Mae and Freddie Mac
have also expressed interest in adapting their programs to include
non-conforming products, and have begun to expand their operations into the
non-conforming sector, providing a secondary market for non-conforming loans and
thereby increasing the liquidity available to our competitors. We also expect
increased competition over the Internet, which has relatively low entry
barriers. Many of these competitors, including large financial corporations
taking advantage of consolidation opportunities in the industry, are
substantially larger and have more capital, or greater access to capital at
lower costs, and greater technical and marketing resources than we have.
Efficiencies in the asset-backed securities market have generally created a
desire for increasingly larger transactions, giving companies with greater
volumes of originations a competitive advantage.
Competition
in the industry can take many forms, including interest rate and cost of a loan,
differences in underwriting standards, convenience in obtaining a loan, customer
service, amount and term of a loan, and marketing and distribution channels.
Additional competition may lower the rates we can charge borrowers and
potentially lower our net interest income.
Our
competitive position may be affected by fluctuations in interest rates and
general economic conditions. During periods of rising interest rates,
competitors that have “locked in” low borrowing costs may have a competitive
advantage. During periods of declining interest rates, competitors may solicit
our borrowers to refinance their loans. During economic slowdowns or recessions,
our borrowers may face new financial difficulties, which may result in increased
defaults, and they may also be receptive to refinancing offers by our
competitors.
We
believe that, in this highly competitive environment, our competitive strengths
are:
| |
· |
our
investment in technology which supports operating efficiencies, maintains
credit decision consistency, and enhances loss mitigation
efforts; |
| |
· |
our
disciplined approach to underwriting and servicing non-conforming mortgage
loans that uses sophisticated and integrated risk management
techniques; |
| |
· |
our
customer-focused processing and underwriting teams that are responsive to
borrowers’ needs; |
| |
· |
our
risk-based pricing approach that uses our historical performance databases
to increase predictability of our returns;
and |
| |
· |
our
low cost funding and liquidity available through the asset-backed
securities market. |
We
believe these strengths enable us to produce higher-quality, better performing
loans than our competitors.
Regulation
The
mortgage lending industry is highly regulated. Our business is subject to
extensive regulation and supervision by various federal, state, and local
government authorities. As of December 31, 2004, we were licensed or exempt from
licensing requirements by the relevant state banking or consumer credit agencies
to originate and service first and second mortgages in 49 states, plus the
District of Columbia. We do not originate loans in the State of Alabama or the
District of Columbia.
The
volume of new or modified laws, rules, and regulations applicable to our
business has increased in recent years and individual municipalities have also
begun to enact laws, rules, and regulations that restrict or otherwise affect
loan origination activities and, in some cases, loan servicing activities. The
laws, rules, and regulations of each of these jurisdictions are different,
complex, and, in some cases, in direct conflict with each other. It may become
increasingly difficult to identify applicable requirements comprehensively, to
interpret laws, rules, and regulations accurately, to program our information
systems properly, and to train our personnel effectively with respect to all of
these laws, rules, and regulations. Therefore, the risk of non-compliance with
these laws, rules, and regulations may be increased.
Our
mortgage lending and servicing activities are subject to the provisions of
various federal laws and their implementing regulations, including the Equal
Credit Opportunity Act of 1974, or ECOA, as amended, the Federal
Truth-in-Lending Act, or TILA, and Regulation Z thereunder, HOEPA, the Fair
Credit Reporting Act of 1970, or FCRA, as amended, the Real Estate Settlement
Procedures Act, or RESPA, the Fair Debt Collection Practices Act, the Home
Mortgage Disclosure Act, or HMDA, the Fair Housing Act and Regulation X
thereunder, the Gramm-Leach-Bliley privacy legislation, and FACT.
Specifically,
TILA was enacted to require lenders to provide consumers with uniform,
understandable information with respect to the terms and conditions of loan and
credit transactions. Among other things, TILA gives consumers a three-business
day right to rescind certain refinance loan transactions that we originate. FCRA
establishes procedures governing the use of consumer credit reports and also
requires certain disclosures when adverse action is taken based on information
in such a report. FACT provides new protections for consumer information,
particularly with respect to identity theft.
HOEPA imposes
additional disclosure requirements and substantive limitations on certain “high
cost” mortgage loan transactions. As a matter of policy, we do not originate
HOEPA-covered loans.
ECOA,
which is implemented by Regulation B, prohibits creditors from discriminating
against applicants on the basis of race, color, sex, age, religion, national
origin or marital status, if all or part of the applicant’s income is derived
from a publicly assisted program or if the applicant has in good faith exercised
any right under the Consumer Credit Protection Act. ECOA also requires
disclosures when adverse action is taken on an application, and prohibits
creditors from requesting certain types of information from loan applicants. The
Federal Fair Housing Act also contains anti-discrimination restrictions. HMDA
requires us to collect and file with the Department of Housing and Urban
Development information on our loan applications and originations.
RESPA
mandates certain disclosures concerning settlement fees and charges and mortgage
servicing transfer practices. It also prohibits the payment or receipt of
kickbacks or referral fees in connection with the performance of settlement
services.
The
Gramm-Leach-Bliley Act imposes requirements on all financial institutions,
including lenders, with respect to their collection, disclosure and use of
nonpublic consumer financial information and requires them to implement and
maintain appropriate safeguards to protect the security of that information.
This act also permits the states to enact more demanding privacy rules.
In
addition, we are subject to applicable state and local laws and the rules and
regulations of various state and local regulatory agencies in connection with
originating, purchasing, processing, underwriting, securitizing, and servicing
mortgage loans.
These
rules and regulations, among other things:
| |
· |
impose
licensing obligations on us; |
| |
· |
establish
eligibility criteria for mortgage loans; |
| |
· |
prohibit
discrimination; |
| |
· |
require
us to devote substantial resources to loan-by-loan analysis of points,
fees, benefits to borrowers, and other factors set forth in laws, which
often differ depending on the state, and in some cases the city or county,
in which the mortgaged property is located; |
| |
· |
require
us to adhere to certain procedures regarding credit reports and personal
information on loan applicants; |
| |
· |
regulate
assessment, collection, foreclosure and claims handling, investment and
interest payments on escrow balances, and payment
features; |
| |
· |
mandate
certain truth-in-lending and other disclosures and notices to borrowers;
and |
| |
· |
may
fix maximum interest rates, fees, and mortgage loan
amounts. |
Compliance
with these laws is complex and labor intensive. We have ceased doing business in
certain jurisdictions in which we believe compliance requirements cannot be
assured at a reasonable cost with the degree of certainty that we require, and
we may cease doing business in additional jurisdictions where we, or our
counterparties, make similar determinations with respect to anti-predatory
lending laws. Failure to comply with legal requirements in jurisdictions where
we do business can lead to, among other things, loss of approved licensing
status, demands for indemnification or mortgage loan repurchases, certain rights
of rescission for mortgage loans, class action lawsuits, administrative
enforcement actions, and civil and criminal penalties.
Any
person or group that acquires more than 10%, or in some cases 5%, of our stock
will become subject to certain state licensing regulations requiring such person
or group periodically to file certain financial and other information
disclosures. If any person or group holding more than 10%, or in some cases 5%,
of our stock fails to meet a state’s criteria, or refuses to adhere to such
filing requirements, our existing licensing arrangements could be jeopardized
and we could lose our authority to conduct business in that state. The loss of
required licenses or authority to conduct business in a state could have a
material adverse effect on our results of operations, financial condition and
business.
In recent
years, federal and several state and local laws, rules, and regulations have
been adopted, or have come under consideration, that are intended to eliminate
certain lending practices, often referred to as “predatory” lending practices,
that are considered to be abusive. Many of these laws, rules, and regulations
restrict commonly accepted lending activities and would impose additional costly
and burdensome compliance requirements on us. These laws, rules, and regulations
impose certain restrictions on loans with points and fees or APRs that meet or
exceed specified thresholds. Some of these restrictions expose a lender to risks
of litigation and regulatory sanction regardless of how carefully a loan is
underwritten. In addition, an increasing number of these laws, rules, and
regulations seek to impose liability for violations on the purchasers of
mortgage loans, regardless of whether a purchaser knew of or participated in the
violation.
The
continued enactment of these laws, rules, and regulations may prevent us from
making certain loans and may cause us to reduce the APR or the points and fees
we charge on the mortgage loans that we originate. The difficulty of managing
the compliance risks presented by these laws, rules, and regulations may
decrease the availability of warehouse financing and the overall demand for the
purchase of our originated loans. These laws, rules, and regulations have
increased, and may continue to increase, our cost of doing business as we have
been, and may continue to be, required to develop systems and procedures to
ensure that we do not violate any aspect of these new requirements.
In
addition, many of these state laws, rules, and regulations are not applicable to
the mortgage loan operations of national banks and federal savings associations,
and their operating subsidiaries, or of federal credit unions. Therefore, the
mortgage loan operations of these institutions
are at a competitive advantage to us since they do not have to comply with many
of these laws.
We seek
to avoid originating loans that meet or exceed the APR or “points and fees”
threshold of these laws, rules, and regulations. If we decide to relax our
self-imposed restrictions on originating mortgage loans subject to these laws,
rules and regulations, we will be subject to greater risks for actual or
perceived non-compliance with the laws, rules and regulations, including demands
for indemnification or mortgage loan repurchases from the parties to whom we
sell mortgage loans, difficulty in obtaining credit to fund our operations,
class action lawsuits, increased defenses to foreclosure of individual mortgage
loans in default, individual claims for significant monetary damages and
administrative enforcement actions. Any of the foregoing could significantly
harm our business, cash flow, financial condition, liquidity and results of
operations.
Regulatory
Developments
Recently
enacted and currently pending federal and state legislative and regulatory
developments regarding mortgage lending practices (including proposals directed
at “predatory lending” and expanding consumer protections), consumer privacy, or
protection and security of customer information could have a significant impact
on our future business activities.
In FACT,
Congress re-enacted the FCRA in an amended form in a legislative package that
included a number of new provisions addressing the handling of consumer credit
information and identity theft. The Federal Trade Commission, or FTC, and the
Federal Reserve Bank, or FRB, were required by the legislation to issue a number
of new implementing regulations during 2004. Although this legislation benefited
lenders by re-enacting federal preemptions that establish a uniform national
framework concerning credit reporting and use of credit information in making
unsolicited offers of credit and by adding certain other preemption provisions
related to use of consumer credit information, it also provides certain
additional consumer protections, particularly with respect to consumer identity
theft. Implementation of these new provisions may increase our costs and add to
our compliance risks. For example, effective December 1, 2004, lenders that use
credit scores in connection with mortgage-related lending must disclose that
score to each borrower. Further, in rules implementing FACT, the agencies have
proposed that any person that possesses covered consumer information must take
reasonable measures to protect against unauthorized access when the information
is disposed. Rules addressing affiliate sharing of customer information have
also been adopted.
Congress
in 2003 also re-enacted the Soldiers and Sailors Civil Relief Act of 1940 as the
Servicemembers Civil Relief Act, or SCR Act, to provide certain protections and
benefits for members of military services on active duty. The SCR Act places an
interest rate cap of 6% on borrowing obligations, including mortgages, incurred
by the borrower before entering active military service. In such cases,
financial institutions may not charge a higher interest rate during the service
member’s period of active service. “Interest rate” includes all charges and fees
except bona fide insurance related to the obligations. Relief under this
provision also extends to obligations on which a covered service member is a
co-obligor. As re-enacted, the SCR Act and its legislative history make it plain
that Congress intends all interest above the 6% limit to be forgiven
by the lender and not just deferred. In addition, for mortgages entered into
before the borrower’s active duty service and that go into default, institutions
may not, in general, foreclose during the period of military service or for
three months thereafter. In view of the large number of U.S. Armed Forces
personnel on active duty and likely to be on active duty in the future,
compliance with the SCR Act may have an adverse effect on our cash flow and
interest income.
Privacy
continues to be a high profile area of the law. The Gramm-Leach-Bliley Act
requires lenders to notify customers of their privacy policy and provide
consumers with the ability to opt-out of sharing certain information with
unaffiliated third parties. We
adopted a privacy policy and adopted controls and procedures to comply with the
law when it took effect on July 1, 2001. In 2003, the FTC
issued rules implementing the provisions in this act requiring financial
services companies, including mortgage lenders, to adopt and maintain standards
and procedures for ensuring the security, integrity and confidentiality of
customer records and information, including protections against anticipated
threats or hazards to such information and unauthorized access to or use of
customer information that could result in substantial harm or inconvenience to
any customer. Individual states are expected to create additional laws relating
to consumer privacy in the future. Congress and a number of states are
considering additional legislation concerning collection, use and security of
consumer information. As permitted under federal law, states may enact privacy
or customer information security legislation that is more stringent than the
requirements of the federal Gramm-Leach-Bliley Act. To the extent that a variety
of inconsistent state privacy rules or requirements are enacted, or additional
federal rules or requirements are implemented, our compliance costs could
substantially increase.
The FTC
also has established a nationwide “do - not - call” registry to supplement
existing state limitations on telemarketing activities. Although certain court
decisions called into question the FTC’s authority to implement this registry,
the FTC put it into operation pending a definitive judicial decision.
In
October 2004, the U.S. Supreme Court declined to hear an appeal seeking to
overturn a ruling by the U.S. Court of Appeals for the Tenth Circuit
that
upheld
the constitutionality of the FTC registry. Millions
of households have listed their telephone numbers on this registry, and the
implementation of the FTC rule may adversely affect telemarketing activities by
us or by vendors of our products. The FTC also has initiated enforcement actions
against alleged violators of the registry requirements after receiving consumer
complaints.
On
July 1, 2005, the FCC intends to implement revisions of its so-called "do
not fax" rules, including revisions that will no longer allow commercial
entities, such as mortgage lenders, to rely upon an exception for " established
business relationships" to send unsolicited faxes for business purposes. When
effective, these rules will make it unlawful for any person to send an
unsolicited facsimile to another machine that contains any material advertising
the commercial availability or quality of any property, good or service, unless
the recipient has expressly permitted the sending of such a facsimile in a
signed, written statement. In addition, each facsimile advertisement must
contain the identity and telephone number of the business on whose behalf the
facsimile is being sent, whether sent directly by that business or through a
third-party service provider. This restriction will directly affect the mortgage
industry practice in which mortgage lenders, including us, send announcements of
rate and product changes to mortgage brokers by a broadcast facsimile delivery.
If the new FCC requirement takes effect, compliance
with this FCC requirement will increase our costs and legal risks. Violators of
these rules may be subject not only to enforcement actions by government
agencies, but also to private suits by affected persons.
A number of
states are considering privacy amendments that may be more demanding than
federal law, including California, which has enacted a number of statutes very
recently — including the California Financial Information Privacy Act, or SB 1,
and the California Online Privacy Protection Act, both of which took effect on
July 1, 2004, and AB 1950. Under SB 1, subject to certain exceptions, a
financial company must allow customers to opt out of the sharing of their
information with affiliates in separately regulated lines of business and must
receive a customer opt-in before confidential customer data may be shared with
unaffiliated companies. Under the new California Online Privacy Protection Act,
all operators of commercial websites and online services that allow interaction
with California consumers, even if no transactions may be effected online, must
post privacy policies meeting statutory requirements. AB 1950 further expands
the reach of California privacy rules by requiring all types of businesses to
maintain “reasonable security measures” for the customer personal information
that they possess or license. In addition, 2003 amendments to the California
Civil Code effective January 1, 2005 require all non-financial companies,
whether located in California or elsewhere, that disclosed personal information
about a California consumer for direct marketing purposes during 2004 to provide
notice to the customer and opportunity to request information regarding
third-party disclosure from the lender. The FTC, which administers the federal
privacy rules for mortgage lenders, has determined that privacy laws in several
states, most recently new privacy laws enacted by Vermont and Illinois, are not
preempted by Gramm-Leach-Bliley. We continue to monitor these state activities
to evaluate the potential impact of any proposed new laws.
As part
of its program to review its regulations on a periodic basis, the Federal
Reserve Board adopted revisions in 2003 to its Regulation B, which implements
the Equal Credit Opportunity Act, which prohibits creditors, including us, from
discriminating against applicants on specified bases such as race, gender,
marital status, or national origin. Among the changes in these rules are
provisions concerning the collection and retention of certain information,
treatment of joint applications and notices of adverse actions.
Proposals
addressing practices labeled as “predatory lending” continue to be considered in
Congress and a number of states. In general, these proposals involve lowering
the existing federal HOEPA or state thresholds for defining a “high-cost” loan,
and establishing enhanced protections and remedies for borrowers who receive
such loans. However, many of these laws and regulations also extend beyond
curbing predatory lending practices to restrict commonly accepted lending
activities, including some of our activities. For example, some of these laws
and regulations prohibit or limit prepayment charges or severely restrict a
borrower’s ability to finance the points and fees charged in connection with a
loan. We cannot predict whether any such proposals will be enacted and what the
effects of any new “predatory lending” legislation might be on us.
Numerous
states and municipalities, including California where we originated more than
25% of our loans in 2004, have enacted or are considering laws to combat
“predatory” or high-cost lending. These laws vary state by state, with some
states implementing laws that track federal
high-cost loan limits and tests, but with other states having much lower
thresholds. We monitor these laws prior to enactment and adopt practices we
consider appropriate to maintain compliance.
We have
in the past ceased to do business in certain states that had enacted “predatory
lending” legislation, although we resumed activities in certain states that
subsequently modified their laws. Any further state legislation in this area may
cause us to withdraw from doing business in the affected states or in other
states in the future. In addition, for reasons of reputation and because of the
enhanced risk, many whole loan buyers elect not to purchase any loan labeled as
a “high cost” loan under any local, state or federal law or regulation.
Accordingly, these laws and regulations could severely constrict the secondary
market for a significant portion of our loan production. This restriction could
effectively preclude us from originating loans that fit within the newly defined
parameters and could have a material adverse effect on our ability to sell or
securitize loans and therefore on our results of operations, financial condition
and business. Adoption of such laws and regulations also could have a material
adverse impact on our business by substantially increasing the costs of
compliance with a variety of inconsistent federal, state and local rules, or by
restricting our ability to charge rates and fees adequate to compensate us for
the risk associated with certain loans.
The scope of
governmental concern with predatory practices in the financial services industry
has continued to expand, and members of Congress have called attention to this
issue. Both the FTC and the Office of Thrift Supervision have recently initiated
enforcement actions against, and entered into enforcement agreements with,
servicers of non-prime mortgages based upon multiple allegations of practices
regarded by the agencies as abusive. These settlements involved both civil fines
and commitments to make significant changes in the servicer's practices. In
addition, the bond rating agencies have addressed alleged "predatory servicing"
activities of servicers of non-prime mortgage loans.
The
federal government also is reconsidering provisions that are important parts of
the legal framework applicable to us as mortgage lenders. RESPA specifies
disclosures for mortgage lenders to provide their customers and other procedures
for mortgage lenders to follow. In 2002, the Department of Housing and
Development, or HUD, undertook to substantially revise the rules implementing
RESPA and modify the disclosures provided mortgage customers. In response to
substantial criticism of HUD’s initial proposals, the agency in early 2003
determined not to adopt final rules and to reconsider its proposals. In late
2003, it was reported that HUD had submitted a revised RESPA rules proposal to
the Office of Management and Budget with an intention to propose new rules in
2004. After a February 2004 HUD staff study on mortgage broker compensation
disclosure concluded that the compensation disclosures proposed by HUD would not
be effective and could be confusing, and that consumer mortgage costs could be
reduced if rules encouraged and facilitated comparison shopping on loans, HUD
withdrew its revised RESPA rule proposal. We cannot predict whether any
re-proposed proposals will be submitted or adopted and what effects any new
RESPA rules might have on us.
Federal
regulators are giving greater scrutiny to the quality and independence of
property appraisals used in mortgage lending. Effective August 19, 2004, HUD
adopted revised rules governing appraisals submitted in connection with loans
originated for the Federal Housing Administration.
These rules provide penalties for lenders who knew, or should have known, that
an appraiser submitted an intentionally inaccurate valuation of a residence. As
adopted, the rules differ from the HUD proposed rule, which would have held
lenders and appraisers equally responsible for inaccurate appraisals. Although
the HUD rules affect only FHA loans, parallel to the HUD initiative is the
reissuance of appraisal guidelines by the federal banking regulators. These
guidelines call for appraiser independence from the lender, separation of the
responsibility of engaging an appraiser from mortgage loan production, and the
evaluation of the appraisal to be separate from both the appraiser and the
mortgage loan officer. Although we are not subject to federal banking
regulation, nor do we currently originate FHA loans, the appraisal practices
established by these federal agencies are likely to affect industry best
practice standards, may be included as contractual requirements by parties with
whom we deal, may be adopted by regulatory bodies having jurisdiction over us,
or our affiliates, or may be asserted in litigation against us.
Further,
federal statutes and rules governing federally chartered banks and thrifts allow
those entities to engage in mortgage lending in multiple states on a
substantially uniform basis and without the need to comply with state licensing
and other laws (including new state “predatory lending” laws described herein)
affecting mortgage lenders. Federal regulators have expressed their position
that these preemption provisions benefit mortgage subsidiaries of federally
chartered institutions as well. In January 2004, the Comptroller of the Currency
finalized preemption rules that confirm and expand the scope of this federal
preemption for national banks and their operating subsidiaries. Such federal
preemption rules and interpretations generally have been upheld in the courts.
Moreover, at least one national rating agency has announced that in recognition
of the benefits of federal preemption, it will not require additional credit
enhancement by federal institutions when they issue securities backed by
mortgages from a state with predatory lending laws. As a non-federal entity, we
will continue to be subject to such rating agency requirements arising from
state or local lending-related laws or regulations. The rating agencies either
will not rate, will impose various additional restrictions on their ratings of,
or will require increased levels of over-collateralization in order to rate,
securitizations involving mortgages that may be “high cost mortgages” under
state statutes. Accordingly, as a mortgage lender that is generally subject to
the laws of each state in which we do business, except as may specifically be
provided in federal rules applicable to all lenders (such as FCRA, RESPA or
TILA), we may be subject to state legal requirements and legal risks under state
laws to which these federally regulated competitors are not subject, and this
disparity may have the effect of giving those federal entities legal and
competitive advantages.
Effective
July 1, 2003, the OTS, the agency that administers the Parity Act for
unregulated housing creditors, withdrew its favorable Parity Act regulations and
Chief Counsel Opinions that authorized lenders to charge prepayment and late
fees in connection with certain adjustable rate mortgages in certain
circumstances notwithstanding contrary state law. In July 2004, the U.S. Court
of Appeals for the District of Columbia upheld the OTS action designating the
Parity Act regulations inapplicable, thereby subjecting non-federal housing
creditors to state law concerning prepayment and late fees. Because our federal
institution competitors continue to have the flexibility to offer products with
the features addressed by the Parity Act, we may be at a competitive
disadvantage compared to those competitors and our loan origination volume may
be reduced. The OTS’s ruling by its terms does not have retroactive effect on
loans originated before
July 1, 2003. However, on April 24, 2003, a New Jersey state appellate court
relied on the new OTS rule to find that the Parity Act did not preempt New
Jersey state law restrictions on prepayment charges in the past. Although this
ruling was reversed on appeal by the New Jersey Supreme Court, if courts in
other jurisdictions were to reach conclusions like the New Jersey appellate
court's decision, those courts might call into question the validity of
prepayment penalty provisions under which we have previously collected
prepayment charges and which we continued to include in our mortgage loan
documentation prior to July 1, 2003 on the basis of Parity Act preemption. If
such a decision were made by a court or agency with jurisdiction over us, we
might be required to refund and waive a significant amount in prepayment
charges.
In addition,
in March 2004, an Illinois Court of Appeals found that the Illinois Interest
Act, which caps fees at 3% for loans with an interest rate in excess of 8%, is
not preempted by federal law. This ruling contradicts the view expressed by
other courts and federal banking agencies that lenders operating under federal
charters may make loans outside their home states at the rates permitted under
home state law. This ruling is not expected to directly impact our future
business because the recent reduction of the scope of the Parity Act has meant
that we can no longer rely on federal preemption. However, this ruling may make
it easier for plaintiffs to file actions seeking various forms of relief against
lenders like us that received fees in the past that exceeded the applicable
thresholds in reliance on federal preemption under the Parity Act.
Furthermore,
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. President Bush has announced an intention to make a general
reform of individual income tax laws a priority proposal in the new Congress.
Because many of our mortgage loans are made to borrowers for the purpose of
consolidating consumer debt or financing other consumer needs, the competitive
advantage 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 to borrowers
could have a material adverse effect on the demand for the loans we offer.
New
reporting requirements under HMDA that became effective in January 2004 will
require lenders beginning in August 2005 to disclose data on high-cost loans, as
well as data on race, ethnicity, and gender. It is expected that the disclosure
of such information will facilitate identification of patterns of discrimination
in pricing and geographic distribution of mortgage loans. The reporting
requirements are also likely to have competitive effects in advance of the
effective date as lenders adjust their policies with respects to loans that
would generate data pertinent to the new reporting requirements. In addition,
the newly available data may give rise to adverse publicity about mortgage
lending practices in the mortgage industry generally, as well as about
particular segments or companies.
Congress
and federal regulators continue to consider a number of proposals that could
have substantial effects on the GSEs, particularly Fannie Mae, Freddie Mac, and
the Federal Home Loan Banks, which provide secondary markets for mortgage loans.
Both the Federal Reserve Board and the Department of the Treasury have expressed
concerns about the rapid growth of Fannie Mae and Freddie Mac and their relative
lack of market discipline. We cannot predict
whether any such proposals will be enacted, what the effects of any new
government-sponsored entities legislation might be on us, and what the effects
might be for us of any regulatory or voluntary changes.
On May
13, 2004, the Securities and Exchange Commission released a proposal to amend
its regulation to codify requirements for the registration, disclosure, and
reporting for mortgage-backed and other asset-backed securities. As proposed,
this rule could result in substantial changes in the costs and burdens in the
issuance of publicly issued asset-backed securities and decrease the number of
firms participating in the market for such securities. In addition, the
substantive requirements of any such Securities and Exchange Commission rules
might also be applied as "best practices" to sellers or servicers of
mortgage-backed securities. The rule proposals have proved highly controversial
and it cannot be predicted whether, when, or in what form any new SEC rules on
asset-backed securities may be adopted in final. We cannot predict how any such
changes that do occur may affect our business.
In late
June 2004, the Basel Committee on Bank Supervision adopted a complex, new
framework for participating countries to follow in adopting revised capital
guidelines for the world's largest banking institutions, many of which have
subsidiaries that are among the largest mortgage lenders in the United States.
Although these changes are not expected to take full effect until 2008, the new
capital rules adopted for regulated U.S. financial institutions may effectively
reduce the capital requirements for mortgages made by the largest institutions
subject to the new Basel framework and thus may have profound effects on the
structure and competition in the mortgage business. We cannot predict how the
new capital regime to be developed based upon the new Basel framework will be
implemented and what effects it will have on our competitors or our
business.
On
November 12, 2004, one of the country's three major arbitration firms, JAMS,
announced that it would no longer enforce contract provisions that prevent
consumers from forming classes when pursuing claims in arbitration. The two
other major arbitration firms, the American Arbitration Association and National
Arbitration Forum, have made no similar changes. Our standard agreements with
our borrowers call for arbitration of disputes and permit the borrower to select
one of the three major arbitration firms as the forum for resolving a dispute. A
class arbitration provides fewer procedural requirements than a class-action
lawsuit, and the different procedures may be more advantageous to class
arbitrations and may increase the possibility of an award to the claimant class.
We cannot predict what effect this change by JAMS may have on our financial
results. As a result of the JAMS decision, loans we produced may be subject to
this decision by JAMS if JAMS is selected as the arbitration provider in a
dispute regarding any such loans.
Regulatory
and legal requirements are subject to change and may become more restrictive,
making our compliance more difficult or expensive or otherwise restricting our
ability to conduct our business as it is now conducted. Changes in these
regulatory and legal requirements—including changes in their enforcement—could
materially and adversely affect our business, financial condition, liquidity and
results of operations.
USA
Patriot Act
The
President of the United States signed the USA PATRIOT Act into law on October
26, 2001. The USA PATRIOT Act establishes a wide variety of new and enhanced
ways of combating international terrorism. The provisions that affect national
banks and other financial institutions most directly are contained in Title III
of the Act. In general, Title III amends current law — primarily the Bank
Secrecy Act — to provide the Secretary of Treasury and other departments and
agencies of the federal government with enhanced authority to identify, deter
and punish international money laundering and other crimes.
Among
other things, the USA PATRIOT Act prohibits financial institutions from doing
business with foreign "shell" banks and requires increased due diligence for
private banking transactions and correspondent accounts for foreign banks. In
addition, financial institutions will have to follow new minimum verification of
identity standards for all new accounts and will be permitted to share
information with law enforcement authorities under circumstances that were not
previously permitted. These and other provisions of the USA PATRIOT Act became
effective at varying times and the Secretary of Treasury and various federal
banking agencies are responsible for issuing regulations to implement the new
law. The
Treasury Department has indicated that it intends to develop regulations that
will apply at least some of the USA PATRIOT Act requirements to nonbanking
lending companies, such as mortgage lenders. To the
extent the USA PATRIOT Act applies to our mortgage banking operations, we may be
subject to additional burdens of compliance and potential liability for failure
to comply.
Environmental
From time
to time, in the ordinary course of our business, we foreclose on properties
securing loans that are in default. To date, we have not been required to
perform any material investigation or clean up activities, nor have we been
subject to any environmental claims. In addition, as the owner or former owner
of a contaminated site, we may be subject to common law claims by third parties
based on damages and costs resulting from environmental contamination emanating
from the property. If we ever become subject to significant environmental
liabilities, our business, financial condition, liquidity and results of
operations could be materially and adversely affected.
Employees
We
employed 1,279 employees as of December 31, 2004. None of our employees are
represented by a union or covered by a collective bargaining agreement.
Executive
Officers and Key Employees
Our
executive officers as of December 31, 2004 are as follows:
Michael
L. Sawyer, Age 48. Mr.
Sawyer is our Chief Executive Officer and President and a Director. Mr. Sawyer
has served our Chief Executive Officer and a Director since 2001, and as our
President from 1998 until 2001 and since June 7, 2004. Before being named
President in 1998, Mr. Sawyer had served as a Director and Senior Vice President
of Underwriting of Saxon Mortgage since 1995. Before joining us, Mr. Sawyer
served as Vice President and Director of Conduit Funding for Household Financial
Services. From 1993 until 1994, Mr. Sawyer was general manager and director of
correspondent lending for Novus Financial Corporation. From 1985 until 1993, Mr.
Sawyer held various managerial positions for Ford Consumer Finance, including
regional underwriting manager and manager of operations. Mr. Sawyer received his
Bachelor’s degree in Liberal Arts from the University of Illinois, and received
his Masters of Business Administration from the University of California,
Irvine.
Bradley
D. Adams, Age 39. Mr.
Adams is our Executive Vice President of Capital Markets. Mr. Adams has served
as our Executive Vice President of Capital Markets since July 2002. Prior to
this position, Mr. Adams had served as Senior Vice President of Capital Markets
of Saxon Mortgage since 1999, and he has run our loan securitization program
since 1996. Before joining us in 1996, Mr. Adams was part of the portfolio
management team at Resource Mortgage Capital, Inc., our parent company at the
time. Mr. Adams has also held various positions in financial forecasting and
management at Best Products Corporation, Hesa Educational Corp., and Growth
Capital Corp. Mr. Adams received his Bachelor of Science degree in Finance and
his Master of Business Administration degree from Virginia Commonwealth
University.
Robert
B. Eastep, Age 41. Mr.
Eastep is our Executive Vice President and Chief Financial Officer. Mr. Eastep
has served as our Executive Vice President and Chief Financial Officer since
June 2002. Previously, Mr. Eastep had served as our Vice President of Strategic
Planning and Controller since 1999. Before joining us, Mr. Eastep worked at
Cadmus Communications, a printing company, as Director of Internal Audit from
1998 to 1999. Before that, Mr. Eastep served as Vice President-Finance for
Central Fidelity Bank, NA (now Wachovia Corporation), a commercial bank, from
1996 to 1998. Before 1996, Mr. Eastep was a Senior Manager in the financial
services practice at KPMG LLP, an international accounting firm. Mr. Eastep
received his Bachelor of Science in Business Administration with honors from
West Virginia University. Mr. Eastep is a licensed Certified Public Accountant
in the Commonwealth of Virginia.
Mark
D. Rogers, Age 52. Mr.
Rogers is our Senior Vice President and Corporate Strategies Director, and is
Executive Vice President for Saxon Capital Holdings, Inc. in charge of
Information Technology, Strategic Planning, Project Management, Corporate
Marketing, and Human Resources and Training. Prior to being named our Senior
Vice President of Operations in 2004, Mr. Rogers had served as our predecessor’s
Senior Vice President since 2002. Before joining us, Mr. Rogers led the creation
and marketing of web based data products for the financial services industry at
Tyler Technologies, a provider of integrated end-to-end information management
solutions and services to local governments, from 1998 to 2001. Mr. Rogers also
held various top management positions during a fourteen-year career at First
American Financial. Mr. Rogers began his career in escrow administration at
Lomas Mortgage USA. Mr. Rogers has been a member of the Mortgage Bankers
Association for 22 years. He studied at Southwest Texas State University and has
completed various real estate lending and mortgage banking related courses.
Richard
D. Shepherd, Age 51. Mr.
Shepherd is our Executive Vice President, General Counsel, and Secretary. Mr.
Shepherd has managed our Legal Department since 1996, and our corporate
secretary functions since 2001. Previously he had served as our Regulatory
Compliance Counsel. Before joining us in 1995, Mr. Shepherd practiced law at
Ragsdale, Beals, Hooper & Seigler (Atlanta, Georgia) and Robert Musselman
and Associates (Charlottesville, Virginia) concentrating in real estate finance
matters. Mr. Shepherd received his Bachelor of Arts degree from the University
of Maryland, and his law degree from the University of Virginia.
Carrie
J. Pettitt, Age 34. Ms.
Pettitt is our Controller, and is Senior Vice President and Controller of Saxon
Capital Holdings, Inc. Ms. Pettitt has served as our controller since October
2003. Prior to joining us in 2003, Ms. Pettitt had served as Senior Manager at
KPMG LLP since 1999, providing financial statement audit and internal control
advisory services primarily to clients in the financial services industry. Ms.
Pettitt was employed from 1995 to 1999 by Dynex Capital, Inc., a mortgage and
consumer finance company, and served as their Assistant Treasurer and Manager of
Investor Relations. Ms. Pettitt began her career with KPMG LLP in 1992
performing financial statement audits, again in the financial services industry.
Ms. Pettitt received a Bachelor of Business Administration, with a Concentration
in Accounting, from The College of William and Mary and is a licensed Certified
Public Accountant in the Commonwealth of Virginia.
Our key
employees as of December 31, 2004 are as follows:
David
L. Dill, Age 41. Mr.
Dill is our Senior Vice President of Servicing, and is President of Saxon
Mortgage Services. Mr. Dill has served as our Senior Vice President of Servicing
since June 2004 and previously served as our Vice President of Servicing. Mr.
Dill joined us in 1998 as Vice President and Loss Mitigation Manager,
responsible for outbound collection and loss mitigation activities on mortgage
loans sixty or more days delinquent. Before joining us, Mr. Dill held various
managerial positions at North Dallas Bank and Trust from 1985 to 1998, most
recently as Vice President of Consumer Lending. Mr. Dill studied at North Lake
Jr. College and has completed real estate lending courses at the Texas Bankers
Association Consumer Lending School.
James
V. Smith, Age 46. Mr.
Smith is our Senior Vice President of Production, and is President of Saxon
Mortgage, and America’s Moneyline. Mr. Smith has served as our Senior Vice
President of Production since June 2004. Mr. Smith previously served as the
Executive Vice President of our wholesale business channel from February 2003 to
June 2004. Before joining us in February 2003, Mr. Smith was Executive Vice
President and Chief Operating Officer of Origen Financial L.L.C., an originator
and servicer of manufactured home loans, from November 1995 to February 2003.
From 1994 until 1995, Mr. Smith served as Assistant Vice President of Conduit
Funding for Household Financial Services in Pomona, California. From 1990 until
1994, Mr. Smith was Executive Vice President for Genesis Management Group in
Atlanta, Georgia. Mr. Smith served as Senior Vice President for Barclays
American Financial from 1988 until 1990. From 1979 until 1988, Mr. Smith
held various managerial positions with Meritor
Credit Corporation and Conseco Finance Corporation, including directing regional
underwriting, operations, servicing, sales and business development functions.
Mr. Smith received his Bachelors of Business Administration in Finance from
Georgia State University in Atlanta, Georgia.
Jeffrey
A. Haar, Age 38. Mr.
Haar is the Executive Vice President of Saxon Mortgage and is in charge of our
correspondent business channel. Mr. Haar joined us as a Regional Account Manager
in 1997. Before joining us, Mr. Haar served as Senior Vice President of Indy
Mac’s Correspondent Lending Division since 1996, and as National Account Manager
from 1993 to 1996. Prior to these positions, Mr. Haar was a Retail Loan Officer
for First Pacific Mortgage and Commerce Security Bank from 1990 to 1993. Mr.
Haar received his Bachelor of Business Administration in Finance from the
University of Toledo.
Bruce
C. Morris, Age 59. Mr.
Morris is Executive Vice President of Saxon Capital Holdings, Inc. and is in
charge of quality control. Mr. Morris has managed our QC Department since 1998.
Before joining us, Mr. Morris was a Senior Asset Manager for SMAI, Inc., an
independent contract firm that managed the liquidation of failed financial
institutions under contract with the RTC/FDIC from 1993 to 1997. Before that,
Mr. Morris held various senior management positions at Ritz-Cohen Joint
Ventures, HomeFed Bank, and SunBelt Savings FSB. Mr. Morris received his
Bachelor of Business Administration degree in Finance and Economics from Stephen
F. Austin University.
Jeffrey
D. Parkhurst, Age 45. Mr.
Parkhurst is Executive Vice President and Chief Credit Officer of Saxon Capital
Holdings, Inc. Prior to being named our Vice President and Chief Credit Officer
in 2003, Mr. Parkhurst served as our Vice President of Wholesale Underwriting
since 1998, and as Vice President of Central Loan Originations for America’s
MoneyLine from 1997 to 1998. Before joining America’s MoneyLine, Mr. Parkhurst
held various managerial positions at Novus Financial Corporation, and served as
Origination Manager from 1992 to 1997. Mr. Parkhurst also held various
managerial positions during a ten-year career at Household Finance Corporation.
Mr. Parkhurst received his Bachelor of Science degree in Economics from Illinois
State University.
Jennifer
B. Sebastian, Age 35. Ms.
Sebastian is our Treasurer, and is Senior Vice President and Treasurer of Saxon
Capital Holdings, Inc. Prior to
being named our Vice President and Treasurer in June 2002, Ms. Sebastian had
served as Vice President and Assistant Treasurer of Saxon Mortgage, Saxon
Mortgage Services and America’s MoneyLine since 2001, as Assistant Vice
President and Assistant Treasurer from 1999 to 2001, and as Cash Manager from
1996 to 1999. Before joining us, Ms. Sebastian served in various financial
positions at Resource Mortgage Capital, Inc., Moody’s Investor Services, and
Northeast Appraisals Corp. Ms. Sebastian received her Bachelor of Science in
Economics with honors from St. Bonaventure University.
Jeffrey
D. Coward, Age 35. Mr.
Coward is Senior Vice President of Saxon Capital Holdings, Inc. in charge of
Pricing and Analytics. Mr. Coward has managed our Pricing and Analytics group
since 1997. Prior to this position, Mr. Coward served as Assistant Vice
President of Secondary Marketing. Mr. Coward joined Saxon Mortgage as a
Secondary Marketing Analyst in 1993. Mr. Coward completed a Pricing Strategy and
Tactics Executive Education Course at the University of Chicago Graduate School
of Business in December 2000. Mr. Coward graduated Cum Laude from Virginia
Commonwealth University with a Bachelor of Science degree in Finance.
Todd
F. Miller, Age 40. Mr.
Miller is our Director of Internal Audit and Senior Vice President of Saxon
Capital Holdings, Inc. Mr. Miller has directed our Internal Audit group since
August 2004. Prior to joining Saxon Capital in August 2004, Mr. Miller was a
group manager in the internal audit division of Capital One Financial
Corporation from 2002 to 2004. From 1993 to 2002, Mr. Miller was employed as
senior manager with KPMG LLP in the financial services assurance sector. Mr.
Miller received his Master of Business Administration from Virginia Commonwealth
University and his Bachelor of Business Administration from James Madison
University. Mr. Miller is a licensed Certified Public Accountant in the
Commonwealth of Virginia, a Certified Internal Auditor and holds the designation
of Certified Risk Professional sponsored by the Bank Administration Institute.
W.
Michael Head, Age 55. Mr.
Head is our Director of Human Capital and Senior Vice President of Saxon Capital
Holdings, Inc. Mr. Head has served in this capacity since November 2004. Prior
to joining us, Mr. Head was Senior Human Capital Consultant for FoxHead
Consulting, a human resource strategy and software consulting organization, in
Nashville, Tennessee from 2003 to 2004, and served as Principal from 1998 to
2000. From 2000 to 2003 Mr. Head was Executive Vice President and Corporate
Human Resources Director for Regions Financial Corporation, a financial services
company, in Birmingham, Alabama. From 1984 to 1998 Mr. Head served as Corporate
Vice President of Human Resources for Ingram Industries Inc. in Nashville,
Tennessee. Before that, Mr. Head was Director of Human Resources and Strategic
Planning for Endata, Inc. in Nashville, Tennessee, from 1977 to 1984. Mr. Head
received his Bachelor of Arts degree in Economics from the University of
Virginia, and his Master of Business Administration Degree from Vanderbilt
University.
Steven
P. Walls, Age 43. Mr. Walls
is Senior Vice President of Saxon Capital Holdings, Inc. in charge of our
Servicing Accounting group. Mr. Walls has directed our Servicing Accounting
group since July 2004. Prior to this position, Mr. Walls served as Director of
Internal Audit of Saxon Capital. Prior to joining Saxon Capital in 2002, Mr.
Walls was a principal for the accounting firm of Cheely, Burcham, Eddins,
Rokenbrod & Carroll, P.C., and its predecessor, VanHuss & Walls, P.C.
from 1995 to 2002. Prior to 1995, Mr. Walls was employed as senior manager with
KPMG LLP in the financial services assurance sector. Mr. Walls received his
Bachelor of Science in Business Administration from the University of Central
Florida. Mr. Walls is a licensed Certified Public Accountant in the Commonwealth
of Virginia and holds the designation of Certified Internal Auditor.
Bobbi
J. Roberts, Age 30. Ms.
Roberts is our Vice President of Investor Relations. Ms. Roberts has served as
our Investor Relations officer since July 2001. Prior to her current position,
Ms. Roberts served as our Senior Business Performance Analyst from March 2000 to
July 2001. Before joining Saxon Capital, Ms. Roberts served as a financial
analyst for GMAC Model Home Finance from December 1999 to March 2000, and as a
production accountant and analyst for Dynex Capital, Inc. from February 1997 to
December 1999, and as an auditor with the
Virginia Auditor of Public Accounts from June 1996 to February 1997. Ms. Roberts
received her Bachelor of Science in Accounting from Virginia Commonwealth
University and is a licensed Certified Public Accountant in the Commonwealth of
Virginia.
Risk
Factors
You
should carefully consider the risks described below. If any of the following
risks actually occurs, our business, financial condition, liquidity and results
of operations could suffer. You should also refer to the other information
contained in this report, including the information provided under “Item 7 -
Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and “Item 8 - Financial Statements and Supplementary
Data”.
Risks
and Effects of Our Business
Our
management has limited experience operating a REIT and we can provide no
assurance that our management’s past experience will be sufficient to
successfully manage our business as a REIT.
Prior to
September 24, 2004, we had never been operated as a REIT. Our management has
limited experience in complying with the income, asset, and other limitations
imposed by the REIT provisions of the Internal Revenue Code. Those provisions
are complex, and the failure to comply with those provisions in a timely manner
could prevent us from qualifying as a REIT or could force us to pay unexpected
taxes and penalties. In such event, our net income would be reduced and we could
incur a loss.
If we
fail to qualify as a REIT, we will be subject to federal income tax at regular
corporate rates. Also, unless the Internal Revenue Service, or the IRS, grants
us relief under certain statutory provisions, we will remain disqualified as a
REIT for four years following the year in which we first fail to qualify. If we
fail to qualify as a REIT, we will have to pay significant income taxes and will
therefore have less money available for investments or for distributions to our
shareholders. This would likely have a significant adverse effect on the value
of our securities.
Our
business requires a significant amount of cash, and if we are unable to obtain
the cash required to execute our business plan, our business and financial
condition will be significantly harmed.
We
require a significant amount of cash to fund our loan originations, to pay our
loan origination expenses and to hold our mortgage loans pending securitization.
We also need cash to meet our working capital and other needs. Furthermore, we
will need cash to meet our minimum REIT dividend distribution requirements.
Because we are required to distribute annually to our shareholders at least 90%
of our REIT taxable income (determined without regard to the dividends paid
deduction and by excluding net capital gains and including, in some instances,
taxable income recognized where we do not receive corresponding cash) to qualify
as a REIT, our ability to reduce debt and finance growth depends in large part
on external sources of
capital. In addition, if our minimum distribution requirements to maintain our
REIT status become large relative to our cash flow as a result of our taxable
income exceeding our cash flow from operations, then we may be required to
borrow funds or raise capital to meet those distribution requirements. We may
not be able to do so on reasonable terms or at all.
We
depend on borrowings and securitizations to fund our mortgage loans and reach
our desired amount of leverage, which exposes us to liquidity risks. If we fail
to obtain or renew sufficient funding on favorable terms or at all, we will be
limited in our ability to make mortgage loans, which will harm our results of
operations.
We depend
on short-term borrowings to initially fund our mortgage loan originations and
reach our desired amount of leverage. Our ability to accumulate loans for
securitization depends to a large extent upon our ability to secure interim
financing on acceptable terms. Accordingly, our ability to achieve our loan
origination and leverage objectives depends on our ability to borrow money in
sufficient amounts and on favorable terms. In addition, we must be able to renew
or replace our maturing short-term borrowings on a continuous basis. We depend
on a few lenders to provide the primary financing facilities for our mortgage
loan originations. As of December 31, 2004, we had interim financing facilities
consisting of $1.625 billion of committed warehouse facilities and committed
repurchase agreement facilities with variable rates of interest with five
separate financial institutions. These facilities generally are committed for
364 days, subject to customary renewal and cancellation provisions. If our
lenders do not allow us to renew our borrowings or we cannot replace maturing
borrowings on favorable terms or at all, we might have to sell our
mortgage-related assets under adverse market conditions or might not be able to
originate mortgage loans, which would harm our results of operations and may
result in permanent losses.
It is
possible that the lenders under our financing facilities could experience
changes in their ability to advance funds to us, independent of our performance
or the performance of our loans. In addition, if the regulatory capital
requirements imposed on our lenders change, they may be required to increase
significantly the cost of the financing facilities that they provide to us.
Moreover, the amount of financing we receive under our financing facilities is
directly related to the lender’s valuation of the mortgage loans that secure the
outstanding borrowings. Our financing facilities grant the lender the absolute
right to re-evaluate the market value of the mortgage loans that secure our
outstanding borrowings at any time. In the event the lender determines that the
value of the mortgage loans has decreased, it has the right to initiate a margin
call. A margin call would require us to transfer additional mortgage loans to
the lender (without any advance of funds from the lender for such transfer of
mortgage loans) or to repay a portion of the outstanding borrowings. Any such
margin call could have a material adverse effect on our business, results of
operations, liquidity and financial condition.
All of
our financing facilities are subject to financial covenants and other
restrictions and contain cross-default provisions. If we are unable to operate
within the covenants and restrictions or obtain waivers, all amounts that we owe
under our financing facilities could become immediately payable. The involuntary
termination of a credit facility, or the acceleration of our debt under a credit
facility, would impact all of our financing facilities and would have a material
adverse effect on our business, financial condition, liquidity and results of
operations.
We rely, and
expect to continue to rely, upon our ability to securitize our mortgage loans to
generate cash for repayment of short-term credit and warehouse facilities and to
finance mortgage loans for the remainder of each mortgage loan’s life. We cannot
assure you that we will be successful in securitizing mortgage loans that we
accumulate in the future. Our ability to complete securitizations of our loans
at favorable prices or at all will depend on a number of factors, including
conditions in the securities markets generally, conditions in the asset-backed
securities market specifically, the availability of credit enhancement on
acceptable economic terms or at all, and the performance of our portfolio of
securitized loans.
We seek
to maintain a ratio of debt-to-equity of between 7:1 and 15:1, although our
ratio may at times be above or below this amount. Our ratio of debt-to-equity as
of December 31, 2004 was 10:1. Although we incur this leverage to enhance our
returns, this leverage, which is fundamental to our business strategy, also
exposes us to liquidity risks.
We
might be prevented from securitizing our mortgage loans at opportune times and
prices, which could adversely affect our ability to generate cash flow.
We rely
on our securitizations to generate cash for repayment of our financing
facilities, origination of new mortgage loans, and general working capital
purposes. We will also rely on this cash to make distributions to our
shareholders to maintain our status as a REIT. We bear the risk of being unable
to securitize our mortgage loans at advantageous times and prices or in a timely
manner, or at all. If it is not possible or economical for us to complete the
securitization of a substantial portion of our mortgage loans, we may exceed our
capacity under our warehouse financing, be unable or limited in our ability to
pay down our financing facilities and originate future mortgage loans, or be
required to liquidate mortgage loans when the market value of the loans is low
and potentially incur a loss on the sale transaction. Furthermore, if we cannot
generate sufficient liquidity upon any such sale, we will be unable to continue
our operations, grow our loan portfolio and maintain our hedging policy. The
occurrence of any of these events would have a material adverse effect on our
business, financial condition, liquidity and results of operations.
We
may not be able to successfully execute our credit enhancement strategies, which
could restrict our access to financing and adversely affect our business.
The
structure we employ in securitization transactions requires credit enhancement.
Since 1997, all of our securitizations have used credit enhancement to improve
the price at which we issue our asset-backed securities. We currently expect
that the credit enhancement for the asset-backed securities will be primarily in
the form of excess interest to create and maintain overcollateralization, which
refers to the extent to which the mortgage loan balance in our securitizations
exceeds the balance of the issued asset-backed securities, designating another
portion of the securities we issue as “subordinate securities” (which have a
lower payment priority and on which the credit risk from the mortgage loans is
concentrated), paying for financial guaranty insurance policies for the loans,
or a combination of the foregoing. There are no direct financial costs to the
use of overcollateralization. By applying excess cash flow (mortgage
interest income net of interest on the asset-backed securities, losses, and
servicing fees) to pay down the asset-backed securities of the trust faster than
the underlying mortgage loans are repaid, we are able to create and maintain any
required overcollateralization. The market for any subordinate securities we
issue could become temporarily illiquid or trade at steep discounts, thereby
reducing the cash flow we receive over time from our mortgage loans subject to
the securities. If we use financial guaranty insurance policies and the expense
of these insurance policies increases, the net interest income we receive will
be reduced. We cannot assure you that credit enhancement features will allow us
to achieve desirable levels of net interest income from the securitizations of
our mortgage loans.
The use
of securitizations with overcollateralization requirements may have a negative
impact on our cash flow. Other performance tests (based on delinquency levels
and cumulative losses) may restrict our ability to receive excess cash flow from
a securitization transaction. In addition, rating agencies may place additional
performance tests based on other criteria in future securitizations. We cannot
assure you that the performance tests will be satisfied. Nor can we assure you,
in advance of completing negotiations with the rating agencies or other key
transaction parties, of the actual terms of such delinquency tests,
overcollateralization terms, cash flow release mechanisms or other significant
factors regarding the calculation of net excess income to us. Failure to
negotiate such terms on a favorable basis or at all may materially and adversely
affect the availability of net excess income to us.
In
addition, the net cash flow income we receive from our securitizations generally
represents a junior security interest. Generally, so long as excess cash flow is
being directed to the senior securities of a securitization trust to achieve
overcollateralization, we will not receive distributions from the related
securitized pool. Also, because the application of the excess cash flow to the
senior securities of a securitization trust depends upon the performance of the
related mortgage loans, there may be material variations in the amount, if any,
of the excess cash flow distributed to us from period to period, and there may
be extended periods when we do not receive excess cash flow. Any variations in
the rate or timing of our receipt of distributions may adversely affect our
business, financial condition, liquidity and results of operations.
We
are subject to increased risk of default, foreclosure and losses associated with
our strategy of lending to lower credit grade borrowers.
We
specialize in originating, purchasing, securitizing and servicing mortgage loans
to credit-impaired borrowers and borrowers that are ineligible to qualify for
loans from conventional mortgage sources, such as Fannie Mae and Freddie Mac,
due to either loan size, credit characteristics or documentation standards.
Credit characteristics that may cause a loan to be ineligible for conventional
mortgage funding include relatively high level of debt service carried by the
borrower, higher LTV of the loan or past credit write-offs, outstanding
judgments, prior bankruptcies or other credit items that cause a borrower to
fail to satisfy Fannie Mae or Freddie Mac underwriting guidelines. Examples of
documentation standards that are not eligible for conventional mortgage loans
may include borrowers who provide limited or no documentation of income in
connection with the underwriting of the related mortgage loans. Loans to lower
credit grade borrowers generally experience higher-than-average delinquency,
default and loss rates than do conforming mortgage loans. As of December 31,
2004, 41% of the loans in
our portfolio were sub-prime, meaning that they have a credit grade of A minus
or below on our proprietary credit grading system. Because we use portfolio
accounting for our securitizations, loan delinquencies and defaults can cause
reductions in our interest income and adversely affect our operating results,
both with respect to unsecuritized loans and loans that we have securitized. If
loan delinquencies and losses exceed expected levels, the fair market value of
the mortgage loans held for investment and as collateral for warehouse
borrowings, as well as the loan servicing-related assets on our consolidated
balance sheet, may be adversely affected. If delinquencies and losses are
greater than we expect, our ability to obtain financing and continue to
securitize loans on attractive terms, or at all, may be adversely affected. If
we underestimate the extent of losses that our loans will incur, or the reserves
that we establish for such losses are insufficient, then our business, financial
condition, liquidity and results of operations will be adversely impacted.
We cannot
be certain that our underwriting criteria or collection methods will afford
adequate protection against the higher risks associated with loans made to lower
credit grade borrowers. If we are unable to mitigate these risks, our business,
financial condition, liquidity and results of operations could be harmed.
Defaults
on the mortgage loans in our securitization pools may impact our ability to
market future pools.
The
performance of mortgage loans we have sold or securitized in the past could
limit our ability to sell or securitize mortgage loans in the future, if the
pools perform poorly. The securitization market depends upon a number of
factors, including general economic conditions, conditions in the securities
markets generally and conditions in the asset-backed securities market
specifically. In addition, the historical performance of the mortgage loans we
originate may impact the perceived value of any future asset-backed securities
we may attempt to issue, which could adversely affect the ratings of our
asset-backed securities. If rating agencies issue unfavorable ratings or lower
their rating relating to our asset-backed securities, the costs of our future
securitizations could increase and we may be limited in our ability to
securitize our mortgage loans, which could have a material adverse effect on our
business, financial condition, liquidity and results of operations. Furthermore,
the rating agencies could require us to increase the over-collateralization
level for our securitizations. Increases in our over-collateralization levels
would have a negative impact on the value of our retained interests in our
securitizations and could require additional capital to fund the
over-collateralization, which may not be available on reasonable terms, or at
all, and which could have a material adverse effect on our business, financial
condition, liquidity and results of operations.
Our
servicing rights may be terminated if delinquencies occur on the loans we
service.
We retain
servicing rights upon the securitization of a pool of mortgage loans and also
provide mortgage loan servicing for third parties. As of December 31, 2004, 70%
of the mortgage loans we serviced by principal balance were owned by third
parties, but may have been included in securitizations issued pursuant to our
shelf registration statement for asset-backed securities. The remainder
represented loans we retained on our balance sheet. In addition to termination
in the event we default in our duties as servicer, our servicing rights may be
terminated
by the trustee at the direction of holders of a majority of the certificates
issued in the securitization if delinquencies or losses on the pool of loans in
a particular securitization exceed prescribed levels at any time. As of December
31, 2004, we service a total of eleven securitizations in our owned
portfolio and 27 third party securitizations, certain of which were issued
pursuant to our shelf registration statement for asset-backed securities. As of
December 31, 2004, delinquencies and losses exceeded the prescribed levels for
eight of the 27 third party securitizations and for none of the securitizations
in our owned portfolio that we service. These eight third party securitizations
had an aggregated unpaid principal balance at December 31, 2004 of $0.6 billion,
which represented 3% of our total servicing portfolio. We can provide no
assurances that our servicing rights will not be terminated in the manner
described above.
We
are subject to risks related to mortgage loans in our portfolio, including
borrower defaults, fraud losses and other losses, which could have a material
adverse effect on our business, financial condition, liquidity and results of
operations.
We are
subject to risks of borrower defaults and bankruptcies, fraud losses and special
hazard losses on the mortgage loans in our portfolio. In the event of any
default under our mortgage loans, we will bear the risk of loss of principal to
the extent of any deficiency between the value of the collateral and the
principal amount of the mortgage loan. Also, the costs of financing the mortgage
loans could exceed the interest income we receive on the mortgage loans. If
these risks materialize, they could have a material adverse effect on our
business, financial condition, liquidity, and results of operations.
If
we do not successfully implement our growth strategy, our financial performance
could be harmed.
We have
experienced rapid growth, which has placed, and will continue to place,
substantial pressure on our infrastructure. To maintain this level of growth, we
may require additional capital and other resources beyond what we expect to have
following the consummation of the transactions described in this prospectus. We
cannot assure you that we will be able to: (1) meet our capital needs; (2)
expand our systems effectively; (3) optimally allocate our human resources; (4)
identify and hire qualified employees; (5) satisfactorily perform our
production, servicing, and securitization functions; or (6) effectively
incorporate the components of any businesses that we may acquire in our effort
to achieve growth. Our failure to manage growth effectively could significantly
harm our business, financial condition, liquidity and results of operations.
The
residential mortgage origination business is a cyclical industry and is expected
to decline in 2005 and upcoming years, which could reduce the level of mortgage
loans we originate in the future and adversely impact our business in the
future.
The
mortgage origination business has historically been a cyclical industry,
enjoying periods of strong growth and profitability followed by periods of
shrinking volumes and industry-wide losses. The residential mortgage industry
has experienced rapid growth over the past four years due to declining and
historically low interest rates. The MBAA has predicted that residential
mortgage originations will decrease in 2005 due to rising interest rates. During
periods
of rising interest rates, refinancing originations decrease as the economic
incentives for borrowers to refinance their existing mortgages are reduced. We
expect this decrease in refinancing to result in a decreased volume of
originations in the foreseeable future. As of December 31, 2004, 23% of the
loans held in our portfolio were purchase mortgages and 77% were refinancings.
Due to stable and decreasing interest rates over recent years, our historical
performance may not be indicative of results in a rising interest rate
environment, and our business, financial condition, liquidity and results of
operations may be adversely affected as interest rates rise.
An
increase in interest rates may reduce overall demand for mortgage loans, reduce
our net interest income or otherwise adversely affect our business or
profitability.
Rising
interest rates could adversely affect our business or profitability in a number
of ways, including the following:
| |
· |
reduce
the overall demand for our mortgage loans as potential customers may
choose not to originate new loans; |
| |
· |
reduce
the spread we earn between the interest we receive on our mortgage loans
and the interest we pay under our financing facilities and on our
asset-backed securities; and |
| |
· |
cause
the fair market value of the loans on our balance sheet, our asset-backed
certificates, and retained interests in securitizations to
decline. |
Each of
the conditions described above could reduce our net interest income or otherwise
have a material adverse effect on our business, financial condition, liquidity
and results of operations.
A
majority of our financing facilities is floating-rate debt that is indexed to
short-term interest rates and adjusts periodically at various intervals.
Interest expense on asset-backed securities is typically adjusted monthly
relative to market interest rates. Because the interest expense we pay on our
asset-backed securities typically adjusts faster than the interest income we
earn on the mortgage loans we securitize, our net interest income can be
volatile in response to increases in interest rates. Net interest losses would
have a material adverse effect on our business, financial condition, liquidity
and results of operations.
In
addition, our adjustable-rate mortgages have interest rate caps, which limit the
amount the interest rates charged to the borrower can increase in each
adjustment period. Our financing facilities borrowings and asset-backed
securities are not subject to similar restrictions. As a result, in a period of
rapidly increasing interest rates, interest rates we pay on our borrowings could
increase without limitation, while interest rates we earn on our adjustable-rate
mortgage loans would be capped. If this occurs, our net interest spread could be
significantly reduced or we could suffer a net interest loss. This may also
reduce the amount of cash we receive over the life of any retained interests in
future securitizations and require us to reduce the carrying value of any
retained interests.
Furthermore,
rising interest rates can increase the level of defaults on our mortgage loans,
which would increase our servicing costs. Increases in our servicing costs would
reduce the value of our servicing rights and could also have a material adverse
effect on the value of our assets and on our business, financial condition,
liquidity and results of operations. As of December 31, 2004, 2003, and 2002,
the delinquency rates on mortgage loans (including REO) that were seriously
delinquent (60+ days past due) that we serviced were 5.26%, 8.89%, and 11.25%,
respectively.
Declining
interest rates could lead to more prepayments of our loans by our customers,
adversely impact the value of our servicing rights or otherwise adversely affect
our results of operations.
In
general, if prevailing interest rates fall below the interest rate on a mortgage
loan, the borrower is more likely to prepay the then higher rate mortgage loan
than if prevailing rates remain at or above the interest rate on the existing
mortgage loan. Unexpected principal prepayments could adversely affect our
results of operations to the extent we are unable to reinvest the funds we
receive at an equivalent or higher yield rate, if at all. If our customers
prepay their mortgage loans sooner than expected, our business, financial
condition, liquidity and results of operations could be materially and adversely
affected. While we seek to minimize prepayment risk through a variety of means
in originating our mortgage loans, we must balance prepayment risk against other
risks and the potential returns on each mortgage loan. Increased levels of
prepayments could reduce our net income and materially and adversely affect our
business, financial condition, liquidity and results of operations.
Declining
interest rates would adversely affect the value of our mortgage servicing rights
and we periodically evaluate the value of these rights for impairment. In a
declining interest rate environment, the increased likelihood of mortgage
prepayments, which would eliminate the servicing rights for the prepaid
mortgages, could lead to an impairment that could have a material adverse impact
on the value of our assets.
In
addition, a decline in prevailing interest rates could have the following
consequences for us:
| |
· |
reduce
our total interest revenue as we compete for loan originations against
other loan providers who offer lower interest
rates; |
| |
· |
diminish
the value of adjustable rate mortgages and servicing assets on our
consolidated balance sheet; and |
| |
· |
reduce
the spreads available to us. |
Each of
the above consequences could have a material adverse effect on our business,
financial condition, liquidity and results of operations.
Our
hedging strategies may not be successful in mitigating the risks associated with
interest rates.
We use
various derivative financial instruments to provide a level of protection
against interest rate risks, but no hedging strategy can protect us completely.
When rates change, we expect the gain or loss on derivatives to be offset by a
related but inverse change in the value of the debt
related to the financing of our mortgage loan portfolio. We cannot assure you,
however, that our use of derivatives will offset the risks related to changes in
interest rates. It is likely that there will be periods in the future during
which we will incur losses on our derivative financial instruments that will not
be fully offset by gains on the debt related to the financing of our mortgage
loan portfolio, which has occurred in the past. The derivative financial
instruments we select may not have the effect of reducing our interest rate
risk. In addition, the nature and timing of hedging transactions may influence
the effectiveness of these strategies. Poorly designed strategies or improperly
executed transactions could significantly increase our risk and lead to material
losses. In addition, hedging strategies involve transaction and other costs. We
cannot assure you that our hedging strategy and the derivatives that we use will
adequately offset the risk of interest rate volatility or that our hedging
transactions will not result in losses.
Our
hedging strategies may be limited by REIT requirements, accounting requirements
for hedging are complicated and any failure to comply with these requirements
could result in losses.
Our
hedging strategy is intended to lessen the effects of interest rate changes and
to enable us to earn net interest income in periods of generally rising,
declining or static, interest rates. Specifically, our hedging program is
formulated with the intent to offset some of the potential adverse effects of
changes in interest rate levels relative to the differences between the interest
rate adjustment indices and maturity or reset periods of our mortgage loans and
our borrowings. In managing our hedge instruments, we consider the effect of the
expected hedging income on the REIT qualification tests that limit the amount of
gross income that a REIT may receive from hedging. To the extent we can do so
consistently with the accounting principles applicable to hedging, and with our
overall hedging strategy, we may from time to time identify hedge instruments as
relating to various hedged liabilities to allow certain hedging income to be
excluded from the 95% income tests. We need to carefully monitor, and may have
to limit, our asset/liability management program to assure that we do not
realize hedging income, or hold hedges having a value, in excess of the amounts
permitted by the REIT gross income and asset tests.
The REIT
provisions of the Internal Revenue Code substantially limit our ability to
hedge. The tax law provides that income and gain derived from transactions
entered into by a REIT in the normal course of its trade or business to hedge
the risk of interest rate, price changes or currency fluctuations with respect
to indebtedness incurred or to be incurred to acquire or carry real estate
assets, such as mortgage loans, represent a source of income that is excluded
for purposes of the 95% gross income test (but not for the 75% gross income
test). The treatment of hedging transactions entered into for the purpose of
hedging assets rather than indebtedness is not clear. In addition, the treatment
of hedging transactions under the quarterly asset tests is not clear. We may
find that in certain instances we must hedge risks incurred by us through
transactions entered into by a taxable REIT subsidiary. Hedging our risk through
a taxable REIT subsidiary would be inefficient on an after-tax basis because of
the tax liability imposed on the taxable REIT subsidiary.
Accounting
for hedges under GAAP is extremely complicated and a number of financial
companies recently have been required to restate their financial statements to
reflect significant losses
because they failed to account for their hedges properly under GAAP on their
financial statements. Any failure by us to account for our hedges properly in
accordance with GAAP on our financial statements could have a material adverse
effect on our earnings.
A
prolonged economic slowdown or a lengthy or severe recession could harm our
operations.
The risks
associated with our business are more acute during periods of economic slowdown
or recession because these periods can be accompanied by decreased demand for
consumer credit and declining real estate values. Because we make a substantial
number of loans to credit-impaired borrowers, rates of delinquencies,
foreclosures, and losses on our loans could be higher than those generally
experienced in the mortgage lending industry during periods of economic slowdown
or recession. In addition, declining real estate values negatively affect
loan-to-value ratios of home equity collateral, which reduces the ability for
borrowers to use home equity to support borrowings and is likely to result in a
decrease in our level of new loan originations. Any sustained period of
increased delinquencies, foreclosures, or losses could adversely affect our
ability to originate, purchase, and securitize loans, which could significantly
harm our business, financial condition, liquidity and results of operations.
We
may be required to repurchase mortgage loans that we have securitized or sold,
or to indemnify purchasers of our loans.
If any of
the mortgage loans do not comply with the representations and warranties that we
make in connection with a securitization or loan sale, we may be required to
repurchase those loans or replace them with substitute loans. If this occurs, we
may have to bear any associated losses directly. In addition, in the case of
loans that we have sold instead of securitized, we may be required to indemnify
persons for losses or expenses incurred as a result of a breach. Repurchased
loans typically are financed at a steep discount to the repurchase price, if at
all. Our repurchases of mortgage loans in the past have not been material to our
operations or our ability to conduct securitizations. Any significant
substitutions, repurchases or indemnifications, however, could significantly
harm our business, financial condition, liquidity and results of operations.
Investors
may require greater returns relative to benchmark rates.
The
securities issued in our securitizations are typically issued with various
ratings and are priced at a spread over a certain benchmark, such as LIBOR or
the yield based on comparable maturity swaps. If the spread that investors
require over the benchmark widens and the rates we charge on our mortgage loans
are not increased accordingly, we may experience a material adverse effect on
our net interest income from our securitizations, resulting in a reduction in
the economic value of the pool of mortgage loans that we have originated. This
could have a material adverse effect on our business, financial condition,
liquidity and results of operations.
We
advance borrowers’ monthly payments for loans we securitize and servicing
expenses for all loans we service before receiving the corresponding payment
from the borrower, which could
have a material adverse effect on our business, financial condition, liquidity
and results of operations.
Under our
securitization servicing agreements, we are required to advance scheduled
payments to the trustee in the amount of the borrower’s monthly mortgage payment
less our servicing fee even if the monthly payment on the underlying mortgage
has not been paid to us. Under all servicing agreements we are also required to
advance servicing expenses related to the mortgage loans (such as payment of
delinquent taxes and foreclosure expenses, etc.). In each case, these advances
of monthly payments and servicing expenses are made from our own funds. Our
obligation to make these advances continues monthly until the related mortgage
loan has been liquidated or we make a determination that such an advance will
not be recovered upon the final liquidation of the related mortgage loan. Even
then, we are unable to recoup such advances until the mortgage loan is brought
current, paid off or liquidated through foreclosure. To the extent we make such
advances without reimbursement by the borrower, we are at risk of not recovering
the amounts we advance. Additionally, we may not have adequate cash from
operations with which to make such advances and may be required to borrow funds,
sell some of our loans or raise capital, which we may not be able to do on
reasonable terms or at all and which could have a material adverse effect on our
business, financial condition, liquidity and results of operations.
We
depend on brokers and correspondent lenders for 72% of our loan production.
We
depend, to a large extent, on brokers and correspondent lenders for our
originations and purchases of mortgage loans. Moreover, our total loan purchases
from correspondent lenders, historically, have been highly concentrated. Our top
three correspondent lenders accounted for 24% and
30% of
our total correspondent loan volume and 7% and
9% of our
total volume for the years ended December 31, 2004 and 2003, respectively. Other
than Accredited Home
Lenders, which accounted for 14% of
our total correspondent loan volume for the year ended December 31, 2004 and
HomeOwners Loan, which accounted for 12% of
our total correspondent loan volume for the year ended December 31,
2003, no
other individual correspondent lender or broker accounted for 10% or more of our
total correspondent loan volume for the years ended December 31, 2004 and 2003.
Our brokers and correspondent lenders are not contractually obligated to do
business with us. Further, our competitors also have relationships with the same
brokers and correspondent lenders and actively compete with us in our efforts to
expand our broker and correspondent networks. Accordingly, we cannot assure you
that we will be successful in maintaining our existing relationships or
expanding our broker and correspondent networks. The failure to do so could
negatively impact the volume and pricing of our loans, which could have a
material adverse effect on our business, financial condition, liquidity and
results of operations.
Our
business may be significantly affected by the economy of California, where we
conduct a significant amount of business.
As of
December 31, 2004, 21% of the mortgage loans in our portfolio that we originated
or purchased were secured by property located in California. An overall decline
in the economy or the residential real estate market, or the occurrence of
natural disasters that are not covered by standard
homeowners’ insurance policies, such as earthquakes, mudslides, or extensive
wildfires, in California could adversely affect the value of mortgaged premises
in California and increase the risk of delinquency, foreclosure, bankruptcy, or
loss on mortgage loans in our portfolio. This would negatively affect our
ability to originate, purchase, and securitize mortgage loans, which could have
a material adverse effect on our business, financial condition, liquidity, and
results of operation.
We
face intense competition that could adversely affect our market share and
revenues.
We face
intense competition from finance and mortgage banking companies and other
mortgage REITs, investment banks, Internet-based lenders, and, to a growing
extent, from traditional bank and thrift lenders who have entered the
non-conforming mortgage market. GSEs, such as Fannie Mae and Freddie Mac, are
also expanding their participation in the non-conforming mortgage market. These
GSEs can benefit from size and cost-of-funds advantages that allow them to
purchase loans with lower rates or fees than we are willing to offer. Although
the GSEs currently are not legally authorized to originate mortgage loans,
including non-prime loans, they are authorized to buy mortgage loans. A material
expansion of GSE involvement in the market to purchase non-prime loans could
alter the dynamics of the industry by virtue of the GSEs’ sheer size, pricing
power and the inherent advantages of a government charter. In addition, if as a
result of their purchasing practices, these GSEs experience significantly
higher-than-expected losses, such experience could adversely affect the overall
investor perception of the non-prime mortgage industry. We also expect increased
competition over the Internet, where entry barriers are relatively low.
The
intense competition in the non-conforming mortgage market has also led to rapid
technological developments, evolving industry standards, and frequent releases
of new products and enhancements. As mortgage products are offered more widely
through alternative distribution channels, such as the Internet, we may be
required to make significant changes to our current retail structure and
information systems to compete effectively. Our inability to continue developing
a successful Internet operation, or to adapt to other technological changes in
the industry, could have a material adverse effect on our business, financial
condition, liquidity and results of operations.
The need to
maintain mortgage loan volume in this competitive environment creates a risk of
price competition in the mortgage industry. Competition in the industry can take
many forms, including interest rates and costs of a loan, convenience in
obtaining a loan, customer service, amount and term of a loan and marketing and
distribution channels. We have experienced significant price competition in our
industry recently. As a result of price competition, we may be forced to lower
the interest rates that we are able to charge borrowers, which would lower our
interest income and the value of the loans in our portfolio. Price-cutting or
discounting reduces profits and will depress earnings if sustained for any
length of time. If our competitors adopt less stringent underwriting standards,
we will be pressured to do so as well, or risk losing market share. If we were
to relax our underwriting standards in response to competitive pressures, we
would be exposed to greater loan risk without compensating increases in pricing.
Increased
competition, including pricing and underwriting pressures, may reduce the volume
of our loan originations, purchases, and securitizations and could have a
material adverse effect on our business, financial condition, liquidity and
results of operations.
Interests
in real property secure our mortgage loans and we may suffer a loss if the value
of the underlying property declines.
Interests
in real property secure the mortgage loans we originate. If the value of the
property underlying a mortgage loan decreases, our risk of loss with respect to
the mortgage loan increases. In the event there is a default under a mortgage
loan, our sole recourse may be to foreclose on the mortgage loan to recover the
outstanding amount under the mortgage loan. If the value of the property is
lower than the amount of the mortgage loan, we will suffer a loss, which could
have a material adverse effect on our business, financial condition, liquidity
and results of operations.
We
may be subject to environmental risks with respect to properties to which we
take title.
From time
to time, in the ordinary course of our business, we foreclose on properties
securing loans that are in default. There is a risk that hazardous or toxic
waste could be found on these properties, and we may be held liable to a
governmental entity or to third parties for property damage, personal injury,
investigation and cleanup costs incurred in connection with the contamination.
Although, to date, we have not been required to perform any material
investigation or clean up activities, nor have we been subject to any
environmental claims, we cannot assure you that this will remain the case in the
future. The costs associated with investigation or remediation activities could
be substantial. In addition, as the owner or former owner of a contaminated
site, we could be subject to common law claims by third parties based on damages
and costs resulting from environmental contamination emanating from the
property. If we ever become subject to significant environmental liabilities,
our business, financial condition, liquidity and results of operations could be
materially and adversely affected.
Terrorist
attacks and other acts of violence or war may affect any market for our common
stock, the industry in which we operate, our operations and our profitability.
Terrorist
attacks may harm our results of operations. We can make no assurances that there
will not be further terrorist attacks against the United States or U.S.
businesses. These attacks or armed conflicts may impact the property
collateralizing our mortgage loans directly or indirectly by undermining
economic conditions in the United States. Furthermore, losses resulting from
terrorist events are generally uninsurable.
Loss
of our key management could result in a material adverse effect on our business.
Our
future success depends to a significant extent on the continued services of our
senior management. We do not maintain “key person” life insurance for any of our
personnel, other than for Michael L. Sawyer, our Chief Executive Officer and
President. The loss of the services of Mr.
Sawyer, Bradley D. Adams, our Executive Vice President—Capital Markets, Robert
B. Eastep, our Executive Vice President and Chief Financial Officer, David L.
Dill, our Senior Vice President—Servicing, or James V. Smith, our Senior Vice
President—Production, could have a material adverse effect on our business,
financial condition, liquidity, and results of operations. Although we have
employment agreements with each of them, we cannot assure you they will remain
employed with us.
In
addition, we depend on our account executives to attract borrowers by, among
other things, developing relationships with other financial institutions,
mortgage companies and brokers, real estate agents and brokers, corporations,
and others. These relationships lead to repeat and referral business. The market
for skilled account executives is highly competitive. Competition for qualified
account executives may lead to increased hiring and retention costs. If we are
unable to attract or retain a sufficient number of skilled account executives at
manageable costs, our business, financial condition, liquidity, and results of
operations could be materially and adversely affected.
Our
dependence on information systems may result in problems if these systems fail
or are interrupted.
We rely
on communications and information systems to conduct our business. As we
implement our growth strategy and increase our volume of loan production over
the Internet, that reliance will increase. Any failure, interruption or breach
in security of our information systems or third-party information systems on
which we rely could cause underwriting or other delays and could result in fewer
loan applications being received. Any such failure, interruption, or compromise
of our systems or security measures we employ could affect our flow of business
and, if prolonged, could harm our reputation. We cannot assure you that possible
failures or interruptions have been adequately addressed by us or the third
parties on which we rely, or that any such failures or interruptions will not
occur. The occurrence of any failures or interruptions could have a material
adverse effect on our business, financial condition, liquidity, and results of
operations.
Regulatory
and Legal Risks
We
incur significant costs related to governmental regulation.
Our
business is subject to extensive regulation, supervision and licensing by
federal, state and local governmental authorities and is subject to various laws
and judicial and administrative decisions imposing requirements and restrictions
on a substantial portion of our operations. Our lending and servicing activities
are subject to numerous federal laws and regulations, including the
Truth-in-Lending Act and Regulation Z (including the Home Ownership and Equity
Protection Act of 1994, or HOEPA), the Equal Credit Opportunity Act and
Regulation B, the Fair Credit Reporting Act, the Real Estate Settlement
Procedures Act, or RESPA, the Fair Housing Act, the Home Mortgage Disclosure
Act, the Fair Debt Collection Practices Act, the privacy requirements of the
Gramm-Leach-Bliley Act, and the Fair and Accurate Credit Transactions Act of
2003, or FACT. We also are required to comply with a variety of state and local
consumer protection laws and are subject to the rules and regulations of, and
examination by, state
regulatory authorities with respect to originating, processing, underwriting,
selling, securitizing and servicing mortgage loans. These requirements can and
do change as statutes and regulations are amended.
These
statutes and regulations, among other things, impose licensing obligations upon
us, establish eligibility criteria for mortgage loans, prohibit discrimination,
provide for inspections and appraisals of properties, require credit reports on
loan applicants, regulate assessment, collection, foreclosure and claims
handling, investment and interest payments on escrow balances and payment
features, mandate certain disclosures and notices to borrowers and, in some
cases, fix maximum interest rates, finance charges, fees and mortgage loan
amounts. We expect to continue to incur significant costs to comply with
governmental regulations, which will have a negative effect on our net income.
The
nationwide scope of our origination and servicing activities exposes us to risks
of noncompliance with an increasing and inconsistent body of complex laws and
regulations at the federal, state, and local levels.
Because
we originate loans nationwide, we must be licensed in all relevant jurisdictions
and comply with the respective laws and regulations of each, as well as judicial
and administrative decisions. We also are subject to an extensive body of
federal laws and regulations. See “Business—Regulation.” Among other things,
these statutes and regulations require our affiliates to be licensed, provide
eligibility criteria for mortgage loans, prohibit discrimination, require
inspections and appraisals of properties securing a mortgage, require credit
reports on mortgage applicants, specify disclosures and notices to borrowers
and, in some cases, set limits on interest rates, finance charges, fees, and
mortgage loan amounts. These rules also may regulate assessment, collection,
foreclosure and claims handling, investment and interest payments on escrow
balances, and payment features. The significant costs to comply with
governmental regulations may have a negative effect on our net income.
The
volume of new or modified laws and regulations has increased in recent years,
and the laws and regulations of each applicable jurisdiction often differ and in
many cases are inconsistent and complex. As our operations continue to grow, it
may be more difficult for us to identify these developments comprehensively, to
interpret changes accurately, to program our technology systems properly to
reflect the changes and to train our personnel effectively with respect to these
laws and regulations. These difficulties potentially increase our exposure to
the risks of noncompliance with these laws and regulations.
Our
failure to comply with these laws can lead to:
| |
· |
civil
and criminal liability, including potential monetary
penalties; |
| |
· |
loss
of state licenses or other approval status required for continued lending
or servicing operations; |
| |
· |
legal
defenses causing delay or otherwise adversely affecting the servicer’s
ability to enforce loans, or giving the borrower the right to rescind or
cancel the loan transaction; |
| |
· |
demands
for indemnification or loan repurchases from purchasers of our
loans; |
| |
· |
litigation,
including class action lawsuits; |
| |
· |
administrative
enforcement actions and fines; |
| |
· |
loss
of the ability to obtain ratings on our securitizations by rating
agencies; or |
| |
· |
the
inability to obtain credit to fund our
operations. |
In
addition, we cannot assure you that more restrictive laws and regulations will
not be adopted in the future, or that governmental bodies will not interpret
existing laws or regulations in a more restrictive manner, which could make
compliance more difficult or expensive. The laws and regulations applicable to
us are subject to administrative or judicial interpretation, but some of these
laws and regulations have been enacted only recently and may not yet have been
interpreted or may be interpreted infrequently. As a result of infrequent or
sparse interpretations, ambiguities in these laws and regulations may leave
uncertainty with respect to permitted or restricted conduct under them. Any
ambiguity under a law to which we are subject may lead to regulatory
investigations, governmental enforcement actions, or private causes of action,
such as class action lawsuits, with respect to our compliance with applicable
laws and regulations. As a mortgage lender, we have been, and expect to continue
to be, subject to regulatory enforcement actions and private causes of action
from time to time with respect to our compliance with applicable laws and
regulations. We can provide no assurance that future regulation will not cause
us to change certain business practices, make refunds, or take other actions
that would be financially or competitively adverse to us.
We or our
subsidiaries are subject to examination by state regulatory authorities in the
states in which we operate. In response to issues arising from these
examinations, we have been required in the past to take corrective actions,
including changes in certain business practices or refunds to certain borrowers.
We can provide no assurance that future examinations will not cause us to change
certain business practices, make refunds or take other actions that would be
financially or competitively detrimental to us.
Further,
we compete with federally chartered institutions and their operating
subsidiaries that also operate in a multistate market environment. Under their
federal charters and federal regulations, these federal entities operate with
the benefit of broad federal preemption of state and local laws regulating their
lending activities. Unlike those competitors, we are generally subject to all
state and local laws applicable to mortgage lenders in each jurisdiction in
which we lend, including new laws directed at non-conforming mortgage lending,
as described below under “Business—Regulation.” At least one national rating
agency has announced that, in recognition of the benefits of federal preemption,
it will not require additional credit enhancement by federal institutions when
they issue securities backed by mortgages from a state with predatory lending
laws. As a non-federal entity, we will continue to be subject to such rating
agency requirements arising from state or local lending-related laws or
regulations. In addition, federally chartered institutions and their operating
subsidiaries have defenses under federal law to allegations of noncompliance
with some state and local laws that are unavailable to us.
Our failure
or the failure of our subsidiaries to obtain and maintain licenses in the
jurisdictions in which we do business could have a material adverse effect on
our results of operations, financial condition, and business.
We operate in
a highly regulated industry, and we and our subsidiaries are subject to
licensing requirements in the various states where we do business. Loan
origination, funding, acquisition, and servicing activities are subject to the
licensing requirements of various states. In addition, if we decide to increase
REIT qualifying assets and income, such as originating and servicing loans at
the REIT level, we will be required to obtain certain new licenses and
approvals. We have not filed all of the applications for these licenses or
received approval with respect to all of the applications we have filed to date.
Until all necessary licenses have been obtained, we will be limited in our
ability to originate, fund, and service loans and we will need to perform these
activities exclusively through our taxable REIT subsidiaries.
In addition,
some states in which we operate may impose regulatory requirements for financial
disclosure about our officers and directors and parties holding certain
percentages of our outstanding shares of stock. If any officer, director or
person holding the relevant threshold percentage of our outstanding shares of
stock fails to meet or refuses to comply with a state’s applicable regulatory
requirements for mortgage lending, we could lose our authority to conduct
business in that state. The loss of our authority to conduct business in a
state, for this or any other reason, could have a material adverse effect on our
business, financial condition, liquidity, and results of operations.
We cannot
assure you that we will be able to obtain or maintain all necessary licenses and
approvals in a timely manner or at all. Failure to obtain and maintain these
licenses and approvals would limit, delay and disrupt (1) our ability to
increase REIT qualifying assets and income and (2) our operations in certain
geographical regions, and perhaps nationwide, and could have a material adverse
effect on our business, financial condition, liquidity and results of
operations.
New
legislation may restrict our ability to make loans, negatively affecting our
revenues.
Several
federal, state, and local laws, rules, and regulations have been adopted in
recent years, or are under consideration, that are intended to eliminate lending
practices labeled as “predatory.” Many of these laws and rules impose certain
restrictions on loans on which certain points and fees or the annual percentage
rate, or APR, exceed specified thresholds. Some of these restrictions expose a
lender to risks of litigation and regulatory sanction no matter how carefully a
loan is underwritten or originated. In addition, an increasing number of these
laws, rules, and regulations seek to impose liability for violations on
purchasers of loans, regardless of whether a purchaser knew of or participated
in the violation. Generally, we avoid making or acquiring loans that exceed
those thresholds because of the costs and risks associated with such loans and
the market valuations and perceptions of such loans.
Congress and
federal government agencies also continue to consider legislative and regulatory
proposals affecting mortgage lending, including “predatory lending.” Among these
proposals are ones that would lower the existing HOEPA thresholds for defining a
“high-cost” loan, and establishing enhanced protections and remedies for
borrowers who receive high-cost loans.
Moreover,
many of the laws and regulations that have been enacted recently or are proposed
extend beyond curbing “predatory lending” practices to restrict commonly
accepted lending activities. For example, some of these laws and regulations
strictly limit a borrower’s ability to include in the loan amount the points and
fees charged in connection with the origination of a mortgage loan or others
restrict or prohibit prepayment charges. Passage of these laws and regulations
in additional jurisdictions could reduce our loan origination volume.
Additionally, this type of legislation and any new legislation may cause us to
withdraw from some jurisdictions.
The
continued enactment of these laws, rules, and regulations may prevent us from
making certain loans and may cause us to reduce the APR or the points and fees
on loans that we do originate. In addition, the difficulty of managing the
compliance risks presented by these laws, rules, and regulations may decrease
the availability of warehouse financing and the overall demand for
non-conforming mortgage loans. These laws, rules, and regulations have required
us to develop systems and procedures to ensure that we do not violate any aspect
of these new requirements. In addition, many of these state laws, rules, and
regulations are not applicable to the mortgage operations of national banks, or
other financial institutions chartered by the federal government, which gives
the mortgage operations of these institutions a competitive advantage over us.
If we decide to relax our self-imposed restrictions on originating and
purchasing loans subject to these laws, we will be subject to greater risks for
actual or perceived non-compliance with such laws, rules, and regulations,
including demands for indemnification or loan repurchases from our lenders and
purchasers of our loans, class action lawsuits, increased defenses to
foreclosure of individual loans in default, individual claims for significant
monetary damages, and administrative enforcement actions. Any of the foregoing
could significantly harm our business, financial condition, liquidity and
results of operations.
In
addition, because of reputational and financial risks, many whole loan
purchasers will not buy, and rating agencies may refuse to rate, any
securitization containing any loan labeled as a “high cost” loan under any
local, state or federal law or regulation. Therefore, these laws and regulations
can severely constrict the secondary market and limit the acceptable standards
of mortgage loan production. Changes in these laws and regulations could
effectively preclude us from originating mortgage loans that are governed by
those rules and could have a material adverse effect on our ability to
securitize or sell mortgage loans and, accordingly, our business, financial
condition, liquidity and results of operations.
Furthermore,
from time to time, members of Congress and government officials have advocated
the elimination of the mortgage interest deduction for federal income tax
purposes, or its reduction based on borrower income, type of loan or principal
amount. The tax deductibility of
mortgage interest gives mortgage products a competitive advantage when compared
to other types of consumer financing, an advantage that could be eliminated or
seriously impaired by such government action. President Bush has announced an
intention to make a general reform of individual income tax laws a priority
proposal in the new Congress. We do not know whether any proposed reform
resulting from President Bush's initiative will affect the mortgage interest
deduction. Accordingly, the reduction or elimination of these tax benefits to
borrowers could have a material adverse effect on the demand for the mortgage
loan products we offer.
The
recent reduction in scope of preemption previously afforded non-depository
lenders under the Alternative Mortgage Transactions Parity Act could have a
material adverse effect on our results of operations, financial condition and
business.
The value of
a mortgage loan depends, in part, upon the expected period of time that the
mortgage loan will be outstanding. If a borrower pays off a mortgage loan in
advance of this expected period, the holder of the mortgage loan does not
realize the full value expected to be received from the loan. A prepayment
penalty payable by a borrower who repays a loan earlier than expected helps
offset the reduction in value resulting from the early payoff. Consequently, the
value of a mortgage loan is enhanced to the extent the loan includes a
prepayment penalty, and a mortgage lender can offer a lower interest rate and/or
lower loan fees on a loan which has a prepayment penalty. Prepayment penalties
are an important feature to obtain value on the loans we originate. Many states,
however, have laws restricting collection of prepayment penalties.
Prior to
September 25, 2002, the Office of Thrift Supervision, or the OTS, had
implemented a rule under the Alternative Mortgage Transactions Parity Act, or
the Parity Act, that allowed non-federal housing creditors such as our company
to rely on the Parity Act to preempt state restrictions on prepayment charges.
On that date, however, the OTS released a new rule that prevents us from relying
on that Parity Act preemption. The effective date of the new rule was July 1,
2003. In July 2004, the U.S. Court of Appeals for the District of Columbia
upheld the OTS action designating the Parity Act regulations inapplicable, which
resulted in non-federal housing creditors being subject to state law concerning
prepayment and late fees. The elimination of this federal preemption requires us
to comply with state restrictions on prepayment charges. These restrictions
prohibit us from charging any prepayment charge in certain states and restrict
the amount and duration of prepayment charges that we may impose in other
states. Currently, we conduct business in 36 states that restrict or prohibit
prepayment charges on mortgage loans. For the years ended December 31, 2004 and
2003, 57% and 55%, respectively, of our loans were made in these 36 states.
On April 24,
2003, a New Jersey state appellate court relied on the new OTS rule to find that
the Parity Act did not preempt New Jersey state law restrictions on prepayment
charges in the past. Although this ruling was recently reversed on appeal by the
New Jersey Supreme Court, if courts in other jurisdictions were to reach
conclusions like the New Jersey appellate court’s decision, those courts might
call into question the validity of prepayment penalty provisions under which we
have previously collected prepayment charges and which we continued to include
in our loan documentation prior to July 1, 2003 on the basis of Parity Act
preemption. If such a decision were made by a court or agency with jurisdiction
over us, we might be required to refund and waive a significant amount in
prepayment charges.
We
may face legal actions in connection with our past activities as a result of
various legislative actions and judicial decisions.
Certain
legislative actions and judicial decisions can give rise to the initiation of
lawsuits against us for activities we conducted in the past. For example, in
March 2004, an Illinois Court of Appeals found that the Illinois Interest Act,
which caps fees at 3% for loans with an interest rate in excess of 8%, is not
preempted by federal law. This ruling contradicts the view of other courts and
federal banking agencies that lenders operating under federal charters may make
loans outside their home states at the rates permitted under home state law.
Although this ruling is not expected to directly impact our future business
because the recent reduction of the scope of the Parity Act has meant that we
can no longer rely on federal preemption, it may make it easier for plaintiffs
to file actions seeking various forms of relief against lenders like us that
received fees in the past that exceeded the applicable thresholds in reliance on
federal preemption under the Parity Act. We may be subject to such actions with
respect to fees we earned when we relied on federal preemption. Actions that may
be brought, if decided against us, could cause us to make refunds to borrowers
and, accordingly, could harm our business, financial condition, liquidity and
results of operations.
If
warehouse lenders and securitization underwriters face exposure stemming from
legal violations committed by the companies to whom they provide financing
services, this could increase our borrowing costs and negatively affect the
market for whole loans and securitizations.
Warehouse
lenders and securitization underwriters may face liability exposure for fraud on
consumers committed by a lender to whom they provided financing and underwriting
services. If courts or regulators adopt this theory, warehouse lenders and
securitization underwriters may face increased litigation as they are named as
defendants in lawsuits and regulatory actions against the mortgage companies
with which they do business. Some warehouse lenders and securitization
underwriters may exit the business, charge more for warehouse lending or
underwriting securitizations, or reduce the prices they pay for whole loans in
order to build in the costs of this potential litigation. This could, in turn,
have a negative effect on our business, financial condition, liquidity, and
results of operations.
We are
subject to various legal actions, which if decided adversely, could have a
material adverse effect on us.
Because
the non-conforming mortgage lending and servicing business, by its nature,
involves the collection of numerous accounts, the validity of liens and
compliance with local, state and federal lending laws, mortgage lenders, and
servicers, including us, are subject to numerous claims and legal actions in the
ordinary course of business. These legal actions include lawsuits brought as
class actions that allege violations of various federal, state and local
consumer protection laws. While we cannot predict the ultimate legal and
financial liability with respect to legal actions brought against us, an adverse
judgment in one or more legal actions could have a material adverse effect on
our financial condition. In addition, in recent years, both state and
federal regulators and enforcement agencies have subjected the practices of
non-conforming mortgage lenders to particularly intense regulatory scrutiny,
which has resulted in a number of well-publicized governmental and other
investigations of other mortgage lenders in our industry. Any such investigation
of us could have a material adverse effect on our business, results of
operations, liquidity and financial condition.
If
many of our borrowers become subject to Servicemembers Civil Relief Act of 2003,
our cash flows and interest income may be adversely affected.
Under the
Servicemembers Civil Relief Act, which re-enacted in 2003 the Soldiers’ and
Sailors’ Civil Relief Act of 1940, a borrower who enters military service after
the origination of his or her mortgage loan generally may not be required to pay
interest above an annual rate of 6%, and the lender is restricted from
exercising certain enforcement remedies, during the period of the borrower’s
active duty status. This act also applies to a borrower who was on reserve
status and is called to active duty after origination of the mortgage loan. In
times of significant and sustained mobilization by the U.S. Armed Forces, the
number of our borrowers who are subject to this act is likely to increase,
thereby reducing our cash flow and the interest payments collected from those
borrowers, and in the event of default, delaying or preventing us from
exercising the remedies for default that otherwise would be available to us.
The
conduct of the independent brokers through whom we originate our wholesale loans
could subject us to fines or other penalties.
The
mortgage brokers through whom we originate wholesale loans have parallel and
separate legal obligations to which they are subject. While these laws may not
explicitly hold the originating lenders responsible for the legal violations of
mortgage brokers, federal and state agencies increasingly have sought to impose
such liability. Recently, for example, the United States FTC entered into a
settlement agreement with a mortgage lender where the FTC characterized a broker
that had placed all of its loan production with a single lender as the “agent”
of the lender; the FTC imposed a fine on the lender in part because, as
“principal,” the lender was legally responsible for the mortgage broker’s unfair
and deceptive acts and practices. The United States Department of Justice in the
past has sought to hold mortgage lenders responsible for the pricing practices
of mortgage brokers, alleging that the mortgage lender is directly responsible
for the total fees and charges paid by the borrower under the Fair Housing Act
even if the lender neither dictated what the mortgage broker could charge nor
kept the money for its own account. Although we exercise little or no control
over the activities of the independent mortgage brokers from whom we obtain our
wholesale loans, we may be subject to claims for fines or other penalties based
upon the conduct of our independent mortgage brokers. Further, we have in the
past made refunds to our borrowers because of the conduct of mortgage brokers
and it is possible that we may in the future be subject to additional payments,
fines or other penalties based upon the conduct of the brokers with whom we do
business.
“Do
not call” registries may limit our ability to market our products and services.
Our marketing
operations, including the activities of brokers who originate loans for us, may
be restricted by the development of various federal and state “do not call” list
requirements that
permit consumers to protect themselves from unsolicited marketing telephone
calls. In 2003, the United States Federal Trade Commission, or the FTC, amended
its rules to establish a national “do not call” registry. Generally, vendors are
prohibited from calling anyone on that registry unless the consumer has
initiated the contact or given prior consent. Although
certain court decisions called into question the FTC’s authority to implement
this registry, the FTC put it into operation pending a definitive judicial
decision. In
October 2004, the U.S. Supreme Court declined to hear an appeal seeking to
overturn a ruling by the U.S. Court of Appeals for the Tenth Circuit
that
upheld
the constitutionality of the FTC registry. Millions
of households have listed their telephone numbers on this registry, and the
implementation of the FTC rule may adversely affect telemarketing activities by
us or by vendors of our products. The FTC also has initiated enforcement actions
against alleged violators of the registry requirements after receiving consumer
complaints. In view
of the public concern with privacy, we cannot assure you that additional rules
that restrict or make more costly our and our vendors’ marketing activities will
not be adopted. Such regulations may restrict our ability to market effectively
our products and services to new customers. Furthermore, compliance with these
regulations may prove costly and difficult, and we, or our vendors, may incur
penalties for improperly conducting our marketing activities.
"Do
not fax" rules will increase our costs and potentially subject us to additional
legal liability.
Because
we rely heavily on broadcast facsimile transmissions to inform mortgage brokers
of changes in our rates and products, we will be subject to greater costs and
potential liability under new "do not fax" rules by the FCC that become
effective on July 1, 2005. When effective, these rules make it unlawful for any
person to send an unsolicited facsimile to another machine that contains any
material advertising the commercial availability or quality of any property,
good, or service, unless the recipient has expressly permitted the sending of
such a facsimile in a signed, written statement. Under these rules our
announcements of rate and product changes may be deemed covered advertisements.
Although we are seeking to receive the required written permission from the
brokers and other persons to whom we send such facsimiles announcements, we
cannot guarantee that one or more of our facsimile announcements will not be
sent to persons who have not executed such a permission. In addition, the rule
requires that each facsimile advertisement must contain the identity and
telephone number of the business on whose behalf the facsimile is being sent,
whether sent directly by that business or through a third-party service
provider. Recipients of unwanted facsimiles thus will receive information
allowing them to seek redress. Violators of these rules may be subject not only
to enforcement actions by government agencies, but also to private suits by
affected persons. Compliance with this FCC requirement will increase our costs
and implementation of the rules will increase our legal risks.
The
fraudulent and negligent acts on the part of loan applicants, mortgage brokers,
appraisers, other vendors, and our employees could subject us to losses.
When we
originate mortgage loans, we rely heavily upon information supplied by third
parties including the information contained in the loan application, property
appraisal, title information and employment and income documentation. If any of
this information is misrepresented and the misrepresentation is not detected
before loan funding, the value of
the
mortgage loan may be significantly lower than expected. Whether the loan
applicant, the mortgage broker, another third party, or one of our employees
makes a misrepresentation, we generally bear the risk of loss associated with
the misrepresentation. A mortgage loan subject to a material misrepresentation
is typically unsaleable or subject to repurchase if it is sold before detection
of the misrepresentation. In addition, the persons and entities making a
misrepresentation are often difficult to locate and it is often difficult to
collect from them any monetary losses we have suffered.
While we
have controls and processes designed to help us identify misrepresented
information in our loan origination operations, we cannot assure you that we
have detected or will detect all misrepresented information in our loan
originations operations.
Compliance
with proposed and recently enacted changes in securities laws and regulations
are likely to increase our costs.
The
Sarbanes-Oxley Act of 2002 and rules and regulations promulgated by the
Securities and Exchange Commission and the Nasdaq National Market have increased
the scope, complexity and cost of corporate governance, reporting and disclosure
practices. We believe that these rules and regulations will make it more costly
for us to obtain director and officer liability insurance, and we may be
required to accept reduced coverage or incur substantially higher costs to
obtain coverage. These rules and regulations could also make it more difficult
for us to attract and retain qualified members of management and our board of
directors, particularly to serve on our audit committee.
We
are subject to significant legal and reputational risks and expenses under
federal and state laws concerning privacy, use, and security of customer
information.
The scope of
business activity affected by “privacy” concerns is likely to expand and will
affect our business. The federal Gramm-Leach-Bliley financial reform legislation
imposes significant privacy obligations on us in connection with the
collections, use, and security of financial and other nonpublic information
provided it by applicants and borrowers. Privacy rules also require us to
protect the security and integrity of the customer information we use and hold.
In addition, we cannot assure you that more restrictive federal, state, or local
statutes, rules, or regulations will not be adopted in the future, or that
governmental bodies will not interpret existing laws or regulations in a more
restrictive manner, and thus make compliance more difficult or expensive. These
requirements also increase the risk that we may be subject to liability for
noncompliance.
California
recently enacted —the California Financial Information Privacy Act, also known
as SB 1, and the California Online Privacy Protection Act, both of which took
effect on July 1, 2004, and AB 1950. Under SB 1, subject to certain exceptions,
a financial company must allow customers to opt out of the sharing of their
information with affiliates in separately regulated lines of business and must
receive a customer opt-in before confidential customer data may be shared with
unaffiliated companies. Under the new California Online Privacy Protection Act,
all operators of commercial websites and online services that allow interaction
with California consumers, even if no transactions may be effected online, must
post privacy policies meeting
statutory requirements. AB 1950
further expands the reach of California privacy rules by requiring all types of
businesses to maintain “reasonable security measures” for the customer personal
information that they possess or license. Certain amendments to the California
Civil Code that require all non-financial companies, whether located in
California or elsewhere, that disclosed personal information about a California
consumer for direct marketing purposes during 2004 to provide notice to the
customer and opportunity to request information regarding third-party disclosure
from the lender, became effective January 1, 2005. A number
of other states are considering privacy laws that may be more demanding than
federal law. The FTC,
which administers the federal privacy rules for mortgage lenders, has determined
that privacy laws in several states, most recently new privacy laws enacted by
Vermont and Illinois, are not preempted by Gramm-Leach-Bliley. In view
of the public concern with privacy, we cannot assure you that additional rules
that restrict or make more costly our activities or those of our vendors will
not be adopted and will not restrict the marketing of our products and services
to new customers.
Because
laws and rules concerning the use and protection of customer information are
continuing to develop at the federal, state and local levels, we expect to incur
increased costs in our effort to be and remain in full compliance with these
requirements. Nevertheless, despite our efforts we will be subject to legal and
reputational risks in connection with our collection and use of customer
information, and we cannot assure you that will not be subject to lawsuits or
compliance actions under such state nor federal privacy requirements. To the
extent that a variety of inconsistent state privacy rules or requirements are
enacted, our compliance costs could substantially increase.
Our
failure to maintain an exemption from the Investment Company Act would harm our
results of operations.
We may invest
in securities of other REITs or similar entities. Although we intend to make
such investments only if our board of directors determines that the proposed
investment would not cause us to be an “investment company” under the Investment
Company Act of 1940, as amended, we could become regulated as an investment
company for purposes of that act, which would substantially reduce our ability
to use leverage and could adversely affect our business, financial condition,
liquidity and results of operations.
Federal
Income Tax Risks Related to Our Qualification as a REIT
Actions we
take to satisfy the requirements applicable to REITs, or our failure to satisfy
such requirements, could have an adverse effect on our financial condition.
Since our
REIT conversion, we have operated in a manner intended to enable us to qualify
as a REIT under the federal tax laws, and we intend to continue to do so. A REIT
generally is not taxed at the corporate level on income it currently distributes
to its shareholders as long as it distributes annually at least 90% of its REIT
taxable income (determined without regard to the dividends paid deduction and by
excluding net capital gain) and complies with certain other requirements. No
assurance can be provided, however, that we will qualify, or be able to remain
qualified, as a REIT, or that new legislation, Department of Treasury
regulations, administrative
interpretations or court decisions will not significantly change the tax laws
with respect to our qualification as a REIT or the federal income tax
consequences of such qualification.
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Required
distributions and payments.
To remain qualified as a REIT, generally we are required each year to
distribute annually to our shareholders at least 90% of our REIT taxable
income (determined without regard to the dividends paid deduction and by
excluding any net capital gain). In addition, we are subject to a 4%
nondeductible excise tax on the amount, if any, by which certain
distributions we make with respect to the calendar year are less than the
sum of (i) 85% of our ordinary income, (ii) 95% of our capital gain net
income for that year, and (iii) any undistributed taxable income from
prior periods. We intend to make distributions to our shareholders to
comply with the minimum 90% distribution requirement and to avoid the
nondeductible excise tax. Differences in timing between taxable income and
cash available for distribution could require us to borrow funds or to
issue additional equity to meet the minimum 90% distribution requirement
(and therefore to maintain our REIT status) and to avoid the nondeductible
excise tax. In addition, our inability to retain earnings (resulting from
the minimum 90% distribution requirement) generally require us to
refinance debt that matures with additional debt or equity. There can be
no assurance that any of these sources of funds, if available at all, will
be available to meet our distribution and tax obligations. Furthermore, to
the extent that we do not comply with covenants contained in our financing
agreements or are otherwise found to be in default under the terms of such
agreements, we could be restricted from paying dividends or from engaging
in other transactions that are necessary for us to maintain our REIT
status. See “Item 7 - Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources -
Financing Facilities.” |
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Consequences
of failure to qualify as a REIT.
If we fail to qualify as a REIT, we will be subject to federal and state
income tax (including any applicable alternative minimum tax) on our
taxable income at regular corporate rates. In addition, unless entitled to
relief under certain statutory provisions, we will be disqualified from
treatment as a REIT for the four taxable years following the year during
which REIT qualification is lost. The additional tax would significantly
reduce the cash available for distribution by us to our shareholders. Our
failure to qualify as a REIT could reduce materially the value of our
common stock. However, if we fail to qualify as a REIT, subject to certain
limitations under the federal tax laws, domestic corporate shareholders
may be eligible for the dividends received deduction with respect to our
distributions and most domestic non-corporate shareholders generally would
be taxed on such distributions at the rates applicable to net capital
gains. |
Distributions
we make to most domestic non-corporate shareholders are generally not eligible
for taxation at capital gains rates, which may adversely affect the price of our
common stock.
Distributions
made to most domestic non-corporate shareholders by a C corporation are
generally eligible to be taxed at rates applicable to net capital gains,
currently subject to a maximum rate of 15%, rather than at rates applicable to
ordinary income, currently subject to a maximum rate of 35%. The 15% rate,
however, generally does not apply to distributions made to most domestic
non-corporate shareholders by a REIT on its stock, except for distributions made
with respect to dividends received by the REIT from its taxable REIT subsidiary
and in other limited circumstances. As a result, our dividends paid to most
domestic non-corporate shareholders are generally taxable to those holders at
ordinary income rates. Although the earnings of a REIT that are distributed to
its shareholders generally are subject to less total federal income taxation
than earnings of a non-REIT C corporation that are distributed to its
shareholders net of corporate level income tax, domestic non-corporate investors
may view the stock of C corporations as more attractive relative to the stock of
a REIT than would otherwise be the case, because dividends from C corporations
generally are taxed at a lower rate to shareholders while dividends paid from
REITs generally are taxed at the same rate as the shareholder’s other ordinary
income.
If we make
distributions in excess of current and accumulated earnings and profits, those
distributions may reduce your adjusted basis in our common stock, and to the
extent such distributions exceed your adjusted basis, you may recognize a
capital gain.
Unless you
are a tax-exempt entity, distributions that we make to you, including
constructive distributions, generally are subject to tax as ordinary income to
the extent of our current and accumulated earnings and profits as determined for
federal income tax purposes. If the amount we distribute to you exceeds your
allocable share of current and accumulated earnings and profits, the excess will
be treated as a return of capital to the extent of your adjusted basis in your
stock, which will reduce your basis in your stock but will not be subject to
tax. To the extent the amount we distribute to you exceeds both your allocable
share of current and accumulated earnings and profits and your adjusted basis,
this excess amount will be treated as a gain from the sale or exchange of a
capital asset.
We
strongly urge you to consult your own tax advisor concerning the effects of our
distributions on your individual tax situation.
Recognition
of excess inclusion income by us could have adverse tax consequences to us or
our shareholders.
We may
recognize excess inclusion income and our shareholders may be required to treat
a portion of the distributions they receive as excess inclusion income. Excess
inclusion income may not be offset with net operating losses, represents
unrelated business taxable income in the hands of an otherwise tax-exempt
shareholder, and is subject to withholding tax, without regard to
otherwise applicable exemptions or rate reductions, to the extent such income is
allocable to a shareholder who is not a U.S. person.
Generally,
excess inclusion income is the income allocable to a REMIC residual interest in
excess of the income that would have been allocable to such interest if it were
a bond having a yield to maturity equal to 120% of the long-term applicable
federal rate, which is a rate based on the weighted average yields of treasury
securities and is published monthly by the IRS for use in various tax
calculations.
Although we
plan to structure our securitization transactions to qualify as non-REMIC
financing transactions for federal income tax purposes, we may recognize excess
inclusion income attributable to the equity interests we retain in those
securitization transactions. In short, if a REIT holds 100% of the sole class of
equity interest in a non-REMIC multi-class mortgage-backed securities offering
that qualifies as a borrowing for federal income tax purposes, the equity
interest retained by the REIT, under regulations that have not yet been issued,
will be subject to rules similar to those applicable to a REMIC residual
interest. Thus, because we intend to undertake non-REMIC multi-class mortgage
backed securities transactions, we may recognize excess inclusion income.
If we
recognize excess inclusion income, we may, under regulations that have not yet
been issued, have to allocate the excess inclusion income to the distributions
we distribute to our shareholders to the extent our REIT taxable income (taking
into account the dividends paid deduction) is less than the sum of our excess
inclusions for the taxable year. If a portion of the distributions we distribute
to you are characterized as excess inclusion income, then you will be taxed with
respect to that excess inclusion income in the same manner that you would be
taxed if you held a REMIC residual interest directly.
Generally, to
maintain our REIT status, we must distribute at least 90% of our taxable income
(determined without regard to the dividends paid deduction and by excluding any
net capital gains) in each year. To the extent the sum of our excess inclusion
income is less than 10% of our total taxable income, we may elect to pay tax on
such excess inclusion income rather than treating a portion of our distributions
as comprising excess inclusion income.
We
could lose our REIT status if the total value of our investment in Saxon Capital
Holdings, Inc., together with any investments in other taxable REIT
subsidiaries, exceeds 20% of the total value of our assets at the close of any
calendar quarter.
At the close
of any calendar quarter, no more than 20% of the value of a REIT’s assets may
consist of stock or securities of one or more taxable REIT subsidiaries.
The sole
taxable REIT subsidiary in which we directly own stock or securities is Saxon
Capital Holdings, Inc. As of December 31, 2004, the stock and securities of
Saxon Capital Holdings, Inc. held by us represented less than 20% of the value
of our total assets. Furthermore, we intend to monitor the value of our
investments in the stock and securities of Saxon Capital Holdings, Inc. (and any
other taxable REIT subsidiary in which we may invest) to ensure compliance
with the above-described 20% limitation. We cannot assure you, however, that we
will always be able to comply with the 20% limitation so as to maintain REIT
status.
Because taxable REIT
subsidiaries are subject to tax at the regular corporate rates, we may not be
able to fully realize the tax benefits we anticipate as a result of being a
REIT.
A taxable
REIT subsidiary must pay income tax at regular corporate rates on any income
that it earns. As a REIT, we conduct many of our historic business activities
through our taxable REIT subsidiaries. Our taxable REIT subsidiaries pay
corporate income tax on their taxable income, and their after-tax net income is
available for distribution to us. Such income, however, is not required to be
distributed.
The
primary benefit that we derive as a result of electing REIT status is the
ability to avoid corporate income tax on our earnings by distributing such
earnings to our shareholders. Certain business activities, such as servicing
loans owned by third parties, must, however, be conducted through a taxable REIT
subsidiary if we are to maintain our compliance with requirements for
qualification as a REIT. Consequently, our ability to achieve the primary
benefit of being a REIT—the avoidance of corporate income tax on our earnings—is
limited to the extent we must conduct our business activities through taxable
REIT subsidiaries.
We
may endanger our REIT status if the dividends we receive from our taxable REIT
subsidiaries exceed applicable REIT gross income tests.
The annual
gross income tests that must be satisfied to ensure REIT qualification may limit
the amount of dividends that we can receive from our taxable REIT subsidiaries
and still maintain our REIT status. Generally, not more than 25% of our gross
income can be derived from non-real estate related sources, such as dividends
from a taxable REIT subsidiary. If, for any taxable year, the dividends we
received from Saxon Capital Holdings, Inc. when added to our other items of
non-real estate related income, represented more than 25% of our total gross
income for the year, we could be denied REIT status, unless we were able to
demonstrate, among other things, that our failure of the gross income test was
due to reasonable cause and not willful neglect.
Moreover, the
limitations imposed by the REIT gross income tests may impede our ability to
distribute assets from Saxon Capital Holdings, Inc. to us in the form of
dividends.
We
may be subject to a penalty tax if interest on indebtedness owed to us by our
taxable REIT subsidiaries accrues at a rate in excess of a commercially
reasonable rate or if transactions between us and our taxable REIT subsidiaries
are entered into on other than arm’s-length terms.
If interest
accrues on an indebtedness owed by a taxable REIT subsidiary to its parent REIT,
the REIT is subject to tax at a rate of 100% on the excess of (1) interest
payments made by a taxable REIT subsidiary to its parent REIT over (2) the
amount of interest that would have been payable had interest accrued on the
indebtedness at a commercially reasonable rate. A tax at a rate of 100% is also
imposed on any transaction between a taxable REIT subsidiary and its
parent
REIT to the extent the transaction gives rise to deductions to the taxable REIT
subsidiary that are in excess of the deductions that would have been allowable
had the transaction been entered into on arm’s-length terms. We scrutinize all
of our transactions with our taxable REIT subsidiaries to ensure that we do not
become subject to these taxes. We cannot assure you, however, that we will be
able to avoid application of these taxes.
Risks
of Ownership of Our Common Stock
We
have not established a minimum distribution payment level, and we cannot assure
you of our ability to make distributions to our shareholders in the future.
We intend to
make quarterly distributions to our shareholders in amounts sufficient to
distribute at least 90% of our REIT taxable income (determined without regard to
the dividends paid deduction and by excluding any net capital gains) each year,
subject to certain adjustments. This, along with other factors, should enable us
to qualify for the tax benefits accorded to a REIT under the Internal Revenue
Code. We have not established a minimum distribution payment level and our
ability to make distributions might be impaired by the risk factors described in
this prospectus. All distributions will be made at the discretion of our board
of directors and will depend on our earnings, our financial condition,
maintenance of our REIT status and such other factors as our board of directors
may deem relevant from time to time. We cannot assure you that we will have the
ability to make distributions to our shareholders in the future.
Our
use of taxable REIT subsidiaries may affect the price of our common stock
relative to the stock price of other REITs.
Although we
expect to conduct a portion of our business through our REIT or one or more
qualified REIT subsidiaries in the future, we also hold a significant portion of
our assets, and conduct a substantial portion of our business, through one or
more taxable REIT subsidiaries. Taxable REIT subsidiaries are corporations
subject to corporate-level tax. This REIT/taxable REIT subsidiary structure may
cause market valuations of our common stock to differ from market valuations of
stock of other publicly-traded REITs that may not use taxable REIT subsidiaries
as extensively as we plan to do as a REIT.
Shares
of our common stock available for future sale could have an adverse effect on
our stock price.
Sales of a
substantial number of shares of our common stock, or the perception that such
sales could occur, could adversely affect prevailing market prices for our
common stock. Also, a substantial number of shares of our common stock will,
pursuant to employee benefit plans, be issued or reserved for issuance from time
to time, and these shares of common stock will be available for sale in the
public markets from time to time. Moreover, additional shares of our common
stock issued in the future may be available for sale in the public markets. We
cannot predict the effect that future sales of shares of our common stock will
have on the market price of our common stock.
The
market price and trading volume of our common stock may be volatile.
The
market price of our common stock may be highly volatile and be subject to wide
fluctuations. In addition, the trading volume in our common stock may fluctuate
and cause significant price variations to occur. We cannot assure you that the
market price of our common stock will not fluctuate or decline significantly in
the future. Some of the factors that could negatively affect our stock price or
result in fluctuations in the price or trading volume of our common stock
include:
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market
reaction to our being a REIT; |
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actual
or anticipated variations in our quarterly operating results or
distributions; |
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changes
in our funds from operations or earnings estimates or publication of
research reports about us, if any, or the real estate
industry; |
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increases
in market interest rates that lead purchasers of our shares to demand a
higher yield; |
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changes
in market valuations of similar companies; |
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changes
in tax laws affecting REITs; |
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adverse
market reaction to any increased indebtedness we incur in the
future; |
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additions
or departures of key management personnel; |
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actions
by institutional shareholders; |
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speculation
in the press or investment community; and |
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general
market and economic conditions. |
Our earnings
and cash distributions could adversely affect our stock price.
It is
generally believed that the market value of the equity securities of a REIT is
primarily based upon the market’s perception of the REIT’s growth potential for
its core portfolio, the value of its real estate portfolio and its prospects for
accretive acquisitions and development. The combination of these factors creates
a market perception of a REIT’s current and potential future cash distributions,
whether from operations, sales, acquisitions, or refinancings. This market
perception is secondarily based upon the value of the underlying assets. For
that reason, our common stock may trade at prices that are higher or lower than
the net asset value per share. To the extent we retain operating cash flow for
investment purposes, working capital reserves, or other purposes rather than
distributing such cash flow to shareholders, these retained funds, while
increasing the value of our underlying assets, may not correspondingly increase
the market price of our common stock. Our failure to meet the market’s
expectation with regard to future earnings and cash distributions would likely
adversely affect the market price of our common stock.
Market
interest rates could have an adverse effect on our stock price.
One of
the factors that will influence the price of our common stock will be the
dividend yield on our common stock (as a percentage of the price of our common
stock) relative to market interest rates. Thus, an increase in market interest
rates may lead prospective purchasers of our common
stock to expect a higher dividend yield, which would adversely affect the market
price of our common stock.
Limits
on ownership of our common stock could have adverse consequences to you and
could limit your opportunity to receive a premium on our stock.
To maintain
our qualification as a REIT for federal income tax purposes, not more than 50%
in value of the outstanding shares of our capital stock may be owned, directly
or indirectly, by five or fewer individuals (as defined in the federal tax laws
to include certain entities). Primarily to facilitate maintenance of our
qualification as a REIT for federal income tax purposes, our charter prohibits
ownership, directly or by the attribution provisions of the federal tax laws, by
any person of more than 9.8% of the lesser of the aggregate number or aggregate
value of the outstanding shares of any class or series of our capital stock. Our
board of directors, in its sole and absolute discretion, may waive or modify the
ownership limit under certain circumstances.
Any shares of
our stock acquired or held in violation of the ownership limit will be
transferred automatically to a trust for the benefit of a designated charitable
beneficiary. The person who acquired such excess shares of our stock will not be
entitled to any distributions on such stock or to vote such excess shares and
will receive, in exchange for such excess shares, a price equal to the lesser of
(1) the price per share such person paid for the shares (or, if the shares were
acquired through a gift, devise or other transaction in which no value was
given, a price per share equal to the market price for the excess shares on the
date such person acquired the shares) or (2) the cash proceeds from the sale of
such excess shares by the trustee. Any additional proceeds from the sale of the
excess shares will be paid to the charitable beneficiary. A transfer of our
common stock to a person who, as a result of the transfer, violates the
ownership limit may be void under certain circumstances, and, in any event, the
transferee would be denied any of the economic benefits of owning our common
stock in excess of the ownership limit. The ownership limit may have the effect
of delaying, deferring, or preventing a change in control and, therefore, could
adversely affect our shareholders’ ability to realize a premium over the
then-prevailing market price for our common stock in connection with a change in
control.
Our governing
documents and governing Maryland law impose limitations on the acquisition of
our common stock and changes in control that could make it more difficult for a
third party to acquire us.
Our charter
and bylaws, and Maryland corporate law, contain a number of provisions that
could delay, defer, or prevent a transaction or a change in control of us that
might involve a premium price for holders of our common stock or otherwise be in
their best interests, including the following:
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Ownership
Limit.
The 9.8% ownership limit described under “Limits on ownership of our
common stock could have adverse consequences to you and could limit your
opportunity to receive a premium on our stock” above may have the effect
of precluding a change in control of us by a third party without the
consent of the our board of directors, even if such change in control
would be in the interest of the our shareholders (and even if such change
in control would not reasonably jeopardize our REIT status).
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Removal
of board of directors.
Our charter provides that, except for any directors who may be elected by
holders of a class or series of shares of capital stock other than common
stock, directors may be removed only for cause and only by the affirmative
vote of shareholders holding at least two-thirds of the shares then
outstanding and entitled to be cast for the election of directors. A
vacancy on the board resulting from the removal of a director by the
shareholders may be filled by the affirmative vote of at least two-thirds
of all the votes entitled to be cast in the election of directors and only
until the next annual meeting of shareholders.
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Preferred
stock; classification or reclassification of unissued shares of capital
stock.
Our charter provides that the total number of shares of stock of all
classes which we have the authority to issue is 101,000,000 shares of
capital stock, initially consisting of 100,000,000 shares of common stock,
par value $0.01 per share, and 1,000,000 shares of preferred stock, par
value $0.01 per share. The board of directors is authorized, without a
vote of shareholders, to classify or reclassify any unissued shares of
stock, including common stock into preferred stock or vice versa, and to
establish the preferences and rights of any preferred or other class or
series of stock to be issued. The issuance of preferred stock or other
stock having special preferences or rights could have the effect of
delaying or preventing a change in control of us even if a change in
control would be in the interest of our shareholders. Because the board of
directors will have the power to establish the preferences and rights of
additional classes or series of stock without a shareholder vote, the
board of directors may afford the holders of any such class or series
preferences, powers and rights, including voting rights, senior to the
rights of holders of common stock. |
| |
· |
Duties
of directors with respect to unsolicited takeovers.
Maryland law provides protection for Maryland corporations against
unsolicited takeovers by limiting, among other things, the duties of the
directors in unsolicited takeover situations. The duties of directors of
Maryland corporations do not require them to (1) accept, recommend or
respond to any proposal by a person seeking to acquire control of the
corporation, (2) authorize the corporation to redeem any rights under, or
modify or render inapplicable, any shareholders rights plan, (3) make a
determination under the Maryland Business Combination Act or the Maryland
Control Share Acquisition Act, or (4) act or fail to act solely because of
the effect the act or failure to act may have on an acquisition or
potential acquisition of control of the corporation or the amount or type
of consideration that may be offered or paid to the shareholders in an
acquisition. Moreover, under Maryland law the act of the directors of a
Maryland corporation relating to or affecting an acquisition or potential
acquisition of control is not subject to any higher duty or greater
scrutiny than is applied to any other act of a director. Maryland law also
contains a statutory presumption that an act of a director of a Maryland
corporation
satisfies the applicable standards of conduct for directors under Maryland
law. |
| |
· |
Maryland
Business Combination Act.
Maryland corporate law, establishes special requirements for “business
combinations” between a Maryland corporation and “interested shareholders”
or any affiliate of an interested shareholder unless certain exemptions
are applicable. An interested shareholder is any person who beneficially
owns 10% or more of the voting power of our then-outstanding voting stock.
Among other things, the law prohibits for a period of five years a merger
and other similar transactions between us and an interested shareholder
unless the board of directors approved the transaction before the party
becoming an interested shareholder. The five-year period runs from the
most recent date on which the interested shareholder became an interested
shareholder. The law also requires a supermajority shareholder vote for
such transactions after the end of the five-year period. This means that
the transaction must be approved by at least:
|
| |
· |
80%
of the votes entitled to be cast by holders of outstanding voting shares;
and |
| |
· |
two-thirds
of the votes entitled to be cast by holders of outstanding voting shares
other than voting shares held by the interested shareholder or an
affiliate of the interested shareholder with whom the business combination
is to be effected. |
The
business combination statute could have the effect of discouraging offers to
acquire us and of increasing the difficulty of consummating any such offers,
even if our acquisition would be in our shareholders’ best interests. Our board
of directors has adopted a resolution exempting us from this statute. However,
our board of directors may repeal or modify this resolution in the future, in
which case the provisions of the Maryland Business Combination Act will be
applicable to business combinations between us and other persons.
| |
· |
Maryland
Control Share Acquisition Act.
Maryland corporate law provides that “control shares” of a Maryland
corporation acquired in a “control share acquisition” have no voting
rights except to the extent approved by a vote of the other shareholders.
Two-thirds of the shares eligible to vote must vote for granting the
“control shares” voting rights. Control shares are shares of stock that,
taken together with all other shares of stock the acquirer previously
acquired, would entitle the acquirer to exercise voting power in electing
directors within one of the following ranges of voting power:
|
| |
· |
one-tenth
or more but less than one-third of all voting
power; |
| |
· |
one-third
or more but less than a majority of all voting power; or
|
| |
· |
a
majority or more of all voting power. |
Control
shares do not include shares of stock the acquiring person is entitled to vote
as a result of having previously obtained shareholder approval. A control share
acquisition means the acquisition of control shares, subject to certain
exceptions.
If a person
who has made (or proposes to make) a control share acquisition satisfies certain
conditions (including agreeing to pay expenses), he may compel our board of
directors to call a special meeting of shareholders to consider the voting
rights of the shares. If such a person makes no request for a meeting, we have
the option to present the question at any shareholders’ meeting.
If voting
rights are not approved at a meeting of shareholders, then, subject to certain
conditions and limitations, we may redeem any or all of the control shares
(except those for which voting rights have previously been approved) for fair
value. We will determine the fair value of the shares, without regard to voting
rights, as of the date of either:
| |
· |
the last control share acquisition; or
|
| |
· |
the
meeting where shareholders considered and did not approve voting rights of
the control shares. |
If voting
rights for control shares are approved at a shareholders’ meeting and the
acquirer becomes entitled to vote a majority of the shares of stock entitled to
vote, all other shareholders may obtain rights as objecting shareholders and,
thereunder, exercise appraisal rights. This means that you would be able to
force us to redeem your stock for fair value. Under Maryland corporate law, the
fair value may not be less than the highest price per share paid in the control
share acquisition. Furthermore, certain limitations otherwise applicable to the
exercise of dissenters’ rights would not apply in the context of a control share
acquisition. The control share acquisition statute would not apply to shares
acquired in a merger, consolidation or share exchange if we were a party to the
transaction. The control share acquisition statute could have the effect of
discouraging offers to acquire us and of increasing the difficulty of
consummating any such offers, even if our acquisition would be in our
shareholders’ best interests.
Our bylaws
contain a provision exempting acquisitions of our shares from the Maryland
Control Share Acquisition Act. However, our board of directors may amend our
bylaws in the future to repeal or modify this exemption, in which case any of
our control shares acquired in a control share acquisition will be subject to
the Maryland Control Share Acquisition Act.
| |
· |
Advance
notice of director nominations and new business.
Our bylaws impose certain advance notice requirements that must be met for
nominations of persons for election to the board of directors and the
proposal of business to be considered by shareholders. The advance notice
provisions contained in our bylaws generally require nominations and new
business proposals by shareholders to be delivered to our secretary not
later than the close of business on the 60th day nor earlier than
the close of business on the 90th day before the date on which we mailed
our proxy materials for the prior year’s annual meeting of shareholders.
|
| |
· |
Meetings
of shareholders; call of special meetings; shareholder action in lieu of
meeting by unanimous consent.
Our bylaws provide that annual meetings of shareholders must be held on a
date and at the time set by the board of directors during the month of
June each year (commencing in June 2005). Special meetings of the
shareholders may be called by the board of directors or on the written
request of shareholders entitled to cast a majority of all the votes
entitled to be cast at the meeting. Any action required or permitted to be
taken by the shareholders must be effected at a duly called annual or
special meeting of shareholders or by unanimous written consent of all
shareholders entitled to vote on the action.
|
| |
· |
Meetings
of shareholders; call of special meetings; shareholder action in lieu of
meeting by unanimous consent.
Our bylaws provide that annual meetings of shareholders must be held on a
date and at the time set by the board of directors during the month of
June each year (commencing in June 2005). Special meetings of the
shareholders may be called by the board of directors or on the written
request of shareholders entitled to cast a majority of all the votes
entitled to be cast at the meeting. Any action required or permitted to be
taken by the shareholders must be effected at a duly called annual or
special meeting of shareholders or by unanimous written consent of all
shareholders entitled to vote on the action.
|
| |
· |
Merger,
consolidation, share exchange, and transfer of our assets.
Pursuant to provisions contained in our charter, subject to the terms of
any class or series of capital stock at the time outstanding, we may merge
with or into another entity, may consolidate with one or more other
entities, may participate in a share exchange or may transfer our assets
within the meaning of Maryland corporate law if approved (1) by a majority
of the entire board of directors and (2) by the affirmative vote of
two-thirds of all the votes entitled to be cast on the matter, except that
any merger with or into a trust organized to change our form of
organization from a corporation to a trust will require the approval of
our shareholders by the affirmative vote only of a majority of all the
votes entitled to be cast on the matter. Under Maryland corporate law,
certain mergers may be accomplished without a vote of shareholders, a
share exchange must be approved by a Maryland successor only by its board
of directors and as set forth in its charter, and our voluntary
dissolution also would require the affirmative vote of two-thirds of all
the votes entitled to be cast on the
matter. |
| |
· |
Amendments
to our charter and bylaws.
The provision contained in our charter relating to restrictions on
transferability of our common stock may be amended only by a resolution
adopted by the board of directors and approved by shareholders by the
affirmative vote of the holders of not less than two-thirds of the votes
entitled to be cast on the matter. As permitted under Maryland corporate
law, our charter and bylaws provide that our board of directors has the
exclusive right to amend our bylaws. Amendments to this provision of our
bylaws also would require board action and approval by two-thirds of all
votes entitled to be cast on the matter. |
Our
principal executive headquarters is located at 4860 Cox Road, Suite 300, in Glen
Allen, VA and contains 34,448 square feet. Our principal mortgage loan
origination headquarters is located at 4880 Cox Road in Glen Allen, VA and
contains 59,948 square feet. Our principal mortgage loan servicing headquarters
is located at 4708 Mercantile Drive, Fort Worth, TX and contains
approximately 106,616 square feet. The leases for these premises expire on
August 31, 2017, July 31, 2005 and March 31, 2011, respectively. We leased
property in the following metropolitan areas for our mortgage loan origination
operations as of December 31, 2004: Phoenix, AZ; Foothill Ranch, CA; Huntington
Beach, CA; Laguna Hills, CA, Walnut Creek, CA; Denver, CO; Milford, CT; Ft.
Lauderdale, FL; Tampa, FL; Atlanta, GA; Indianapolis, IN; Oakbrook Terrace, IL;
New Orleans, LA; Livonia, MI; Greenbelt, MD; Las Vegas, NV; Raleigh, NC; Omaha,
NE; Cherry Hill, NJ; Buffalo, NY; Hauppauge, NY; Portland, OR; Pittsburgh, PA;
Dallas, TX; and Richmond, VA. We do not consider any specific leased location to
be material to our operations. We believe that equally suitable alternative
locations are available in all areas where we currently do business. On May 10,
2004, we entered into a 12-year build-to-suit lease for approximately 115,000
square feet in Glen Allen, VA with Highwoods Realty Limited Partnership that is
expected to commence in July 2005. Upon completion, this building will become
our principal mortgage loan origination headquarters. We also own a condominium
unit in Glen Allen, VA that is used for temporary corporate housing. In the
opinion of our management, our properties are adequately covered by insurance.
Because
we are subject to many laws and regulations, including but not limited to
federal and state consumer protection laws, we are regularly involved in
numerous lawsuits filed against us, some of which seek certification as class
action lawsuits on behalf of similarly situated individuals. If class actions
are certified and there is an adverse outcome or we do not otherwise prevail in
the following matters, we could suffer material losses, although we intend to
vigorously defend these lawsuits.
Josephine
Coleman v. America’s MoneyLine, Inc. is a
matter filed on November 20, 2002 in the Circuit Court of the Third Judicial
Circuit, Madison County, Illinois, Case No. 02L1557. This case was filed as a
class action alleging consumer fraud and unjust enrichment under Illinois law
and similar laws of other states. Ms. Coleman alleges that she was improperly
charged a fee for overnight delivery of mortgage loan documents. In January
2005, the parties entered into a settlement agreement pursuant to which
America’s MoneyLine agreed to pay an immaterial amount comprised of a payment to
Ms. Coleman and an agreed-upon amount of her attorneys’ fees in exchange for
dismissal of the suit. The Court entered an order dismissing the suit with
prejudice as to Ms. Coleman on January 21, 2005.
Margarita
Barbosa, et al. v. Saxon Mortgage Services, Inc. (f/k/a Meritech Mortgage
Services, Inc.) et al. is a
matter filed on November 19, 2002 in the United States District Court for the
Northern District of Illinois, Eastern Division, Case No. 02C6323. This is a
class action suit alleging violation of the Illinois Interest Act, the Illinois
Consumer Fraud Act, similar laws, if any, in other states, and a breach of
contract. The plaintiffs allege that we violated Illinois law by collecting
prepayment penalties in accordance with the terms of the mortgages of certain
borrowers whose loans had been accelerated due to default, and which later were
prepaid by the borrowers. We believe that approximately 27 mortgage loans we
originated in Illinois are subject to the allegations. In addition, the
plaintiffs allege that their claims apply to loans that we made in all other
states in addition to Illinois, where we collected prepayment penalties in these
particular circumstances. The claim of Ms. Barbosa was separated from the
potential class action by a
motion to compel arbitration pursuant to the arbitration provision of her
mortgage loan, and the claim has been settled. The mortgage loans of some or all
of the other plaintiffs in the alleged class do not contain arbitration
provisions. The court dismissed the sole federal law claim alleged by the
plaintiffs against a non-affiliated defendant, and as a result dismissed without
prejudice the state law claims against Saxon Mortgage Services and the other
remaining defendants on jurisdictional grounds. The remaining named plaintiff
re-filed the case on August 8, 2003 as Loisann Singer, et al. v. Saxon Mortgage
Services (f/k/a Meritech Mortgage Services, Inc.), et al. in the Circuit Court
of Cook County, Illinois, Case No. 03CH 13222, and on our motion, the case was
removed to the U.S. District Court for the Northern District of Illinois on
September 10, 2003. The parties have agreed to a settlement in exchange for a
dismissal which would require us to pay $0.2 million to the group of 27 former
Illinois borrowers and their attorneys. The court has entered an order approving
the settlement, and we are in the process of performing our obligations under
the settlement agreement. Each of the 27 former borrowers may choose to opt out
of the settlement and may pursue individual actions against us. The settlement
would not preclude former borrowers in other states from bringing similar
claims, or attempting to assert similar claims as a class action. There were no
material developments in this legal proceeding during the quarter ended December
31, 2004.
Shirley
Hagan, et al. v. Concept Mortgage Corp., Saxon Mortgage, Inc. and
others is a
class action lawsuit filed on February 27, 2003 in the Circuit Court of Wayne
County, Michigan. The suit alleges that the defendant mortgage companies,
including Saxon Mortgage, violated HOEPA, TILA and RESPA with respect to the
fees and interest rates charged to plaintiffs and the related loan disclosures,
in connection with the plaintiffs’ loans and the loans of a similarly situated
class of borrowers. The suit seeks rescission of the affected loans, damages
with interest, and costs and attorneys fees. We removed the case to federal
court and filed a motion to compel arbitration, which was granted by the
Magistrate Judge and subsequently appealed by the plaintiffs. The District Court
affirmed the Magistrate Judge’s order and arbitration was initiated. In August
2004, a settlement agreement was entered into with respect to this matter. The
settlement provides for the reduction in the outstanding balances and interest
rates of the plaintiffs’ loans and provides for payment of the plaintiffs’ legal
fees in an approximate amount of $30,000. We are currently in the process of
satisfying our obligations under the settlement agreement. There were no
material developments in this legal proceeding during the quarter ended December
31, 2004.
Bauer,
et al., v. Saxon Mortgage Services, Inc., et al. is a
matter filed on December 1, 2004 in the Civil District Court for the Parish of
Orleans, State of Louisiana, Case No. 2004-17015. On January 26, 2005, the
plaintiffs filed a motion to dismiss the case without prejudice, and the court
entered an order dismissing the case on January 31, 2005. On February 17, 2005,
the plaintiffs re-filed the case as two separate class action lawsuits,
Bauer,
et al., v. Dean Morris, et al., filed as
Case No. 05-2173 in the Civil District Court for the Parish of Orleans, State of
Louisiana, and Patterson,
et al., v. Dean Morris, et al., filed as
Case No. 05-2174 in the Civil District Court for the Parish of Orleans, State of
Louisiana. In the Bauer case, we are not a named defendant but may owe defense
and indemnification to Deutsche Bank Trust Company Americas, N.A., as custodian
of a mortgage loan for which one named plaintiff is mortgagor. Our subsidiary,
Saxon Mortgage Services, Inc., is a named defendant in the Patterson case. In
both cases, the named plaintiffs allege misrepresentation, fraud, conversion and
unjust enrichment
on the part of a law firm hired by a number of defendants, including our
subsidiary, Saxon Mortgage Services, Inc., to enforce mortgage loan obligations
against borrowers who had become delinquent pursuant to the terms of their
mortgage loan documents. Specifically, the plaintiffs alleged that the law firm
quoted inflated court costs and sheriff’s fees on reinstatement proposals to the
plaintiffs. In both cases, the Plaintiffs seek certification as a class action,
compensatory damages, pre-judgment interest, attorneys’ fees, litigation costs,
and other unspecified general, special and equitable relief. At the present
time, we cannot predict the outcome of the case.
We are
subject to other legal proceedings arising in the normal course of our business.
In the opinion of management, the resolution of these other proceedings is not
expected to have a material adverse effect on our financial position or our
results of operations.
None.
Our
common stock has been quoted on the Nasdaq National Market under the symbol
“SAXN” since January 16, 2002. Prior to that time there was no public market for
our common stock. On March 3, 2005, the last reported price of our common stock
on the Nasdaq National Market was $18.00 per share. Based upon information
supplied to us by the registrar and transfer agent for our common stock, the
number of common shareholders of record on March 3, 2005 was 41, not including
beneficial owners in nominee or street name. We believe that a significant
number of shares of our common stock are held in nominee name for beneficial
owners. The following table sets forth, for the periods indicated, the high and
low sales prices per share of our common stock on the Nasdaq National
Market.
| |
High |
Low |
|
2003: |
|
|
First
quarter |
$13.96 |
$10.76 |
|
Second
quarter |
$19.01 |
$12.81 |
|
Third
quarter |
$18.65 |
$15.30 |
|
Fourth
quarter |
$22.15 |
$17.15 |
| |
|
|
|
2004: |
|
|
|
First
quarter |
$30.75 |
$21.23 |
|
Second
quarter |
$29.87 |
$21.60 |
|
Third
quarter |
$29.15 |
$20.85 |
|
Fourth
quarter |
$26.58 |
$18.25 |
We are
expecting to transfer our common stock from the Nasdaq National Market to the
New York Stock Exchange on Friday, March 18, 2005 under the symbol
“SAX.”
On
December 15, 2004, our Board of Directors declared a special dividend of
$1.72 per share of common stock payable on December 31, 2004 to shareholders of
record on December 23, 2004. On December 15, 2004, our Board of
Directors also declared a fourth quarter
regular dividend of $0.58 per share of common stock payable on January 14, 2005
to shareholders of record on December 23, 2004. Prior to that time, we had never
declared or paid any cash dividends on our common stock. In order to comply with
REIT qualification requirements, we expect to continue to make quarterly
distributions to shareholders totaling, on an annual basis, at least 90% of our
REIT taxable income (determined without regard to the deduction for dividends
paid and by excluding any net capital gain). The actual amount and timing of
dividends to be declared by our Board of Directors will depend on our financial
condition and earnings and other factors that our Board of Directors deems
relevant.
Our
2004 Public Offering
On
September 20, 2004, the Securities and Exchange Commission declared effective
our registration statement on Form S-11 (File No. 333-116028) in connection with
its initial public offering of common stock. Friedman, Billings, Ramsey &
Co., Inc. acted as the sole book runner and lead manager in the offering. We
initially registered $500,000,000 in shares of our common stock and sold 17.0
million shares at $22.75 per share for aggregate gross proceeds of $386.8
million on September 24, 2004.
From
September 20, 2004 through December 31, 2004, we estimate that we incurred
approximately $25.8 million in expenses in connection with the offering,
comprised of underwriting discounts and commissions, financial advisory fees,
and other offering expenses. Of that amount, $1.4 million consisted of direct
payments to our attorneys and various other organizations and $24.4 million
consisted of indirect payments to our underwriters. After deducting the expenses
described above, the net offering proceeds we received in the offering were
approximately $361.0 million.
From
September 20, 2004 through December 31, 2004, we used the net proceeds from this
offering as follows:
| |
· |
Approximately
$131.4 million to pay the cash component of the merger consideration due
to persons and entities that held shares of Old Saxon Capital common stock
immediately before the effective time of the merger;
and |
| |
· |
$229.6
million for working capital. |
The
following selected financial data for the years ended December 31, 2004, 2003,
2002, for the period July 6, 2001 to December 31, 2001, and as of December 31,
2004, 2003, 2002 and 2001 have been derived from our consolidated financial
statements, which have been audited by our independent auditors. The following
selected financial data for the period January 1, 2001 to July 5, 2001, for the
year ended December 31, 2000, and as of December 31, 2000 have been derived from
our predecessor’s consolidated financial statements, which have been audited by
our independent auditors. You should read the information below along with all
other financial information and analysis presented in this annual report on Form
10-K, including the sections captioned “Management’s Discussion and Analysis of
Financial Condition and Results
of Operations” and our consolidated financial statements and related notes
included elsewhere herein.
On
September 24, 2004, we completed our conversion to a REIT. The transaction was
structured as a merger of Old Saxon with and into Saxon Capital Holdings, Inc.,
a wholly owned subsidiary of New Saxon. The consolidated statements of
operations, shareholders’ equity, and cash flows for the year ended December 31,
2004 include ninety-eight days’ effects of the merger. The merger had no effect
on our consolidated financial statements, as this was a merger of companies
under common control. See Note 1(a) to the Consolidated Financial
Statements.
Prior to
July 6, 2001, we sold our mortgage loans, while retaining certain residual
interests, through securitizations structured as sales, with a corresponding
one-time recognition of gain or loss, under GAAP. Since July 6, 2001, we
structure our securitizations as financing transactions. These securitizations
do not meet the qualifying special purpose entity criteria under Statement of
Financial Accounting Standard No 140, or SFAS No. 140, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, because
after the loans are securitized, the securitization trust may acquire
derivatives relating to beneficial interests retained by us; also we as
servicer, subject to applicable contractual provisions, have sole discretion to
use our best commercial judgment in determining whether to sell or work out any
loans securitized through the securitization trust that become troubled.
Accordingly, following a securitization, the mortgage loans remain on our
consolidated balance sheets, and the securitization indebtedness replaces the
warehouse debt associated with the securitized mortgage loans. We record
interest income on the mortgage loans and interest expense on the securities
issued in the securitization over the life of the securitization, and do not
recognize a gain or loss upon completion of the securitization. We believe this
accounting treatment more closely matches the recognition of income with the
actual receipt of cash payments. This change has significantly impacted our
results of operations after July 6, 2001, compared to our results for periods
prior to July 6, 2001.
| |
Saxon
Capital, Inc. (1) |
SCI
Services, Inc. (predecessor) |
| |
December
31, |
| |
2004 |
2003 |
2002 |
2001 |
2000 |
| |
(in
thousands) |
|
Balance
Sheet Data: |
|
|
|
|
|
|
Mortgage
loan portfolio, net |
$5,990,310 |
$4,680,047 |
$3,572,246 |
$1,702,481 |
$103,954 |
|
Interest-only
residual assets |
— |
— |
— |
— |
298,415 |
|
Mortgage
servicing rights, net |
98,995 |
41,255 |
24,971 |
33,847 |
47,834 |
|
Servicing
related advances (2) |
113,129 |
98,588 |
102,558 |
101,645 |
30,847 |
|
Total
assets |
6,539,131 |
5,059,081 |
4,163,162 |
1,899,349 |
572,408 |
|
Warehouse
financing |
600,646 |
427,969 |
474,442 |
283,370 |
88,225 |
|
Securitization
financing |
5,258,344 |
4,237,375 |
3,347,251 |
1,326,660 |
— |
|
Total
liabilities |
5,920,202 |
4,714,035 |
3,876,816 |
1,647,351 |
228,871 |
|
Shareholders’
equity |
618,929 |
345,046 |
286,346 |
251,998 |
343,537 |
|
|
|
Saxon
Capital, Inc. (1) |
SCI
Services, Inc.
(predecessor) |
| |
|
For
the Year Ended December 31, |
|
|
|
|
|
|
|
|
|
2004 |
|
2003 |
|
2002 |
|
For
the Period July 6, 2001 to December 31, 2001 |
|
For
the Period January 1, 2001 to July 5, 2001 |
|
For
the Year Ended December 31, 2000 |
|
|
(dollars
in thousands, except per share data) |
Operating
Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income |
|
$ |
395,347 |
|
$ |
333,064 |
|
$ |
226,399 |
|
$ |
50,964 |
|
$ |
15,331 |
|
$ |
34,444 |
|
|
Interest
expense |
|
|
(155,805 |
) |
|
(123,303 |
) |
|
(87,068 |
) |
|
(23,457 |
) |
|
(11,524 |
) |
|
(24,875 |
) |
Net
interest income |
|
|
239,542 |
|
|
209,761 |
|
|
139,331 |
|
|
27,507 |
|
|
3,807 |
|
|
9,569 |
|
|
Provision
for mortgage loan losses |
|
|
(41,647 |
) |
|
(33,027 |
) |
|
(28,117 |
) |
|
(11,861 |
) |
|
(8,423 |
) |
|
(6,403 |
) |
Net
interest income after provision for mortgage loan losses |
|
|
197,895 |
|
|
176,734 |
|
|
111,214 |
|
|
15,646 |
|
|
(4,616 |
) |
|
3,166 |
|
Gain
on sale of mortgage assets |
|
|
3,500 |
|
|
2,533 |
|
|
365 |
|
|
— |
|
|
32,892 |
|
|
79,234 |
|
|
Servicing
income, net of amortization and impairment |
|
|
33,636 |
|
|
32,134 |
|
|
22,924 |
|
|
11,577 |
|
|
16,670 |
|
|
23,677 |
|
Total
net revenues |
|
|
235,031 |
|
|
211,401 |
|
|
134,503 |
|
|
27,223 |
|
|
44,946 |
|
|
106,077 |
|
General
and administrative, payroll and other expenses |
|
|
(142,446 |
) |
|
(109,756 |
) |
|
(90,293 |
) |
|
(37,467 |
) |
|
(43,798 |
) |
|
(70,236 |
) |
Impairment
of assets, net |
|
|
— |
|
|
— |
|
|
— |
|
|
—
|
|
|
(7,301 |
) |
|
(108,445 |
) |
|
Impairment
of goodwill |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
(44,963 |
) |
|
— |
|
|
Total
operating expenses |
|
|
(142,446 |
) |
|
(109,756 |
) |
|
(90,293 |
) |
|
(37,467 |
) |
|
(96,062 |
) |
|
(178,681 |
) |
Income
(loss) before taxes |
|
|
92,585 |
|
|
101,645 |
|
|
44,210 |
|
|
(10,244 |
) |
|
(51,116 |
) |
|
(72,604 |
) |
|
Income
tax benefit (expense) |
|
|
12,980 |
|
|
(36,509 |
) |
|
(16,833 |
) |
|
3,957 |
|
|
21,609 |
|
|
24,084 |
|
|
Net
income (loss) |
|
$ |
105,565 |
|
$ |
65,136 |
|
$ |
27,377 |
|
$ |
(6,287 |
) |
$ |
(29,507 |
) |
$ |
(48,520 |
) |
Basic
earnings per common share (3) |
|
$ |
3.04 |
|
$ |
2.28 |
|
$ |
0.97 |
|
$ |
(0.22 |
) |
$ |
(1.05 |
) |
$ |
(1.73 |
) |
Average
common shares outstanding (basic) |
|
|
34,702,370 |
|
|
28,518,128 |
|
|
28,103,695 |
|
|
28,050,100 |
|
|
28,050,100 |
|
|
28,050,100 |
|
Diluted
earnings per common share (3) |
|
$ |
2.89 |
|
$ |
2.16 |
|
$ |
0.94 |
|
$ |
(0.22 |
) |
$ |
(1.05 |
) |
$ |
(1.73 |
) |
Average
common shares outstanding (diluted) |
|
|
36,521,893 |
|
|
30,116,305 |
|
|
29,165,184 |
|
|
28,050,100 |
|
|
28,050,100 |
|
|
28,050,100 |
|
Dividends
declared per common share |
|
$ |
2.30 |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
|
— |
|
| |
Saxon
Capital, Inc. (1) |
SCI
Services, Inc.
(predecessor) |
| |
For
the Year Ended December 31, |
|
|
|
| |
2004 |
2003 |
2002 |
For
the Period
July
6, 2001 to December 31, 2001 |
For
the Period
January
1, 2001 to
July
5, 2001 |
For
the Year Ended December 31, 2000 |
|
(dollars
in thousands) |
|
Other
Data: |
|
|
|
|
|
|
|
Total
mortgage loan production (4) |
$3,764,628 |
$2,842,942 |
$2,484,074 |
$1,112,661 |
$1,220,575 |
$2,088,503 |
|
Wholesale
production (4) |
$1,500,303 |
$1,174,573 |
$1,034,278 |
$501,780 |
$463,607 |
$712,746 |
|
Retail
originations (4) |
$964,760 |
$762,657 |
$645,949 |
$252,819 |
$194,703 |
$233,753 |
|
Correspondent
production (4) |
$1,029,529 |
$905,712 |
$615,288 |
$358,062 |
$562,265 |
$1,142,004 |
|
Called
loans (4)(5) |
$270,036 |
— |
$188,559 |
— |
— |
— |
|
Mortgage
loans securitized |
$3,199,949 |
$2,650,167 |
$2,204,816 |
$1,352,698 |
$661,456 |
$2,098,659 |
|
Total
serviced assets at period end |
$20,165,942 |
$9,899,523 |
$7,575,560 |
$6,355,304 |
$6,286,078 |
$5,588,598 |
|
Average
principal balance per loan serviced at period end (6) |
$150 |
$127 |
$109 |
$96 |
$95 |
$93 |
|
Number
of retail branches at period end |
25 |
27 |
20 |
17 |
16 |
16 |
|
Average
number of wholesale account executives (7) |
128 |
132 |
121 |
106 |
105 |
99 |
|
Ratios: |
|
|
|
|
|
|
|
Average
equity to average assets (8) |
8.3% |
6.8% |
8.9% |
15.4% |
36.9% |
56.8% |
|
Return
on average equity (8) (9) |
21.9% |
20.6% |
10.2% |
(6.0)% |
(23.2)% |
(14.1)% |
|
Return
on average assets (8) (9) |
1.8% |
1.4% |
0.9% |
(0.9)% |
(8.6)% |
(8.0)% |
|
Asset
Quality Data - at period end
(Total
Servicing Portfolio): |
|
|
|
|
|
|
|
Total
seriously delinquent including real estate owned - at period end (10)
|
5.3% |
8.9% |
11.3% |
12.0% |
N/A |
10.1% |
|
Total
seriously delinquent excluding real estate owned - at period
end |
4.7% |
7.8% |
9.7% |
10.2% |
N/A |
8.7% |
|
Annual
losses on serviced portfolio as a percentage of total serviced assets - at
period end |
0.5% |
1.1% |
1.3% |
1.3% |
N/A |
0.8% |
|
Asset
Quality Data - at period end
(Owned
Portfolio): |
|
|
|
|
|
|
|
Total
seriously delinquent including real estate owned - at period end
(10) |
6.6% |
7.7% |
7.1% |
3.8% |
— |
— |
|
Total
seriously delinquent excluding real estate owned - at period
end |
5.8% |
6.9% |
6.4% |
3.6% |
— |
— |
|
Annual
losses on owned portfolio as a percentage of total owned assets - at
period end |
0.8% |
0.6% |
0.3% |
— |
— |
— |
________________
| (1) |
|
We
acquired all of the issued and outstanding capital stock of our
predecessor from Dominion Capital on July 6, 2001. |
| (2) |
|
During
2001, we changed our presentation of recording advances and recoveries
from securitizations from a net basis to a gross basis. |
| (3) |
|
Earnings
per common share for the periods prior to July 6, 2001 were calculated
based upon the assumption that the shares issued as of July 6, 2001
were
outstanding for all periods presented. |
| (4) |
|
Principal
balances only. |
| (5) |
|
Called
loans occur upon exercise of the clean-up call option by us, as servicer
or master servicer, of the securitized pools of our predecessor for which
Dominion
Capital retained residual interests. In some cases the rights to exercise
the call option, as well as the pool of called loans, may be owned by an
unaffiliated
third party. With respect to 2002, the clean-up call options in some
instances were held by us and in others were held by Dominion
Capital. |
| (6) |
|
Total
outstanding principal balance of loans serviced divided by number of loans
serviced. |
| (7) |
|
Average
account executives are calculated as a simple average over the time period
indicated. Includes area and regional sales management positions.
|
| (8) |
|
Average
equity and average assets are calculated as a simple average over the time
period indicated. |
| (9) |
|
Data
for incomplete years has been annualized. |
| (10) |
|
Seriously
delinquent is defined as loans that are 60 or more days delinquent,
foreclosed, REO, or held by a borrower who has declared bankruptcy and is
60
or more days contractually delinquent. |
| |
|
N/A Information
not available. |
Management’s
discussion and analysis of financial condition and results of operations
contained within this annual report on Form 10-K is more clearly understood when
read in conjunction with our consolidated financial statements and related notes
(see Item 8. “Consolidated Financial Statements and Supplementary Data”) and
other information included herein.
The
following sets forth the table of contents for this management’s discussion and
analysis of financial condition and results of operations.
Company
Overview
We are in
the business of originating, securitizing, and
servicing non-conforming mortgage loans, including sub-prime residential
mortgage loans. We operate through three business segments. These segments
are:
· Portfolio
Management, or our portfolio segment;
· Mortgage Loan Servicing, or our
servicing segment;
· Mortgage
Loan Operations, or our mortgage loan production segment;
Through
our taxable REIT subsidiary, Saxon Capital Holdings, Inc., and its subsidiaries,
which we refer to collectively as our taxable REIT subsidiaries, we originate or
purchase mortgage loans for our portfolio segment through our wholesale, retail,
and correspondent channels, which we refer to collectively as our “mortgage loan
production segment”. We earn most of our revenues from the interest income from
those mortgages through our portfolio segment and from servicing loans for other
companies through our servicing segment. We pay interest to finance our mortgage
loan portfolio and servicing advances and incur general and administrative
expenses to operate our business. We maintain
a provision for mortgage loan losses that may occur from
impaired mortgage loans that are in our portfolio. We fund
our mortgage loan originations through short-term warehouse lines of credit and
through repurchase facilities. These short-term facilities are replaced by
permanent financing when we securitize the loans. When our
qualified REIT subsidiaries securitize our mortgage loans, they structure those
transactions as financing transactions. As such, the mortgage loans and related
debt to finance those loans remain on our balance sheet.
Industry
Overview and Prospective Trends
Described
below are some of the marketplace conditions and prospective trends that may
impact our future results of operations.
According
to the MBAA website as of January 21, 2005, lenders in the United States
originated $2.9 trillion in single-family mortgage loans in 2004. Approximately
44% of the loan originations in 2004 were attributable to mortgage loan
refinancings by customers taking advantage of the decline in interest rates. As
of January 21, 2005, lenders in the United States are expected to originate
approximately $2.5 trillion in single-family mortgage loans in 2005. We believe
that the projected decline is largely attributable to a reduction in refinancing
of conforming loans as interest rates rise. Generally, we believe sub-prime
borrowers are not solely motivated by fluctuations in interest rates. Thus, we
do not expect the same level of decline in the non-conforming market, as
discussed in Item 1, “Business - Mortgage Loan Portfolio - Mortgage Loan
Portfolio by Borrower Purpose.”
The
non-conforming, residential mortgage industry has undergone rapid consolidation
in recent years. Today the industry is dominated by a small number of large
companies, with the top three mortgage lenders controlling a combined 27% of the
mortgage origination market as of December 31, 2003, up from 15% as of December
31, 1997. We expect this consolidation trend to continue in the future, as
market forces drive out weaker competitors. To compete effectively, we will be
required to maintain a high level of operational, technological and managerial
expertise, as well as an ability to attract capital at a competitive
cost.
The
non-conforming, residential mortgage industry is subject to extensive
regulation, supervision and licensing by federal, state and local governmental
authorities and our business is subject to various laws and judicial and
administrative decisions imposing requirements and restrictions on a substantial
portion of our operations. Changes to laws, regulations or regulatory policies
can have a significant adverse effect on our operations and profitably. For
example, proposed
state and federal legislation targeted at predatory lending could have the
unintended consequence of raising the cost or otherwise reducing the
availability of mortgage credit for non-prime borrowers. This could result in a
reduction of otherwise legitimate non-prime lending opportunities and is likely
to increase our legal and compliance costs.
Over the
last several years, the housing price index has increased faster than the
consumer price index and growth in personal income. We expect that this trend
will slow in the coming years. Over the long term, however, we anticipate that
housing appreciation will be positively correlated with both consumer price
inflation and growth in personal income. Rising housing values point to healthy
demand for purchase-money mortgage financing, increased average loan balances
and a reduction in the risk of loss on sale of foreclosed real estate in the
event a loan defaults. However, as housing values appreciate, prepayments of
existing mortgages tend to increase as borrowers look to realize the additional
equity in their homes. If our forecasts are incorrect and housing prices fall
dramatically, our future results of operations would be adversely
affected.
Revenues
Our
principal elements of revenues are interest income and prepayment penalty income
generated from our portfolio of non-conforming mortgage loans in our qualified
REIT subsidiaries. Additional components of revenues are gains on sale from the
sale of loans, and servicing income, all generated at our taxable REIT
subsidiaries.
In
general, the primary factors in our business that affect our revenues are
changes in interest rates and changes in the size of our mortgage loan portfolio
and servicing portfolio. Decreases in interest rates generally result in a
decrease in the interest rates we charge on the mortgage loans we originate, but
also result in growth in our mortgage loan portfolio. Decreases also lead to
increases in loan prepayments, which result in increases in prepayment penalty
income, but decrease servicing income. In addition, decreases in interest rates
reduce our cost to borrow, but because loan originations tend to rise during
periods of decreased interest rates, generally lead to increases in our
borrowings.
Conversely,
increases in interest rates generally result in an increase in the interest
rates we charge on the mortgage loans we originate. Increases in interest rates
also lead to decreases in loan prepayments, reducing prepayment penalty income,
but increasing servicing income. In addition, increases in interest rates
increase our cost to borrow but, because loan originations tend to decline
during periods of increased interest rates, generally lead to decreases in our
borrowings. Descriptions of certain components of our revenues are set forth
below.
Interest
Income. Interest
income primarily
represents interest earned on our owned
mortgage loan portfolio.
Components of interest income include the gross interest received on a mortgage
loan, less amortization of deferred costs to originate the loan, amortization of
premiums and discounts, and amortization of the net hedge loss on closed hedges.
We record
prepayment penalty income and contractual servicing fees on our owned mortgage
loan portfolio as interest income.
Prepayment penalty income is recorded when collected for loans in which a
borrower chose to prepay before a contractual time period. Contractual servicing
fees are recorded when collected.
Yield
adjustments include premiums and discounts on mortgage loans, net deferred
origination costs and nonrefundable fees.
Interest
expense. Interest
expense includes the interest and fees we pay on our warehouse lines, our
repurchase facilities, and under our securitizations, as well as the
amortization of premiums, discounts, bond issuance costs, and accumulated other
comprehensive income relating to cash flow hedging activity.
Provision
for mortgage loan losses. We
record provision for
mortgage loan losses on our mortgage loan portfolio, which includes securitized
loans and unsecuritized loans, for projected losses on current existing
delinquencies. See “ -
Critical Accounting Policies - Allowance for Loan Loss.”
Servicing
income, net of amortization and impairment.
Servicing income, net of amortization and impairment represents all contractual
and ancillary servicing revenues (primarily late fees and electronic payment
processing fees) for servicing third party loans.
Ancillary fees collected on our mortgage loan portfolio are also classified as
servicing income. Servicing income, net of amortization and impairment does not
include contractual servicing fees relating to our owned mortgage loan
portfolio, which are a component of interest income.
Prepayments of mortgage loans in our servicing portfolio result in our no longer
receiving servicing fees or ancillary fees from mortgage loans that are prepaid
and may cause us to experience impairment of our mortgage
servicing rights.
The
following table illustrates how our servicing income is presented on our
consolidated statements of operations:
| |
Recorded
in Servicing Income, Net |
Recorded
in Interest Income |
|
Third Party
Portfolio: |
|
|
|
Contractual
Fees |
X |
|
|
Ancillary
Fees |
X |
|
| |
|
|
|
Owned
Portfolio: |
|
|
|
Contractual
Fees |
|
X |
|
Ancillary
Fees |
X |
|
|
Prepayment
Fees |
|
X |
Expenses
Our
primary components of expenses are expected to be interest expense on our
warehouse lines and repurchase facilities and securitizations, general and
administrative expenses, and payroll and related expenses.
In
general, the primary factors in our business that lead to increased expenses are
the volume and credit mix of mortgage loans we originate or purchase, the number
of retail branches we operate, the number of sales representatives we employ,
the volume of third party servicing we acquire, the costs to comply with
governmental regulations, and the costs of being a public company. As our loan
production and loan portfolio increase we would generally expect to hire
additional employees and we would also expect our variable expenses to increase.
Also, we may incur additional marketing and advertising expenses in order to
achieve our production goals. We would also expect to incur higher expenses in
years where we open additional retail branches or new production centers, which
would result in increased office rent, equipment rent and insurance costs. There
are also increased cash requirements that are associated with being a public
company, such as investor relations’ responsibilities and expending the
resources necessary to ensure that we have met the requirements set forth by the
Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission and others by
hiring outside consultants and additional employees when required. From time to
time, we may also be required to upgrade existing computer systems and focus on
other beneficial projects, and during those periods we will experience increased
expenses. Descriptions of certain components of our expenses are set forth
below.
Payroll
and related expenses. Payroll
and related expenses include
salaries, benefits, payroll taxes, and severance. A portion
of these expenses, primarily commission and salary expense, are capitalized in
accordance with Statement of Financial Accounting Standards, or SFAS, No. 91,
“Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Costs of Leases,” as a direct cost for loan
origination. The deferral of these expenses occurs when the loan is originated
and then is recognized over the life of the loan.
General
and administrative expenses. General
and administrative expenses consist
primarily of office and equipment rent, insurance, telephone, license fees,
professional, travel and entertainment expenses, depreciation, and advertising
and promotional expenses.
Other
Data
In this
Management's Discussion and Analysis of Financial Condition and Results of
Operations, we present certain data that we consider helpful in understanding
our financial condition and results of operations. Descriptions of these
financial measures are set forth below.
Net
Interest Margin. Net
interest margin is calculated as the difference between our interest income and
interest expense divided by our average interest-earning assets. Average
interest-earning assets are calculated using a daily average balance over the
time period indicated.
Reconciliation
of trust losses and charge-offs. We
present a reconciliation of securitization trust losses and charge-offs because
management believes that it is meaningful to show both measures of losses since
it is a widely accepted industry practice to evaluate losses on a trust
level and the information is provided on a monthly basis to the investors in
each securitization. GAAP requires losses to be recognized immediately upon a
loan being transferred to REO, whereas a trust does not recognize a loss on REO
until the loan is sold. This causes a timing difference between charge-offs and
trust losses. In addition, the trust losses exclude losses resulting from
delinquent loan sales.
Reconciliation
of GAAP net income to estimated tax net income. As a
REIT, we are required to distribute at least 90% of our annual REIT taxable
income to shareholders. REIT taxable income is calculated under federal tax laws
in a manner that, in certain respects, differs from the calculation of
consolidated net income pursuant to GAAP. For example, items such as loan
production expenses, loan losses, and equity-based compensation expenses may
cause differences to arise between tax and GAAP income. REIT taxable income will
exclude the income of the REIT’s taxable REIT subsidiaries except to the extent
its taxable REIT subsidiary distributes income to the REIT as a
dividend.
Working
capital. It is
common business practice to define working capital as current assets less
current liabilities. We do not have a classified balance sheet and therefore
calculate our working capital using our own internally defined formula, which is
generally calculated as unrestricted cash and investments as well as
unencumbered assets that can be pledged against existing committed facilities
and converted to cash in five days or less.
REIT
Conversion
On
September 24, 2004, we completed our conversion to a REIT. The merger had no
effect on the consolidated financial statements, as this was a merger of
companies under common control. Use of the terms “we” or “our” in this section
refers to or include our applicable subsidiaries.
Pursuant
to the merger agreement, Old Saxon merged with and into Saxon Capital Holdings,
Inc., a wholly-owned subsidiary of New Saxon formed for the purpose of effecting
the REIT conversion, and New Saxon succeeded to and continued the operations of
Old Saxon, changing its name to “Saxon Capital, Inc.” At the effective time of
the merger, each outstanding share of Old Saxon common stock was converted into
the right to receive one share of New Saxon common stock and a cash payment of
$4.00. Our common stock is currently quoted on Nasdaq under the symbol “SAXN.”
New Saxon issued 17.0 million shares of its common stock in a public offering
that occurred simultaneously with the merger, resulting in $386.8 million in
gross proceeds, part of which was used to pay the cash portion of the merger
consideration.
We have
applied REIT rules for federal income tax and accounting purposes beginning at
the effective time of the merger. To qualify for tax treatment as a REIT, the
parent company must meet certain income and asset tests and distribution
requirements. Generally, we will not be subject to federal income tax at the
corporate level to the extent we distribute 90% of our taxable income to our
shareholders and comply with certain other requirements. Our
strategy is to accumulate
in our qualified REIT subsidiaries a portfolio of non-conforming mortgage loans
that we originate in our qualified REIT subsidiaries or taxable REIT
subsidiaries to produce stable net interest income and dividends to our
shareholders. We also sell loans in our taxable REIT subsidiaries and generate
origination fees and servicing income in those subsidiaries, enabling us to
increase our capital by retaining the after tax income in those subsidiaries,
subject to the limitations imposed by REIT tax rules.
With the
exception of the impact of taxes and dividends following the REIT conversion, we
expect that our historical results of operations will be comparable to our
results of operations following the REIT conversion.
We
experienced increased costs primarily related to additional staffing to ensure
compliance with REIT qualification rules in connection with the REIT conversion
in 2004. However, we expect the benefits of the conversion will compensate for
such increased costs.
Earnings
of our taxable REIT subsidiaries are taxed and retained in the subsidiaries as
retained earnings. To the extent that our taxable REIT subsidiaries do not
dividend these retained earnings to us, these earnings will not be distributed
as dividends to our shareholders. We anticipate that we will be able to grow
shareholder equity through the retained earnings of our taxable REIT
subsidiaries.
Revenue
Growth and Increased Expenses
In 2005,
we expect market interest rates to rise and competitive pressures to remain
intense. In addition, because of our intent to focus to some extent on higher
interest rates, lower credit grade products, the credit quality characteristics
of our mortgage loan production for 2005 may be lower than we experienced in
2004. As a result, we expect to earn higher interest rates on the loans we
originate in 2005 than the interest rates earned on loans we originated in 2004.
However, we may also experience more delinquencies and defaults, the risk of
which is typically greater with lower credit grade loans over time.
In 2005,
compared to 2004 and 2003, we expect our taxable REIT subsidiaries to continue
to increase the percentage of their contribution to our consolidated income,
while the growth of our portfolio slows as we sell lower-margin loans in whole
loan sales rather than retaining them in our portfolio. We anticipate selling
approximately five to ten percent of our first quarter 2005 production in whole
loan sales, and depending on market conditions, we may continue making whole
loan sales at this rate throughout the remainder of 2005. We also anticipate
that the REIT will fund more of its mortgage loans in its own name, which we
expect will be more efficient than acquiring these loans from our taxable REIT
subsidiaries.
In
addition, we intend to continue to grow our mortgage loan portfolio and
servicing portfolio, which will produce higher levels of net interest income,
increase our provision for mortgage loan losses, and produce higher levels of
servicing income. With our expected increase in our mortgage loan portfolio and
servicing portfolio in 2005, we expect to incur higher levels of payroll and
related expenses and general and administrative expenses compared to 2004 and
2003.
Management’s
Discussion and Analysis of Financial Condition and Results of Operations
discusses our consolidated financial statements, which have been prepared in
accordance with GAAP. The preparation of these consolidated financial statements
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities as of the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. On an
on-going basis, management evaluates its estimates and judgments. Management
bases its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates and the estimates will change under different
assumptions or conditions.
Critical
accounting estimates are defined as those that reflect significant judgments and
uncertainties and potentially result in materially different outcomes under
different assumptions and conditions. Our critical accounting estimates are
discussed below and consist of:
| |
· |
accounting
for net interest income; |
| |
· |
allowance
for loan loss; |
| |
· |
mortgage
servicing rights; |
| |
· |
accounting
for hedging activities; |
| |
· |
deferral
of direct loan origination fees and costs;
and |
| |
· |
accounting
for income taxes. |
Accounting
for Net Interest Income
Net
interest income is calculated as the difference between our interest income and
interest expense. Interest income on our mortgage loan portfolio is a
combination of accruing interest based on the outstanding balance and
contractual terms of the mortgage loans and the amortization of yield
adjustments using the interest method, principally the amortization of premiums,
discounts, and other net capitalized fees or costs associated with originating
our mortgage loans. These yield adjustments are amortized against interest
income over the lives of the assets using the interest method adjusted for the
effects of estimated prepayments. Management does not currently use the payment
terms required by each loan contract in the calculation of amortization. Because
we hold a large number of similar loans for which prepayments are probable, we
currently use a prepayment model to project loan prepayment activity based upon
loan age, loan type and remaining prepayment penalty coverage. Estimating
prepayments and estimating the remaining lives of our mortgage loan portfolio
requires management judgment, which involves consideration of possible future
interest rate environments and an estimate of how borrowers will behave in those
environments. Reasonableness tests are performed against past history, mortgage
asset pool specific events, current economic outlook and loan age to verify the
overall prepayment projection. If these mortgage loans prepay faster than
originally projected, GAAP requires us to write down the remaining
capitalized yield adjustments at a faster speed than was originally projected,
which would decrease our current net interest income.
Interest
expense on our warehouse and securitization financings is a combination of
accruing interest based on the contractual terms of the financing arrangements
and the amortization of premiums, discounts, bond issuance costs, and
accumulated other comprehensive income relating to cash flow hedging using the
interest method.
Mortgage
prepayments generally increase on our adjustable rate mortgages when fixed
mortgage interest rates fall below the then-current interest rates on
outstanding adjustable rate mortgage loans. Prepayments on mortgage loans are
also affected by the terms and credit grades of the loans, conditions in the
housing and financial markets and general economic conditions. We have sought to
minimize the effects caused by faster than anticipated prepayment rates by
lowering premiums paid to acquire mortgage loans and by purchasing and
originating mortgage loans with prepayment penalties. Those penalties typically
expire two to three years from origination. As of December 31, 2004,
approximately 76% of our mortgage loan portfolio had active prepayment penalty
features. We anticipate that prepayment rates on a significant portion of our
adjustable rate mortgage portfolio will increase as these predominately
adjustable rate loans reach their initial adjustments during 2004 and 2005 due
to the high concentration of two to three year hybrid loans we originated or
purchased during 2002 and 2003. The constant prepayment rate, or CPR, currently
used to project cash flows is 35 percent over twelve months. If prepayment
speeds increase to 50%, our net interest income would decrease by $47.6 million
due to the additional yield adjustment amortization. The following table
presents the effects on our net interest income related to changes in our yield
adjustment amortization for the year ended December 31, 2004 under various
prepayment rate scenarios. Actual prepayment penalty income is recorded as cash
is collected and is not recorded based on CPR assumptions. Therefore, in
instances where our CPR increases, we anticipate also having an increase in
prepayment penalty income.
|
|
|
|
Impact
on Net
Interest
Income |
|
Constant
Prepayment Rate: |
|
|
|
|
Increase
in CPR of 50% |
|
$ |
(47,577 |
) |
Increase
in CPR of 25% |
|
$ |
(25,036 |
) |
Decrease
in CPR of 25% |
|
$ |
23,842 |
|
Decrease
in CPR of 50% |
|
$ |
50,698 |
|
_______________
(1) The
constant prepayment rate, or CPR, means a prepayment assumption which represents
a constant assumed rate of prepayment each month relative to the then
outstanding principal balance of a pool of mortgage loans for the life of such
mortgage loans.
Allowance
for Loan Loss
The
allowance for loan loss is established through the provision for mortgage loan
losses, which is charged to earnings on a monthly basis. The accounting estimate
of the allowance for loan loss is considered critical as significant changes in
the mortgage loan portfolio, which includes both securitized and unsecuritized
mortgage loans, and/or economic conditions may affect the allowance for loan
loss and our results of operations. The assumptions used by management regarding
these key estimates are highly uncertain and involve a great deal of judgment.
Provisions
are made to the allowance for loan loss for currently impaired loans in the
outstanding mortgage loan portfolio. We define a mortgage loan as impaired at
the time the loan becomes 30 days delinquent under its payment terms.
Charge-offs to the allowance are recorded at the time of liquidation or at the
time the loan is transferred to REO. The allowance for loan loss is regularly
evaluated by management for propriety by taking into consideration factors such
as: changes in the nature and volume of the loan portfolio; trends in actual and
forecasted portfolio performance and credit quality, including delinquency,
charge-off and bankruptcy rates; and current economic conditions that may affect
a borrower’s ability to pay. An internally developed roll rate analysis, static
pool analysis and historical losses are the primary tools used in analyzing our
allowance for loan loss. Our roll rate analysis is defined as the historical
progression of our loans through the various delinquency statuses. Our static
pool analysis provides data on individual pools of loans based on year of
origination. These tools take into consideration historical information
regarding delinquency and loss severity experience and apply that information to
the portfolio and the portfolio’s basis adjustments. Loss severity is defined as
the total loss amount divided by the actual unpaid principal balance at the time
of liquidation. Total loss amounts include all accrued interest and interest
advances, fees, principal balances, all costs of liquidating and all other
servicing advances for taxes, property insurance, and other servicing costs
incurred and invoiced to us within 90 days following the liquidation date. If
actual results differ from our estimates, we may be required to adjust our
provision accordingly. Likewise, the use of different estimates or assumptions
could produce different provisions for loan losses. The table below presents the
impact on our allowance for loan loss if the assumptions utilized in our model
had been varied as follows:
| |
December
31, 2004 |
| |
($
in thousands) |
|
Allowance
for loan loss balance |
$37,310 |
| |
|
| |
Increase
(decrease) in allowance |
|
Delinquency: |
|
|
Increase
in delinquency of 10% |
$4,651 |
|
Increase
in delinquency of 25% |
$12,189 |
|
Decrease
in delinquency of 10% |
$(4,334) |
|
Decrease
in delinquency of 25% |
$(10,226) |
| |
|
|
Loss
severity: |
|
|
Increase
in loss severity of 10% |
$3,258 |
|
Increase
in loss severity of 25% |
$8,145 |
|
Decrease
in loss severity of 10% |
$(3,258) |
|
Decrease
in loss severity of 25% |
$(8,145) |
| |
|
|
Delinquency
and loss severity: |
|
|
Increase
in delinquency and loss severity of 10% |
$8,374 |
|
Increase
in delinquency and loss severity of 25% |
$23,382 |
|
Decrease
in delinquency and loss severity of 10% |
$(7,159) |
|
Decrease
in delinquency and loss severity of 25% |
$(15,815) |
The
following charts present the impact on the balance of the allowance for loan
loss based on the changes in the assumptions above:
The
allowance for loan losses was impacted in 2004 by increased loan production.
However, this loan production consisted primarily of a higher quality credit mix
than in previous years. As of December 31, 2004, our portfolio weighted average
median credit score was 617 compared to 610 at December 31, 2003. As a result,
the increase in allowance for loan losses related to our higher production was
partially offset by the effects of a higher credit grade portfolio. These
effects include lower delinquencies and lower loss severities. See additional
discussion in “- Provision for Mortgage Loan Losses”. As long as our credit mix
remains in this range, we expect delinquencies, loss severities and losses to be
lower than previously experienced. We are currently experiencing an average loss
severity of approximately 35% on our owned
portfolio, compared to a loss severity assumption of 41% currently utilized in
our loan loss allowance model. This difference in assumptions compared to actual
experience reflects the recent active refinance environment and significant
housing appreciation, both of which have resulted in lower loss severities in
our relatively unseasoned owned portfolio. Because loss severities typically
increase as a portfolio gets older and refinance activity is expected to
decrease in coming years, management expects our average loss severities to
increase and as such, believes that the assumptions used are the most
appropriate to determine our currently existing probable losses.
Mortgage
Servicing Rights
The
valuation of mortgage servicing rights, or MSRs, requires that we make estimates
of numerous market assumptions. Interest rates, prepayment speeds, servicing
costs, discount rates, and the payment performance of the underlying loans
significantly affect the fair value and the rate of amortization of MSRs. In
general, during periods of declining interest rates, the value of MSRs decline
due to increasing prepayments attributable to increased mortgage refinancing
activity.
The
carrying values of the MSRs are amortized in proportion to, and over the period
of, the anticipated net servicing income on a discounted basis. MSRs are
assessed periodically to determine if there has been any impairment to the
carrying value, based on the fair value as of the date of the assessment and by
stratifying the MSRs based on underlying loan characteristics, including the
date of the related securitization. We obtain quarterly independent valuations
for our MSRs. At December 31, 2004, key economic assumptions and the sensitivity
of the current fair value for the MSRs to immediate changes in those assumptions
were as follows:
| |
December
31, 2004 |
| |
($
in thousands) |
|
Book
value of MSRs |
$98,995 |
|
Fair
value of MSRs |
$155,059 |
|
Expected
weighted-average life (in years) |
3.87
|
|
Weighted
average constant prepayment rate (1) |
29
CPR |
|
Weighted
average discount rate |
15.66% |
| |
|
| |
Impact
on Fair Value at December 31, 2004 |
|
Constant
Prepayment Rate: |
|
|
Increase
in CPR of 20% |
$(23,757) |
|
Increase
in CPR of 25% |
$(29,006) |
|
Increase
in CPR of 50% |
$(52,039) |
|
Decrease
in CPR of 20% |
$29,471 |
|
Decrease
in CPR of 25% |
$37,974 |
|
Decrease
in CPR of 50% |
$89,909 |
| |
|
|
Discount
Rate: |
|
|
Using
a discount rate of 10% |
$23,395 |
|
Using
a discount rate of 12% |
$14,347 |
|
Using
a discount rate of 18% |
$(7,282) |
|
Using
a discount rate of 20% |
$(13,101) |
_______________
| (1) |
The constant prepayment rate, or CPR, means a
prepayment assumption which represents a constant assumed rate of
prepayment each month relative to the then outstanding principal balance
of a pool of mortgage loans for the life of such mortgage loans.
|
The
following charts present the impact on the fair value balance of the MSRs based
on the changes in the assumptions above:
Due to
subsequent changes in economic and other relevant conditions, the actual rates
of prepayments and defaults and the value of collateral generally differ from
our initial estimates, and these differences are sometimes material. If actual
prepayment and default rates were higher than those assumed, we would earn less
mortgage servicing income, which would adversely affect the value of the MSRs.
Significant changes in prepayment speeds, delinquencies, and losses may result
in impairment of most of our MSRs, and would be recorded in our consolidated
statements of operations.
The
valuation of MSRs was impacted primarily in 2004 by the purchases of $84.9
million of rights to service $11.5 billion of mortgage loans and by an increase
in prepayment speeds on certain aged third party servicing rights. As a result
of increased actual and future prepayment speed assumptions, we recorded a
permanent impairment of $0.8 million and a temporary impairment of $6.8 million
on our MSR’s. It is possible that we may experience a reversal of this temporary
impairment (in whole or in part) if there is a decrease in future prepayment
speed assumptions. For the valuation of the third party portion of our loan
servicing portfolio as of December 31, 2004 we utilized a prepayment speed
assumption of 29 CPR. The prepayment speed assumption used to value the
servicing rights is an average of the CPR over the remaining life of the
servicing rights, and is appropriate given the product mix of the third party
portfolio. Because the interest rate cycle we
have experienced has caused faster prepayment speeds and the expectation is for
higher interest rates and slower prepayment speeds, we believe that the
assumptions used are the most appropriate given the current market conditions,
to determine the valuation of our MSRs.
Accounting
for Hedging Activities
We
incorporate the use of derivative instruments to manage certain risks. We have
qualified for hedge accounting treatment for all of our derivative instruments,
which are accounted for as cash flow hedges. A key element to qualify for hedge
accounting is the maintenance of adequate documentation of the hedging
relationship and our risk management objective and strategy for undertaking the
hedge. To qualify, on the date a derivative instrument agreement is entered
into, we designate the derivative as a hedge of a forecasted transaction or of
the variability of cash flows to be paid related to a recognized liability.
Our
forecasted transaction is an asset-backed securitization, an essential element
in our business model. Historically, we have completed an asset-backed
securitization approximately three to four times a year. The
asset-backed market utilizes the swap curve as base interest rates when pricing
the type of debt securities we issue. As a result, we utilize swaps or
instruments that emulate swaps to minimize the interest rate risk over the life
of the mortgage financing cycle.
To
qualify for hedge accounting, we must demonstrate initially, and on an ongoing
basis, that our derivative instruments are expected and have demonstrated to be
highly effective at offsetting the designated risk. The determination of
effectiveness is the primary assumption and estimate used in accounting for our
hedge transactions. We consider the swap rate and Eurodollar prices used in our
assessment and measurement of effectiveness to be the most appropriate data
points to use given the characteristics of the derivative and hedged item. In
instances where we use swaps as a hedge, the swap rate is fixed and compared
monthly to the one-month London Inter-Bank Offered Rate, or LIBOR, index. The
payment of interest on our bonds issued in a securitization transaction is also
based on one-month LIBOR. Since our swaps and bond payments are based upon the
same index on the same reset day, the change in the cash flows of the swaps are
assumed by us to equal the change in cash flows of the hedgd items. Likewise,
when we use options as a hedge, such as caps and floors, the change in the cash
flows of the options are assumed to equal the change in cash flows of the hedged
item because these options are based on the LIBOR index. In the case where we
may use Eurodollar futures, the correlation calculation is calculated by
capturing historic swap rates and the corresponding Eurodollar prices, and then
calculating a financing rate, for the maturity deemed necessary. The impact of
market changes on the hedged item and the derivative are recorded over the
relevant hedging periods and correlation statistics are evaluated by performing
a regression analysis on a quarterly basis. Quarterly data points are selected
and used in the regression analysis to determine a correlation percentage. The
difference between a 100% correlation result (slope) and our actual correlation
percentage is used to calculate the ineffective portion related to the
Eurodollar futures, which is recorded primarily as expense in the Statement of
Operations. For the
year ended December 31, 2004, we recorded $0.1 million of expense related to
ineffectiveness of hedging activities, which approximated a 1% differential in
effectiveness. Although there is no way to predict this ineffectiveness during
each period, we expect there to be a certain amount of ineffectiveness ranging
between 2% and 6% when using Eurodollar futures given the inherent basis
differences. If this ineffectiveness had been 6%, we would have recorded
approximately $0.7 million of expense in the income statement.
The
effective portion is initially recorded in accumulated other comprehensive
income and is amortized into earnings monthly based on the projected cash flow
stream of the underlying hedged transaction, using certain prepayment
assumptions. At December 31, 2004, we had $5.8 million of unamortized hedge
position expense in accumulated other comprehensive income and $30.2 million of
basis adjustments on mortgage loans related to previous fair value hedging
activity. The CPR currently used to project cash flows is 35 percent over twelve
months, and is appropriate given the product mix of our mortgage loan portfolio.
If prepayment speeds increase by 50%, our amortization expense would increase by
$24.5 million. The following table presents the effects on our amortization
expense under various prepayment rate scenarios.
| |
Impact
on Amortization Expense for the Year Ended December 31,
2004 |
|
Constant
Prepayment Rate: |
|
|
Increase
in CPR of 50% |
$24,467 |
|
Increase
in CPR of 25% |
$12,791 |
|
Decrease
in CPR of 25% |
$(12,555) |
|
Decrease
in CPR of 50% |
$(26,573) |
_______________
| (1) |
The constant prepayment rate, or CPR, means a
prepayment assumption which represents a constant assumed rate of
prepayment each month relative to the then outstanding principal
balance of a pool of mortgage loans for the life of such mortgage
loans. |
If we had
been unable to qualify certain of our interest rate risk management activities
for hedge accounting, then the change in fair value of the associated derivative
financial instruments would have been reflected in current period earnings, but
the impact from the change in anticipated cash flows of the related liability
would not have, which would have created an earnings mismatch. The change in
fair value for the year ended December 31, 2004 that was recorded in accumulated
other comprehensive income was a gain of $1.6 million, and if we had not
qualified for hedge accounting this amount would have increased current period
earnings.
Deferral
of Direct Loan Origination Fees and Costs
We
collect certain nonrefundable fees associated with our loan origination
activities. In addition, we incur certain direct loan origination costs in
connection with these activities. The net of such amounts is recognized over the
life of the related loans as an adjustment of yield, as discussed above in the
section relating to our critical accounting estimate with respect to accounting
for net interest income.
The
amount of deferred nonrefundable fees is determined based on the amount of such
fees collected at the time of loan closing. We determine the amount of direct
loan origination costs to be deferred based on an estimate of the standard cost
per loan originated. The standard cost per loan is based on the amount of time
spent and costs incurred by loan origination personnel in the performance of
certain activities directly related to the origination of funded mortgage loans.
These activities include evaluating the prospective borrower’s financial
condition, evaluating and recording collateral and security arrangements,
negotiating loan terms, processing
loan documents and closing the loan. Management believes these estimates reflect
an accurate cost estimate related to successful loan origination efforts for the
year ended December 31, 2004 as defined by GAAP. Management evaluates its time
and cost estimates quarterly to determine if updates and refinements to the
deferral amounts are necessary. Updates would be considered necessary if it was
determined that the time spent and/or costs incurred related to performing the
above activities had significantly changed from the previous period. This
estimate is made for all loans originated by our wholesale and retail channels.
Correspondent production is not included, as we purchase these loans as closed
loans and therefore, loan origination costs related to these purchases are
recorded as incurred. In 2004, we deferred $7.0 million in net loan origination
costs and recorded net amortization of deferred loan origination costs of $3.2
million.
Accounting
for Income Taxes
Significant
management judgment is required in developing our provision for income taxes,
including the determination of deferred tax assets and liabilities and any
valuation allowances that might be required against the deferred tax asset. As
of December 31, 2004, we had not recorded a valuation allowance on our deferred
tax assets based on management’s belief that operating income will, more likely
than not, be sufficient to realize the benefit of these assets over time. The
evaluation of the need for a valuation allowance takes into consideration our
taxable income, current tax position, and estimates of taxable income in the
near term. The tax character (ordinary versus capital) and the carryforward
periods of certain tax attributes such as capital losses and tax credits must
also be considered. Significant judgment is required in considering the relative
impact of negative and positive evidence related to the ability to realize
deferred tax assets. In the event that actual results differ from these
estimates or if our current trend of positive taxable income changes, we may be
required to record a valuation allowance on our deferred tax assets, which could
have a material adverse effect on our consolidated financial condition and
results of operations. We recognize deferred tax assets if we believe that it is
more likely than not, given all available evidence, that all of the benefits of
the carryforward losses and other deferred tax assets will be realized.
Management believes that, based on the available evidence, it is more likely
than not that we will realize the benefit from our deferred tax
assets.
We have
sought to comply with the REIT provisions of the Internal Revenue Code for the
year ended December 31, 2004 and intend to continue to do so. Accordingly, we
expect to not be subject to federal or state income tax on net income that is
distributed to shareholders to the extent that our annual distributions to
shareholders are equal to at least 90% of our REIT taxable income (determined
without regard to the deduction for dividends paid and by excluding any net
capital gain) for a
given year and as long as certain asset, income and stock ownership tests are
met. In the event that we do not qualify as a REIT in any year, we will be
subject to federal income tax as a domestic corporation and the amount of our
after-tax cash available for distribution to our shareholders will be reduced.
However, our taxable REIT subsidiaries will be subject to federal and state
income tax and we intend to continue to employ the accounting policy described
above with respect to our taxable REIT subsidiaries.
Year
Ended December 31, 2004 versus Year Ended December 31, 2003
Overview. Net
income increased $40.5 million, or 62%, to $105.6 million for the year ended
December 31, 2004 from $65.1 million for the year December 31, 2003. The
increase was primarily the result of a decrease in our income tax expense and
increased net interest income due to growth in our mortgage loan portfolio,
partially offset by an increase in total operating expenses and provision for
mortgage loan losses. Due to the higher rated credit quality mix we originated
in 2004 and 2003, we continue to see lower weighted average coupons on our
mortgage loan portfolio, and we continue to experience lower delinquencies in
the 2004 and 2003 portfolios compared to the 2002 and 2001 portfolios. In
addition, marketplace perception that interest rates would increase in the near
future resulted in higher refinance activity, which generated higher prepayment
penalty income during 2004 compared to 2003. To the extent interest rates
continue to rise in 2005, we would expect an increase in the interest rates we
charge on the mortgage loans we originate, decreases in our loan prepayments,
and increases in our servicing income. In addition, because of our intent to
focus to some extent on higher interest rate, lower credit grade products, the
credit quality characteristics of our mortgage loan production may be lower than
we experienced in 2004. As a result, we expect to charge higher interest rates
on the loans we originate in 2005 than the interest rates earned on loans we
originated in 2004. However, we may also experience more delinquencies and
defaults over time, the risk typically associated with lower credit grade loans.
Revenues
Total
Net Revenues. Total
net revenues increased $23.6 million, or 11%, to $235.0 million for the year
ended December 31, 2004 from $211.4 million for the year ended December 31,
2003. The increase in total net revenues was due to an increase in net interest
income after provision for mortgage loan losses resulting from the continued
growth of our owned portfolio as well as an increase in prepayment penalty
income. Our servicing income, net of amortization and impairment, grew only 5%
for the year ended December 31, 2004 compared to the year ended December 31,
2003, primarily as a result of higher levels of amortization of our MSRs due to
a faster prepayment environment.
Interest
Income.
Interest income increased $62.2 million, or 19%, to $395.3 million for the year
ended December 31, 2004, from $333.1 million for the year ended December 31,
2003. The increase in interest income was due primarily to: (1) an increase in
gross interest income from growth in our mortgage loan portfolio, partially
offset by the impact of lower interest rates; (2) an increase in prepayment
penalty income resulting from an increase in the prepayments of mortgages held
in our owned portfolio; and (3) a decrease in the amortization of fair value
hedges. These increases were partially offset by an increase in amortization of
yield adjustments for the year ended December 31, 2004.
As shown
in the table below, for the year ended December 31, 2004 compared to the year
ended December 31, 2003, our interest income increased $67.6 million due to an
increase in the size of our mortgage loan portfolio, partially offset by a
decrease of $9.5 million as a result of declining interest rates on our mortgage
loan portfolio.
Rate/Volume
Table For the Year Ended December 31, 2004 Compared to the Year Ended December
31, 2003
| |
Year
Ended December 31, 2004 Compared to
Year
Ended December 31, 2003 |
| |
Change
in Rate |
Change
in Volume |
Total
Change in Interest Income |
|
($ in
thousands) |
|
Securitized
loans |
$(6,374) |
$54,798 |
$48,424 |
|
Warehouse
loans |
(1,604) |
13,257 |
11,653 |
|
Mortgage
bonds |
(1,557) |
(436) |
(1,993) |
|
Other |
— |
(24)
|
(24)
|
|
Total
|
$(9,535) |
$67,595
|
$58,060
|
|
Prepayment
penalty income |
— |
— |
4,223 |
| |
|
|
$62,283 |
The
increase in interest income correlates to the growth of our mortgage loan
portfolio. Our mortgage loan portfolio increased $1.3 billion, or 28%, to $6.0
billion as of December 31, 2004 from $4.7 billion as of December 31, 2003.
However, this growth was offset partially by the 64 basis point decrease in the
gross weighted-average coupon rate due to the increase in the credit grade of
our mortgage loan portfolio and the liquidation of higher weighted average
coupon loans. Our weighted-average credit score increased to 617 as of December
31, 2004, from 610 as of December 31, 2003. We anticipate that our gross
interest income in dollars will continue to grow as our mortgage loan portfolio
grows if interest rates rise. We also expect that our interest income may
increase in 2005 if we originate or purchase lower credit grade loans that
typically yield higher interest. See Item 1, “Business -- Mortgage Loan
Portfolio.”
Prepayment
penalty income increased
$4.2 million, or 13%, to $35.8 million for the year ended December 31, 2004 from
$31.6 million for the year ended December 31, 2003. The marketplace perception
that interest rates would begin to rise in the near future appears to have
contributed to the increase in prepayment penalty income earned, since mortgage
loan prepayments tend to increase when interest rates are expected to increase.
We expect that prepayment penalty income may decrease in 2005 if prepayments
slow. However, we also expect to generate higher interest income on the loans we
originate during a rising interest rate environment to offset this decline.
Effective July 1, 2003, government regulations related to the Alternative
Mortgage Transactions Parity Act were amended to restrict the ability of
state-chartered mortgage lenders to charge prepayment penalties on certain types
of mortgage loans. Management expects that these amendments also could reduce
our prepayment penalty income in future periods.
Amortization
expense of yield adjustments increased $0.6 million, or 2%, to $27.1 million for
the year ended December 31, 2004 from $26.5 million for the year ended December
31, 2003. This increase was predominantly caused by the amortization related to
the yield adjustments on loans originated during 2003 and 2004, which increased
due to the origination and purchase of more mortgage loans. This increase in
yield adjustments was offset by a decrease in our premiums paid on loans since
2001, mainly due to a significant increase in higher credit quality mortgage
loan production from 2002 to 2004. To the extent we begin to originate lower
credit grade loans in 2005, we would anticipate paying higher premiums for those
loans. We expect that the amortization of yield adjustments will continue to
increase in the future due to our anticipated mortgage loan portfolio growth,
and that generally our amortization of yield adjustments should increase as our
interest income increases. We also expect our amortization of yield adjustments
to fluctuate as prepayment speeds fluctuate in the future.
The
amortization expense of fair value hedges decreased $10.7 million, or 40%, to
$15.8 million for the year ended December 31, 2004 from $26.5 million for the
year ended December 31, 2003. The amortization of fair value hedges should
decline in future years as the existing balance of $30.2 million as of December
31, 2004 continues to decrease. We do not expect to use fair value hedges in the
future, as we now use cash flow hedging for all hedging
transactions.
The
following table presents the average yield on our interest-earning assets for
the years ended December 31, 2004, and 2003.
Interest
Income Yield Analysis For the Years Ended December 31, 2004 and
2003
| |
Year
Ended December 31, 2004 |
Year
Ended December 31, 2003 |
| |
Average
Balance |
Interest
Income |
Average
Yield |
Average
Balance |
Interest
Income |
Average
Yield |
| |
($
in thousands) |
|
Gross |
$5,182,719 |
$402,484 |
7.77% |
$4,214,186 |
$354,529 |
8.41% |
|
Less
amortization of yield adjustments (1) |
— |
(27,107) |
(0.52)% |
— |
(26,495) |
(0.63)% |
|
Less
amortization of fair value hedges |
— |
(15,813) |
(0.31)% |
— |
(26,530) |
(0.63)% |
| |
$5,182,719 |
$359,564 |
6.94% |
$4,214,186 |
$301,504 |
7.15% |
|
Add
prepayment penalty income |
— |
35,783 |
0.69% |
— |
31,560 |
0.75% |
|
Total
interest-earning assets |
$5,182,719 |
$395,347 |
7.63% |
$4,214,186 |
$333,064 |
7.90% |
_______________
(1) Yield
adjustments include premiums, discounts, net deferred origination costs and
nonrefundable fees.
Interest
Expense.
Interest expense increased $32.5 million, or 26%, to $155.8 million for the year
ended December 31, 2004 from $123.3 million for the year ended December 31,
2003. The table below presents the total change in interest expense from the
year ended December 31, 2003 to the year ended December 31, 2004, and the amount
of the total change that is attributable to increasing interest rates and an
increase in our outstanding debt related to an increase in our loan production.
Our interest expense increased $2.6 million as a result of higher interest rates
on our interest bearing liabilities and increased $29.9 million due to an
increase in our borrowings relating to an increase in our mortgage loan
production.
Rate/Volume
Table For the Year Ended December 31, 2004 Compared to the Year Ended December
31, 2003
| |
Year
Ended December 31, 2004 Compared to
Year
Ended December 31, 2003 |
| |
Change
in Rate |
Change
in Volume |
Total
Change in Interest Expense |
| |
($
in thousands) |
|
Securitization
financing |
$1,656 |
$27,161 |
$28,817
|
|
Warehouse
financing: |
|
|
|
|
Lines
of credit |
125 |
2,031 |
2,156 |
|
Repurchase
agreements |
798 |
1,441 |
2,239 |
|
Other |
3
|
(713) |
(710) |
|
Total
|
$2,582 |
$29,920 |
$32,502
|
As seen
in the table below, the increase in interest expense was primarily related to an
increase in the average balance of borrowings of $1.1 billion, or 26%, to $5.4
billion for the year ended December 31, 2004 from $4.3 billion for the year
ended December 31, 2003, as a result of the growth in our mortgage loan
portfolio. This interest expense increase was partially offset by the accretion
of yield adjustments for the year ended December 31, 2004 as well as a decrease
in the average yield on certain interest-bearing liabilities. The accretion of
yield adjustments decreased $10.2 million, or 31%, to $22.2 million for the year
ended December 31, 2004 from $32.4 million for the year ended December 31, 2003.
This was due to increased amortization of bond issuance costs as a result of
issuing more bonds.
The table
below presents the average yield on our interest-bearing liabilities for the
years ended December 31, 2004 and 2003.
Interest
Expense Yield Analysis For the Years Ended December 31, 2004 and
2003
| |
Year
Ended December 31, 2004 |
Year
Ended December 31, 2003 |
| |
Average
Balance |
Interest
Expense |
Average
Yield |
Average
Balance |
Interest
Expense |
Average
Yield |
| |
($
in thousands) |
|
Warehouse
financing |
$151,973 |
$4,057 |
2.67% |
$75,621 |
$1,901 |
2.51% |
|
Less
compensating balance credits (1) |
— |
(1,189) |
(0.78)% |
— |
(891) |
(1.17)% |
|
Net
warehouse financing |
$151,973 |
$2,868 |
1.89% |
$75,621 |
$1,010 |
1.34% |
| |
|
|
|
|
|
|
|
Repurchase
agreements |
332,517 |
7,251 |
2.18% |
263,320 |
5,012 |
1.90% |
| |
|
|
|
|
|
|
|
Securitization
financing: |
|
|
|
|
|
|
|
Gross |
4,884,442 |
162,284 |
3.32% |
3,937,608 |
142,365 |
3.62% |
|
Less
net accretion of yield adjustments (2) |
— |
(22,153) |
(0.45)% |
— |
(32,381) |
(0.82)% |
|
Add
amortization of cash flow hedges |
— |
101 |
— |
— |
1,431 |
0.03% |
|
Net
securitization financing: |
4,884,442 |
140,232 |
2.87% |
3,937,608 |
111,415 |
2.83% |
| |
|
|
|
|
|
|
|
Notes
payable |
18,011 |
1,443 |
8.00% |
25,000 |
2,000 |
8.00% |
|
Other
expenses |
— |
4,011 |
— |
— |
3,866 |
— |
|
Total
interest-bearing liabilities |
$5,386,943 |
$155,805 |
2.89% |
$4,301,549 |
$123,303 |
2.87% |
______________
|
(1) |
Compensating
balance credits represent the amount of credits against interest expense
placed on the value of balances held by our financial
institutions. |
|
(2) |
Yield
adjustments include premiums, discounts, bond issuance costs and
accumulated other comprehensive income relating to cash flow hedging
related to our bonds. |
Net Interest
Margin. Our net
interest margin decreased to 4.6% for the year ended December 31, 2004, from
5.0% for the year ended December 31, 2003. The decline in our net interest
margin was primarily attributable to an increase in the cost of our borrowings
due to an increase in one-month LIBOR, as well as our shift in credit mix to
loans with lower weighted average coupons and prepayments of higher coupon
loans. While there may be an immediate impact on our net interest margin due to
changes in one-month LIBOR, the impact of the anticipated changes in cash flows
for our hedges is included in other comprehensive income in shareholders’ equity
on our consolidated balance sheets and is recognized into earnings over the
expected life of the variable rate bonds. This may result in short-term
mismatches and changes in our borrowing costs and the effect of our hedges, but
over the term of the debt, the hedges should effectively protect the interest
margin. We expect, based on the current interest rate environment, that our
hedges will positively impact our net interest margin throughout 2005.
Provision
for Mortgage Loan Losses.
Provision for mortgage loan losses increased $8.6 million, or 26%, to $41.6
million for the year ended December 31, 2004, from $33.0 million for the year
ended December 31, 2003. The increase in the provision was primarily
attributable to an increase in delinquencies as the portfolio continues to age.
However, because our portfolio shifted in credit mix to a higher quality
portfolio in 2004 and 2003, expected future losses on 2003 and 2004 production
may decrease compared to 2001 and 2002 production. The improved credit
performance may lower the required future provision for mortgage loan losses. We
did not make any significant changes in our reserve methodologies or assumptions
during the years ended December 31, 2004 and 2003.
We saw a
decrease in delinquency rates and loan loss experience in our owned servicing
portfolio for loans originated in 2004 compared to loans originated in 2003 and
2002. We believe this is the result of the credit mix of the loans we originated
or purchased in 2004. Our weighted average median credit score rose to 621 for
the year ended December 31, 2004 from 606 for the year ended December 31, 2002;
loans with higher credit scores typically have lower frequency of foreclosure
and loss. The table below shows seriously delinquent outstanding principal
balances and cumulative charge-offs by securitization.
| |
December
31, |
| |
2004 |
2003 |
2004 |
2003 |
|
Seriously
Delinquent (1) Outstanding Principal Balance |
Cumulative
Charge-Offs |
| |
($
in thousands) |
|
2001
Securitizations |
$74,450 |
$118,120 |
$44,070 |
$27,661 |
|
2002
Securitizations |
124,739 |
172,842 |
31,582 |
12,992 |
|
2003
Securitizations |
95,312 |
59,924 |
7,509 |
433 |
|
2004
Securitizations |
79,312 |
— |
998 |
— |
|
Warehouse |
19,346 |
7,893 |
4,448 |
3,825 |
|
Total |
$393,159 |
$358,779 |
$88,607 |
$44,911 |
________________
(1) Seriously
delinquent is defined as loans that are 60 or more days delinquent, foreclosed,
REO, or held by a borrower who has declared bankruptcy and is 60 or more days
contractually delinquent.
Also, by
looking at the portfolio on a static pool basis, or each year’s production over
time, we are experiencing a decrease in overall losses on our 2004 and 2003
production as compared to our 2002 and 2001 production, as losses from
production in the earlier years were charged-off and replaced with loans of
higher credit quality. Loss severities have been increasing, which is expected
as aged REO properties begin to liquidate, even though property values are
presumed to increase. Because loss severities typically increase as the
portfolio gets older and refinance activity is expected to decrease, management
expects our average loss severities to increase.
The
following table sets forth information about the delinquency and loss experience
of our owned servicing portfolio and is followed by a reconciliation between
trust losses and charge-offs.
Delinquency
and Loss Experience Of Our Owned Portfolio
| |
December
31, |
| Total
Delinquencies and Loss Experience |
2004 |
2003 |
2002 |
|
($
in thousands) |
|
Total
outstanding principal balance (at period end) |
$5,950,965 |
$4,665,770 |
$3,505,255 |
|
Delinquency
(at period end): |
|
|
|
|
30-59
days: |
|
|
|
|
Principal
balance |
$290,525 |
$295,754 |
$209,600 |
|
Delinquency
percentage |
4.88% |
6.34% |
5.98% |
|
60-89
days: |
|
|
|
|
Principal
balance |
$83,225 |
$68,019 |
$68,263 |
|
Delinquency
percentage |
1.40% |
1.46% |
1.95% |
|
90
days or more: |
|
|
|
|
Principal
balance |
$51,767 |
$43,773 |
$37,685 |
|
Delinquency
percentage |
0.87% |
0.94% |
1.08% |
|
Bankruptcies
(1): |
|
|
|
|
Principal
balance |
$110,846 |
$94,524 |
$55,339 |
|
Delinquency
percentage |
1.86% |
2.03% |
1.58% |
|
Foreclosures: |
|
|
|
|
Principal
balance |
$121,571 |
$134,654 |
$78,910 |
|
Delinquency
percentage |
2.04% |
2.89% |
2.25% |
|
Real
estate owned (2): |
|
|
|
|
Principal
balance |
$49,699 |
$37,896 |
$22,878 |
|
Delinquency
percentage |
0.84% |
0.81% |
0.65% |
|
Total
seriously delinquent including real estate owned (3) |
$393,159 |
$358,779 |
$247,461 |
|
Total
seriously delinquent including real estate owned (3) |
6.61% |
7.69% |
7.06% |
|
Total
seriously delinquent excluding real estate owned |
$343,460 |
$320,883 |
$224,583 |
|
Total
seriously delinquent excluding real estate owned |
5.77% |
6.88% |
6.41% |
|
Net
losses on liquidated loans - trust basis (4) |
$46,725 |
$27,766 |
$8,844 |
|
Percentage
of trust basis losses on liquidated loans |
0.79% |
0.60% |
0.25% |
|
Loss
severity on liquidated loans (5) |
40.97% |
34.31% |
31.68% |
|
Charge-offs
(6) |
$45,769 |
$30,914 |
$14,097 |
|
Percentage
of charge-offs on liquidated loans |
0.77% |
0.66% |
0.40% |
________________
|
(1) |
Bankruptcies
include both non-performing and performing loans in which the related
borrower is in bankruptcy. Amounts included for contractually current
bankruptcies for the owned portfolio for December 31, 2004, 2003, and 2002
are $19.6 million, $15.2 million, and $12.4 million, respectively.
|
|
(2) |
When
a loan is deemed to be uncollectible and the property is foreclosed, it is
transferred to REO at net realizable value and periodically evaluated for
additional impairments. Net realizable value is defined as the property’s
fair value less estimated costs to sell. Costs of holding this real estate
and related gains and losses on disposition are credited or charged to
operations as incurred; and therefore, are not included as part of our
allowance for loan loss. |
|
(3) |
Seriously
delinquent is defined as loans that are 60 or more days delinquent,
foreclosed, REO, or held by a borrower who has declared bankruptcy and is
60 or more days contractually delinquent. |
|
(4) |
Net
losses on liquidated loans for our portfolio exclude losses relating to
sales of delinquent called loans purchased at a discount and certain
recoveries during 2004 and 2002 of $11.1 million and $12.6 million,
respectively. |
|
(5) |
Loss
severity is defined as the total loss amount divided by the actual unpaid
principal balance at the time of liquidation. Total loss amounts include
all accrued interest and interest advances, fees, principal balances, all
costs of liquidating and all other servicing advances for taxes, property
insurance, and other servicing costs incurred and invoiced to us within 90
days following the liquidation date. |
|
(6) |
Charge-offs
represent the losses recognized in our financial statements in accordance
with GAAP. See reconciliation of trust losses to charge-offs
below. |
Reconciliation
of Trust Losses and Charge-offs
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
| |
(in
thousands) |
|
Losses
- trust basis |
$46,725 |
$27,766 |
$8,844 |
|
Loan
transfers to real estate owned |
38,477 |
23,218 |
8,861 |
|
Realized
losses on real estate owned |
(37,869) |
(21,372) |
(7,255) |
|
Timing
differences between liquidation and claims processing |
(1,511) |
2,395 |
598 |
|
Loss
from delinquent loan sale applied to reserve |
359 |
250 |
1,368 |
|
Basis
adjustments applied against loss |
— |
(279) |
— |
|
Interest
not advanced on warehouse |
(353) |
(693) |
— |
|
Other |
(59) |
(371) |
1,681 |
|
Charge-offs
(1) |
$45,769 |
$30,914 |
$14,097 |
________________
(1) Charge-offs
represent the losses recognized in our financial statements in accordance with
GAAP.
Servicing
Income, Net of Amortization and Impairment.
Servicing income, net of amortization and impairment, increased $1.5 million, or
5%, to $33.6 million for the year ended December 31, 2004 from $32.1 million for
the year ended December 31, 2003. The increase in gross servicing income was
primarily the result of a higher average total servicing portfolio due to the
continued growth in our owned portfolio, which generates servicing income in the
form of ancillary fees, as well as the acquisition of additional third party
servicing rights. This increase was offset by an increase of $19.8 million of
amortization and impairment expense of MSRs for the year ended December 31,
2004, compared to the year ended December 31, 2003. The increase in MSR
amortization expense was due to increased prepayment speeds during 2004 as
compared to 2003, as well as increased servicing acquisitions and the use of
discounted projected net servicing income as opposed to undiscounted projected
net servicing income as a prospective change in estimate in the first quarter of
2004, which further accelerated amortization expense and was more consistent
with the underlying methods used to determine fair value. The increase in the
MSR impairment was due to increased prepayment speeds during the year ended
December 31, 2004. We expect our servicing income, net of amortization and
impairment, to increase as we grow our third party servicing portfolio. To the
extent prepayment speeds decline in the future, we would also anticipate a
decline in our amortization and impairment expense assuming a constant level in
our mortgage loan servicing portfolio. Information relating to our servicing
income is shown in the table below:
Servicing
Income For the Year Ended December 31, 2004 Compared to the Year Ended December
31, 2003
| |
Year
Ended December 31, |
| |
2004 |
2003 |
Variance
|
| |
($
in thousands) |
|
Average
third party servicing portfolio |
$8,015,875 |
$4,179,976 |
92% |
|
Average
owned portfolio |
$5,127,211 |
$4,103,386 |
25% |
|
Average
total servicing portfolio |
$13,143,086 |
$8,283,362 |
59% |
|
Gross
servicing income |
$60,844 |
$39,542 |
54% |
|
Amortization
and impairment |
$27,208 |
$7,408 |
267% |
| |
|
|
|
|
Servicing
fees - third party portfolio (1) (2) |
62 |
66 |
|
|
Amortization
- third party portfolio (1) |
24 |
17 |
|
|
Impairment
- third party portfolio (1) |
10 |
1 |
|
|
Other
servicing income - total servicing portfolio (1)(3) |
9 |
14 |
|
|
Servicing
income - total servicing portfolio (1) |
46 |
48 |
|
___________
| |
(1) |
Annualized
and in basis points. |
| |
(2) |
Includes
master servicing fees. |
| |
(3) |
Includes
primarily late fees, electronic processing fees, and tax service fee
expense. Ancillary fees are collected and recorded within other servicing
income for both the third party portfolio as well as the owned portfolio.
|
Expenses
Payroll
and Related Expenses. Payroll
and related expenses increased $16.0 million, or 27%, to $74.3 million for the
year ended December 31, 2004 from $58.3 million for the year ended December 31,
2003. Specifically:
| |
· |
Severance
expense increased $1.6 million, or 320%, to $2.1 million for the year
ended December 31, 2004 from $0.5 million for the year ended December 31,
2003. The severance expense increase was due to the resignation of our
President/Chief Operating Officer in June 2004 and the associated
provisions contained in his employment agreement relating thereto;
|
| |
· |
Executive
compensation plan expense increased $4.6 million, or 1,533%, to $4.9
million for the year ended December 31, 2004 from $0.3 million for the
year ended December 31, 2003 primarily due to the vesting of all
restricted stock units in connection with the REIT
conversion; |
| |
· |
Salary
expense increased $3.0 million, or 6%, to $49.4 million for the year ended
December 31, 2004 from $46.4 million for the year ended December 31, 2003,
primarily because we employed 1,279 predominantly full time employees as
of December 31, 2004, compared to1,188 as of December 31, 2003. This
increase in employees was due primarily to increased staffing necessary
for the third and fourth quarter 2004 servicing portfolio growth. The
increase in salary expense was also attributed to normal merit increases
granted year over year; |
| |
· |
Bonus
expense increased $4.0 million, or 69%, to $9.8 million for the year ended
December 31, 2004 from $5.8 million for the year ended December 31,
2003. |
| |
· |
Commission
expense increased $5.4 million, or 29%, to $23.9 million for the year
ended December 31, 2004 from $18.5 million for the year ended December 31,
2003. These increases were due primarily to increased mortgage loan
production during the year ended December 31,
2004; |
| |
· |
Deferred
payroll and related expenses, as they related to direct loan origination
costs, increased $5.0 million, or 20%, to $29.7 million for the year ended
December 31, 2004 from $24.7 million for the year ended December 31, 2003.
The increase was due primarily to an increase in mortgage loan production
during the year ended December 31, 2004. |
We expect
payroll and related expenses to continue to increase as we continue to grow our
staffing to support further loan production growth, third party servicing
acquisitions, and to ensure compliance with REIT qualification rules.
General
and Administrative Expenses. General
and administrative expenses increased $11.6 million, or 25%, to $57.4 million
for the year ended December 31, 2004, from $45.8 million for the year ended
December 31, 2003. The following factors contributed to the increase in general
and administrative expenses:
| |
· |
a
$0.9 million increase for the year ended December 31, 2004, compared to
the year ended December 31, 2003, in insurance expense relating to
increases in our directors’ and officers’ liability insurance coverage;
|
| |
· |
a
$1.3 million increase for the year ended December 31, 2004 compared to the
year ended December 31, 2003, in advertising expenses incurred for our
mortgage loan production segment; |
| |
· |
a
$0.6 million increase for the year ended December 31, 2004 compared to the
year ended December 31, 2003, in appraisal and credit report expenses,
primarily due to higher originations; |
| |
· |
a
$1.0 million increase for the year ended December 31, 2004 compared to the
year ended December 31, 2003, in temporary office assistance;
and |
| |
· |
a
$5.1 million increase for the year ended December 31, 2004 compared to the
year ended December 31, 2003, in increased consulting and auditing
services relating to Sarbanes-Oxley Act of 2002 and Securities and
Exchange Commission requirements. |
Income
Tax Benefit. We
recorded a $13.0 million tax benefit during 2004 that included the impact of the
structure and formation transactions related to our REIT conversion. The
primary driver of this benefit was that our dividends were in excess of our GAAP
earnings, which resulted in a tax benefit being recorded, as we will not be
subject to tax on the amount of dividends distributed. In addition, certain
deferred tax assets and liabilities will not be recognized going forward within
the REIT structure, and those items are reflected as a net tax benefit in the
tax provision. The write-off of these deferred items is a one-time benefit.
Reconciliation
of GAAP Net Income to Estimated Tax Net Income
| |
For
the Year Ended December 31, 2004 |
| |
($
in thousands) |
|
GAAP
pre -tax net income |
$92,585 |
|
Taxable
REIT subsidiary losses (1) |
26,691 |
|
Income
from securitized loans (2) |
8,351 |
|
Miscellaneous
other |
(731) |
|
Qualified
REIT taxable income |
$126,896 |
________________
| |
(1) |
The
taxable loss incurred in the taxable REIT subsidiaries during 2004 related
primarily to the exercise of the non-qualified stock options in connection
with the REIT conversion. |
| |
(2) |
Income
from securitized loans includes the following: (a) GAAP to tax income
differences on securitizations, (b) intercompany gains on transactions
between the qualified REIT subsidiary and taxable REIT subsidiary, and (c)
mark to market adjustments on loans prior to securitization for tax
purposes. |
Year
Ended December 31, 2003 Versus Year Ended December 31, 2002
Overview. Net
income increased $37.7 million, or 138%, to $65.1 million for 2003, from $27.4
million in 2002. The increase was primarily the result of growth in our mortgage
loan portfolio, partially offset by a decline in net interest income, and an
increase in servicing income, net of amortization and impairment during 2003.
The decline in net interest income largely reflected a shift in our mortgage
loan portfolio to a higher rated credit quality mix resulting from significant
mortgage refinancing activity, which resulted in a lower weighted average coupon
on our mortgage loan portfolio. This trend has benefited our provision for loan
losses. In addition, the higher refinance activity has generated higher
prepayment penalty income during 2003 compared with 2002.
Revenues
Total
net revenues. Total
net revenues increased $76.9 million, or 57%, to $211.4 million for the year
ended December 31, 2003, from $134.5 million for the year ended December 31,
2002. Our increase in total net revenues was due to an increase in net interest
income after provision for mortgage loan losses resulting from the continued
growth of our owned portfolio and an increase in our servicing
income.
Interest
Income.
Interest income increased $106.7 million, or 47%, to $333.1 million for 2003,
from $226.4 million for 2002. The increase in interest income was due primarily
to an increase in gross interest income from increases in loan production,
partially offset by the impact of lower interest rates, and an increase in
prepayment penalty income resulting from the declining interest rate
environment. These increases were partially offset by an increase in
amortization of basis adjustments and fair value hedges. As shown in the table
below, for the year ended December 31, 2003 as compared to 2002, our interest
income decreased $27.0 million as a result of a declining interest rate
environment and increased $133.7 million due to an increase in our mortgage loan
production.
Rate/Volume
Table For the Year Ended December 31, 2003 Compared to the Year Ended December
31, 2002
|
Change
from Year Ended December 31, 2002 to December 31, 2003 |
Change
in Rate |
Change
in Volume |
Total
Change in Interest Income |
| |
($
in thousands) |
|
Securitized
loans |
$(21,325) |
$131,153
|
$109,828
|
|
Warehouse
loans |
(3,716) |
834
|
(2,882) |
|
Mortgage
bonds |
(1,958) |
1,669
|
(289) |
|
Other |
— |
8
|
8
|
|
Total
|
$(26,999) |
$133,664
|
$106,665
|
The
growth in interest income was correlated to the expansion of our mortgage loan
portfolio. The mortgage loan portfolio increased 31% from $3.6 billion at
December 31, 2002 to $4.7 billion at December 31, 2003. However, this growth was
offset partially by the 64 basis point decrease in the gross weighted-average
coupon due to the declining interest rate environment experienced during 2003
and an increase in credit grade in our mortgage loan portfolio. New production
for the year ended December 31, 2003 had a weighted average coupon rate of
approximately 7.7% as compared to loans being removed from our portfolio at
approximately 9.0%. Our weighted-average credit score increased to 610 at
December 31, 2003 from 600 at December 31, 2002. See “Business - Mortgage Loan
Portfolio”.
Prepayment
penalty income increased $19.3 million, or 160%, to $31.6 million for 2003, from
$12.3 million for 2002. The declining interest rate environment in 2003
contributed to the increase in prepayment penalty income earned, since mortgage
loan prepayments tend to increase as interest rates decline.
Amortization
expense of yield adjustments increased $14.1 million, or 114%, to $26.5 million
for 2003, from $12.4 million for 2002. This increase was predominantly caused by
the amortization related to the yield adjustments on loans originated during
2003, which increased due to the origination and purchase of more mortgage
loans.
The
amortization expense of fair value hedges increased $20.7 million, or 357%, to
$26.5 million for 2003 from $5.8 million in 2002. The loss on our fair value
hedges increased significantly in 2002. During 2002, we had used a combination
of swaps and Eurodollar futures to manage the interest rate risk inherent in
financing our portfolio. The market value of these instruments can be volatile
and cause cash outlays in the event of declining rates, as seen in 2002. This
increase in loss resulted in a higher balance to amortize during
2003.
The
following table presents the average yield on our interest-earning assets for
the years ended December 31, 2003 and 2002, respectively.
Interest
Income Yield Analysis For the Year Ended December 31, 2003 Compared to the Year
Ended December 31, 2002
| |
Year
Ended December 31, 2003 |
Year
Ended December 31, 2002 |
| |
Average
Balance |
Interest
Income |
Average
Yield |
Average
Balance |
Interest
Income |
Average
Yield |
| |
($
in thousands) |
|
Gross |
$4,214,186 |
$354,529 |
8.41% |
$2,566,292 |
$232,350 |
9.05% |
|
Less
amortization of yield adjustments (1) |
— |
(26,495) |
(0.63)% |
— |
(12,447) |
(0.49)% |
|
Less
amortization of fair value hedges |
— |
(26,530) |
(0.63)% |
— |
(5,840) |
(0.23)% |
| |
$4,214,186 |
$301,504 |
7.15% |
$2,566,292 |
$214,063 |
8.33% |
|
Add
prepayment penalty income (2) |
— |
31,560 |
0.75% |
— |
12,336 |
0.48% |
|
Total
interest-earning assets |
$4,214,186 |
$333,064 |
7.90% |
$2,566,292 |
$226,399 |
8.81% |
_______________
| (1) |
Yield
adjustments include premiums, discounts, net deferred origination costs
and nonrefundable fees. |
|
(2) |
Previously
we recorded prepayment penalty income as a component of net servicing
income. We have reclassified prepayment penalty income earned on our owned
portfolio to interest income for all periods
presented. |
Interest
Expense.
Interest expense increased $36.2 million, or 42%, to $123.3 million for 2003,
from $87.1 million for 2002. The table below presents the total change in
interest expense from December 31, 2002 to 2003, and the amount of the total
change that was attributable to changes in interest rates and an increase in our
outstanding debt related to an increase in our loan production.
As shown
in the table below, for the year ended December 31, 2003 as compared to 2002,
our interest expense decreased $12.4 million as a result of a declining interest
rate environment and increased $48.6 million due to an increase in our
borrowings relating to an increase in our mortgage loan production.
Rate/Volume
Table For the Year Ended December 31, 2003 Compared to the Year Ended December
31, 2002
|
Change
from Year Ended December 31, 2002 to December 31, 2003 |
Change
in Rate |
Change
in Volume |
Total
Change in
Interest
Expense |
| |
($
in thousands) |
|
Securitization
financing |
$(10,780) |
$47,991
|
$37,211
|
|
Warehouse
financing: |
|
|
|
|
Lines
of credit |
(125) |
206
|
81
|
|
Repurchase
agreements |
(1,446) |
(311) |
(1,757) |
|
Other |
— |
700
|
700
|
|
Total
|
$(12,351) |
$48,586
|
$36,235
|
As seen
in the table below, this increase was primarily related to the average balance
of borrowings increasing 65% from $2.6 billion for the year ended December 31,
2002, to $4.3 billion for 2003, as a result of the growth in our mortgage loan
portfolio. This interest expense increase was partially offset by the accretion
of basis adjustments for the year ended December 31, 2003, as well as a decrease
in the average yield on interest-bearing liabilities resulting from declining
interest rates in 2003. The accretion of basis adjustments increased from $17.7
million in 2002 to $32.4 million in 2003, or 83%. This was due to increased bond
premiums associated with $2.4 billion of bonds issued during 2003 as a result of
our mortgage loan securitizations. The table below presents the average yield on
our interest-bearing liabilities for the years ended December 31, 2003 and 2002,
respectively.
Interest
Expense Yield Analysis For the Year Ended December 31, 2003 Compared to the Year
Ended December 31, 2002
| |
Year
Ended December 31, 2003 |
Year
Ended December 31, 2002 |
| |
Average
Balance |
Interest
Expense |
Average
Yield |
Average
Balance |
Interest
Expense |
Average
Yield |
| |
($
in thousands) |
|
Warehouse
financing |
$75,621 |
$1,901 |
2.51% |
$60,845 |
$1,888 |
3.10% |
|
Less
compensating balance credits (1) |
— |
(891) |
(1.17)% |
— |
(965) |
(1.58)% |
|
Net
warehouse financing |
75,621 |
1,010 |
1.34% |
60,845 |
923 |
1.52% |
| |
|
|
|
|
|
|
|
Repurchase
agreements |
263,320 |
5,012 |
1.90% |
276,634 |
6,733 |
2.43% |
| |
|
|
|
|
|
|
|
Securitization
financing: |
|
|
|
|
|
|
|
Gross |
3,937,608 |
142,365 |
3.62% |
2,279,536 |
93,293 |
4.09% |
|
Less
accretion of basis adjustments (2) |
— |
(32,381) |
(0.82)% |
— |
(17,707) |
(0.78)% |
|
Add
amortization (accretion) of cash flow hedges |
— |
1,431 |
0.03% |
— |
(1,382) |
(0.05)% |
|
Net
securitization financing: |
3,937,608 |
111,415 |
2.83% |
2,279,536 |
74,204 |
3.26% |
| |
|
|
|
|
|
|
|
Notes
payable |
25,000 |
2,000 |
8.00% |
25,000 |
2,000 |
8.00% |
|
Other
expenses |
— |
3,866 |
— |
— |
3,208 |
— |
|
Total
interest-bearing liabilities |
$4,301,549 |
$123,303 |
2.87% |
$2,642,015 |
$87,068 |
3.30% |
| |
|
|
|
|
|
|
_______________
|
(1) |
Compensating
balance credits represent the amount of credits against interest expense
placed on the value of balances held by our financial
institutions. |
|
(2) |
Basis
adjustments include premiums, discounts, bond issuance costs and
accumulated other comprehensive income relating to cash flow hedging
related to our bonds. |
Net
Interest Margin. For the
year ended December 31, 2003, our net interest margin was 5.0%, as compared to
5.4% for the year ended December 31, 2002. We experienced lower interest margin
during 2003 related to higher weighted average coupon collateral being replaced
by lower weighted average coupon collateral, higher prepayments speeds, higher
credit quality production, and increased amortization of our hedge positions.
Provision
for Mortgage Loan Losses.
Provision for mortgage loan losses increased $4.9 million, or 17%, to $33.0
million for 2003, from $28.1 million for 2002. This increase was a result of an
increase in delinquent loan balances due to the aged portion of our mortgage
loan portfolio. However, our provision for mortgage loan losses did not increase
at the same rate as our mortgage loan portfolio due to the improved credit
quality of our originations in 2003 compared to 2002, which directly impacted
our delinquency rates. Our mortgage loan portfolio’s weighted average median
credit score increased to 610 as of December 31, 2003 from 600 as of December
31, 2002. We did not make any significant changes in our reserve methodologies
or assumptions during the years ended December 31, 2003 and 2002.
We saw a
slight increase in delinquency rates and loan loss experience in our owned
mortgage loan portfolio in 2003 by year of origination, or vintage, due to the
aging and growth of the portfolio.
The
following table sets forth information about the delinquency and loss experience
of our owned mortgage loan portfolio and is followed by a reconciliation between
trust losses and charge-offs.
Delinquency
and Loss Experience Of Our Owned Portfolio
| |
December
31, |
| |
2003 |
2002 |
2001
(1) |
|
Total
Delinquencies and Loss Experience |
Owned
Portfolio |
| |
($
in thousands) |
|
Total
outstanding principal balance (at period end) |
$4,665,770 |
$3,505,255 |
$1,665,060 |
|
Delinquency
(at period end): |
|
|
|
|
30-59
days: |
|
|
|
|
Principal
balance |
$295,754 |
$209,600 |
$133,261 |
|
Delinquency
percentage |
6.34% |
5.98% |
8.00% |
|
60-89
days: |
|
|
|
|
Principal
balance |
$68,019 |
$68,263 |
$22,202 |
|
Delinquency
percentage |
1.46% |
1.95% |
1.33% |
|
90
days or more: |
|
|
|
|
Principal
balance |
$43,773 |
$37,685 |
$9,153 |
|
Delinquency
percentage |
0.94% |
1.08% |
0.55% |
|
Bankruptcies
(2): |
|
|
|
|
Principal
balance |
$94,524 |
$55,339 |
$7,332 |
|
Delinquency
percentage |
2.03% |
1.58% |
0.44% |
|
Foreclosures: |
|
|
|
|
Principal
balance |
$134,654 |
$78,910 |
$24,308 |
|
Delinquency
percentage |
2.89% |
2.25% |
1.46% |
|
Real
Estate Owned: |
|
|
|
|
Principal
balance |
$37,896 |
$22,878 |
$3,578 |
|
Delinquency
percentage |
0.81% |
0.65% |
0.21% |
|
Total
Seriously Delinquent including real estate owned (3) |
7.69% |
7.06% |
3.81% |
|
Total
Seriously Delinquent excluding real estate owned |
6.88% |
6.41% |
3.59% |
|
Net
losses on liquidated loans - trust basis (4) (5) |
$27,766 |
$8,844 |
$20 |
|
Charge-offs
(5) (6) |
$30,914 |
$14,097 |
$1,315 |
|
Percentage
of trust basis losses on liquidated loans |
0.60% |
0.25% |
— |
|
Loss
severity on liquidated loans (7) |
34.31% |
31.68% |
4.79% |
________________
(1) We began
structuring our securitizations as financing transactions beginning July 6,
2001; therefore, there were no portfolio balances before July 6,
2001.
(2) Bankruptcies
include both non-performing and performing loans in which the related borrower
is in bankruptcy. Amounts included for contractually current bankruptcies for
the owned portfolio for December 31, 2003, 2002, and 2001 are $15.2 million,
$12.4 million, and $2.7 million, respectively.
(3) Seriously
delinquent is defined as loans that are 60 or more days delinquent, foreclosed,
REO, or held by a borrower who has declared bankruptcy and is 60 or more
days contractually delinquent.
(4) Net
losses on liquidated loans for our portfolio exclude losses of $12.6 million
relating to sales of delinquent called loans purchased at a discount and certain
recoveries during 2002.
(5) Amounts
are for the year ended December 31, 2003, 2002, and 2001,
respectively.
(6) Charge-offs
represent the losses recognized in our financial statements in accordance with
GAAP. See reconciliation of trust to charge-offs below.
(7) Loss
severity is defined as the total loss amount divided by the actual unpaid
principal balance at the time of liquidation. Total loss amounts include all
accrued interest and interest advances, fees, principal balances, all costs of
liquidating and all other servicing advances for taxes, property insurance, and
other servicing costs incurred and invoiced to us within 90 days following the
liquidation date.
Reconciliation
of Trust Losses and Charge-offs
| |
For
the Years Ended December 31, |
|
|
2003 |
2002 |
2001 |
| |
($
in thousands) |
|
Losses
- trust basis |
$27,766 |
$8,844 |
$20 |
|
Loan
transfers to real estate owned |
23,218 |
8,861 |
893 |
|
Realized
losses on real estate owned |
(21,372) |
(7,255) |
— |
|
Timing
differences between trust and financial |
2,395 |
598 |
— |
|
Loss
from delinquent loan sale applied to reserve |
250 |
1,368 |
685 |
|
Basis
adjustments applied against loss |
(279) |
— |
— |
|
Interest
not advanced on warehouse |
(693) |
— |
— |
|
Other |
(371) |
1,681 |
(283) |
|
Charge-offs |
$30,914 |
$14,097 |
$1,315 |
________________
(1) Charge-offs
represent the losses recognized in our financial statements in accordance with
GAAP.
Servicing
Income, Net of Amortization and Impairment.
Servicing income, net of amortization and impairment, increased $9.2 million, or
40%, to $32.1 million for 2003, from $22.9 million for 2002. The increase in
gross servicing income of $1.1 million was primarily the result of a higher
average total servicing portfolio for the year ended December 31, 2003 due to
the continued growth in our owned portfolio, which generates servicing income in
the form of ancillary fees, as well as the acquisition of additional third party
servicing. We also experienced a decrease of $8.1 million of amortization and
impairment expense of MSRs for the year ended December 31, 2003 as compared to
the year ended December 31, 2002. In 2003, we began using a third party source
to determine our anticipated future cash flows in order to calculate
amortization. The decrease in MSR amortization was due to the aging of the
associated third party loan portfolio as well as the timing of our acquisition
of new purchases during 2003, while the decrease in the MSR impairment was due
to the expectation that prepayment speeds will decrease in 2004. Information
relating to our servicing income is shown in the table below:
Servicing
Income For the Year Ended December 31, 2003 Compared to the Year Ended December
31, 2002
| |
Year
Ended December 31, |
|
| |
2003 |
2002 |
%
Variance |
| |
($
in thousands) |
|
|
Average
third party servicing portfolio (1) |
$4,179,976 |
$4,444,150 |
(6)% |
|
Average
owned portfolio (1) |
$4,103,386 |
$2,521,282 |
63% |
|
Average
total servicing portfolio (1) |
$8,283,362 |
$6,965,432 |
19% |
|
Gross
servicing income |
$39,542 |
$38,154 |
4% |
|
Amortization
and impairment |
$7,408 |
$15,230 |
(51)% |
| |
|
|
|
|
Servicing
fees - third party portfolio (2) (32) |
66 |
59 |
|
|
Amortization
- third party portfolio (2) |
17 |
30 |
|
|
Impairment
- third party portfolio (2) |
1 |
4 |
|
|
Other
servicing income - total servicing portfolio (2)(4) |
14 |
17 |
|
|
Servicing
income - total servicing portfolio (2) |
48 |
55 |
|
___________
| |
(1) |
Average portfolio balances for 2003 and 2002 were
computed using a daily average and a simple average,
respectively. |
| |
(2) |
Annualized and in basis points. |
|
(3) |
Includes
master servicing fees. |
| |
(4) |
Includes
primarily late fees, electronic processing fees, and tax service fee
expense. Ancillary fees are collected and recorded within other servicing
income for both the third party portfolio as well as the owned
portfolio. |
Total
expenses increased $19.5 million, or 22%, to $109.8 million for 2003, from $90.3
million for 2002. The increase was due primarily to the growth in our mortgage
loan production and total servicing portfolio.
Payroll
and Related Expenses. Payroll
and related expenses increased $7.9 million, or 16%, to $58.3 million for 2003
from $50.4 million for 2002. Specifically, salary expense increased 17% from
$37.9 million in 2002 to $44.4 million in 2003, bonus expense increased 14% from
$5.1 million in 2002 to $5.8 million in 2003, and commission expense increased
14% from $16.2 million in 2002 to $18.5 million in 2003. These amounts primarily
increased because of the 14% increase in average employees from 2002 to 2003,
from an average of 996 to 1,134 employees. The increase in salary expense was
also attributed to the accrual of $1.4 million for the settlement of a lawsuit
brought under the federal Fair Labor Standards Act in January 2003, and the
normal merit increases granted for the year. Salary expense was partially offset
by a decrease in severance expense of $1.0 million for 2003 as compared to 2002.
Deferred
payroll and related expenses increased $4.7 million, or 24%, to $24.7 million in
2003 from $20.0 million in 2002, mainly due to an increase in production and an
increase in our net cost to produce during 2003.
We
employed 1,188 predominantly full time employees as of December 31, 2003,
compared to 1,077 predominantly full time employees as of December 31, 2002, an
increase of 10%.
General
and Administrative Expenses. General
and administrative expenses increased $5.5 million, or 14%, to $45.8 million for
2003, from $40.3 million for 2002. The following factors contributed to the
increase in general and administrative expenses in 2003 compared to 2002:
| |
· |
$1.9
million increase in advertising expense, $0.3 million increase in training
expense, and $0.7 million increase in appraisal and other miscellaneous
funding expenses driven by an increase in mortgage loan fundings.
|
| |
· |
$0.5
million increase in rent expense, $0.3 million increase in equipment lease
expense and maintenance agreement expense, $0.1 million increase in
depreciation expense, and $0.4 million increase in employee relations,
employee training, and various office expenses associated with opening and
operating additional retail branches. |
| |
· |
$1.2
million increase in insurance expense relating to increases in our
directors and officers liability insurance.
|
| |
· |
$1.5
million increase in professional and consulting services direct expense
generally related to increased consulting, legal and accounting services
relating to Sarbanes-Oxley Act of 2002 and Securities and Exchange
Commission requirements and services in connection with funding projects
and our proposed REIT conversion. |
| |
· |
$0.3
million increase in direct expenses related to the completion of our
servicing system conversion during 2003. |
| |
· |
$1.0
million increase in litigation expense as a result of the settlement of
four lawsuits in 2003. |
Income
Taxes. We
experienced a 35.9% effective tax rate for the year ended December 31, 2003,
compared to a 38.1% effective tax rate for the year ended December 31, 2002. On
January 1, 2003, we elected REIT status for one of our subsidiaries, which
created a $3.2 million net state tax benefit and resulted in a lower effective
tax rate for 2003.
We
operate our business through three core business segments: portfolio, servicing,
and mortgage loan production. All segments except the portfolio segment are
operated by our taxable REIT subsidiaries. In this section, we discuss
performance and results of our business segments for the years ended December
31, 2004, 2003, and 2002. See Note 21 to our audited consolidated financial
statements for additional information about the results of our business
segments.
Portfolio
Segment
The
portfolio segment uses our equity capital and borrowed funds to invest in our
mortgage loan portfolio, which produces net interest income. Further details
regarding our mortgage loan portfolio are discussed in Item 1, “Business -
Mortgage Loan Portfolio.” We evaluate the performance of our portfolio segment
based on total net revenues. Total net revenues for the portfolio segment
increased $34.5 million, or 25%, to $171.7 million for the year ended December
31, 2004 from $137.2 million for the year ended December 31, 2003. The increase
in total net revenues was due to an increase in net interest income after
provision for mortgage loan losses resulting from the continued growth of our
owned portfolio as well as an increase in prepayment penalty
income.
Servicing
Segment
The
servicing segment services loans, seeking to ensure that loans are repaid in
accordance with their terms. We evaluate the performance of our servicing
segment based on servicing income, net of amortization and impairment; cost to
service a loan; and delinquency levels as measures of the performance of the
segment. We believe these measures assist investors by allowing them to evaluate
the performance of our servicing segment. The following discussion highlights
changes in our servicing segment for the periods indicated.
Our
Mortgage Loan Servicing Portfolio
In
addition to servicing mortgage loans that we originate or purchase through our
taxable REIT subsidiaries and retain in our portfolio, we also service mortgage
loans for other lenders and investors. For the year ended December 31, 2004, we
purchased the rights to service $11.5 billion of mortgage loans.
Our loan
servicing portfolio as of December 31, 2004 is summarized below:
| |
Number
of Loans |
Principal
Balance |
Percent
of Total |
Average
Loan Balance |
| |
($
in thousands) |
|
Owned
Portfolio: |
|
|
|
|
|
Saxon
Capital, Inc. (1) |
42,8177 |
$5,950,9655 |
30% |
$1399 |
| |
|
|
|
|
|
Third
Party Servicing: |
|
|
|
|
|
Greenwich
Capital, Inc. |
57,8922 |
9,325,1888 |
|
1611 |
|
Credit
Suisse First Boston |
17,7977 |
2,985,2900 |
|
1688 |
|
Dominion
Capital |
8,5822 |
603,2822 |
|
700 |
|
Barclays
Bank, PLC. |
6,1188 |
1,244,5699 |
|
2033 |
|
Dynex
Capital, Inc. |
3833 |
34,2377 |
|
899 |
|
Fannie
Mae |
2477 |
13,8699 |
|
566 |
|
Other
investors |
3033 |
8,5422 |
|
288 |
|
Total
third party servicing |
91,3222 |
14,214,9777 |
70% |
1566 |
|
Total |
134,1399 |
$20,165,9422 |
|
$1500 |
_________________
| (1) |
Includes
loans we originated and purchased since July 6,
2001. |
Our
mortgage loan servicing portfolio, including loans recorded on our consolidated
balance sheets, increased $10.3 billion, or 104%, to $20.2 billion as of
December 31, 2004, from $9.9 billion as of December 31, 2003. The increase was
due primarily to the origination and purchase of $3.8 billion of mortgage loans
as well as the acquisition of servicing rights related to $11.5 billion of
mortgage loans owned by non-affiliated companies during 2004. This increase was
partially offset by prepayments and losses totaling $5.3 billion.
We
believe we can continue to increase our servicing portfolio because competition
in the non-conforming mortgage loan industry has been adversely affected by
limited access to capital, lower than anticipated performance of seasoned
portfolios, and industry consolidation. Competitors with limited access to
capital have shifted their operations to selling loans, along with the related
servicing rights, or have entered into strategic alliances with investment banks
to increase their liquidity and access to the capital markets. This has resulted
in an increasing number of asset-backed securities being issued by entities that
do not perform servicing, which is presenting opportunities for us to increase
the size of our portfolio of loans serviced for third parties. We anticipate
purchasing third party servicing rights for an additional $8.6 billion of
mortgage loans during 2005, of which $1.3 billion were purchased through
February 2005 for approximately $9.8 million.
We
include all costs to service mortgage loans in our owned portfolio and our third
party servicing portfolio within the servicing segment. We reduced our cost to
service to 23 basis points for the year ended December 31, 2004, from 26 basis
points for the year ended December 31, 2003 due to an increase in our overall
servicing portfolio and credit quality of the owned portfolio, as well as a
continued focus on operating efficiencies. Our servicing expenses increased $3.0
million during the fourth quarter of 2004 relating to increased staffing to
support expected future growth and expenses incurred to set up imaged
files. We expect to see further reductions in our cost to service as we continue
to grow our mortgage loan servicing portfolio in 2005.
Our
Delinquency and Loss Experience - Total Servicing
Portfolio
We
experienced a decline in seriously delinquent accounts for our total servicing
portfolio to 5.26% for the year ended December 31, 2004 from 8.89% for the year
ended December 31, 2003, and from 11.25% for the year ended December 31, 2002.
This was mainly a result of the higher credit quality of new production since
2001, as well as the higher credit quality of our additional third party
purchases since 2002, and the volume of recent third party purchases. Higher
delinquencies on our third party servicing portfolio will negatively impact our
servicing income and the fair value of our MSRs, and cause us to pay more in
servicing advances. The following tables set forth information about the
delinquency and loss experience of the mortgage loans we service (which are
primarily loans we have originated or purchased and that have been or will be
securitized) for the periods indicated.
| |
December
31, |
| |
2004 |
2003 |
2002 |
|
Total
Delinquencies and Loss Experience (1) |
Total
Servicing Portfolio |
| |
($
in thousands) |
|
Total
outstanding principal balance (at period end) |
$20,165,942 |
$9,899,523 |
$7,575,560 |
|
Delinquency
(at period end): |
|
|
|
|
30-59
days: |
|
|
|
|
Principal
balance |
$956,478 |
$605,980 |
$504,229 |
|
Delinquency
percentage |
4.74% |
6.12% |
6.66% |
|
60-89
days: |
|
|
|
|
Principal
balance |
$247,863 |
$138,253 |
$160,058 |
|
Delinquency
percentage |
1.23% |
1.40% |
2.11% |
|
90
days or more: |
|
|
|
|
Principal
balance |
$172,124 |
$96,388 |
$110,260 |
|
Delinquency
percentage |
0.85% |
0.97% |
1.46% |
|
Bankruptcies
(2): |
|
|
|
|
Principal
balance |
$279,331 |
$300,282 |
$277,447 |
|
Delinquency
percentage |
1.39% |
3.03% |
3.66% |
|
Foreclosures: |
|
|
|
|
Principal
balance |
$314,253 |
$298,658 |
$245,069 |
|
Delinquency
percentage |
1.56% |
3.02% |
3.23% |
|
Real
estate owned: |
|
|
|
|
Principal
balance |
$107,939 |
$107,202 |
$118,960 |
|
Delinquency
percentage |
0.54% |
1.08% |
1.57% |
|
Total
seriously delinquent including real estate owned (3) |
$1,061,368 |
$880,242 |
$851,975 |
|
Total
seriously delinquent including real estate owned (3) |
5.26% |
8.89% |
11.25% |
|
Total
seriously delinquent excluding real estate owned |
$953,429 |
$773,040 |
$733,015 |
|
Total
seriously delinquent excluding real estate owned |
4.73% |
7.81% |
9.68% |
|
Net
losses on liquidated loans - trust basis (4) |
$103,871 |
$107,646 |
$94,683 |
|
Percentage
of trust basis losses on liquidated loans |
0.52% |
1.09% |
1.25% |
|
Loss
severity on liquidated loans (5) |
46.18% |
42.03% |
39.46% |
__ ______________
| (1) |
Includes all loans we service. |
| (2) |
Bankruptcies include both non-performing and
performing loans in which the related borrower is in bankruptcy. Amounts
included for contractually current bankruptcies for the total servicing
portfolio for December 31, 2004, 2003, and 2002 are $47.5 million, $43.7
million, and $46.6 million, respectively. |
| (3) |
Seriously delinquent is defined as loans that
are 60 or more days delinquent, foreclosed, REO, or held by a borrower who
has declared bankruptcy and is 60 or more days contractually delinquent.
|
| (4) |
Net losses on liquidated loans exclude losses
relating to sales of delinquent called loans purchased at a discount and
certain recoveries during 2004 and 2002 of $11.1 million and $12.6
million, respectively. |
| (5) |
Loss severity is defined as the total loss
amount divided by the actual unpaid principal balance at the time of
liquidation. Total loss amounts include all accrued interest and interest
advances, fees, principal balances, all costs of liquidating and all other
servicing advances for taxes, property insurance, and other servicing
costs incurred and invoiced to us within 90 days following the liquidation
date. |
Delinquency
by Credit Grade by Year Funded (1)(2)
|
Year |
Original
Balance |
Balance
Outstanding |
Percentageof
Original Remaining |
Cumulative
Loss
Percentage
(3) |
Loss
Severity (4) (5) |
| |
($
in thousands) |
|
|
|
|
Pre-divestiture: |
|
|
|
|
|
1996 |
$741,645 |
$14,558 |
2% |
1.92% |
31.32% |
|
1997 |
$1,769,538 |
$57,507 |
3% |
3.21% |
38.86% |
|
1998 |
$2,084,718 |
$126,339 |
6% |
4.02% |
39.38% |
|
1999 |
$2,381,387 |
$260,960 |
11% |
4.79% |
41.47% |
|
2000 |
$2,078,637 |
$291,355 |
14% |
4.99% |
42.98% |
|
2001 |
$499,879 |
$84,684 |
17% |
3.16% |
35.50% |
|
Post-divestiture: |
|
|
|
|
|
2001 |
$1,833,357 |
$367,418 |
20% |
2.86% |
38.23% |
|
2002 |
$2,484,074 |
$757,693 |
31% |
0.97% |
32.86% |
|
2003 |
$2,842,942 |
$1,521,879 |
54% |
0.15% |
22.59% |
|
2004 |
$3,764,628 |
$2,832,836 |
75% |
— |
18.54% |
_________________
| (1) |
Includes loans originated or purchased by our predecessor
and us. |
| (2) |
As of December 31, 2004. |
| (3) |
Includes securitization losses and losses incurred from
loan repurchases, delinquent loan sales, and unsecuritized
loans. |
|
(4) |
Loss
severity is defined as the total loss amount divided by the actual unpaid
principal balance at the time of liquidation. Total loss amounts include
all accrued interest and interest advances, fees, principal balances, all
costs of liquidating and all other servicing advances for taxes, property
insurance, and other servicing costs incurred and invoiced to us within 90
days following the liquidation date. |
| (5) |
Loss severity amounts are cumulative for each respective
funded year. |
Mortgage
Loan Production Segment
The
mortgage loan production segment is composed of our wholesale, correspondent and
retail business channels, and it purchases and originates non-conforming
residential mortgage loans through relationships with various mortgage
companies, mortgage brokers, and correspondent lenders, and directly to
borrowers through its 21 branch offices. The mortgage loan production segment
records interest income, interest expense, and provision for mortgage loan
losses on the mortgage loans it holds prior to selling its loans to the
portfolio segment. It also collects revenues, such as origination and
underwriting fees and certain other non-refundable fees, that are deferred and
recognized over the life of the loan as an adjustment to interest income
recorded in the portfolio segment. With our continued investment in technology
and our mortgage loan production segment, we expect to see continued
improvements in our efficiency in 2005.
We
evaluate the performance of our mortgage loan production segment based on
production levels. We believe the characteristics and level of mortgage loan
production assists investors by allowing them to evaluate performance of our
mortgage loan production segment. The following discussion highlights changes in
our mortgage loan production segment.
Wholesale
Channel
In 2004,
wholesale loan production increased $0.3 billion, or 25%, to $1.5 billion for
the year ended December 31, 2004 from $1.2 billion for the year ended December
31, 2003, and increased $0.5 billion, or 50%, from $1.0 billion for the year
ended December 31, 2002. This
favorable production trend was primarily the result of a declining interest rate
environment as well as a change in our pricing methodology designed to enable us
to become more competitive and gain market share. Our weighted average median
credit scores increased 25 points to 630 for the year ended December 31, 2004
from 605 for the year ended December 31, 2002. We saw an
increase in our average balance per loan and the number of loans originated for
the year ended December 31, 2004 compared to the years ended December 31, 2003
and 2002.
The
following table sets forth selected information about our wholesale loan
production for the years ended December 31, 2004, 2003, and 2002:
| |
For
the Year Ended December 31, |
Variance |
| |
2004 |
2003 |
2002 |
2004-2002 |
| |
($
in thousands) |
|
Loan
production |
$1,500,303 |
$1,174,573 |
$1,034,278 |
45.06% |
|
Average
principal balance per loan |
$165 |
$148 |
$142 |
16.20% |
|
Number
of loans originated |
9,094 |
7,946 |
7,284 |
24.85% |
|
Combined
weighted average initial loan to value (LTV) |
81.02% |
80.03% |
79.26% |
2.22% |
|
Percentage
of first mortgage loans owner occupied |
91.39% |
89.53% |
92.87% |
(1.59)% |
|
Percentage
with prepayment penalty |
70.68% |
73.31% |
78.64% |
(10.12)% |
|
Weighted
average median credit score (1) |
630 |
634 |
605 |
25
points |
|
Percentage
fixed rate mortgages |
19.81% |
27.98% |
21.58% |
(8.20)% |
|
Percentage
adjustable rate mortgages |
80.19% |
72.02% |
78.42% |
2.26% |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
8.09% |
8.36% |
9.12% |
(11.29)% |
|
Adjustable
rate mortgages |
6.84% |
7.39% |
8.70% |
(21.38)% |
|
Gross
margin - adjustable rate mortgages (2) |
5.69% |
4.94% |
5.25% |
8.38% |
|
Average
number of account executives |
128 |
132 |
121 |
5.79% |
|
Volume
per account executive |
$11,721 |
$8,898 |
$8,548 |
37.12% |
|
Loans
originated per account executive |
71 |
60 |
60 |
18.33% |
|
Number
of funding days |
253 |
252 |
252 |
1
day |
|
Volume
per funding day |
$5,930 |
$4,661 |
$4,104 |
44% |
_______________
| |
(1) |
The
credit score is determined based on the median of FICO, Empirica, and
Beacon credit scores. |
| |
(2) |
The
gross margin is the amount added to the applicable index rate, subject to
rate caps and limits, to determine the interest
rate. |
Correspondent
Channel
Over the
past three years we have generally seen a steady decline in our bulk purchases
and an increase in our flow production. The decreasing rate environment brought
a number of new investors into the bulk loan market, which increased competition
and caused pricing to escalate to levels that would not provide us with an
adequate return on investment in the bulk market. We maintained our pricing
discipline in the bulk market and as a result we have seen a decline in our bulk
production, but we have concentrated our efforts on increasing flow production.
If pricing competition lessens and the bulk market becomes more economical for
us, we may choose to increase our bulk volume going forward.
Correspondent
bulk loan production decreased $23.2 million, or 11%, to $182.2 million for the
year ended December 31, 2004 from $205.4 million for the year ended December 31,
2003, and decreased $52.1 million, or 22%, from $234.3 million for the year
ended December 31, 2002. Our weighted average median credit scores for
correspondent bulk production loans increased to 604 for the year ended December
31, 2004 from 585 for the year ended December 31, 2002. However, we experienced
declines in our weighted average interest rates on such loans over the same
periods. We saw an increase in our average balance per loan for correspondent
bulk production loans for the year ended December 31, 2004 compared to the years
ended December 31, 2003 and 2002. We also saw declines in the percentage of our
bulk production with prepayment penalties, primarily related to amended
government regulations, and we expect this trend to continue.
The
following table sets forth selected information about loans purchased by our
correspondent channel through bulk delivery for the years ended December 31,
2004, 2003, and 2002:
| |
For
the Year Ended December 31, |
Variance |
| |
2004 |
2003 |
2002 |
2004-2002 |
| |
($
in thousands) |
|
Loan
production - bulk |
$182,179 |
$205,372 |
$234,349 |
(22.26)% |
|
Average
principal balance per loan |
$171 |
$142 |
$133 |
28.57% |
|
Number
of loans originated |
1,067 |
1,443 |
1,762 |
(39.44)% |
|
Combined
weighted average initial LTV |
79.48% |
81.18% |
79.33% |
0.19% |
|
Percentage
of first mortgage loans owner occupied |
98.01% |
96.64% |
94.74% |
3.45% |
|
Percentage
with prepayment penalty |
80.44% |
92.13% |
94.41% |
(14.80)% |
|
Weighted
average median credit score (1) |
604 |
571 |
585 |
19
points |
|
Percentage
fixed rate mortgages |
22.63% |
22.48% |
21.79% |
3.85% |
|
Percentage
adjustable rate mortgages |
77.37% |
77.52% |
78.21% |
(1.07)% |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
7.24% |
8.43% |
9.10% |
(20.44)% |
|
Adjustable
rate mortgages |
7.25% |
8.46% |
9.13% |
(20.59)% |
|
Gross
margin - adjustable rate mortgages (2) |
6.00% |
6.62% |
7.08% |
(15.25)% |
|
Number
of funding days |
253 |
252 |
252 |
1
day |
|
Volume
per funding day |
$720 |
$815 |
$930 |
(23%) |
_______________
| (1) |
The credit score is determined based on the median of
FICO, Empirica, and Beacon credit scores. |
| (2) |
The
gross margin is the amount added to the applicable index rate, subject to
rate caps and limits, to determine the interest
rate. |
Correspondent
flow loan production increased $147.1 million, or 21%, to $847.4 million for the
year ended December 31, 2004 from $700.3 million for the year ended December 31,
2003, and increased $466.5 million, or 122%, from $380.9 million for the year
ended December 31, 2002. We saw significant increases in our average balance per
loan and in the number of loans originated for the year ended December 31, 2004
compared to the year ended December 31, 2002. Our weighted average median credit
scores for correspondent flow production loans increased to 623 for the year
ended December 31, 2004 from 600 for the year ended December 31, 2002. Our
percentage of fixed rate mortgage originations of such loans declined almost 35%
from 2002 to 2004 while our percentage of adjustable rate mortgage originations
of such loans increased over 19% for the same period. In 2004, we experienced a
significant decrease in our average coupon rate for both fixed rate and
adjustable rate correspondent flow production loans compared to 2003 and 2002.
We also saw declines in the percentage of correspondent flow loan production
with prepayment penalties, primarily related to amended government regulations,
and we expect this trend to continue.
The
following table sets forth selected information about loans purchased by our
correspondent channel through flow delivery for the years ended December 31,
2004, 2003, and 2002:
| |
For
the Year Ended December 31, |
Variance |
| |
2004 |
2003 |
2002 |
2004-2002 |
| |
($ in
thousands) |
|
|
Loan
production - flow |
$847,350 |
$700,340 |
$380,939 |
122.44% |
|
Average
principal balance per loan |
$174 |
$158 |
$143 |
21.68% |
|
Number
of loans originated |
4,879 |
4,446 |
2,664 |
83.15% |
|
Combined
weighted average initial LTV |
79.58% |
78.82% |
75.72% |
5.10% |
|
Percentage
of first mortgage loans owner occupied |
92.82% |
94.15% |
95.58% |
(2.89)% |
|
Percentage
with prepayment penalty |
74.49% |
79.26% |
84.98% |
(12.34)% |
|
Weighted
average median credit score (1) |
623 |
606 |
600 |
23
points |
|
Percentage
fixed rate mortgages |
23.11% |
30.64% |
35.42% |
(34.75)% |
|
Percentage
adjustable rate mortgages |
76.89% |
69.36% |
64.58% |
19.06% |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
7.94% |
8.06% |
8.98% |
(11.58)% |
|
Adjustable
rate mortgages |
6.94% |
7.92% |
9.10% |
(23.74)% |
|
Gross
margin - adjustable rate mortgages (2) |
4.84% |
5.00% |
5.34% |
(9.36)% |
|
Number
of funding days |
253 |
252 |
252 |
1
day |
|
Volume
per funding day |
$3,349 |
$2,779 |
$1,512 |
121% |
_______________
| (1) |
The credit score is determined based on
the median of FICO, Empirica, and Beacon credit scores. |
| (2) |
The gross margin is the amount added to
the applicable index rate, subject to rate caps and limits, to determine
the interest rate. |
The
following table sets forth selected information about our sales representatives
in the correspondent channel for the years ended December 31, 2004, 2003, and
2002:
| |
For
the Year Ended December 31, |
Variance |
| |
2004 |
2003 |
2002 |
2004-2002 |
| |
($
in thousands) |
|
|
Loan
production - bulk |
$182,179 |
$205,372 |
$234,349 |
(22.26)% |
|
Loan
production - flow |
$847,350 |
$700,340 |
$380,939 |
122.44% |
|
Total
loan production |
$1,029,529 |
$905,712 |
$615,288 |
67.32% |
|
Number
of loans originated |
5,946 |
5,889 |
4,426 |
34.34% |
|
Average
number of sales representatives |
8 |
6 |
6 |
33.33% |
|
Volume
per sales representative |
$128,691 |
$150,952 |
$102,548 |
25.49% |
|
Loan
production per sales representative |
743 |
982 |
738 |
0.68% |
|
Number
of funding days |
253 |
252 |
252 |
1
day |
|
Volume
per funding day |
$4,069 |
$3,594 |
$2,442 |
67% |
Retail
Channel
Retail
originations increased $202.1 million, or 26%, to $964.8 million for the year
ended December 31, 2004 from $762.7 million for the year ended December 31,
2003, and increased $318.9 million, or 49%, from $645.9 million for the year
ended December 31, 2002. The number of retail loans originated also increased
for the year ended December 31, 2004 compared to the years ended December 31,
2003 and 2002. This favorable production trend was primarily the result of a
declining interest rate environment as well as a change in our pricing
methodology designed to enable us to become more competitive and gain market
share. We have
also become more efficient in our retail channel with an increase in our volume
per loan officer for 2004 as compared
to 2003, and we expect to see continued efficiencies in the retail channel in
2005. For the year ended December 31, 2004 compared to the year ended December
31, 2003, we experienced a significant decline in the production of fixed rate
retail loans while our production of adjustable rate retail loans increased.
Over the past two years, our weighted average interest rates declined for both
fixed and adjustable rate retail loans. We also saw declines in the percentage
of our retail production with prepayment penalties, primarily related to amended
government regulations, and we expect this trend to continue.
The
following table sets forth selected information about our retail loan
originations for the years ended December 31, 2004, 2003, and 2002:
| |
For
the Year Ended December 31, |
Variance |
| |
2004 |
2003 |
2002 |
2004-2002 |
| |
($
in thousands) |
|
|
Loan
originations |
$964,760 |
$762,657 |
$645,949 |
49.36% |
|
Average
principal balance per loan |
$130 |
$130 |
$127 |
2.36% |
|
Number
of loans originated |
7,433 |
5,865 |
5,086 |
46.15% |
|
Combined
weighted average initial LTV |
79.81% |
79.11% |
79.47% |
0.43% |
|
Percentage
of first mortgage loans owner occupied |
96.18% |
94.33% |
95.85% |
0.34% |
|
Percentage
with prepayment penalty |
64.68% |
63.31% |
76.07% |
(14.97)% |
|
Weighted
average median credit score (1) |
613 |
617 |
615 |
(2)
points |
|
Percentage
fixed rate mortgages |
49.48% |
59.51% |
57.28% |
(13.62)% |
|
Percentage
adjustable rate mortgages |
50.52% |
43.49% |
42.72% |
18.26% |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
7.11% |
7.31% |
8.16% |
(12.87)% |
|
Adjustable
rate mortgages |
7.12% |
7.55% |
8.31% |
(14.32)% |
|
Gross
margin - adjustable rate mortgages (2) |
6.09% |
5.66% |
5.70% |
6.84% |
|
Average
number of loan officers |
219 |
231 |
174 |
25.86% |
|
Volume
per loan officer |
$4,405 |
$3,302 |
$3,712 |
18.67% |
|
Loans
originated per loan officer[ |
34 |
25 |
29 |
17.24% |
|
Number
of funding days |
253 |
252 |
252 |
1
day |
|
Volume
per funding day |
$3,813 |
$3,026 |
$2,563 |
49% |
_______________
| (1) |
The credit score is determined based on
the median of FICO, Empirica, and Beacon credit scores. |
| (2) |
The gross margin is the amount added to
the applicable index rate, subject to rate caps and limits, to determine
the interest rate. |
Called
Loans
Through
our taxable REIT subsidiaries we generally have the option, called a clean-up
call option, to purchase mortgage loans in a securitized pool for which we act
as servicer or master servicer once the aggregate principal balance of the
remaining mortgage loans in the securitized pool is less than a specified
percentage (generally 10%) of the original aggregate principal balance of the
pool at the time of the securitization. We refer to the loans we acquire upon
exercise of a clean-up call option as called loans. We routinely review the
securitized pools subject to clean-up call options, and frequently determine it
to be to our advantage to call those loans.
Because
our called loan purchases represent a more seasoned portfolio than the new
production we have originated through our wholesale, correspondent, and retail
channels, we have provided data below regarding the characteristics of our
called loan production for the periods indicated.
During
2004 we called loans in the amount of $270.0 million. There were no loans called
in 2003. The following table sets forth selected information about our called
loans for the years ended December 31, 2004, 2003, and 2002:
| |
For
the Years Ended December 31, |
Variance |
| |
2004 |
2003 |
2002 |
2004-2002 |
| |
($
in thousands) |
|
Called
loans purchased |
$270,036 |
— |
$188,559 |
43.21% |
|
Average
principal balance per loan |
$71 |
— |
$80 |
(11.25)% |
|
Number
of loans called |
3,788 |
— |
2,363 |
60.30% |
|
Combined
weighted average initial LTV |
79.13% |
— |
76.44% |
3.52% |
|
Percentage
of first mortgage loans owner occupied |
90.97% |
— |
87.39% |
4.10% |
|
Percentage
with prepayment penalty |
1.60% |
— |
42.07% |
(96.20)% |
|
Weighted
average median credit score (1) |
601 |
— |
612 |
(11)
points |
|
Percentage
fixed rate mortgages |
68.31% |
— |
60.23% |
13.42% |
|
Percentage
adjustable rate mortgages |
31.69% |
— |
39.77% |
(20.32)% |
|
Weighted
average interest rate: |
|
|
|
|
|
Fixed
rate mortgages |
9.75% |
— |
9.98% |
(2.30)% |
|
Adjustable
rate mortgages |
9.83% |
— |
10.04% |
(2.09)% |
|
Gross
margin - adjustable rate mortgages (2) |
6.20% |
— |
5.48% |
13.14% |
_______________
| (1) |
The credit score is determined based on
the median of FICO, Empirica, and Beacon initial credit
scores. |
| (2) |
The gross margin is the amount added to
the applicable index rate, subject to rate caps and limits, to determine
the interest rate. |
Year
Ended December 31, 2004 Compared to Year Ended December 31,
2003
Net
Mortgage Loan Portfolio. Our net
mortgage loan portfolio increased $1.3 billion, or 28%, to $6.0 billion as of
December 31, 2004 from $4.7 billion as of December 31, 2003. This increase was
the result of the origination and purchase of $3.8 billion of mortgage loans
offset by principal payments of $2.2 billion and loan sales of $0.3 billion. We
expect that our mortgage loan portfolio will continue to grow as we continue to
originate and purchase mortgage loans. However, we anticipate the growth rate
will be slower than historical growth rates as our portfolio
ages and more seasoned mortgage loans are paid off. A detailed discussion of our
portfolio characteristics is discussed in Item 1, “Business, -- Mortgage Loan
Portfolio.”
Allowance
for Loan Loss. The
allowance for loan loss decreased $6.1 million, or 14%, to $37.3 million as of
December 31, 2004 from $43.4 million as of December 31, 2003. This decrease was
due to charge-offs of $45.8 million from primarily our 2001 and 2002
securitizations, which were provided for in previous periods, offset by
additional provision of $39.7 million. The decrease in the allowance for loan
loss was also due to the higher credit quality loans produced in 2004 and 2003
compared to 2002 and 2001. We expect our allowance for loan loss may increase in
the future as our portfolio continues to grow.
MSRs,
net. MSRs,
net increased $57.7 million, or 140%, to $99.0 million as of December 31, 2004
from $41.3 million as of December 31, 2003. This increase was primarily due to
purchases of $84.9 million of rights to service $11.5 billion of mortgage loans
during the year ended December 31, 2004. The increase in MSRs was partially
offset by amortization of servicing rights of $19.5 million during 2004, which
was higher than the amortization of servicing rights in 2003 due to our
additional servicing acquisitions as well as the use of discounted projected net
servicing income as a prospective change in estimate, which further accelerated
amortization expense and is more consistent with the underlying methods used to
determine fair value. Also, a temporary impairment of $6.9 million and a
permanent impairment of $0.8 million further offset the increase. The impairment
of MSRs was primarily the result of increased prepayment speeds during 2004 on
certain aged third party servicing portfolios. We have sought to strategically
position ourselves to take advantage of the increased supply of servicing assets
in the marketplace and have been able to purchase servicing assets at what we
believe to be favorable prices. We anticipate that the demand for non-conforming
servicing will continue and that we will continue to purchase servicing rights
in the future, which would increase our net servicing income. We anticipate
purchasing third party servicing rights for an additional $8.6 billion of
mortgage loans during 2005, of which $1.3 billion have been purchased through
February 2005 for approximately $9.8 million.
Servicing
Related Advances.
Servicing related advances increased $14.5 million, or 15%, to $113.1 million as
of December 31, 2004 from $98.6 million as of December 31, 2003. The increase
was primarily due to the increase in our third party servicing balances.
Trustee
Receivable. Trustee
receivable increased $37.5 million, or 50%, to $112.1 million as of December 31,
2004 from $74.6 million as of December 31, 2003. The increase was primarily due
to the completion of three securitizations during 2004. Our trustee receivable
balance increased at a greater rate than our mortgage loan portfolio balance
during 2004, primarily because more loans were paid as scheduled as shown by our
lower delinquency rates. On each payment date, the trust distributes SAST
securitization loan payments to their related bondholders. These loan payments
are collected by the trust before the cut-off date, which is typically the
17th of each
month. Therefore, all principal payments received after the cut-off date are
recorded as a trustee receivable and reduce our mortgage loan portfolio on our
consolidated balance sheet. The trustee retains these principal payments until
the following payment date. As we
continue to securitize mortgage loans, we anticipate our trustee receivable
balance to increase.
Other Assets. Other
assets increased $12.2 million, or 17%, to $84.9 million as of December 31, 2004
from $72.7 million as of December 31, 2003. The
increase in other assets is primarily the result of an increase of $15.6 million
in current tax receivable, offset by payments received on mortgage bonds of $3.6
million.
Warehouse
Financing.
Warehouse financing increased $172.6 million, or 40%, to $600.6 million as of
December 31, 2004 from $428.0 million as of December 31, 2003. We expect our
warehouse financing to continue to fluctuate from one reporting period to the
next as a result of the timing of our securitizations and to generally increase
in proportion to our mortgage loan production.
Securitization
Financing.
Securitization financing increased $1.1 billion, or 26%, to $5.3 billion as of
December 31, 2004 from $4.2 billion as of December 31, 2003. This increase
resulted primarily from the execution of three asset-backed securitizations,
which resulted in bonds being issued in the amount of $3.2 billion during 2004.
This increase was primarily offset by bond and certificate payments of $2.2
billion. In general, we expect increases in our securitization financing as we
experience increased mortgage loan production and continue to securitize our
mortgage loans.
Note
Payable. Note
payable decreased $25.0 million, or 100%, to none as of December 31, 2004 from
$25.0 million as of December 31, 2003 as a result of the retirement of our note
payable during the third quarter of 2004.
Shareholders’
Equity. Shareholders’
equity increased $273.9 million, or 79%, to $618.9 million as of December 31,
2004, from $345.0 million as of December 31, 2003. The increase in shareholders’
equity was due primarily to the issuance of an additional 17 million shares,
partially offset by: (1) certain costs associated with the REIT conversion and
stock issuance of $33.4 million and (2) the payment of merger consideration of
$131.4 million, and the vesting and exercise of a majority of Old Saxon’s
outstanding stock warrants, restricted stock units, and stock options and a
corresponding tax benefit of $15.3 million associated with the stock option
exercises resulting from the REIT conversion. The remaining increase was
primarily related to net income of $105.6 million for the year ended December
31, 2004 offset by the declaration of dividends in the aggregate amount of
$114.6 million.
We expect
to continue making quarterly distributions to shareholders totaling at least 90%
of our annual REIT taxable income (determined without regard to the deduction
for dividends paid and by excluding any net capital gain). The actual amount and
timing of dividends will be declared by our Board of Directors and will depend
on our financial condition and earnings. While we expect our shareholders’
equity to increase in the future due to continued growth in our net income,
we anticipate shareholders’ equity to grow relatively slowly because we expect
to make regular quarterly distributions.
Cash
increased by $7.6 million during the year ended December 31, 2004. The overall
change in cash was comprised of the following:
| |
For
the Years Ended December 31, |
| |
2004 |
2003 |
| |
($
in thousands) |
|
Cash
provided by operations |
$99,918
|
$83,725
|
|
Cash
used by investing activities |
(1,455,579) |
(933,093) |
|
Cash
provided by financing activities |
1,363,268 |
846,515 |
|
Increase
(decrease) in cash |
$7,607
|
$(2,853)
|
Operating
Activities. Cash
provided by operations for the year ended December 31, 2004 was $99.9 million,
reflecting an improvement of $16.2 million, or 19%, compared to the prior year.
This change was the result of increased net income from operations adjusted for
non-cash items such as depreciation and amortization, deferred income taxes and
provision for mortgage loan losses. Our earnings are primarily from net interest
income and servicing income, offset by general and administrative expenses as
well as tax expense. Further details are discussed in “Consolidated
Results.”
The
overall increase in cash provided by operations for the year ended December 31,
2004 was somewhat offset by increases in trustee receivable balances and
servicing related advances of $37.5 million and $14.5 million, respectively. The
increase in trustee receivable balances resulted from the continued growth in
the underlying mortgage loan portfolio. The increase in the servicing related
advances resulted from the overall growth in the servicing
portfolio.
Investing
Activities. Cash
used for investing activities was $1.5 billion for the year ended December 31,
2004. Investing activities consist principally of the origination and purchase
of mortgage loans as well as the acquisition of MSRs. The origination and
purchase of mortgage loans totaled $3.8 billion for the year ended December 31,
2004. In addition, MSRs were purchased totaling $84.9 million. These decreases
to cash were partially offset by cash received from principal payments on our
mortgage loan portfolio totaling $2.1 billion and proceeds from the sale of
mortgage loans and REO which totaled $270.7 million and $56.3 million,
respectively.
Capital
expenditures during the year ended December 31, 2004 were $6.3 million and
related primarily to various information technology enhancements.
Financing
Activities. Cash
provided by financing activities during the year ended December 31, 2004 was
$1.4 billion and was primarily the result of proceeds from the issuance of
securitization financing of $3.2 billion and net proceeds from additional
warehouse financing of $172.7 million.
These
proceeds were partially offset by principal payments on securitization
financings of $2.2 billion, and bond issuance costs of $12.4 million relating to
the SAST 2004-1, SAST 2004-2, and SAST 2004-3 securitizations. Fluctuations in
warehouse and securitization financing period over period can occur due to the
timing of securitizations and the related repayment of the warehouse financing
facilities.
Derivative
financial instrument transactions during the year ended December 31, 2004 used
primarily as cash flow hedges with the objective of hedging interest rate risk
related to our financing activities resulted in a decrease in cash of $5.9
million.
Additional
increases in cash provided by financing activities for the year ended December
31, 2004 were the result of the issuance of 17 million additional shares of
common stock resulting in proceeds of $386.8 million and $40.1 million as a
result of the vesting and exercise of outstanding stock warrants and stock
options as well as issuances under the employee stock purchase plan. Additional
decreases in cash provided by financing activities for the year ended December
31, 2004 were the result of $131.4 million paid as merger consideration, $85.7
million paid as dividends, $33.4 million paid related to expenses in connection
with the REIT conversion and the issuance of additional shares of common stock,
and the payment of $25.0 million for the retirement of the note
payable.
Trends. Fourth
quarter dividends for the year ended December 31, 2004 in the amount of $28.9
million were paid on January 14, 2005. Due to our election to be treated as a
REIT, we expect to continue making quarterly distributions to shareholders, the
amount and timing of which will be determined by our Board of
Directors.
At this
time, we see no material negative trends that we believe would affect our access
to long-term borrowings, short-term borrowings or bank credit lines sufficient
to maintain our current operations or that would likely cause us to be in danger
of any debt covenant default.
Material
Planned Expenditures. On May
10, 2004, we entered into a 12-year build-to-suit lease for approximately
115,000 square feet in Glen Allen, VA with Highwoods Realty Limited Partnership
that is expected to commence in July 2005. Upon completion, this building will
become our principal mortgage loan origination headquarters, and will also
contain a second servicing center to support the growth of our servicing segment
as well as to serve as a secondary site for servicing for disaster recovery
purposes. Various costs approximating $8.1 million relating to additional
computer equipment and furniture and fixtures will be required to ensure the
building is ready for use by July 2005. A majority of these additional assets
will be leased under operating leases with terms between two and five years that
will commence in 2005. Also, rent expense for this building will approximate
$1.2 million for 2005 and approximately $2.6 million annually thereafter through
the end of the lease term; however, we will vacate our current principal
mortgage loan origination headquarters which will reduce our annual rent expense
by approximately $0.8 million. Working capital funds will be used to fulfill
these cash requirements.
Working
Capital
We intend
to maintain sufficient working capital to fund the cash flow needs of our
operations in the event we are unable to generate sufficient cash flows from
operations to cover our operating requirements. Using our definition of working
capital, we calculated our working capital as of December 31, 2004 to be
approximately $224.0 million. Under the commonly defined working capital
definition, we calculated our working capital as of December 31, 2004 to be
$420.0 million. A reconciliation between our working capital calculation and the
common definition of working capital is provided below. Management focuses on
our internally defined calculations of working capital rather than the commonly
used definition of working capital because management believes our definition
provides a better indication of how much liquidity we have available to conduct
business at the time of the calculation.
|
Working
Capital Reconciliation - December 31, 2004 |
Saxon
Defined
Working
Capital |
Commonly
Defined
Working
Capital |
| |
($
in thousands) |
|
Unrestricted
cash |
$12,852 |
$12,852 |
|
Borrowing
availability |
63,686 |
— |
|
Trustee
receivable |
— |
112,062 |
|
Accrued
interest receivable |
— |
56,132 |
|
Accrued
interest payable |
— |
(8,045) |
|
Unsecuritized
mortgage loans - payments less than one year |
429,505 |
674,596 |
|
Warehouse
financing facility - payments less than one year |
(282,092) |
(523,277) |
|
Servicing
advances |
— |
113,129 |
|
Financed
advances - payments less than one year |
— |
(34,667) |
|
Securitized
loans - payments less than one year |
— |
1,575,480 |
|
Securitized
financing - payments less than one year |
— |
(1,558,258) |
|
Total |
$223,951 |
$420,004 |
Financing
Facilities
We need
to borrow substantial sums of money each quarter to originate and purchase
mortgage loans. We rely upon several counterparties to provide us with financing
facilities to fund our loan originations and purchases, as well as fund a
portion of our servicing advances and servicing rights. Our ability to fund
current operations and accumulate loans for securitization depends to a large
extent upon our ability to secure short-term financing on acceptable terms.
To
accumulate loans for securitization, we borrow money on a short-term basis
through committed secured warehouse lines of credit and committed repurchase
agreements. In addition to funding loans prior to securitization, some of our
committed facilities allow us to finance advances that are required by our
mortgage servicing contracts, mortgage bonds and mortgage servicing
rights.
Committed
Facilities. The
material terms and features of our financing facilities in place at December 31,
2004 are as follows:
JPMorgan
Chase Bank Syndicated Warehouse Facility. We
executed a $300.0 million syndicated warehouse facility with JPMorgan Chase Bank
effective March 31, 2004. The warehouse facility provides the ability to finance
first lien loans and wet collateral and includes a $45.0
million sub-limit for servicing rights and a $25.0 million sub-limit for
servicing advances. The warehouse facility expires on March 30, 2005. The
facility was amended effective August 30, 2004 to permit the REIT conversion and
was amended again effective December 29, 2004 increasing the sub-limit for
servicing rights to $75.0 million. In conjunction with entering into this
warehouse facility with JPMorgan Chase, we terminated a JPMorgan Chase warehouse
facility and a JPMorgan Chase repurchase facility effective March 31,
2004.
Greenwich
Capital Repurchase Facilities. We have
a $150.0 million facility with Greenwich Capital Financial Products, Inc. that
provides the ability to finance first lien loans. The facility expires on June
26, 2006. This facility amount previously was $175.0 million and the facility
was due to expire on June 25, 2005, but was amended effective August 30, 2004
to, among other things, decrease the facility amount to $150.0 million, extend
the termination date to June 26, 2006, and permit the REIT conversion. We also
have a $175.0 million facility with Greenwich Capital Financial Products, Inc.
that allows us to borrow against first and second lien loans and wet collateral.
The facility amount previously was $150.0 million and the facility was due to
expire on July 17, 2004. The facility was amended effective July 16, 2004
extending the termination date of the facility to September 1, 2004 and was
further amended effective August 30, 2004 to, among other things, increase the
total committed facility amount to $175.0 million, extend the termination date
to August 29, 2005, and permit the REIT conversion.
Bank
of America, N.A. Repurchase Facility. We have
a $300.0 million facility with Bank of America, N.A. that provides us with the
ability to borrow against first and second lien loans and provides a sub-limit
for wet collateral. The facility originally was due to expire on June 23, 2004,
but was amended effective June 23, 2004 extending the termination date of the
facility to August 22, 2004 and subsequently amended effective August 20, 2004
extending the termination date of the facility to June 23, 2005 and to permit
the REIT conversion.
CSFB
Repurchase Facility. We have
a $300.0 million facility with Credit Suisse First Boston Mortgage Capital, LLC
which provides us with the ability to borrow against first lien loans including
wet collateral. The facility originally had a committed facility amount of
$100.0 million and was due to expire on April 3, 2004, but was amended effective
March 31, 2004 increasing the total committed facility amount to $300.0 million
and extending the termination date of the facility to September 20, 2004. The
facility was amended effective August 20, 2004 extending the termination date to
April 30, 2005 and to permit the REIT conversion.
Merrill
Lynch Repurchase Facility. We have
a $400.0 million facility with Merrill Lynch Mortgage Capital, Inc. which
provides us with the ability to borrow against first lien loans and also
provides a sub-limit for wet collateral. The facility originally was due to
expire on May 7, 2004, but was amended effective May 3, 2004 extending the
termination date of the facility to September 1, 2004. The facility was further
amended effective August 6, 2004 to extend the termination date of the facility
to November 19, 2004 and amended effective August 20, 2004 to permit the REIT
conversion. Effective November 19, 2004, the facility was again amended to
extend the termination date to November 18, 2005.
As of
December 31, 2004 we had committed revolving warehouse and repurchase facilities
in the amount of approximately $1.6 billion. The table below summarizes our
facilities and their expiration dates as of December 31, 2004. We believe this
level of committed financing will allow us flexibility to execute our
asset-backed securitizations in accordance with our business plans.
|
Counterparty
Committed Lines |
Facility
Amount |
Expiration
Date |
|
($
in thousands) |
|
JP
Morgan Chase Bank |
$
300,000 |
March
30, 2005 |
|
Greenwich
Capital Financial Products, Inc. |
175,000 |
August
29, 2005 |
|
Greenwich
Capital Financial Products, Inc. |
150,000 |
June
26, 2006 |
|
Bank
of America, N.A. |
300,000 |
June
23, 2005 |
| CS
First Boston Mortgage Capital, LLC |
300,000 |
April
30, 2005 |
| Merrill
Lynch Mortgage Capital, Inc. |
400,000 |
November
18, 2005 |
| Total
committed facilities |
$1,625,000 |
|
The
amount we have outstanding on our committed facilities at any quarter end
generally is a function of the pace of mortgage loan purchases and originations
relative to the timing of our securitizations. Although we expect to issue
asset-backed securities on a quarterly basis, our intention is to maintain
committed financing facilities equal to approximately six months of mortgage
production to provide us with flexibility in timing our securitizations.
We had
$600.6 million of warehouse borrowings collateralized by residential mortgages
outstanding as of December 31, 2004. As we complete securitization transactions,
a portion of the proceeds from the long-term debt issued in the securitization
will be used to pay down our short-term borrowings. Therefore, the amount of
short-term borrowings will fluctuate from quarter to quarter, and could be
significantly higher or lower than the $600.6 million we held as of December 31,
2004, as our mortgage production and securitization programs continue.
Our
financing facilities require us to comply with various customary operating and
financial covenants, including tests relating to our tangible net worth,
liquidity, and leverage requirements. In addition, some of the facilities may
subject us to cross default features. In the event of default, we may be
prohibited from paying dividends and making distributions under certain of our
financing facilities without the prior approval of our lenders. We do not
believe that these existing financial covenants will restrict our operations or
growth. To the extent that we fail to comply with the covenants contained in our
financing agreements or are otherwise found to be in default under the terms of
such agreements, we could be restricted from paying dividends or from engaging
in other transactions that are necessary for us to maintain our REIT status. Our
failure to qualify as a REIT could reduce materially the value of our common
stock. See “Risk Factors - Federal Income Tax Risks Related to Our Qualification
as a REIT - Actions
we take to satisfy the requirements applicable to REITs, or our failure to
satisfy such requirements, could have an adverse effect on our financial
condition.” We
were in compliance with all covenants under the agreements for the year ended
December 31, 2004.
Securitization
Financing
Mortgage
Loan Securitization Facilities. We have
historically financed, and expect to continue to finance, our mortgage loan
portfolio on a long-term basis by issuing asset-backed securities. We believe
that issuing asset backed securities provides us a low cost method of financing
our mortgage loan portfolio. In addition, it allows us to reduce our interest
rate risk on our fixed rate loans by securitizing them. Our ability to issue
asset backed securities depends on the overall performance of our assets, as
well as the continued general demand for securities backed by non-conforming
mortgage loans and home equity loans.
Generally,
we are not legally obligated to make payments to the holders of the asset-backed
securities issued as part of our securitizations. Instead, the holders of the
asset-backed securities can look for repayment only from the cash flows from the
real estate specifically collateralizing the debt.
Servicing
Advance Facility. On July
13, 2004 we established a new servicing advance facility, Saxon Advance
Receivables Note Trust. The facility allows for the issuance of multiple series
of notes to finance principal, interest and other servicing advances that we are
required to make for our owned portfolio as well as those related to certain
third party servicing contracts. The initial Series 2004-1 Notes included two
classes of term notes with a combined face value of $95.0 million and one class
of variable funding notes with a maximum of $65.0 million. The initial amount
issued under the Series 2004-1 Notes amounted to $109.2 million. The December
31, 2004 amount outstanding under the Series 2004-1 Notes was $118.0 million.
The terms of the Series 2004-1 Notes require the Notes to begin to amortize at
various dates through October 2006. We anticipate the facility will be able to
issue new notes to meet our future advance funding needs. In conjunction with
the new facility, the existing Saxon Advance Receivables Backed Certificates
2002-A and Saxon Advance Receivables Backed Certificates 2003-A facilities were
both terminated.
Our
servicing advance facility requires us to comply with various customary
operating covenants and performance tests on the underlying receivables related
to payment rates and minimum balance. In the event of a breach, the Notes issued
by the servicing advance facility may begin to amortize earlier than scheduled.
We do not believe that these existing covenants and performance tests will
restrict our operations or growth. We were in compliance with all covenants and
performance tests under the servicing advance facility as of and for the year
ended December 31, 2004.
As of
December 31, 2004, securitization financing related to mortgage loans and
servicing advances on our consolidated balance sheet was approximately $5.3
billion.
Off
Balance Sheet Items
In
connection with the approximately $603.3 million of mortgage loans securitized
in off balance sheet transactions from May 1996 to July 5, 2001, and which were
still outstanding as of December
31, 2004, and in connection with the sales of mortgage loans to nonaffiliated
parties, our subsidiaries made representations and warranties about certain
characteristics of the loans, the borrowers, and the underlying properties. In
the event of a breach of these representations and warranties, our subsidiaries
may be required to remove loans from a securitization and replace them with cash
or substitute loans, and to indemnify parties for any losses related to such
breach. As of December 31, 2004 our subsidiaries neither had nor expected to
incur any material obligation to remove any such loans, or to provide any such
indemnification.
In the
normal course of business, we are subject to indemnification obligations related
to the sale of residential mortgage loans. Under these obligations, we are
required to repurchase certain mortgage loans that fail to meet the standard
representations and warranties included in the sales contracts. From time to
time, we have been required to repurchase loans that we sold; however, the
liability for the fair value of those obligations has been immaterial.
Our
subsidiaries are subject to premium recapture expenses in connection with the
sale of residential mortgage loans. Premium recapture expenses represent
repayment of a portion of certain loan sale premiums to investors on previously
sold loans that are repaid within six months of the loan sale. We accrue an
estimate of the potential refunds of premium received on loan sales based upon
historical experience. As of December 31, 2004 and 2003, the liability recorded
for premium recapture expenses was $0.1 million and $0.2 million, respectively.
Our
subsidiaries had commitments to fund mortgage loans with agreed upon rates of
approximately $240.3 million and $144.3 million as of December 31, 2004 and
December 31, 2003, respectively. This does not necessarily represent future cash
requirements, as some portion of the commitments are likely to expire without
being drawn upon or may be subsequently declined for credit or other
reasons.
Contractual
Obligations and Commitments
Our
subsidiaries are obligated under non-cancelable operating leases for property
and equipment. Future minimum rental payments for all of our operating leases as
of December 31, 2004 and December 31, 2003 totaled $22.7 million and $21.8
million, respectively.
We
anticipate purchasing third party servicing rights for an additional $8.6
billion of mortgage loans during 2005, of which $1.3 billion were purchased
through February 2005 for approximately $9.8 million.
The
following tables summarize our contractual obligations under our financing
arrangements by payment due date and commitments by expiration dates as of
December 31, 2004.
|
Payments
Due by Period
($
in thousands) |
|
Contractual
Obligations -
As
of December 31, 2004 |
Total |
Less
than 1 year |
1-3
years |
3-5
years |
After
5 years |
|
Warehouse
financing facility - line of credit |
$282,092
|
$282,092
|
$— |
$— |
$— |
|
Repurchase
agreements |
318,554 |
241,185 |
77,369 |
— |
— |
|
Securitization
financing (1) |
5,258,344 |
1,592,925 |
1,747,092 |
610,785 |
1,307,542 |
|
Purchase
obligations (2) |
254,746 |
246,242 |
8,504 |
— |
— |
Operating
leases (3) |
53,944 |
9,199 |
18,254 |
8,456 |
18,035 |
|
Total
contractual cash obligations |
$6,167,680 |
$2,371,643 |
$1,851,219 |
$619,241 |
$1,325,577 |
________________
| |
(1) |
Amounts
listed are bond payments based on anticipated recovery of the underlying
principal and interest servicing advances and on anticipated receipt of
principal and interest on underlying mortgage loan collateral using
historical prepayment speeds. |
| |
(2) |
Amounts
included represent contractual obligations and expected related expenses
for which committed amounts are in excess of $1.0 million for computer and
communications technology services, telephone services, technology
licensing, and commitments to fund mortgage loans with agreed upon rates.
Contracts we believe allow for termination with minimal or no penalties
are excluded from the table above. |
| |
(3) |
Includes
operating lease payments relating to our new principal mortgage loan
origination headquarters expected to begin in July
2005. |
Related
Party Transactions
As of
December 31, 2004 and December 31, 2003, we had $9.0 million and $12.0 million,
respectively, of unpaid principal balances within our mortgage loan portfolio
related to mortgage loans originated for our officers and employees. These
mortgage loans were underwritten to our underwriting guidelines. When making
loans to our officers and employees, we waive loan origination fees that
otherwise would be paid to us by the borrower, and reduce the interest rate by
25 to 50 basis points from the market rate. Effective December 1, 2002, we no
longer renew or make any new loans to our executive officers or directors. We
have never made loans to any of our outside directors.
Impact
of New Accounting Standards
The
Financial Accounting Standards Board, or FASB, issued FASB Statement No. 123
(Revised 2004), Share-Based
Payment.
Statement 123R replaces FASB Statement No. 123, Accounting
for Stock-Based Compensation, and
supersedes APB Opinion No. 25, Accounting
for Stock Issued to Employees. Statement
123, as originally issued in 1995, established as preferable a fair-value-based
method of accounting for share-based payment transactions with employees. The
new FASB revised rule requires that the compensation cost relating to
share-based payment transactions be recognized in financial statements. That
cost is to be measured based on the fair value of the equity or liability
instruments issued. Publicly traded entities (other than those filing
as small
business issuers) will be required to apply Statement 123R as of the first
interim or annual reporting period that begins after June 15, 2005. Effective
September 13, 2004, upon shareholder approval of the merger agreement required
in connection with the REIT conversion, all outstanding stock options and
restricted stock units granted by Old Saxon immediately vested. New Saxon
assumed all outstanding options and warrants to acquire Old Saxon’s common stock
that were not exercised on or before September 24, 2004. In connection with the
accelerated vesting of the options, Old Saxon recorded compensation expense for
all options outstanding as of September 13, 2004. (See Note 17 for more
information.) As a result, the adoption of FASB 123R is not expected to have a
material impact on our financial position, results of operations, or cash
flows.
The FASB
issued FASB Statement No. 153, Exchange
of Nonmonetary Assets - An Amendment of APB Opinion No. 29. This
statement addresses the measurement of exchanges of similar productive assets in
paragraph 21(b) of APB Opinion No. 29, Accounting
for Nonmonetary Transactions, and
replaces it with an exception for exchanges that do not have commercial
substance. The statement specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. The provisions of this statement are
effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. The adoption of FASB 153 is not expected to have a material
impact on our financial position, results of operations, or cash
flows.
Inflation
affects us most significantly in the area of loan originations and can have a
substantial effect on interest rates. Interest rates normally increase during
periods of high inflation (or in periods when the Federal Reserve Bank attempts
to prevent inflation) and decrease during periods of low inflation. See “Item
7A—Quantitative and Qualitative Disclosures about Market Risk—Management of
Interest Rate Risk.”
We define
market risk as the sensitivity of income to changes in interest rates. Changes
in prevailing market interest rates may have two general effects on our
business. First, any general increase in mortgage loan interest rates may tend
to reduce customer demand for new mortgage loans, which can negatively impact
our future production volume and our projected income. Second, increases or
decreases in interest rates can cause changes in the interest income on the
mortgage loans that we own or are committed to fund, and as a result, cause
changes in our net income. We refer to this second type of risk as our “managed
interest rate risk”. Substantially all of our managed interest rate risk arises
from debt related to the financing of our mortgage loan portfolio.
Interest
rate risk is managed within an overall asset/liability management framework. The
principal objective of asset/liability management is to manage the sensitivity
of net income to changing interest rates.
Overview
of Our Interest Rate Risk Profile
We view
our interest rate risk profile relative to the financing vehicle that is used
during the life of our mortgage loans. We have short-term and long-term
financings that expose us to interest rate risk for the duration of the
respective financing.
Short-term
Financing. Short-term
financing exists from the time mortgage loans are originated until they are
securitized. Our short-term financings, or warehouse borrowings, are dependent
upon floating LIBOR rates with a one-month maturity. Because nearly all the
collateral backing these financings have an initial fixed interest rate, and the
financing instruments are subject to monthly changes in LIBOR, our net interest
income is subject to fluctuations.
Long-term
Financing. Long-term
financing is typically decided by an asset securitization structure. This
structure can have financing terms that may be fixed for the life of the
financing or subject to changes in LIBOR rates, as described in the paragraph
above.
A fixed
financing structure is typically collateralized by fixed rate assets. Because
both the asset and liability have fixed rates for the term of the financing,
interest rate risk due to fluctuation in LIBOR rates does not exist, resulting
in stable net interest income for the term of the financing.
A
floating financing structure can be collateralized by fixed or floating rate
assets. Nearly all of our mortgage loans have an initial period that is fixed
relative to the floating financing structure. For this reason we are subject to
net interest income fluctuations caused by changes in LIBOR rates. This
fluctuation in net interest income can exist for the entire term of the
financing.
Since our
net interest income is subject to fluctuating LIBOR rates during the term of our
financings, we attempt to minimize our exposure to rate fluctuations by hedging
our interest rate risk.
Types
of Managed Interest Rate Risk
Our
managed interest rate risks include repricing, basis, and prepayment
risk.
Repricing
Risk. Financing
rates are subject to change from the time we originate mortgage products until
long-term financing is structured. Repricing risk is caused by the potential
differences in these financing rates. To minimize the impact of fluctuating
financing rates on interest expense, we manage our risks through a regimented
hedging routine. This hedging strategy involves buying market instruments that
match the sensitivity of long-term financings. By doing this we are able to
manage our interest expense for the life of our financing.
Interest
Rate Risk. Interest
rate risk results when the terms of mortgage loans differ from financing terms
of our borrowings that are collateralized by those mortgage loans. As a result,
our financing rates can change differently than the interest rates we charge on
our mortgage loans.
Changes in the financing rates of our borrowings relative to the mortgage loans
supporting those financings cause fluctuations in net interest income. For this
reason our management of this risk involves buying market instruments that
increase in value while our interest expense declines in value.
Prepayment
Risk. Prepayment
risk results from the ability of customers to pay off their mortgage loans
before maturity. Generally, prepayments tend to increase in falling interest
rate environments as a result of borrowers refinancing fixed-rate and
adjustable-rate loans to lower the coupon on their mortgage; conversely
prepayments tend to decrease in rising interest rate environments. As a result,
falling interest rate environments tend to cause decreases in the balance of our
mortgage loan portfolio and related decreases in our interest income. For this
reason we consider many prepayment alternatives when managing interest rate risk
to avoid a negative impact to net interest income that can be caused by too many
hedge instruments relative to the amount of assets remaining. Fortunately the
same interest rate decline that tends to accelerate prepayments also lowers the
cost of our liabilities and improves net interest income on the remaining
portfolio.
Management
of Interest Rate Risk. To manage
repricing, interest rate, and prepayment risks, we use various derivative
instruments such as options on futures, Eurodollar futures, interest rate caps
and floors, interest rate swaps and options on interest rate swaps. Generally,
we seek to match derivative instruments to types of financings, in order to
offset negative impacts in our interest expense. We intend to keep the
derivatives in place until the risk is minimized to a level where the risk of
fluctuation in interest expense is acceptable to management. Through the
structure of our long-term financings, we generally have, and seek to realize,
opportunities to manage our interest rate risk, particularly with respect to
fixed-rate mortgage loans, by seeking to match the terms of the fixed-rate
mortgage loans with the fixed-rate portion of the long-term financing. We
continue to manage interest rate risks associated with variable-rate financings
beyond the point of long-term financing by seeking to identify differences in
the basis between our mortgage loans and related long-term financing, and to
manage the repricing characteristics of our liabilities by continuing to
purchase, hold, and sell appropriate financial derivatives.
In
selecting financial derivatives for interest rate risk management, we seek to
select interest rate caps and floors, interest rate swaps, sales of futures and
purchases of options on futures designed to provide protection should interest
rates on our debt rise. We seek to select derivatives with values that can be
expected to rise and produce returns tending to offset increased borrowing costs
in a rising rate environment.
Counterparty
Risk. An
additional risk that arises from our borrowing (including repurchase agreements)
and derivative activities is counterparty risk. These activities generally
involve an exchange of obligations with unaffiliated banks or companies,
referred to in such transactions as “counterparties” If a counterparty were to
default, we could potentially be exposed to financial loss. We seek to mitigate
this risk by limiting our derivatives transactions to counterparties that we
believe to be well established, reputable and financially strong.
Maturity
and Repricing Information
As shown
in the tables below, from December 31, 2003 to December 31, 2004, there was an
increase in our hedging activity due to the addition of new mortgage assets to
our portfolio and the belief that interest rates would increase in the future.
The following tables summarize the notional amounts, expected maturities and
weighted average strike rates for interest rate floors, caps, swaps, options and
futures that we held as of December 31, 2004 and 2003.
| |
As
of December 31, 2004 |
| |
2005 |
2006 |
2007 |
2008 |
2009 |
Thereafter |
| |
($
in thousands) |
|
Caps
bought - notional: |
$898,216 |
$686,583 |
$18,167 |
— |
— |
— |
|
Weighted
average rate |
3.92% |
3.39% |
3.25% |
— |
— |
— |
|
Caps
sold - notional: |
$865,966 |
$686,583 |
$18,167 |
— |
— |
— |
|
Weighted
average rate |
5.13% |
4.46% |
5.00% |
— |
— |
— |
|
Futures
sold - notional: |
225,000 |
$695,000 |
$570,000 |
$12,500 |
$6 |
— |
|
Weighted
average rate |
3.57% |
3.99% |
4.33% |
5.08% |
5.45% |
— |
|
Swaps
bought - notional: |
500,000 |
$700,000 |
$200,000 |
— |
— |
— |
|
Weighted
average rate |
2.31% |
3.53% |
3.91% |
— |
— |
— |
|
Puts
bought - notional: |
50,000 |
— |
— |
— |
— |
— |
|
Weighted
average rate |
2.25% |
— |
— |
— |
— |
— |
|
Puts
sold - notional: |
$112,500 |
$250,000 |
— |
— |
— |
— |
|
Weighted
average rate |
4.11% |
3.75% |
— |
— |
— |
— |
|
Total
notional: |
$2,651,682 |
$3,018,166 |
$806,334 |
$12,500 |
$6 |
$— |
| |
As
of December 31, 2003 |
| |
2004 |
2005 |
2006 |
2007 |
2008 |
Thereafter |
| |
($
in thousands) |
|
Caps
bought - notional: |
$1,115,750 |
$927,466 |
$321,417 |
— |
— |
— |
|
Weighted
average rate |
2.92% |
3.87% |
3.35% |
— |
— |
— |
|
Caps
sold - notional: |
$1,025,000 |
$899,299 |
$321,417 |
— |
— |
— |
|
Weighted
average rate |
3.61% |
5.09% |
5.04% |
— |
— |
— |
|
Futures
sold - notional: |
— |
$37,500 |
$112,500 |
— |
— |
— |
|
Weighted
average rate |
— |
3.88% |
4.31% |
— |
— |
— |
|
Puts
bought - notional: |
$250,000 |
$50,000 |
— |
— |
— |
— |
|
Weighted
average rate |
1.50% |
2.25% |
— |
— |
— |
— |
|
Puts
sold - notional: |
$112,500 |
$437,500 |
— |
— |
— |
— |
|
Weighted
average rate |
2.78% |
4.03% |
— |
— |
— |
— |
|
Total
notional: |
$2,503,250 |
$2,351,765 |
$755,334 |
$— |
$— |
$— |
Analyzing
Rate Shifts
In our
method of analyzing the potential effect of interest rate changes, we study the
published forward yield curves for applicable interest rates and instruments,
and we then develop various interest rate scenarios for those yield curves based
on assumptions concerning economic growth rates, market conditions, and
inflation rates, as well as the timing, duration, and amount of corresponding
FRB responses, in order to determine hypothetical impacts on relevant interest
rates. We use this method of analysis as a means of valuation to manage our
interest rate risk on our mortgage loan financing over long periods of time. The
table below represents the change in our interest expense as determined by
changes in our debt costs and offsetting values of derivative instruments under
the four different analysis scenarios that we used as of December 31, 2004 and
the four scenarios that we used as of December 31, 2003.
| |
Effect
on Interest Expense of Assumed Changes in Interest Rates Over a Three Year
Period |
| |
December
31, 2004 |
December
31, 2003 |
| |
Scenario
1 |
Scenario
2 |
Scenario
3 |
Scenario
4 |
Scenario
1 |
Scenario
2 |
Scenario
3 |
Scenario
4 |
|
($
in thousands) |
|
Change
in interest expense |
$65,786 |
$40,758 |
$(219) |
$(40,701) |
$10,066 |
$(824) |
$(10,827) |
$(42,369) |
|
Change
in interest expense from hedging instruments: |
|
|
|
|
|
|
|
|
|
Futures |
(12,302) |
(11,698) |
(1,322) |
5,834 |
(479) |
(667) |
(385) |
1,133 |
|
Swaps |
(11,753) |
(7,866) |
(276) |
6,766 |
— |
— |
— |
— |
|
Puts |
1,702 |
1,178 |
(19) |
(310) |
(615) |
192 |
153 |
250 |
|
Caps |
(6,885) |
(3,967) |
168 |
661 |
(2,310) |
(556) |
969 |
2,129 |
|
Total
change in interest expense from hedging instruments |
$(29,238) |
$(22,353) |
$(1,449) |
$12,951 |
$(3,404) |
$(1,031) |
$737 |
$3,512 |
|
Net
change in interest expense |
$36,548 |
$18,405 |
$(1,668) |
$(27,750) |
$6,662 |
$(1,855) |
$(10,090) |
$(38,857) |
Each
scenario is more fully discussed below, and tables of the hypothetical yield
curves are included below.
Scenario
1 - Under this scenario we show mortgage loan and derivative valuations based
upon an assumed aggressive response from the Board of Governors of the Federal
Reserve System, or the FRB, with the assumption that the economy is growing at a
pace inconsistent with the FRB desire to maintain a stable or declining
inflation environment. Under this scenario, we assume a hypothetical interest
rate increase of approximately 225 basis points over a twelve-month period. Such
an increase provides us with a view of the interest expense changes assuming a
comparable rise in financing rates. Making these assumptions as of December 31,
2004, we estimate that our interest expense would increase by $65.8 million.
However, we estimate that this amount would be partially offset by a decline in
interest expense from our hedging instruments of $29.2 million. The net effect
of this scenario would be a potential increase of $36.5 million in our interest
expense. As of December 31, 2003, we estimated that our interest expense could
increase by approximately $6.7 million under this scenario.
Scenario
2 - In this scenario we assume a slightly less severe hypothetical rise in
interest rates compared to Scenario 1, but longer in duration. Under this
scenario, we assume that interest rates have the potential to rise approximately
250 basis points over a two year period. Making these assumptions as of December
31, 2004, we estimate that our interest expense would increase by $40.8 million.
However, we estimate that this amount would be partially offset by a decline in
interest expense from our hedging instruments of $22.4 million. The net effect
of this scenario would be a potential increase of $18.4 million in our interest
expense. As of December 31, 2003, we estimated that our interest expense could
decline by approximately $1.9 million under this scenario.
Scenario
3 - In this scenario we assume relatively stable hypothetical short-term rates.
This scenario assumes that the FRB pauses their increasing rate scenario to
assess the lagging impact of previous rate increases on the domestic and global
economy. After a six to nine month pause, the FRB increases rates another 100
basis points over the next 12 months. Given these assumptions as of December 31,
2004, we estimate that our interest expense from changes in borrowing costs and
hedging instruments would decrease by $0.2 million and $1.4 million,
respectively,
for a total potential decline in interest expense of $1.7 million. As of
December 31, 2003, we estimated that our interest expense could decline by
approximately $10.1 million under this scenario.
Scenario
4 -This scenario assumes that the FRB becomes concerned about the future
prospects of economic growth and holds rates steady for one year and then
returns to an increasing rate cycle. Over the subsequent 24 months the FRB
raises rates 150 basis points. Given these assumptions at December 31, 2004, we
estimate that our interest expense would decline by approximately $40.7 million,
which would partially be offset by an estimated increase in interest expense
from hedging instruments of approximately $13.0 million, for a total potential
decline in interest expense of approximately $27.8 million. At December 31,
2003, we estimated that our interest expense could decline by approximately
$38.9 million under this scenario.
The
hypothetical yield curve data for each scenario at December 31, 2004 and
December 31, 2003 are as follows:
| |
December
31, 2004 |
|
Month |
Current
Market (1) |
Scenario
1 |
Scenario
2 |
Scenario
3 |
Scenario
4 |
|
Jan-05 |
2.39 |
2.89 |
2.61 |
2.63 |
2.35 |
|
Mar-05 |
2.91 |
3.40 |
2.89 |
2.89 |
2.36 |
|
Jun-05 |
3.18 |
3.91 |
3.40 |
2.89 |
2.39 |
|
Sep-05 |
3.39 |
4.43 |
3.65 |
3.15 |
2.40 |
|
Dec-05 |
3.56 |
4.69 |
3.91 |
3.40 |
2.65 |
|
Mar-06 |
3.68 |
4.70 |
4.41 |
3.65 |
3.15 |
|
Jun-06 |
3.78 |
4.71 |
4.67 |
3.91 |
3.66 |
|
Sep-06 |
3.87 |
4.72 |
4.92 |
4.16 |
3.66 |
|
Dec-06 |
3.97 |
4.73 |
4.93 |
4.17 |
3.67 |
|
Mar-07 |
4.05 |
4.75 |
4.93 |
4.17 |
3.67 |
|
Jun-07 |
4.13 |
4.76 |
4.94 |
4.18 |
3.68 |
|
Sept-07 |
4.22 |
4.77 |
4.94 |
4.43 |
4.18 |
|
Dec-07 |
4.31 |
4.78 |
4.95 |
4.43 |
4.18 |
________________
(1)
Current market is depicted using the forward Eurodollar Futures Curve. The
Eurodollar Future curve is the series of benchmark rates of Libor with a 3-month
maturity. The series of 3 month rates depicted represent the current market
expectations of Libor spot rates in the future based on expectations of economic
activity.
| |
December
31, 2003 |
|
Month |
Current
Market (1) |
Scenario
1 |
Scenario
2 |
Scenario
3 |
Scenario
4 |
|
Jan-04 |
1.12 |
1.13 |
1.13 |
1.10 |
1.10 |
|
Mar-04 |
1.23 |
1.36 |
1.14 |
1.11 |
0.86 |
|
Jun-04 |
1.43 |
1.86 |
1.14 |
1.14 |
0.89 |
|
Sep-04 |
1.76 |
2.11 |
1.61 |
1.14 |
1.06 |
|
Dec-04 |
2.16 |
2.37 |
1.87 |
1.62 |
1.07 |
|
Mar-05 |
2.57 |
2.62 |
2.37 |
2.12 |
1.57 |
|
Jun-05 |
2.99 |
2.87 |
2.87 |
2.62 |
2.37 |
|
Sep-05 |
3.36 |
3.38 |
3.38 |
3.13 |
2.88 |
|
Dec-05 |
3.66 |
3.88 |
3.88 |
3.88 |
3.13 |
|
Mar-06 |
3.90 |
4.13 |
4.38 |
4.38 |
3.38 |
|
Jun-06 |
4.14 |
4.64 |
4.89 |
4.42 |
3.34 |
|
Sep-06 |
4.35 |
4.67 |
4.67 |
4.39 |
3.17 |
|
Dec-06 |
4.56 |
4.89 |
4.64 |
4.39 |
3.14 |
________________
| (1) |
Current
market is depicted using the forward Eurodollar Futures Curve. The
Eurodollar Future curve is the series of benchmark rates of Libor with a
3-month maturity. The series of 3 month rates depicted represent the
current market expectations of Libor spot rates in the future based on
expectations of economic activity. |
These
scenarios are provided for illustrative purposes only and are intended to assist
in the understanding of our sensitivity to changes in interest rates. While
these scenarios are developed based on current economic and market conditions,
we cannot make any assurances as to the predictive nature of assumptions made in
this analysis.
Our
consolidated financial statements and the related notes, together with our
Independent Auditors’ Report thereon are set forth on pages F-1 through F-36 of
this annual report on Form 10-K.
None.
We
carried out an evaluation, as required by Exchange Act Rule 13a-5(b), under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as of the end of
the period covered by this annual report. Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that, as of the date of
such evaluation, our disclosure controls and procedures are effective in
ensuring that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms, and in timely alerting them to material
information relating to us (including our consolidated subsidiaries) required to
be included in the periodic reports we are required to file and submit to the
Securities and Exchange Commission under the Exchange Act. There have been no
significant changes in our internal controls or other factors that could
significantly affect those controls subsequent to the date of such evaluation.
There
were no changes in our internal controls over financial reporting during the
fourth quarter of 2004 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Saxon
Capital, Inc.
Management
of Saxon Capital, Inc. (the “Company”) is responsible for establishing and
maintaining adequate internal control over financial reporting and for the
assessment of the effectiveness of internal control over financial reporting. As
defined by the Securities and Exchange Commission, internal control over
financial reporting is a process designed by, or under the supervision of the
Company’s principal executive and principal financial officers, or persons
performing similar functions, and effected by the Company’s board of directors,
management, and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles.
The
Company’s internal control over financial reporting is supported by written
policies and procedures that:
| |
· |
Pertain
to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of the Company’s
assets; |
| |
· |
Provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that the Company’s receipts and expenditures
are being made only in accordance with authorizations of its management
and directors; and |
| |
· |
Provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company’s assets that
could have a material effect on the financial
statements. |
In
connection with the preparation of the Company’s annual financial statements,
management of the Company has undertaken an assessment of the effectiveness of
the Company’s internal control over financial reporting as of the end of the
Company’s most recent fiscal year based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the “COSO Framework”). Management's
assessment included an evaluation of the design of the Company’s internal
control over financial reporting and testing of the operational effectiveness of
the Company’s internal control over financial reporting. The controls that were
subject of management’s assessment included: controls over initiating,
recording, processing and reconciling account balances and controls related to
the prevention, identification and detection of fraud.
Based on
this assessment, management did not identify any material weakness in the
Company’s internal control, and management has concluded that the Company’s
internal control over financial reporting was effective as of December 31,
2004.
Deloitte
& Touche LLP, the independent registered public accounting firm that audited
the Company’s financial statements included in this annual report on Form 10-K,
has issued an attestation report on management’s assessment of the Company’s
internal control over financial reporting, a copy of which is included in this
annual report on Form 10-K.
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Shareholders of
Saxon
Capital, Inc.
Glen
Allen, VA
We have
audited management’s assessment, included in the accompanying Management’s
Report on Internal Control over Financial Reporting, that Saxon Capital, Inc.
and subsidiaries (the “Company”) maintained effective internal control over
financial reporting as of December 31, 2004, based on criteria established in
Internal
Control—Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission. The
Company’s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an
opinion on management’s assessment and an opinion on the effectiveness of the
Company’s internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating management’s assessment,
testing and evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for
our opinions.
A
company’s internal control over financial reporting is a process designed by, or
under the supervision of, the company’s principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company’s board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control
over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our
opinion, management’s assessment that the Company maintained effective internal
control over financial reporting as of December 31, 2004, is fairly stated, in
all material respects, based on the criteria established in Internal
Control—Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission. Also
in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2004, based on the
criteria established in Internal
Control—Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
Commission.
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheet of the Company
as of December 31, 2004, and the related consolidated statement of operations,
shareholders’ equity, and cash flows for the Company
for the year ended December 31, 2004 and our report dated
March 15, 2005 expressed an unqualified opinion on those financial
statements.
/s/
Deloitte & Touche LLP
Princeton,
NJ
March 15,
2005
None.
The names and
ages of the executive officers and the positions each of them has held for the
past five years are included in Item 1, Part I of this annual report on Form
10-K as permitted by the General Instruction G(3) to Form 10-K. Information
concerning our code of conduct is also included in Item 1, Part 1 of this annual
report on Form 10-K. All other information called for by this item will be
included in our definitive proxy statement for use in connection with our 2005
Annual Meeting of Shareholders, to be filed with the Securities and Exchange
Commission within 120 days of December 31, 2004 and is incorporated herein by
reference as if set forth in full herein as permitted by the General Instruction
G(3) to Form 10-K.
The
information called for by this item will be included in our definitive proxy
statement for use in connection with our 2005 Annual Meeting of Shareholders, to
be filed with the Securities and Exchange Commission within 120 days of December
31, 2004 and is incorporated herein by reference as if set forth in full herein
as permitted by the General Instruction G(3) to Form 10-K.
The
following table sets forth information relating to our equity compensation plans
as of December 31, 2004:
|
Plan
Category |
Number
of securities to be issued upon exercise of outstanding options, warrants
and restricted stock units |
Weighted-average
exercise price of outstanding options, warrants and restricted stock
units |
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a)) |
| |
(a) |
(b) |
(c) |
|
Equity
compensation plans approved by security holders |
11,000 |
$10.10 |
1,085,664
(1) |
Equity
compensation plans not approved by security holders (2) |
8,000 |
$10.00 |
— |
|
Total |
19,000 |
$10.06 |
1,085,664 |
________________
| |
(1) |
Includes
994,535 shares reserved for issuance under our Employee Stock Purchase
Plan. The maximum number of shares or other awards authorized for issuance
under the Stock Incentive Plan is reset as of January 1 of each year at
the greater of (i) 2,998,556; (ii) 10.69% of the total number of then
outstanding shares of our common stock as of January 1 of each year; or
(iii) the maximum number that has been previously awarded or granted under
the Stock Incentive Plan, provided that the total number of shares
authorized to be issued under the Stock Incentive Plan may not exceed
6,000,000 shares. |
| |
(2) |
In
connection with our private offering in 2001, we granted warrants to
Friedman, Billings, Ramsey & Co., Inc. to purchase an aggregate of
1,200,000 shares of our common stock, at an exercise price of $10.00 per
share. The warrants are exercisable for a period of five years, commencing
on July 6, 2001. As of December 31, 2004, warrants to purchase an
aggregate of 1,192,000 had been exercised. |
Effective
September 13, 2004, upon shareholder approval of the merger agreement in
connection with the REIT conversion, all outstanding stock options and
restricted stock units granted by Old Saxon vested. New Saxon assumed all
outstanding options and warrants to acquire Old Saxon’s common stock that were
not exercised on or before September 24, 2004.
The
additional information called for by this item will be included in our
definitive proxy statement for use in connection with our 2005 Annual Meeting of
Shareholders, to be filed with the Securities and Exchange Commission within 120
days of December 31, 2004, and is incorporated herein by reference as if set
forth in full herein as permitted by the General Instruction G(3) to Form
10-K.
The
information called for by this item will be included in our definitive proxy
statement for use in connection with our 2005 Annual Meeting of Shareholders, to
be filed with the Securities and Exchange Commission within 120 days of December
31, 2004, and is incorporated herein by reference as if set forth in full herein
as permitted by the General Instruction G(3) to Form 10-K.
The
information called for by this item will be included in our definitive proxy
statement for use in connection with our 2005 Annual Meeting of Shareholders, to
be filed with the Securities and Exchange Commission within 120 days of December
31, 2004, and is incorporated herein by reference as if set forth in full herein
as permitted by the General Instruction G(3) to Form 10-K.
(a) The
following documents are filed as part of this report:
—See
Index to Consolidated Financial Statements on page F-1 of this annual report on
Form 10-K.
| |
2. |
Financial
Statement Schedules. |
None.
—See
Exhibit Index.
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 in the city of Richmond, Commonwealth
of Virginia, on March 15, 2005.
| |
|
|
| |
SAXON CAPITAL,
INC. |
|
|
|
|
By: |
/s/ Michael L.
Sawyer |
| |
Name: |
Michael L. Sawyer |
| |
Title: |
Chief Executive
Officer |
Each
person whose signature appears below hereby authorizes Michael L. Sawyer and
Robert B. Eastep, or either of them, as attorneys-in-fact to sign on his behalf,
individually, and in each capacity stated below, and to file with the Securities
and Exchange Commission, any amendments and/or supplements to the annual report
on Form 10-K, with exhibits thereto, and other documents in connection
therewith, hereby ratifying and confirming all that either of said
attorneys-in-fact, or substitute or substitutes, may do or cause to be done by
virtue hereof.
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 |
Capacity
in which to Sign |
Date |
| |
|
|
|
/s/
Richard A. Kraemer |
Chairman
of the Board of Directors |
March
15, 2005 |
|
Richard
A. Kraemer |
|
/s/
Michael L. Sawyer |
Chief
Executive Officer and Director (principal executive
officer) |
March
15, 2005 |
|
Michael
L. Sawyer |
|
/s/
Thomas J. Wageman |
Director |
March
15, 2005 |
|
Thomas
J. Wageman |
|
/s/
David D. Wesselink |
Director |
March
15, 2005 |
|
David
D. Wesselink |
|
/s/
Robert B. Eastep |
Chief
Financial Officer (principal financial and accounting officer)
|
March
15, 2005 |
|
Robert
B. Eastep |
INDEX
TO FINANCIAL STATEMENTS
| |
Page |
|
|
F-1 |
|
|
F-2 |
|
|
F-3 |
|
|
F-4 |
|
|
F-5 |
|
|
F-7 |
To the
Board of Directors and Shareholders of
Saxon
Capital, Inc.
Glen
Allen, Virginia
We have
audited the accompanying consolidated balance sheets of Saxon Capital, Inc. and
subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related
consolidated statements of operations, shareholders’ equity, and cash flows for
the Company for each of the three years in the period ended December 31,
2004. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of the Company as of December 31, 2004 and
2003, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Company’s internal
control over financial reporting as of December 31, 2004, based on the criteria
established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report dated March
15, 2005 expressed an unqualified opinion on management’s assessment of the
effectiveness of the Company’s internal control over financial reporting and an
unqualified opinion on the effectiveness of the Company’s internal control over
financial reporting.
/s/
Deloitte & Touche LLP
Princeton,
NJ
March 15,
2005
Saxon
Capital, Inc.
($
in thousands, except share data)
| |
December
31,
2004
|
December
31,
2003 |
|
Assets: |
|
|
|
Cash |
$12,852 |
$5,245 |
|
Accrued
interest receivable |
56,132 |
54,080 |
|
Trustee
receivable |
112,062 |
74,614 |
| |
|
|
|
Mortgage
loan portfolio |
6,027,620 |
4,723,416 |
|
Allowance
for loan loss |
(37,310) |
(43,369) |
|
Net
mortgage loan portfolio |
5,990,310 |
4,680,047 |
| |
|
|
|
Restricted
cash |
1,495 |
1,257 |
|
Servicing
related advances |
113,129 |
98,588 |
|
Mortgage
servicing rights, net |
98,995 |
41,255 |
|
Real
estate owned |
24,860 |
23,787 |
|
Derivative
assets, including cash margin |
16,573 |
7,556 |
|
Deferred
tax asset |
27,825 |
— |
|
Other
assets |
84,898 |
72,652 |
|
Total
assets |
$6,539,131 |
$5,059,081 |
|
Liabilities
and shareholders’ equity: |
|
|
|
Liabilities: |
|
|
|
Accrued
interest payable |
$8,045 |
$8,602 |
|
Dividends
payable |
28,909 |
— |
|
Warehouse
financing |
600,646 |
427,969 |
|
Securitization
financing |
5,258,344 |
4,237,375 |
|
Derivative
liabilities |
1,809 |
249 |
|
Note
payable |
— |
25,000 |
|
Deferred
tax liability |
— |
907 |
|
Other
liabilities |
22,449 |
13,933 |
|
Total
liabilities |
5,920,202 |
4,714,035 |
|
Commitments
and contingencies - Note 19 |
|
|
|
Shareholders’
equity: |
|
|
|
Common
stock, $0.01 par value per share, 100,000,000 shares authorized; shares
issued and outstanding: 49,849,386 and 28,661,757 as of December 31, 2004
and 2003, respectively |
498 |
287 |
|
Additional
paid-in capital |
625,123 |
264,030 |
|
Other
comprehensive loss, net of tax of $(2,446) and $(3,500) |
(3,842) |
(5,497) |
|
Net
(accumulated deficit) retained earnings: |
|
|
|
Cumulative
dividends declared |
(114,641) |
— |
|
Retained
earnings |
111,791 |
86,226 |
|
Net
(accumulated deficit) retained earnings |
(2,850) |
86,226 |
| |
|
|
|
Total
shareholders’ equity |
618,929 |
345,046 |
|
Total
liabilities and shareholders’ equity |
$6,539,131 |
$5,059,081 |
The
accompanying notes are an integral part of these consolidated financial
statements.
Saxon
Capital, Inc.
($
in thousands, except share data)
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002
|
|
Revenues: |
|
|
|
|
Interest
income |
$395,347 |
$333,064 |
$226,399 |
|
Interest
expense |
(155,805) |
(123,303) |
(87,068) |
|
Net
interest income |
239,542 |
209,761 |
139,331 |
|
Provision
for mortgage loan losses |
(41,647) |
(33,027) |
(28,117) |
|
Net
interest income after provision for mortgage loan losses |
197,895 |
176,734 |
111,214 |
|
Servicing
income, net of amortization and impairment |
33,636 |
32,134 |
22,924 |
|
Gain
on sale of mortgage assets |
3,500 |
2,533 |
365 |
|
Total
net revenues |
235,031 |
211,401 |
134,503 |
|
Expenses: |
|
|
|
|
Payroll
and related expenses |
(74,323) |
(58,322) |
(50,437) |
|
General
and administrative expenses |
(57,373) |
(45,815) |
(38,425) |
|
Depreciation |
(5,923) |
(3,880) |
(1,903) |
|
Other
(expense) income |
(4,827) |
(1,739) |
472 |
|
Total
operating expenses |
(142,446) |
(109,756) |
(90,293) |
|
Income
before taxes |
92,585 |
101,645 |
44,210 |
|
Income
tax benefit (expense) |
12,980 |
(36,509) |
(16,833) |
|
Net
income |
$105,565 |
$65,136 |
$27,377 |
|
Earnings
per common share: |
|
|
|
|
Average
common shares - basic |
34,702,370 |
28,518,128 |
28,103,695 |
|
Average
common shares - diluted |
36,521,893 |
30,116,305 |
29,165,184 |
|
Basic
earnings per common share |
$3.04 |
$2.28 |
$0.97 |
|
Diluted
earnings per common share |
$2.89 |
$2.16 |
$0.94 |
|
Dividends
declared per common share |
$2.30 |
— |
— |
The
accompanying notes are an integral part of these consolidated financial
statements.
Saxon
Capital, Inc.
($
in thousands)
| |
Common
Shares
Outstanding |
Common
Stock |
Additional
Paid-in
Capital |
Accumulated
Other
Comprehensive
(Loss)
Income |
Cumulative
Dividends Declared |
Retained
Earnings
(Accumulated Deficit) |
Total |
|
Balance
as of January 1, 2002 |
28,050,100 |
$281 |
$258,004 |
— |
— |
$(6,287) |
$251,998 |
|
Issuance
of common stock |
185,681 |
1 |
1,917
|
— |
— |
— |
1,918 |
|
Costs
associated with issuance of common stock |
— |
— |
(654) |
— |
— |
— |
(654) |
|
Comprehensive
income:
Net
income |
— |
— |
— |
— |
— |
27,377 |
|
|
Mortgage
bonds: |
|
|
|
|
|
|
|
|
Change
in unrealized gain |
— |
— |
— |
994 |
— |
— |
|
|
Reclassification
adjustment |
— |
— |
— |
(232) |
— |
— |
|
|
Tax
effect |
— |
— |
— |
(297) |
— |
— |
|
|
Cash
flow hedging instruments: |
|
|
|
|
|
|
|
|
Change
in unrealized gain |
— |
— |
— |
9,976 |
— |
— |
|
|
Reclassification
adjustment |
— |
— |
— |
(1,382) |
— |
— |
|
Tax
effect |
— |
— |
— |
(3,352) |
— |
— |
|
|
Total
comprehensive income |
— |
— |
— |
5,707 |
— |
27,377 |
33,084 |
|
Balance
as of December 31, 2002 |
28,235,781 |
$282 |
$259,267 |
$5,707 |
— |
$21,090 |
$286,346 |
|
Issuance
of common stock |
425,976 |
5 |
4,496 |
— |
— |
— |
4,501 |
|
Compensation
expense on restricted stock units |
— |
— |
267 |
— |
— |
— |
267 |
|
Comprehensive
income:
Net
income |
— |
— |
— |
— |
— |
65,136 |
|
|
Mortgage
bonds: |
|
|
|
|
|
|
|
|
Change
in unrealized loss |
— |
— |
— |
(2,033) |
— |
— |
|
|
Reclassification
adjustment |
— |
— |
— |
(27) |
— |
— |
|
|
Tax
effect |
— |
— |
— |
803 |
— |
— |
|
|
Cash
flow hedging instruments: |
|
|
|
|
— |
|
|
|
Change
in unrealized gain |
— |
— |
— |
(17,677) |
— |
— |
|
|
Reclassification
adjustment |
— |
— |
— |
1,385 |
— |
— |
|
|
Tax
effect |
— |
— |
— |
6,345 |
— |
— |
|
|
Total
comprehensive income (loss) |
— |
— |
— |
(11,204) |
— |
65,136
|
53,932
|
|
Balance
as of December 31, 2003 |
28,661,757 |
$287 |
$264,030 |
$(5,497) |
— |
$86,226 |
$345,046 |
Saxon
Capital, Inc.
($
in thousands)
| |
Common
Shares Outstanding |
Common
Stock |
Additional
Paid-in
Capital |
Accumulated
Other
Comprehensive
(Loss)
Income |
Cumulative
Dividends Declared |
Retained
Earnings
(Accumulated Deficit) |
Total |
|
Balance
as of December 31, 2003 |
28,661,757 |
$287 |
$264,030 |
$(5,497) |
— |
$86,226 |
$345,046 |
|
Issuance
of common stock |
21,187,629 |
211 |
426,686 |
— |
— |
— |
426,897 |
|
Costs
related to REIT conversion and stock issuance |
— |
— |
(33,422) |
— |
— |
— |
(33,422) |
|
Compensation
expense on restricted stock units |
— |
— |
3,880 |
— |
— |
— |
3,880 |
|
Stock
option exercise tax benefit |
— |
— |
15,325 |
— |
— |
— |
15,325 |
|
REIT
conversion merger consideration |
— |
— |
(51,376) |
— |
— |
(80,000) |
(131,376) |
|
Dividends
declared ($2.30 per common share) |
— |
— |
— |
— |
(114,641) |
— |
(114,641) |
|
Comprehensive
income:
Net
income |
— |
— |
— |
— |
— |
105,565 |
|
|
Mortgage
bonds: |
|
|
|
|
|
|
|
|
Change
in unrealized loss |
— |
— |
— |
(39) |
— |
— |
|
|
Reclassification
adjustment |
— |
— |
— |
842 |
— |
— |
|
|
Tax
effect |
— |
— |
— |
(312) |
— |
— |
|
|
Cash
flow hedging instruments: |
|
|
|
|
|
|
|
|
Change
in unrealized loss |
— |
— |
— |
1,577 |
— |
— |
|
|
Reclassification
adjustment |
— |
— |
— |
328 |
— |
— |
|
|
Tax
effect |
— |
— |
— |
(741) |
— |
— |
|
|
Total
comprehensive income |
— |
— |
— |
1,655 |
— |
105,565 |
107,220 |
|
Balance
as of December 31, 2004 |
49,849,386 |
$498 |
$625,123 |
$(3,842) |
$(114,641) |
$111,791 |
$618,929 |
The
accompanying notes The
accompanying notes are an integral part of these consolidated financial
statements.
Saxon
Capital, Inc.
($
in thousands)
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
|
Operating
Activities: |
|
|
|
|
Net
income from operations |
$105,565 |
$65,136 |
$27,377 |
|
Adjustments
to reconcile net income to net cash provided by operating
activities: |
|
|
|
|
Depreciation
and amortization |
51,520 |
33,761 |
14,911 |
|
Deferred
income taxes |
(28,732) |
18,495 |
(5,816) |
|
Impairment
of assets |
11,706 |
1,934 |
1,803 |
|
Gain
from sale of assets |
(3,500) |
(2,533) |
(365) |
|
Provision
for loan losses |
41,647 |
33,027 |
28,117 |
|
(Recovery)
provision for advanced interest losses |
(1,938) |
1,029 |
5,211 |
|
(Increase)
decrease in servicing related advances |
(14,541) |
3,970 |
(913) |
|
Increase
in accrued interest receivable |
(2,052) |
(15,451) |
(22,856) |
|
(Decrease)
increase in accrued interest payable |
(557) |
1,171 |
4,234 |
|
Increase
in trustee receivable |
(37,448) |
(30,486) |
(37,347) |
|
Net
change in other assets and other liabilities |
(21,752) |
(26,328) |
16,932 |
|
Net
cash provided by operating activities |
99,918 |
83,725 |
31,288 |
|
Investing
Activities: |
|
|
|
|
Purchase
and origination of mortgage loans |
(3,815,035) |
(2,886,057) |
(2,512,653) |
|
Principal
payments on mortgage loan portfolio |
2,120,344 |
1,464,591 |
576,035 |
|
Proceeds
from the sale of mortgage loans |
270,749 |
189,223 |
49,881 |
|
Proceeds
from the sale of real estate owned |
56,261 |
31,353 |
5,132 |
|
(Increase)
decrease in restricted cash |
(238) |
300,178 |
(301,435) |
|
Purchases
of derivative instruments |
— |
—
|
(55,303) |
|
Purchase
of mortgage bonds |
— |
(3,000) |
(6,969) |
|
Principal
payments received on mortgage bonds |
3,584 |
2,313 |
3,495 |
|
Acquisition
of mortgage servicing rights |
(84,948) |
(23,691) |
(6,354) |
|
Capital
expenditures |
(6,296) |
(8,003) |
(4,864) |
|
Net
cash used in investing activities |
(1,455,579) |
(933,093) |
(2,253,035) |
|
Financing
Activities: |
|
|
|
|
Proceeds
from issuance of securitization financing |
3,240,446 |
2,482,061 |
2,616,954 |
|
Bond
issuance costs |
(12,380) |
(20,754) |
(9,983) |
|
Principal
payments on securitization financing |
(2,182,963) |
(1,552,649) |
(576,719) |
|
Proceeds
from (repayment of) warehouse financing, net |
172,677 |
(46,473) |
191,072 |
|
Purchases
of derivative instruments |
(5,879) |
(20,171) |
— |
|
Proceeds
received from issuance of stock |
426,897 |
4,501 |
1,918 |
|
Payment
of expenses related to REIT conversion and stock issuance |
(33,422) |
— |
— |
|
Payment
of dividends |
(85,732) |
— |
— |
|
Payment
of merger consideration |
(131,376) |
— |
— |
|
Repayment
of note payable |
(25,000) |
— |
— |
|
Net
cash provided by financing activities |
1,363,268 |
846,515 |
2,223,242 |
|
Net
increase (decrease) in cash |
7,607 |
(2,853) |
1,495 |
|
Cash
at beginning of year |
5,245 |
8,098 |
6,603 |
|
Cash
at end of year |
$12,852 |
$5,245 |
$8,098 |
|
Supplemental
Cash Flow Information: |
|
|
|
|
Cash
paid for interest |
$178,081 |
$152,919 |
$101,340 |
|
Cash
paid for taxes |
$13,836 |
$41,878 |
$16,904 |
|
Non-Cash
Financing Activities: |
|
|
|
|
Transfer
of mortgage loans to real estate owned |
$90,209 |
$57,004 |
$23,879 |
The
accompanying notes are an integral part of these consolidated financial
statements.
(1) Organization
and Summary of Significant Accounting Policies
(a) The
Company and Principles of Consolidation
Saxon
Capital, Inc., a Delaware corporation (“Old Saxon”) was formed on April 23, 2001
and acquired all of the issued and outstanding capital stock of SCI Services,
Inc. from Dominion Capital, Inc., a wholly-owned subsidiary of Dominion
Resources, Inc., on July 6, 2001. Saxon Capital, Inc., a Maryland corporation
(formerly known as Saxon REIT, Inc.) (“New Saxon,” and together with Old Saxon,
referred to herein as “Saxon” or the “Company”), was formed on February 5, 2004
for the purpose of effecting Old Saxon’s conversion to a real estate investment
trust, or REIT. A merger agreement effecting the REIT conversion was approved by
the boards of directors and shareholders of the constituent entities and the
merger was completed on September 24, 2004. The merger had no effect on the
consolidated financial statements, as this was a merger of companies under
common control.
Pursuant
to the merger agreement, Old Saxon merged with and into Saxon Capital Holdings,
Inc. (“Saxon Capital Holdings”), a wholly-owned subsidiary of New Saxon, and New
Saxon succeeded to and continued the operations of Old Saxon, changing its name
to “Saxon Capital, Inc.” At the effective time of the merger, each outstanding
share of Old Saxon common stock was converted into the right to receive one
share of New Saxon common stock and a cash payment of $4.00. The Company’s
common stock is currently quoted on Nasdaq under the symbol “SAXN.” New Saxon
issued an additional 17.0 million shares of its common stock in a public
offering simultaneously with the merger, which resulted in $386.8 million in
gross proceeds, part of which was used to pay the cash portion of the merger
consideration.
The
Company applies REIT rules for federal income tax and accounting purposes since
the effective date of the merger. To qualify for tax treatment as a REIT, the
parent company must meet certain income and asset tests and distribution
requirements. Generally, the Company will not be subject to federal income tax
at the corporate level to the extent it distributes 90% of its taxable income to
its shareholders and complies with certain other requirements.
The
Company, through its wholly-owned subsidiaries Saxon Mortgage, Inc. (“Saxon
Mortgage”) and America’s MoneyLine, Inc. (“America’s MoneyLine”), is
licensed to originate loans or is exempt from licensing requirements, in 49
states. Its activities consist primarily of originating and purchasing
single-family residential mortgage loans and home equity loans through three
production channels —
wholesale,
correspondent, and retail. The Company may also, as servicer of record, purchase
loans from prior securitizations pursuant to the clean-up call provisions of the
trusts. Loans originated or purchased by the Company are secured by a mortgage
on the borrower’s property. The Company then either sells these loans or
accumulates such loans until a sufficient volume has been reached to securitize
into an asset-backed security. In addition, the Company, through its
wholly-owned subsidiary Saxon Mortgage Services, Inc. (“Saxon Mortgage
Services”), services and sub-services single-family mortgage loans throughout
the country that have been purchased or originated by the Company, in addition
to loans held by third parties. The Company, headquartered in Glen Allen,
Virginia, has operation centers of its subsidiaries in Fort Worth, Texas and
Foothill Ranch, California and 25 branch offices located throughout the country
at December 31, 2004. The focus of the Company is on originating and purchasing
loans to homebuyers who generally do not meet the underwriting guidelines of one
of the government-sponsored entities such as the Federal Home Loan Mortgage
Corporation, (“Freddie Mac”), the Federal National Mortgage Association,
(“Fannie Mae”), and the Government National Mortgage Association, (“Ginnie
Mae”). Use of the term “Company” throughout these Notes to Consolidated
Financial Statements shall be deemed to refer to or include the applicable
subsidiaries of the Company.
The
consolidated financial statements of the Company include the accounts of all
wholly-owned subsidiaries. All inter-company balances and transactions have been
eliminated in consolidation.
(b) Use
of Estimates
The
preparation of financial statements in conformity with GAAP 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 amount of revenues and expenses during
the reporting period. Actual results could differ from those estimates. The
recorded balances most affected by the use of estimates are net interest income,
the allowance for loan loss, valuation of servicing rights, hedging activities,
deferral of certain direct loan origination costs, and income
taxes.
(c) Trustee
Receivable
Loan
payments are collected by each securitization trust and distributed to their
related bondholders on the bond payment cut-off date, typically the
17th of each
month. Therefore, principal, interest, and prepayment penalty payments received
subsequent to the cut-off date are recorded as a trustee receivable on the
consolidated balance sheet to offset the bond payment liability. In addition,
collections on securitized escrow and corporate advances received subsequent to
the cut-off date are recorded as a trustee receivable on the consolidated
balance sheets to offset the bond payment liability. These payments are retained
by the trustee until the following remittance date.
(d) Mortgage
Loan Portfolio
Mortgage
loans are recorded at cost, held for investment and consist of mortgage loans
secured by single-family residential properties (which may include manufactured
homes affixed to and classified as real property under applicable law),
condominiums, and one-to-four unit properties. Loan origination fees and certain
direct loan origination costs, as well as any premiums or discounts from
acquiring mortgage loans are deferred as an adjustment to the cost basis of the
loans. These fees and costs are amortized over the life of the loan on an
interest method basis assuming a 35 constant prepayment rate.
The
Company structures securitizations as financing transactions, and accordingly
holds the securitized mortgage loans for investment, as opposed to recognizing a
sale transaction that would generate a gain or loss. These securitizations do
not meet the qualifying special purpose entity criteria because after the loans
are securitized, the securitization trust may acquire derivatives relating to
beneficial interests retained by the Company; also, the Company, as servicer,
subject to applicable contractual provisions, has sole discretion to use its
best commercial judgment in determining whether to sell or work out any mortgage
loans securitized through a securitization trust that becomes troubled.
Accordingly, following a securitization, the mortgage loans remain on the
consolidated balance sheets and the securitization indebtedness replaces the
warehouse debt associated with the securitized mortgage loans. The Company
records interest income on the mortgage loans and interest expense on the debt
securities issued in the securitization over the life of the debt obligations,
instead of recognizing a one-time gain or loss upon completion of a
securitization that was structured as a sale.
(e) Provision
for Mortgage Loan Losses
The
Company evaluates the propriety of its allowance for loan loss on a monthly
basis. Provision for loan losses on both securitized and unsecuritized mortgage
loans is recorded to maintain the allowance for loan loss at an appropriate
level for currently existing probable losses of principal, interest and fees,
uncollected and advanced interest, and associated unamortized basis adjustments.
Provision amounts are charged as a current period expense to operations. The
Company charges off uncollectible loans against the allowance for loan loss at
the time of liquidation or at the time the loan is transferred to real estate
owned. The Company defines a mortgage loan as impaired at the time the loan
becomes 30 days delinquent under its payment terms. Probable losses are
determined based on segmenting the portfolios by their contractual delinquency
status, applying the Company’s historical loss experience, and other relevant
economic data. Allowance for loan loss estimates are evaluated monthly and
adjustments are reported in earnings when they become known. As these estimates
are influenced by factors outside of the Company’s control and due to the
characteristics of the portfolio and migration into various credit risks, such
as mortgagee payment patterns and economic conditions, there is uncertainty
inherent in these estimates, making it reasonably possible that they could
change.
(f) Called
Loans
Called
loans are performing or non-performing mortgage loans currently acquired from
outstanding securitizations related to off balance sheet transactions pursuant
to the clean-up call option that the servicer holds. This option permits the
servicer to purchase the remaining securitized loans when the total outstanding
amount falls to a specified level, typically 10% of the original principal
balance. Called loans are recorded on the consolidated balance sheets at the
purchase price paid by the Company, which approximates fair value. The Company
intends to either securitize or sell the mortgage loans that it acquires in
these transactions.
(g) Restricted
Cash
Restricted
cash of the Company relates to amounts pledged as collateral to certain trusts.
It may also include amounts related to prefunded securitizations. Prefunded
amounts are held in a trust account and made available during the prefunding
period to purchase subsequent mortgage loans to put into the related
securitization. At the end of the prefunding period, any prefunded amounts not
used to purchase mortgage loans are distributed as principal prepayments to the
certificate holders. Any interest earned on the restricted cash balance is
returned to the Company once the prefunding is fulfilled.
(h) Securitization
of Servicing Related Advances
The
Company has securitized a portion of its servicing related advances related to
the principal, interest, escrow and corporate advances the Company is obligated
to make as servicer. This securitization is structured as a financing
transaction. Accordingly, the servicing related advances remain on the
consolidated balance sheet to offset the securitization
indebtedness.
(i) Mortgage
Servicing Rights
The
Company purchases third party servicing rights and accordingly recognizes the
right to service those mortgage loans as an asset on its consolidated balance
sheets. Mortgage servicing rights are amortized in proportion to and over the
period of the estimated net servicing income on a discounted basis, and are
recorded at the lower of amortized cost or fair value by risk strata on the
consolidated balance sheets. Mortgage servicing rights are assessed periodically
to determine if there has been any impairment to the recorded balance, based on
fair value at the date of the assessment and by stratifying the mortgage
servicing rights based on underlying loan characteristics, specifically by date
of the related securitization. In addition, the Company periodically evaluates
its mortgage servicing rights for permanent impairment to determine if the
carrying value before the application of the valuation allowance is recoverable.
When the Company determines that a portion of the mortgage servicing rights are
not recoverable, the related mortgage servicing rights and the previously
established valuation allowance are correspondingly reduced to reflect the
permanent impairment.
(j) Real
Estate Owned
When a
loan is deemed to be uncollectible and the property is foreclosed, it is
transferred to real estate owned at net realizable value. Net realizable value
is defined as the property’s fair value less estimated costs to sell. Individual
real estate owned properties are periodically evaluated, and additional
impairments are recorded as required. The majority of the costs of holding this
real estate and related gains and losses on disposition are credited or charged
to operations as incurred.
(k) Derivative
Financial Instruments
The
Company may use a variety of financial instruments to hedge the exposure to
changes in interest rates. The Company may enter into interest rate swap
agreements, interest rate cap agreements, interest rate floor agreements,
financial forwards, financial futures and options
on financial instruments (collectively referred to as “Interest Rate
Agreements”) to manage the sensitivity to changes in market interest rates. The
Interest Rate Agreements used have an active secondary market, and none are
obtained for speculation or trading. These Interest Rate Agreements are intended
to provide income and cash flow to offset the potential for reduced net interest
income and cash flow under certain interest rate environments. At trade date,
these instruments and their hedging relationship are identified, designated and
documented.
The
Company currently accounts for its derivative financial instruments as cash flow
hedges with the objective of hedging interest rate risk, specifically forecasted
interest expense. On the date the derivative contract is entered into, the
Company designates the derivative as a cash flow hedge, which hedges the
Company’s anticipated interest expense from its forecasted issuance of its
variable rate debt through its asset-backed securitization program.
Historically, the Company has completed an asset-backed securitization
approximately three to four times a year. The fair value of the Company’s
derivative instruments, along with any margin accounts associated with the
contracts, are included on the consolidated balance sheets. Any changes in the
fair value of derivative instruments are reported in accumulated other
comprehensive income. Accumulated other comprehensive income is amortized or
accreted into earnings through interest expense on a level yield basis. Changes
in the fair value of derivative instruments related to hedge ineffectiveness and
activity not qualifying for hedge treatment are recorded as adjustments to
current period earnings.
The
Company documents the relationships between hedging instruments and hedged
items, as well as the Company’s risk-management objective and strategy for
undertaking various hedge transactions. This process includes linking
derivatives to specific liabilities on the balance sheet or related exposures.
The Company also assesses, both at the hedge’s inception and on an ongoing
basis, whether the derivatives used in hedging transactions are highly effective
in offsetting changes in the variability of cash flows of the hedged items. When
it is determined that a derivative is not highly effective as a hedge or that it
has ceased to be a highly effective hedge, the Company discontinues hedge
accounting prospectively, as discussed below.
When
hedge accounting is discontinued, the derivative will continue to be recorded on
the balance sheet at its fair value, if not settled. The effective position
previously recorded remains in accumulated other comprehensive income and
continues to be amortized or accreted into earnings with the hedged item;
however, changes in the fair value of an ineffective hedge subsequent to the
date it was determined to be ineffective is recognized in the current period
earnings.
If the
hedged risk is extinguished or is not probable of occurring, the Company
typically terminates any applicable hedges and recognizes any remaining related
accumulated other comprehensive income balance to income or expense. However, if
the Company continues to hold the derivatives, they continue to be recorded on
the balance sheet at fair value with any changes being recorded to current
period earnings.
(l) Interest
Income
The
Company earns interest income on mortgage loans as contractually due. Interest
income is suspended for any mortgage loans on which principal or interest
payments are more than three months contractually past due; however, accrual of
income on these nonaccrual mortgage loans is resumed if the receivable becomes
less than three months contractually past due. Accrued interest losses are
provided for within the allowance for loan loss. Prepayment penalty income is
included within interest income when collected.
(m) Servicing
Revenue Recognition
Mortgage
loans serviced require regular monthly payments from borrowers. Income on loan
servicing is generally recorded as payments are collected and is based on a
percentage of the principal balance of the respective loans. Loan servicing
expenses are charged to operations when incurred. The contractual servicing fee
is recorded as a component of interest income on the consolidated statements of
operations for loans owned by the Company, and it is recorded as servicing
income on the consolidated statements of operations for loans serviced for
others.
(n) Stock
Options
The
Company has elected to follow the intrinsic value method in accounting for its
stock options issued to employees and non-employee directors. Accordingly, the
Company did not recognize compensation expense upon the issuance of its stock
options because the option terms were fixed and the exercise price equaled the
market price of the underlying stock on the grant date. Effective
September 13, 2004, upon approval by Old Saxon’s shareholders of the merger
agreement required in connection with the REIT conversion, all outstanding stock
options and restricted stock units immediately vested and were expensed at that
time. See Note 17 for further discussion.
The
following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value method to options granted to employees
using the Black-Scholes option pricing model.
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
| |
($
in thousands, except share data) |
|
Net
income, as reported |
$105,565 |
$65,136 |
$27,377 |
|
Add:
stock-based compensation expense included in reported net income, net of
related tax effects |
199 |
¾ |
¾ |
|
Deduct:
total stock-based compensation expense determined under fair value based
method for all awards, net of related tax effects |
(4,194) |
(2,536) |
(2,407) |
|
Pro
forma net income |
$101,570 |
$62,600 |
$24,970 |
|
Earnings
per share: |
|
|
|
|
Basic
- as reported |
$3.04 |
$2.28 |
$0.97 |
|
Basic
- pro forma |
$2.93 |
$2.20 |
$0.89 |
|
Diluted
- as reported |
$2.89 |
$2.16 |
$0.94 |
|
Diluted
- pro forma |
$2.78 |
$2.08 |
$0.86 |
(o) Federal
Income Taxes
The
Company has elected to be taxed as a REIT under the Internal Revenue Code and
the corresponding provisions of state law. In order to qualify as a REIT, the
Company must distribute at least 90% of its annual REIT taxable income
(exclusive of undistributed taxable income of taxable subsidiaries) to
stockholders within the time frame set forth in the tax rules and meet certain
other requirements. If these requirements are met, the Company generally will
not be subject to Federal or state income taxation at the corporate level with
respect to the REIT taxable income it distributes to its stockholders. In 2004,
the Company retained approximately 10% of its ordinary REIT taxable income and
paid corporate income taxes on this retained income while continuing to maintain
its REIT status. Accordingly, the Company has recorded a provision for income
taxes based upon its estimated current liability for Federal and state income
tax purposes in its consolidated statements of operations.
The
Company has elected to treat Saxon Capital Holdings and its subsidiaries as
taxable REIT subsidiaries (each a “TRS”). In general, a TRS of the Company may
hold assets that the Company cannot hold directly and generally may engage in
any real estate or non-real estate related business. A TRS is subject to
corporate federal income tax and will be taxed as a regular C corporation. The
taxable income of Saxon Capital Holdings and its subsidiaries is not included in
REIT taxable income and is subject to state and Federal income taxes at the
applicable statutory rates. Saxon Capital Holdings provides for any deferred
income taxes to reflect estimated future tax effects. Deferred income taxes, to
the extent they exist, reflect estimated future tax effects of temporary
differences between the amount of assets and liabilities for financial reporting
purposes and such amounts as measured by tax laws and regulations.
(p) Property
and Equipment
Property
and equipment are stated at cost. Depreciation is computed using the
straight-line method over a period of three to forty years. Additions to
property, equipment, leasehold improvements, and major replacements or
improvements are capitalized at cost. Maintenance, repairs and minor
replacements are expensed when incurred.
(q) Reclassifications
Certain
amounts for 2003 and 2002 have been reclassified to conform to presentations
adopted in 2004.
(r) Recently
Issued Accounting Standards
The
Financial Accounting Standards Board, or FASB, issued FASB Statement No. 123
(Revised 2004), Share-Based
Payment.
Statement 123R replaces FASB Statement No. 123, Accounting
for Stock-Based Compensation, and
supersedes APB Opinion No. 25, Accounting
for Stock Issued to Employees. Statement
123, as originally issued in 1995, established as preferable a fair-value-based
method of accounting for share-based payment transactions with employees. The
new FASB revised rule requires that the compensation cost relating to
share-based payment transactions
be recognized in financial statements. That cost will be measured based on the
fair value of the equity or liability instruments issued. Public entities (other
than those filing as small business issuers) will be required to apply Statement
123R as of the first interim or annual reporting period that begins after June
15, 2005. Effective September 13, 2004, upon shareholder approval of the merger
agreement required in connection with the REIT conversion, all outstanding stock
options and restricted stock units granted by Old Saxon immediately vested. New
Saxon assumed all outstanding options and warrants to acquire the Company’s
common stock that were not exercised on or before September 24, 2004. In
connection with the accelerated vesting of the options, the Company recorded
compensation expense for all options outstanding as of September 13, 2004. (See
Note 17 for more information.) As a result, the adoption of FASB 123R is not
expected to have a material impact on the Company’s financial position, results
of operations, or cash flows.
The FASB
issued FASB Statement No. 153, Exchange
of Nonmonetary Assets - An Amendment of APB Opinion No. 29. This
statement addresses the measurement of exchanges of similar productive assets in
paragraph 21(b) of APB Opinion No. 29, Accounting
for Nonmonetary Transactions, and
replaces it with an exception for exchanges that do not have commercial
substance. The statement specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. The provisions of this statement are
effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. The adoption of FASB 153 is not expected to have a material
impact on the Company’s financial position, results of operations, or cash
flows.
(2) Subsequent
Events
On
January 25, 2005, the Company closed a $1.0 billion asset backed
securitization.
On
January 27, 2005, the Company granted 789,500 restricted stock units to some of
the Company’s employees, including each executive officer. The restricted stock
units will vest on the fifth anniversary of the date of grant. In addition, on
January 27, 2005, the Company granted 20,000 restricted stock units to each of
the Company’s three non-employee directors. The restricted stock units will vest
in four equal annual installments on each of the first, second, third, and
fourth anniversaries of the date of grant. The grantees of the restricted stock
units will be entitled to receive all dividends and other distributions paid
with respect to the common shares of the Company underlying such restricted
stock units at the time such dividends or distributions are paid to holders of
common shares.
On
February 16, 2005 and February 18, 2005, the Company closed operations in the
Indianapolis, Indiana and Omaha, Nebraska retail branches, respectively. On
March 2, 2005 and March 4, 2005, the Company closed operations in the Buffalo,
New York and Walnut Creek, California retail branches, respectively. The closing
of these retail branches is expected to reduce the Company’s fixed cost
structure of its branch network. The Company expects to recognize $1.1
million of expense during the first quarter of 2005 in connection with
branch closings, consisting of termination benefits, contract termination
costs and other associated costs of $0.1 million, $0.9 million, and $0.1
million, respectively.
Through
February 2005, the Company purchased $1.3 billion in third party servicing
rights for approximately $9.8 million.
(3) Earnings
Per Share
Basic
earnings per share is based on the weighted average number of common shares
outstanding, excluding any dilutive effects of options, warrants, or restricted
stock units. Diluted earnings per share is based on the weighted average number
of common shares, dilutive stock options, dilutive stock warrants, and dilutive
restricted stock units outstanding during the year. Computations of earnings per
share were as follows:
| |
|
For
the Year Ended December 31, |
| |
|
2004 |
2003 |
2002 |
| |
|
($
in thousands, except per share data) |
|
Basic: |
|
|
|
|
|
|
|
|
Net
income |
|
$ |
105,565 |
|
$ |
65,136 |
|
$ |
27,377 |
|
|
Weighted
average common shares outstanding |
|
|
34,702 |
|
|
28,518 |
|
|
28,104 |
|
|
Earnings
per share |
|
$ |
3.04 |
|
$ |
2.28 |
|
$ |
0.97 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
Diluted: |
|
|
|
|
|
|
|
|
|
|
|
Net
income |
|
$ |
105,565 |
|
$ |
65,136 |
|
$ |
27,377 |
|
|
Weighted
average common shares outstanding |
|
|
34,702 |
|
|
28,518 |
|
|
28,104 |
|
|
Dilutive
effect of stock options, warrants and restricted stock
units |
|
|
1,820 |
|
|
1,598 |
|
|
1,061 |
|
|
Weighted
average common shares outstanding - diluted |
|
|
36,522 |
|
|
30,116 |
|
|
29,165 |
|
|
Earnings
per share |
|
$ |
2.89 |
|
$ |
2.16 |
|
$ |
0.94 |
|
(4) Mortgage
Loan Portfolio
Mortgage
loans reflected on the Company’s consolidated balance sheets as of December 31,
2004 and 2003 were comprised of the following:
| |
December
31, 2004 |
December
31, 2003 |
| |
($
in thousands) |
|
Securitized
mortgage loans - principal balance |
$5,123,071 |
$4,078,468 |
|
Unsecuritized
mortgage loans - principal balance |
782,716 |
529,161 |
|
Premiums,
net of discounts |
75,562 |
53,066 |
|
Hedge
basis adjustments |
30,245 |
46,058 |
|
Deferred
origination costs, net |
11,288 |
9,374 |
|
Fair
value adjustments |
4,738 |
7,289 |
|
Total |
$6,027,620 |
$4,723,416 |
From time
to time, the Company’s subsidiaries may choose to sell certain mortgage loans
rather than securitize them. The following chart summarizes the Company’s
activity with respect to sold mortgage loans during the periods
presented.
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
| |
($
in thousands) |
|
Performing
mortgage loans sold: |
|
|
|
|
Non
conforming first lien mortgages |
$69,274 |
$76,115 |
$7,685 |
|
Conforming
first lien mortgages (1) |
9,627 |
521 |
¾ |
|
Second
lien mortgages |
138,409 |
105,906 |
22,134 |
|
Delinquent
mortgage loans (2) |
47,375 |
¾ |
22,984 |
|
Total
mortgage loans sold |
264,685 |
182,542 |
52,803 |
|
Basis
adjustments |
2,595 |
4,324 |
(2,646) |
|
Cash
received |
270,749 |
189,223 |
50,522 |
|
Gain
on sale of mortgage loans (2)(3) |
$3,469 |
$2,357 |
$365 |
___________
| (1) |
Loans that generally meet the underwriting
guidelines of one of the government-sponsored entities such as Freddie
Mac, Fannie Mae, and Ginnie Mae. |
| (2) |
Includes real estate owned, or REO, that was
part of a delinquent loan sale. |
| (3) |
Total
gain on sale of mortgage assets of $3.5 million and $2.5 million on the
consolidated statements of operations for the years ended December 31,
2004 and December 31, 2003 includes the gain recognized on sale of other
assets. |
(5) Allowance
for Loan Loss
The
Company is exposed to risk of loss from its mortgage loan portfolio and
establishes the allowance for loan loss taking into account a variety of
criteria including the contractual delinquency status and historical loss
experience. The allowance for loan loss is evaluated monthly and adjusted based
on this evaluation.
Activity
related to the allowance for loan loss for the mortgage loan portfolio for the
years ended December 31, 2004, 2003, and 2002 is as follows:
| |
|
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
| |
($
in thousands) |
|
Beginning
balance |
$43,369 |
$40,227 |
$20,996 |
|
Provision
for loan losses (1) |
39,710 |
34,056 |
33,328 |
|
Charge-offs |
(45,769) |
(30,914) |
(14,097) |
|
Ending
balance |
$37,310 |
$43,369 |
$40,227 |
________________
|
(1) |
Includes
$(1.9) million, $1.0 million, and $5.2 million for the years ended
December 31, 2004, 2003, and 2002 respectively, related to advanced
interest paid to securitization trusts but not yet collected. This amount
is included as a component of interest income in the consolidated
statements of operations. |
(6) Mortgage
Servicing Rights
As of
December 31, 2004, the fair value of the mortgage servicing rights in total was
$155.1 million, compared to $46.8 million as of December 31, 2003. The following
table summarizes activity in mortgage servicing rights for the years ended
December 31, 2004, 2003, and 2002:
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
| |
($
in thousands) |
|
Balance,
beginning of period |
$41,255 |
$24,971 |
$33,847 |
|
Purchased |
84,948 |
23,692 |
6,354 |
|
Amortization |
(19,516) |
(6,955) |
(13,427) |
|
Temporary
impairment |
(6,937) |
(453)
|
(234) |
|
Permanent
impairment |
(755) |
— |
(1,569) |
|
Balance,
end of period |
$98,995 |
$41,255 |
$24,971 |
The Company
recognized a permanent impairment during the third quarter of 2004 because
experienced prepayments on loans were significantly higher than the assumptions
used to amortize the servicing rights. The following table summarizes the
activity of our valuation allowance:
| |
Valuation
Allowance |
| |
($
in thousands) |
|
Balance
as of January 1, 2002 |
$— |
|
Temporary
impairment |
(1,803) |
|
Permanent
impairment |
1,569 |
|
Balance
as of December 31, 2002 |
(234) |
|
Temporary
impairment |
(453) |
|
Permanent
impairment |
— |
|
Balance
as of December 31, 2003 |
(687) |
|
Temporary
impairment |
(7,692) |
|
Permanent
impairment |
755
|
|
Balance
as of December 31, 2004 |
$(7,624) |
As of
December 31, 2004, the following table summarizes the remaining estimated
projected amortization expense for the carrying value of the mortgage servicing
rights for each of the five succeeding years and thereafter:
| |
Years
Ending December 31, |
| |
($
in thousands) |
|
2005 |
$35,857 |
|
2006 |
22,655 |
|
2007 |
15,314 |
|
2008 |
10,417 |
|
2009 |
7,095 |
|
Thereafter |
15,281 |
|
Total |
$106,619 |
As of
December 31, 2004 and 2003, the fair value and weighted average life in
years of the mortgage servicing rights were as follows:
| |
2004
|
2003 |
| |
Fair
Value |
Weighted-average
life
of collateral |
Fair
Value |
Weighted-average
life
of collateral |
| |
($
in thousands) |
|
Pre-divestiture: |
|
|
|
|
|
1998
Securitizations |
$636 |
2.57 |
$2,445 |
4.02 |
|
1999
Securitizations |
1,392 |
2.34 |
4,566 |
3.44 |
|
2000
Securitizations |
1,744 |
2.14 |
5,952 |
3.40 |
|
2001
Securitizations |
587 |
2.51 |
1,721 |
3.30 |
|
Post-divestiture: |
|
|
|
|
|
2001
Third party purchases |
98 |
2.22 |
280 |
2.72 |
|
2002
Third party purchases |
1,887 |
2.68 |
6,711 |
3.49 |
|
2003
Third party purchases |
8,314 |
3.64 |
25,169 |
4.49 |
|
2004
Third party purchases |
140,401 |
3.95 |
— |
— |
|
Total |
$155,059 |
|
$46,844 |
|
The table
below indicates the key economic assumptions and the sensitivity to immediate
20%, 25% and 50% adverse prepayment speeds used to value mortgage servicing
rights as of December 31, 2004:
| |
|
| |
Current
Assumptions |
20%
Adverse
Effect |
25%
Adverse
Effect |
50%
Adverse
Effect |
| |
($ in
thousands) |
|
Pre-divestiture: |
|
|
|
|
|
1998
Securitizations |
37
CPR - 42 CPR |
$(135) |
$(165) |
$(293) |
|
1999
Securitizations |
39
CPR - 57 CPR |
(409) |
(500) |
(916) |
|
2000
Securitizations |
30
CPR - 54 CPR |
(550) |
(674) |
(1,281) |
|
2001
Securitizations |
29
CPR - 32 CPR |
(128) |
(157) |
(300) |
|
Post-divestiture: |
|
|
|
|
|
2001
Third party purchases |
42
CPR - 46 CPR |
(27) |
(32) |
(58) |
|
2002
Third party purchases |
34
CPR - 45 CPR |
(429) |
(522) |
(927) |
|
2003
Third party purchases |
28
CPR - 34 CPR |
(1,441) |
(1,758) |
(3,140) |
|
2004
Third party purchases |
25
CPR - 34 CPR |
(20,638) |
(25,198) |
(45,124) |
|
Total |
|
$(23,757) |
$(29,006) |
$(52,039) |
The table
below indicates the immediate sensitivity on the current fair value of mortgage
servicing rights using a 16% and 18% discount rate as of December 31, 2004:
| |
|
Current
Assumptions |
|
16%
Discount
Rate |
|
|
18%
Discount
Rate |
|
| |
|
($
in thousands) |
|
|
|
Pre-divestiture: |
|
|
|
|
|
|
|
|
1998
Securitizations |
|
|
12.64%
- 13.28 |
% |
$ |
(34 |
) |
$ |
(54 |
) |
|
1999
Securitizations |
|
|
12.00%
- 16.46 |
% |
|
(69 |
) |
|
(114 |
) |
|
2000
Securitizations |
|
|
13.14%
- 14.10 |
% |
|
(69 |
) |
|
(123 |
) |
|
2001
Securitizations |
|
|
13.29 |
% |
|
(25 |
) |
|
(42 |
) |
|
Post-divestiture: |
|
|
|
|
|
|
|
|
|
|
|
2001
Third party purchases |
|
|
13.74 |
% |
|
(4 |
) |
|
(7 |
) |
|
2002
Third party purchases |
|
|
13.98%
- 16.11 |
% |
|
(32 |
) |
|
(98 |
) |
|
2003
Third party purchases |
|
|
15.84%
- 15.89 |
% |
|
(21 |
) |
|
(361 |
) |
|
2004
Third party purchases |
|
|
14.99%
-16.22 |
% |
|
(589 |
) |
|
(6,482 |
) |
|
Total |
|
|
|
|
$ |
(843 |
) |
$ |
(7,281 |
) |
These
sensitivities are hypothetical and should be used with caution. As the figures
indicate, changes in fair value based on a constant percent variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. The effect
of a variation in a particular assumption on the fair value of the mortgage
servicing rights is calculated without changing any other assumption; in
reality, changes in one factor may result in changes in another (for example,
increases in market interest rates may result in lower prepayments and increased
credit losses), which might magnify or counteract the
sensitivities.
(7) Loan
Servicing Portfolio
As of
December 31, 2004 and 2003, the Company serviced a portfolio consisting of
loans in all 50 states. The loan servicing portfolio as of December 31,
2004 and 2003 is summarized below:
| |
December
31, 2004 |
December
31, 2003 |
|
Investor |
Number
of Loans |
Principal
Balance |
Number
of
Loans |
Principal
Balance |
| |
($
in thousands) |
|
Greenwich
Capital, Inc |
57,892 |
$9,325,188 |
20,217 |
$3,342,800 |
|
Saxon
Capital, Inc. (1) |
42,817 |
5,950,965
|
35,056 |
4,665,770 |
|
Credit
Suisse First Boston |
17,797 |
2,985,290 |
3,301 |
388,791 |
|
Barclays
Bank, PLC |
6,118 |
1,244,569 |
— |
— |
|
Dominion
Capital |
8,582 |
603,282 |
17,800 |
1,358,506 |
|
Dynex
Capital, Inc |
383 |
34,237 |
567 |
54,922 |
|
Fannie
Mae |
247 |
13,869 |
251 |
5,679 |
|
Other
investors |
303 |
8,542 |
749 |
83,055 |
|
Total |
134,139 |
$20,165,942 |
77,941 |
$9,899,523 |
_________________
| (1) |
Includes loans securitized by Saxon
Capital, Inc. since July 6, 2001. |
The
following table summarizes information about the delinquency of the Company’s
loan servicing portfolio:
| |
December
31, |
| |
Owned
Portfolio |
Total
Servicing Portfolio |
|
Total
Delinquencies and Loss Experience |
2004 |
2003 |
2004 |
2003 |
| |
($
in thousands) |
|
Total
outstanding principal balance (at period-end) |
$5,950,965 |
$4,665,770 |
$20,165,942 |
$9,899,523 |
|
Delinquency
(at period-end): |
|
|
|
|
|
30-59
days: |
|
|
|
|
|
Principal
balance |
$290,525 |
$295,754 |
$956,478 |
$605,980 |
|
Delinquency
percentage |
4.88% |
6.34% |
4.74% |
6.12% |
|
60-89
days: |
|
|
|
|
|
Principal
balance |
$83,225 |
$68,019 |
$247,863 |
$138,253 |
|
Delinquency
percentage |
1.40% |
1.46% |
1.23% |
1.40% |
|
90
days or more: |
|
|
|
|
|
Principal
balance |
$51,767 |
$43,773 |
$172,124 |
$96,388 |
|
Delinquency
percentage |
0.87% |
0.94% |
0.85% |
0.97% |
|
Bankruptcies
(1): |
|
|
|
|
|
Principal
balance |
$110,846 |
$94,524 |
$279,331 |
$300,282 |
|
Delinquency
percentage |
1.86% |
2.03% |
1.39% |
3.03% |
|
Foreclosures: |
|
|
|
|
|
Principal
balance |
$121,571 |
$134,654 |
$314,253 |
$298,658 |
|
Delinquency
percentage |
2.04% |
2.89% |
1.56% |
3.02% |
|
Real
Estate Owned: |
|
|
|
|
|
Principal
balance |
$49,699 |
$37,896 |
$107,939 |
$107,202 |
|
Delinquency
percentage |
0.84% |
0.81% |
0.54% |
1.08% |
|
Total
Seriously Delinquent including real estate owned (2) |
6.61% |
7.69% |
5.26% |
8.89% |
|
Total
Seriously Delinquent excluding real estate owned |
5.77% |
6.88% |
4.73% |
7.81% |
|
Charge-offs |
$45,769 |
$30,914 |
— |
— |
|
Percentage
of charge-offs on liquidated loans |
0.77% |
0.66% |
— |
— |
|
Loss
severity on liquidated loans (3) |
40.97% |
34.31% |
46.18% |
42.03% |
________________
|
(1) |
Bankruptcies
include both non-performing and performing loans in which the related
borrower is in bankruptcy. Amounts included for contractually current
bankruptcies for the Company’s mortgage loan portfolio for December 31,
2004 and 2003 are $19.6 million and $15.2 million, respectively. Amounts
included for contractually current bankruptcies for the total servicing
portfolio for December 31, 2004 and 2003 are $47.5 million and $43.7
million, respectively. |
|
(2) |
Seriously
delinquent is defined as loans that are 60 or more days delinquent,
foreclosed, REO, or held by a borrower who has declared bankruptcy and is
60 or more days contractually delinquent. |
|
(3) |
Loss
severity is defined as the total loss amount divided by the actual unpaid
principal balance at the time of liquidation. Total loss amounts include
all accrued interest and interest advances, fees, principal balances, all
costs of liquidating and all other servicing advances for taxes, property
insurance, and other servicing costs incurred and invoiced to us within 90
days following the liquidation date. |
(8) Servicing
Related Advances
When
borrowers are delinquent in making monthly payments on mortgage loans included
in a securitization, the Company generally is required to advance principal and
interest payments (for
loans serviced for others), and insurance premiums, property taxes, and property
protection costs with respect to the delinquent mortgage loans to the extent
that the advances are ultimately recoverable from proceeds of the related loan
or mortgaged property.
Servicing
related advances as of December 31, 2004 and 2003 were as follows:
| |
December
31, 2004 |
December
31, 2003 |
| |
($
in thousands) |
|
Escrow
advances (taxes and insurance) |
$27,476 |
$32,932 |
|
Foreclosure
and other advances |
19,838 |
15,962 |
|
Principal
and interest advances |
65,815 |
49,694 |
|
Total
servicing related advances (1) |
$113,129 |
$98,588 |
_________________
| |
(1) |
Includes
amounts outstanding of $96.2 million and $82.7 million of servicing
related advances that were securitized as of December 31, 2004 and 2003,
respectively. |
(9) Other
Assets
Other
assets as of December 31, 2004 and 2003 consisted of the
following:
| |
December
31, 2004 |
December
31, 2003 |
|
|
($
in thousands) |
|
Income
tax receivable |
$35,181 |
$19,566 |
|
Bond
issuance costs |
23,286 |
25,373 |
|
Property
and equipment, net |
13,128 |
12,712 |
|
Prepaid
expenses |
4,514 |
4,192 |
|
Goodwill |
3,213 |
3,213 |
|
Mortgage
bond, net |
1,317 |
4,925 |
|
Other
assets |
4,259 |
2,671 |
|
Total
other assets |
$84,898 |
$72,652 |
(10) Property
and Equipment
Property
and equipment as of December 31, 2004 and 2003 consisted of the
following:
| |
December
31, 2004 |
December
31, 2003 |
| |
($
in thousands) |
|
Computers
and software |
$17,636 |
$14,397 |
|
Projects
in process |
3,972 |
1,260 |
|
Leasehold
improvements |
2,412 |
2,309 |
|
Furniture
and equipment |
1,104 |
863 |
|
Buildings |
247 |
246 |
|
Total
property and equipment |
25,371 |
19,075 |
|
Accumulated
depreciation and amortization |
(12,243) |
(6,363) |
|
Total
property and equipment, net |
$13,128 |
$12,712 |
Property
and equipment is included in other assets in the accompanying consolidated
balance sheets. Depreciation expense was $5.9 million, $3.9 million, and $1.9
million for the years ended December 31, 2004, 2003, and 2002,
respectively.
(11) Investor
Funds and Escrow
Investor
funds totaling $749.3 million and $171.9 million were held in
segregated bank accounts as of December 31, 2004 and 2003, respectively. These
funds are applicable to mortgage loans serviced for investors. Included in
investor funds are escrow funds totaling $53.8 million, and $34.8 million
as of December 31, 2004 and 2003, respectively, which were also held in
segregated bank accounts. These funds are applicable to mortgage loans being
serviced. The funds and the related liabilities of the accounts are not included
in the accompanying financial statements.
(12) Warehouse
Financing, Securitization Financing and Note Payable
A summary
of the amounts outstanding under these agreements as of December 31, 2004 and
2003 is as follows:
| |
December
31, 2004 |
December
31, 2003 |
| |
($
in thousands) |
|
Debt
Outstanding |
|
|
|
Warehouse
financing - loans and servicing advances |
$282,092 |
$101,055 |
|
Repurchase
agreements - loans |
317,500 |
325,474 |
|
Repurchase
agreements - mortgage bonds (1) |
1,054 |
1,440 |
|
Securitization
financing - servicing advances |
117,988 |
100,239 |
|
Securitization
financing - loans and real estate owned |
5,125,572 |
4,079,050 |
|
Securitization
financing - net interest margin |
14,784 |
58,086 |
|
Note
payable |
— |
25,000 |
|
Total |
$5,858,990 |
$4,690,344 |
|
Outstanding
Collateral |
|
|
|
Warehouse
financing - loans and servicing advances |
$432,336 |
$189,918 |
|
Repurchase
agreements - loans |
322,642 |
330,815 |
|
Repurchase
agreements - mortgage bonds |
1,317 |
1,800 |
|
Securitization
financing - servicing advances (2) |
133,051 |
113,064 |
|
Securitization
financing - net interest margin, loans and real estate
owned |
5,197,167 |
4,129,784 |
|
Total |
$6,086,513 |
$4,765,381 |
|
Total
Available Committed Borrowings |
|
|
|
Warehouse
financing - loans and servicing advances |
$300,000 |
$140,000 |
|
Repurchase
agreements - loans and mortgage bonds |
1,325,000 |
1,275,000 |
|
Securitization
financing - servicing advances |
160,000 |
130,000 |
|
Total |
$1,785,000 |
$1,545,000 |
|
Remaining
Capacity to Borrow |
|
|
|
Warehouse
financing - loans and servicing advances |
$17,908 |
$38,945 |
|
Repurchase
agreements - loans and mortgage bonds |
1,006,446 |
949,526 |
|
Securitization
financing - servicing advances |
42,012 |
29,761 |
|
Total |
$1,066,366 |
$1,018,232 |
___________________
| |
(1) |
Amount
outstanding was borrowed against an uncommitted
facility. |
| |
(2) |
Includes
$2.1 million of principal and $23.6 million of interest on our mortgage
loan portfolio as of December 31, 2004 and $1.6 million of principal and
$21.9 million of interest on our mortgage loan portfolio as of December
31, 2003, which is included within the mortgage loan portfolio and accrued
interest balances on our consolidated balance sheets, respectively.
|
The
following table summarizes our contractual obligations as of December 31,
2004:
|
As
of December 31, 2004 |
Total |
Less
than
1
year |
1-3
years |
3-5
years |
After
5
years |
| |
($
in thousands) |
|
Warehouse
financing - loans and servicing advances |
$282,092
|
$282,092 |
$— |
$— |
$— |
|
Repurchase
agreements - loans |
317,500 |
241,185 |
76,315 |
— |
— |
|
Repurchase
agreements - mortgage bonds |
1,054 |
— |
1,054 |
— |
— |
|
Securitization
financing - servicing advances (1) |
117,988 |
34,667 |
39,315 |
14,549 |
29,457 |
|
Securitization
financing - loans and real estate owned (2) |
5,125,572 |
1,543,474 |
1,707,777 |
596,236 |
1,278,085 |
|
Securitization
financing - net interest margin (2) |
14,784 |
14,784 |
— |
— |
— |
|
Total
contractual cash obligations |
$5,858,990 |
$2,116,202 |
$1,824,461 |
$610,785 |
$1,307,542 |
________________
|
(1) |
Amounts
shown are estimated bond payments based on anticipated recovery of the
underlying principal and interest servicing
advances. |
|
(2) |
Amounts
shown are estimated bond payments based on anticipated receipt of
principal and interest on underlying mortgage loan collateral using
historical prepayment speeds. |
A summary
of interest expense and the weighted average cost of funds is as
follows:
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
| |
($
in thousands) |
|
Interest
Expense |
|
|
|
|
Warehouse
financing |
$2,869 |
$1,004 |
$923 |
|
Repurchase
agreements |
7,251 |
4,976 |
6,733 |
|
Securitization
financing |
140,232 |
111,415 |
74,204 |
|
Notes
payable |
1,443 |
2,000 |
2,006 |
|
Other |
4,010 |
3,908 |
3,202 |
|
Total |
$155,805 |
$123,303 |
$87,068 |
| |
|
|
|
|
Weighted
Average Cost of Funds |
|
|
|
|
Warehouse
financing |
1.89% |
1.34% |
1.52% |
|
Repurchase
agreements |
2.18% |
1.90% |
2.43% |
|
Securitization
financing |
2.87% |
2.83% |
3.26% |
|
Notes
payable |
8.00% |
8.00% |
8.00% |
|
Total |
2.89% |
2.87% |
3.30% |
During
the year ended December 31, 2004, the Company completed three securitizations of
mortgage loans, totaling $3.2 billion in principal balances and $46.0 million in
unamortized basis adjustments.
Under its
borrowing agreements, the Company is subject to certain debt covenants and is
required to maintain or satisfy specified financial ratios and tests, as well as
other customary covenants, representations and warranties. In the event of
default, the Company may be prohibited from paying dividends and making
distributions under certain of its financing facilities without the prior
approval of its lenders. As of December 31, 2004, the Company was in compliance
with all its covenants under the respective borrowing agreements.
(13) Employee
Savings Plan
The
Company’s employees are eligible to participate in the SCI Services, Inc. 401(k)
Plan provided they are 18 years of age and scheduled to work at least 1,000
hours annually. Under the current plan, a maximum of 25% of the employees’
eligible earnings can be contributed to the plan on a pre-tax basis, and up to
20% of the employees’ eligible earnings can be contributed on an after-tax
basis. The pre-tax and after-tax contributions in combination cannot exceed 20%.
The Company also makes matching contributions in proportion to employees’
pre-tax contributions. Effective January 1, 2004, the Company increased the
company match to 4% of the employees’ eligible earnings. Throughout 2003 and
2002 the Company contributed 3% of the employee’s eligible earnings.
From
April 2002 until December 31, 2003, the Company allowed senior management
employees the option of deferring a portion of eligible income into a
non-qualified deferred compensation plan. Eligible employees could defer up to
15% of their base salary and up to 100% of their annual bonus payment into this
plan on a pre-tax basis. The Company could also make discretionary matching
contributions in proportion to employees’ deferred earnings. Throughout 2003 and
2002, the Company contributed 50% of the employees’ first 2% of total deferred
earnings. This plan was closed to any additional deferrals as of December 31,
2003 and was terminated on January 26, 2004. All plan assets were distributed to
plan participants in 2004.
The total
expense related to the Company’s matching contributions for all plans for the
years ended December 31, 2004, 2003 and 2002 was $1.3 million, $0.6 million, and
$0.6 million, respectively.
(14) Income
Taxes
The
Company recorded a $13.0 million tax benefit during 2004 which included the
impact of the structure and formation transactions with regards to the Company's
REIT conversion as outlined in the Company's registration statement on Form S-11
declared effective by the Securities and Exchange Commission on September 20,
2004. The benefit associated with the Company’s REIT conversion consists
of a reversal of $3.9 million in net deferred tax liabilities, which will not
result in taxable amounts in future years as a result of our conversion to REIT
status, and $30.1 million relating to income recognized in our qualified REIT
subsidiary for the nine months ended September 30, 2004, that is now not subject
to corporate taxation.
The
components of the provision for income taxes for the years ended December 31,
2004, 2003, and 2002 consist of the following:
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
| |
($
in thousands) |
|
Federal |
|
|
|
|
Current |
$3,422 |
$30,573 |
$30,243 |
|
Deferred |
(14,084) |
4,759 |
(15,408) |
|
State |
|
|
|
|
Current |
293 |
1,455 |
5,031 |
|
Deferred |
(2,611) |
(278) |
(3,033) |
|
Total
income tax (benefit) expense |
$(12,980) |
$36,509 |
$16,833 |
The
amounts provided for income taxes differ from the amount provided at the
statutory federal rate as follows:
| |
For
the Year Ended December 31, |
| |
2004 |
2003 |
2002 |
| |
($
in thousands) |
|
Federal
income tax expense at statutory rate |
$32,405 |
$35,615 |
$15,473 |
|
Nontaxable
REIT income |
(40,124) |
— |
— |
|
Write-off
of deferred liabilities - REIT conversion |
(3,927) |
— |
— |
|
State
income tax (benefit) expense, net |
(928) |
1,178 |
1,998 |
|
Federal
tax expense (benefit) of state tax deduction |
325 |
(412) |
(699) |
|
Other
expense (benefit), net |
(731) |
128 |
61 |
|
Total
income tax (benefit) expense |
$(12,980) |
$36,509 |
$16,833 |
The
income tax effects of temporary differences that give rise to the net deferred
tax asset (liability) as of December 31, 2004 and 2003 are as
follows:
| |
December
31, 2004 |
December
31, 2003 |
| |
($
in thousands) |
|
Deferred
tax asset: |
|
|
|
Tax
gain on sale of loans |
$5,081 |
$33,111 |
|
Amortization
of intangibles |
11,776 |
8,177 |
|
Deferred
revenue |
2,464 |
129 |
|
Mark
to market adjustment |
1,841 |
— |
|
Depreciation |
885 |
— |
|
Gain
on sale of loans to qualified REIT subsidiary |
6,605 |
— |
|
Original
issue discount |
3,535 |
730 |
|
Accumulated
other comprehensive income |
1,702 |
3,500 |
|
Other |
2,263 |
— |
|
Total
deferred tax asset |
$36,152 |
$45,647 |
| |
|
|
|
Deferred
tax liability: |
|
|
|
Allowance
for loan loss |
$(316) |
$(617) |
|
Depreciation |
— |
(175) |
|
Hedging
transactions |
(8,011) |
(42,166) |
|
Other |
— |
(3,596) |
|
Total
deferred tax liability |
$(8,327) |
$(46,554) |
| |
|
|
|
Net
deferred tax asset (liability) |
$27,825 |
$(907) |
The
Company may retain up to 10% of its REIT taxable income and pay corporate income
taxes on this retained income while continuing to maintain its REIT status. At
this time, the Company intends to retain up to 10% of its 2004 ordinary
REIT taxable income and, accordingly, the Company has recorded a provision for
income taxes based upon its estimated liability for Federal and state income tax
purposes in the consolidated statements of operations. The difference between
the federal tax and book basis of the Company’s assets and liabilities is a net
tax-deductible temporary difference of $27.8 million as of December 31, 2004
(consisting of tax-deductible temporary differences of $36.1 million and taxable
temporary differences of $8.3 million).
Under the
Code, a dividend declared by a REIT in October, November, or December of a
calendar year and payable to shareholders of record as of a specified date in
such year will be deemed to have been paid by the REIT and received by the
shareholders on the last day of that calendar year, provided the dividend is
actually paid before February 1st of the
following calendar year, and provided that the REIT has any remaining
undistributed REIT taxable income on the record date. Therefore, the regular
dividends declared in the fourth quarter of 2004, which were paid in January
2005, are considered taxable income to shareholders in 2004 (the year
declared).
As a
result of the conversion to REIT status, federal income taxes on the portion of
the income distributed by the Company’s qualified REIT subsidiary are payable
directly by its shareholders pursuant to the Internal Revenue Code. Accordingly,
with respect to such taxable income, no provision for federal or state income
tax has been included in the Company’s financial statements.
The
Company recognizes all of its deferred tax assets if it believes that it is more
likely than not, given all available evidence, that all of the benefits of the
carryforward losses and other deferred tax assets will be realized. Management
believes that, based on the available evidence, it is more likely than not that
the Company will realize the benefit from its deferred tax assets.
(15) Derivatives
The
Company accounts for its derivative financial instruments as cash flow hedges,
which hedge the Company’s variable rate debt. As of December 31, 2004 and 2003,
the fair value of the Company’s derivatives totaled $10.0 million and $5.5
million, respectively. As of December 31, 2004 and 2003, the mark to market
adjustment on effective hedges recorded in accumulated other comprehensive
income (loss) was $(5.8) million with a tax benefit of $2.3 million and $(7.7)
million with a tax benefit of $3.0 million, respectively. Accumulated other
comprehensive income (loss) related to cash flow hedging is amortized into
earnings through interest expense as the hedged item affects earnings. The
expected effect of amortization of the accumulated
other comprehensive income (loss) on earnings for the next twelve months is $1.2
million of expense, depending on future repayment of debt. The maximum term over
which the Company is hedging its exposure for forecasted transactions is 57
months. Hedge ineffectiveness resulted in $0.1 million of expense, $0.5 million
of expense, and $0.4 million of income for the years ended December 31, 2004,
2003, and 2002, respectively. These ineffective portions are included as part of
other (expense) income on the consolidated statements of operations.
As of
December 31, 2004 and 2003, the Company had $30.2 million and $46.3 million,
respectively, of basis adjustments on mortgage loans related to previous fair
value hedging activity. These basis adjustments are amortized into earnings
through interest income as a yield adjustment of the previously hedged
loans.
(16) Shareholders’
Equity
On
September 20, 2004, New Saxon issued an additional 17.0 million shares of its
common stock in a public offering, which resulted in $386.8 million in gross
proceeds, part of which was used to pay the cash portion of the merger
consideration of $131.4 million. During 2004, the Company deducted from proceeds
$33.4 million in costs related to the REIT conversion and its subsequent
issuance of common stock. The REIT conversion also resulted in the vesting and
exercise of a majority of Old Saxon’s outstanding stock warrants, restricted
stock units, and stock options and a corresponding tax benefit of $15.3 million
associated with the stock option exercises. On December 15, 2004, the Company
declared a fourth quarter ordinary income dividend of $0.58 per share of common
stock and a special ordinary income dividend of $1.72 per share of common stock
totaling $114.6 million for shareholders of record on December 23,
2004.
(17)
Stock
Compensation Plans
Stock
Incentive Plan -
Pursuant to the merger agreement in connection with the REIT conversion, the
Company assumed the Saxon Capital, Inc. 2001 Stock Incentive Plan (the “Stock
Incentive Plan”), which provides for the issuance of restricted common stock,
stock appreciation rights, dividend equivalent rights, stock options, or unit
awards based on the value of the Company’s common stock to eligible employees
and other eligible participants. The maximum number of shares or other awards
authorized for issuance under the Stock Incentive Plan is reset as of January 1
of each year at the greater of (i) 2,998,556; (ii) 10.69% of the total number of
then outstanding shares of common stock of the Company as of January 1 of each
year; or (iii) the maximum number that has been previously awarded or granted
under the Stock Incentive Plan, provided that the total number of shares
authorized to be issued under the Stock Incentive Plan may not exceed 6,000,000
shares.
The
Compensation Committee of the Board of Directors administers the Stock Incentive
Plan, and has full authority to select the recipients of awards, to decide when
awards are to be made, to determine the type and number of awards, and to
establish the vesting requirements as well as other features and conditions of
each award.
Effective
September 13, 2004, upon shareholder approval of the merger agreement required
in connection with the REIT conversion, all outstanding stock options and
restricted stock units granted by Old Saxon vested. New Saxon assumed all
outstanding options and warrants to acquire the Company’s common stock that were
not exercised on or before September 24, 2004. In connection with the
accelerated vesting of the options, the Company recorded compensation expense of
$0.3 million for all options outstanding as of September 13, 2004.
The
following table summarizes the transactions relating to the Company’s stock
options for the period ended December 31, 2004:
| |
Number
of Options |
Weighted
Average
Exercise
Price |
|
Options
outstanding, January 1, 2002 (includes 2,730,500 options outstanding under
the Stock Incentive Plan) |
3,205,500 |
$10.02 |
|
Options
granted |
100,062 |
$11.80 |
|
Options
exercised |
(102,562) |
$10.02 |
|
Options
cancelled |
(32,250) |
$10.10 |
|
Options
outstanding, December 31, 2002 (includes 2,701,000 options outstanding
pursuant to the Stock Incentive Plan) |
3,170,750 |
$10.08 |
|
Options
granted |
60,000 |
$12.54 |
|
Options
exercised |
(367,750)
|
$10.01 |
|
Options
cancelled |
(93,000) |
$10.05 |
|
Options
outstanding, December 31, 2003 (includes 2,295,000 options outstanding
under the Stock Incentive Plan and 475,000 outstanding to the Company’s
non-employee board members) |
2,770,000 |
$10.14 |
|
Options
granted |
— |
— |
|
Options
exercised |
(2,726,500) |
$10.14 |
|
Options
cancelled |
(32,500) |
$10.05 |
|
Options
outstanding, December 31, 2004 (includes 11,000 options with a remaining
contractual life of 6.8 years outstanding under the Stock Incentive
Plan) |
11,000 |
$10.10 |
No
options were granted for the year ended December 31, 2004. The weighted average
fair value of options granted in 2003 and 2002 was $8.18 and $7.91 per share,
respectively. The Black-Scholes option pricing model was used with the following
weighted average assumptions for options issued in the respective
years:
| |
Year
Ended
December
31, 2003 |
Year
Ended
December
31, 2002 |
|
Risk-free
interest rate |
3.96% |
4.18%
- 4.47% |
|
Dividend
yield |
— |
— |
|
Volatility
factor |
50.00% |
51.08% |
|
Weighted
average expected life |
10
years |
10
years |
Restricted Stock Units - On
September 4, 2003, the Company granted 180,000 restricted stock units under the
Company’s Stock Incentive Plan to the Company’s Chief Executive Officer, Chief
Operating Officer and Chief Financial Officer, and the Company granted 60,000
restricted stock units to its non-employee directors. All 240,000 outstanding
restricted stock units that were not previously vested were vested and the
related shares were delivered following approval of the merger agreement
required for the REIT conversion. Compensation expense related to the restricted
stock units for the period ended December 31, 2004 was $3.9
million.
Warrants - In
connection with the Company’s private offering in 2001, the Company granted
warrants to Friedman, Billings, Ramsey & Co., Inc. (“FBR”) to purchase an
aggregate of 1,200,000 shares of our common stock, of which 1,192,000 have been
exercised as of December 31, 2004. The 8,000 remaining warrants have an exercise
price of $10.00 per share and are exercisable until they expire on July 6,
2006.
Employee
Stock Purchase Plan - The
Company’s Employee Stock Purchase Plan authorizes the issuance of up to a total
of 1,000,000 shares of common stock to participating employees. The 1,000,000
share aggregate limitation shall be adjusted proportionately for any increase or
decrease in the number of outstanding shares of the stock. Under the terms of
the Stock Purchase Plan, eligible employees may have up to 15% of eligible
compensation deducted from their pay during each offering period to purchase
common stock. Purchases are made on the last trading day of the offering period.
The per share purchase price is 85% of the last transaction price per share of
our common stock on the last trading day of the offering period. Activity
related to the Company’s Employee Stock Purchase Plan for the periods presented
is as follows:
| |
Shares
Issued |
Issuance
Price |
Proceeds |
| |
(amounts
in thousands, except issuance price) |
|
For
the Year Ended December 31, 2002: |
|
|
|
|
January
30, 2002 |
30.3 |
$9.80 |
$297 |
|
March
28, 2002 |
8.3 |
$12.55 |
$104 |
|
June
28, 2002 |
12.2 |
$13.83 |
$169 |
|
September
30, 2002 |
18.4 |
$9.41 |
$173 |
|
December
31, 2002 |
14.0 |
$10.63 |
$148 |
|
For
the Year Ended December 31, 2003: |
|
|
|
|
March
31, 2003 |
20.3 |
$11.31 |
$230 |
|
June
30, 2003 |
12.5 |
$14.69 |
$184 |
|
September
30, 2003 |
14.6 |
$14.57 |
$213 |
|
December
31, 2003 |
10.8 |
$17.81 |
$192 |
|
For
the Year Ended December 31, 2004: |
|
|
|
|
March
31, 2004 |
11.3 |
$24.14 |
$273 |
|
June
30, 2004 |
15.2 |
$19.41 |
$295 |
|
September
20, 2004 |
9.9 |
$23.15 |
$229 |
|
December
31, 2004 |
5.5 |
$20.39 |
$112 |
(18) Disclosure
about Financial Instruments
Fair
value of financial instruments is defined as the amount at which the instrument
could be exchanged in a current transaction between willing parties other than
in a forced or liquidation sale. In cases where market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. In that regard,
the derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instrument. Certain financial instruments due to their nature
and all non-financial instruments are excluded from this
disclosure.
The
following methods and assumptions were used to estimate the fair value of the
Company’s financial instruments:
Mortgage
loan portfolio - The
mortgage loan portfolio’s fair value is determined by the projected carrying
cost or a market price based upon estimated securitization prices.
The fair
value of the principal balance of the mortgage loan portfolio at December 31,
2004 and 2003 is $6.0 billion and $4.8 billion, respectively. At
December 31, 2004 and 2003, the carrying values of the mortgage loan
portfolio are $6.0 billion and $4.7 billion, respectively.
Mortgage
bonds - Mortgage
bonds are held on the consolidated balance sheets at fair value in Other Assets.
The mortgage bonds’ fair value is based on the remaining principal and interest
cash flows at December 31, 2004 and 2003, discounted at 15%.
Derivative
instruments -Derivative
instruments are recorded at fair value on the consolidated balance sheets at
December 31, 2004 and 2003 using broker prices.
Mortgage
servicing rights - Mortgage
servicing rights are initially recorded at cost and subsequently amortized in
proportion to and over the period of the anticipated net cash flows from
servicing the loans to arrive at the carrying value. Fair value of the mortgage
servicing rights is based on independent appraisals. The fair value of the
mortgage servicing rights at December 31, 2004 and 2003 is $155.1 million and
$46.8 million, respectively. At December 31, 2004 and 2003, the carrying
value of the mortgage servicing rights is $99.0 million and $41.3 million,
respectively.
Securitization
financing -
Securitization financing is the debt associated with the asset-backed
securitizations and is floating with interest rates that adjust to market rates.
The carrying values for securitization financing at December 31, 2004 and 2003
approximate fair value.
Note
payable - The fair
value of the note payable with a fixed interest rate is determined by the
present value of future payments based on interest rate conditions at December
31, 2004 and 2003. The fair value of the note payable at December 31, 2004 and
2003 is none and $24.7 million, respectively. At December 31, 2004 and 2003, the
carrying value of the note payable is none and $25.0 million,
respectively.
Warehouse
financing - Warehouse
financing is secured by unsecuritized mortgage loans and is floating with
interest rates that adjust to market rates, and accordingly the carrying value
is considered a reasonable estimate of fair value.
(19) Commitments
and Contingencies
Leases
The
Company’s subsidiaries are obligated under non-cancelable operating leases for
real property and equipment. Minimum annual rental payments as of December 31,
2004 are as follows:
| |
Real
Property |
Equipment |
Total |
|
Years
Ending December 31, |
($
in thousands) |
|
2005 |
$5,166 |
$2,807 |
$7,973 |
|
2006 |
4,131 |
529 |
4,660 |
|
2007 |
3,556 |
14 |
3,570 |
|
2008 |
2,528 |
— |
2,528 |
|
2009 |
1,747 |
— |
1,747 |
|
Thereafter |
2,234 |
— |
2,234 |
|
Total |
$19,362 |
$3,350 |
$22,712 |
For the
years ended December 31, 2004, 2003, and 2002, rental and lease expense amounted
to $9.6 million, $8.7 million, and $6.8 million, respectively.
Mortgage
Loans
As of
December 31, 2004 and 2003, the Company’s subsidiaries had commitments to fund
mortgage loans with agreed-upon rates of approximately $240.3 million and $144.3
million, respectively. These amounts do not necessarily represent future cash
requirements, as some portion of the commitments are likely to expire without
being drawn upon or may be subsequently declined for credit or other reasons.
In
connection with the approximately $603.3 million of mortgage loans securitized
in off balance sheet transactions from May 1996 to July 5, 2001, and which are
still outstanding as of December 31, 2004, and in connection with the sales of
mortgage loans to nonaffiliated parties, the Company’s subsidiaries made
representations and warranties about certain characteristics of the loans, the
borrowers, and the underlying properties. In the event of a breach of these
representations and warranties, those subsidiaries may be required to remove
loans from a securitization and replace them with cash or substitute loans, and
to indemnify parties for any losses related to such breach. As of December 31,
2004 those subsidiaries neither had nor expect to incur any material obligation
to remove any such loans, or to provide any such indemnification.
In the
normal course of business, the Company is subject to indemnification obligations
related to the sale of residential mortgage loans. Under these obligations, the
Company is required to repurchase certain mortgage loans that fail to meet the
standard representations and warranties included in the sales contracts. From
time to time, the Company has been required to repurchase loans that it sold;
however, the liability for the fair value of those obligations has been
immaterial.
Our
subsidiaries are subject to premium recapture expenses in connection with the
sale of residential mortgage loans. Premium recapture expenses represent
repayment of a portion of certain loan sale premiums to investors on previously
sold loans that are repaid within six months of the loan sale. We accrue an
estimate of the potential refunds of premium received on loan sales based upon
historical experience. As of December 31, 2004 and 2003, the liability recorded
for premium recapture expense was $0.1 million and $0.2 million, respectively.
Mortgage
Servicing Rights
The
Company anticipates purchasing third party servicing rights for an additional
$8.6 billion of mortgage loans during 2005, of which $1.3 billion have been
purchased through February 2005 for approximately $9.8 million.
Legal
Matters
Because
the business of the Company’s subsidiaries involves the collection of numerous
accounts as well as the validity of liens and compliance with various state and
federal lending laws, the Company and its subsidiaries are subject to various
legal proceedings in the normal course of business. In management’s opinion, the
resolution of these lawsuits will not have a material adverse effect on the
financial position or the results of operations of the Company.
America’s
MoneyLine is named in a case brought as a class action in Illinois. This is a
class action suit alleging consumer fraud and unjust enrichment under Illinois
law and similar laws of other states. The plaintiff alleges that she was
improperly charged a fee for overnight delivery of mortgage loan documents. The
case has been settled in a manner in which it will not have a material adverse
effect on the financial position or results of operations of the
Company.
Saxon
Mortgage Services, was named in a matter filed in the United States District
Court for the Northern District of Illinois, Eastern Division as a class action.
The plaintiffs alleged that Saxon Mortgage Services collected prepayment
penalties on loans that had been accelerated, constituting violations of the
Illinois Interest Act, the Illinois Consumer Fraud Act, similar laws, if any, in
other states, and a breach of contract. The claims of one of the named
plaintiffs have been settled, and the claims of the remaining named plaintiff
against Saxon Mortgage Services have been dismissed without prejudice. The
remaining named plaintiff re-filed the action in State Court. On the Company’s
motion, the action was removed to Federal Court. The parties agreed to a
settlement that would require the Company to pay approximately $0.2 million to a
group of 27 former Illinois borrowers and their attorneys in exchange for a
dismissal. Accordingly, the Company accrued $0.2 million in the Company’s
consolidated financial statements
for the year ended December 31, 2003. The Court has entered an order approving
the settlement, and we are in the process of performing our obligations under
the settlement agreement. Each of the 27 former borrowers may choose to opt out
of the settlement and may pursue individual actions against us. The settlement
would not preclude former borrowers in other states from bringing similar
claims, or attempting to assert similar claims as a class action.
Insurance
Policies
As of
December 31, 2004, the Company carried a primary directors and officers
liability insurance policy for $10 million, excess directors and officer’s
liability insurance policies totaling $40 million and a key man life insurance
policy in the amount of $4.8 million. In addition, the Company carried a
banker’s professional liability/lenders liability policy, a fiduciary
liability insurance policy and an employment practices liability policy for $10
million each; a mortgage protection insurance policy with a mortgagee interest
limit of $15 million and a mortgagee liability limit of $10 million; a financial
institutions bond with an aggregate limit of $30 million and a per loss limit of
$15 million; a commercial umbrella policy of $15 million; a commercial general
liability policy with a $5 million aggregate limit and $1 million per occurrence
limit; a property insurance policy, a workers compensation insurance policy, and
a business automobile insurance policy each with $1 million per occurrence
limit; and an employed lawyers liability insurance policy with a $1 million
aggregate limit and a $1 million per occurrence limit. For the years ended
December 31, 2004, 2003, and 2002, insurance expense amounted to $3.7 million,
$2.8 million, and $1.6 million, respectively.
(20) Related
Party Transactions
At
December 31, 2004 and 2003, the Company had $9.0 million and $12.0 million,
respectively, of unpaid principal balances within its mortgage loan portfolio
related to mortgage loans originated for executive officers, officers, and
employees of the Company. These mortgage loans were underwritten to the
Company’s underwriting guidelines. When making loans to officers and employees,
the Company waives loan origination fees that otherwise would be paid to the
Company by the borrower and reduces the interest rate by 25 basis points from
the market rate. Effective December 1, 2002, the Company no longer renews or
makes any new loans to its executive officers or directors. The Company has
never made loans to any of its outside directors.
(21) Segments
The
operating segments reported below are the segments of the Company for which
separate financial information is available and for which amounts are evaluated
regularly by management in deciding how to allocate resources and in assessing
performance. The Company’s segment information for the years ended December 31,
2003 and 2002 has been restated to reflect a change in the composition of its
reportable segments.
The
portfolio segment uses the Company’s equity capital and borrowed funds to invest
in its mortgage loan portfolio, thereby producing net interest income. The
servicing segment services loans, seeking to ensure that loans are repaid in
accordance with their terms. The mortgage loan production segment purchases and
originates non-conforming residential mortgage loans through relationships with
various mortgage companies, mortgage brokers, and correspondent lenders, and
directly to borrowers through its 25 branch offices. The mortgage loan
production segment records interest income, interest expense, and provision for
mortgage loan losses on the mortgage loans it holds prior to selling its loans
to the portfolio segment.
The
mortgage loan production segment collects revenues, such as origination and
underwriting fees and other certain nonrefundable fees, that are deferred and
recognized over the life of the loan as an adjustment to interest income
recorded in the portfolio segment.
Management
evaluates assets only for the servicing and portfolio segments. Assets not
identifiable to an individual segment are corporate assets, which are comprised
of cash and other assets.
| |
For
the Year Ended December 31, 2004 |
| |
Qualified
REIT Subsidiary (1) |
Taxable
REIT
Subsidiary
(1) |
Taxable
REIT
Subsidiary
(1) |
|
|
| |
Portfolio |
Mortgage
Loan
Production |
Servicing |
Eliminations |
Total |
| |
($
in thousands) |
|
Interest
income |
$363,465 |
$41,792 |
$5,031 |
$(14,941) |
$395,347 |
|
Interest
expense |
(153,713) |
(13,743) |
(1,890) |
13,541 |
(155,805) |
|
Net
interest income |
209,752 |
28,049 |
3,141 |
(1,400) |
239,542 |
|
Provision
for mortgage loan losses |
(38,011) |
(3,636) |
— |
— |
(41,647) |
|
Net
interest income after provision for mortgage loan
losses |
171,741 |
24,413 |
3,141 |
(1,400) |
197,895 |
|
Servicing
income, net of amortization and impairment |
— |
— |
48,803 |
(15,167) |
33,636 |
|
(Loss)
gain on sale of mortgage assets |
|
3,469 |
31 |
|
3,500 |
|
Total
net revenues |
171,741 |
27,882 |
51,975 |
(16,567) |
235,031 |
|
Operating
expenses |
(31,197) |
(111,296) |
(34,890) |
39,764 |
(137,619) |
|
Other
(expense) income |
(3,307) |
17,975 |
(972) |
(18,523) |
(4,827) |
|
Income
(loss) before taxes |
137,237 |
(65,439) |
16,113 |
4,674 |
92,585 |
|
Income
tax (expense) benefit |
19,240 |
(9,174) |
2,259 |
655 |
12,980 |
|
Net
income (loss) |
$156,477 |
$(74,613) |
$18,372 |
$5,329 |
$105,565 |
___________________
| |
(1) |
The
Company’s REIT conversion was effective September 24,
2004. |
| |
For
the Year Ended December 31, 2003 |
| |
Portfolio |
Mortgage
Loan
Production |
Servicing |
Eliminations |
Total |
| |
($
in thousands) |
|
Interest
income |
$283,575 |
$34,301 |
$3,748 |
$11,440 |
$333,064 |
|
Interest
expense |
(113,337) |
(14,027) |
(2,840) |
6,901 |
(123,303) |
|
Net
interest income |
170,238 |
20,274 |
908 |
18,341 |
209,761 |
|
Provision
for mortgage loan losses |
(33,010) |
(17) |
— |
— |
(33,027) |
|
Net
interest income after provision for mortgage loan losses |
137,228 |
20,257 |
908 |
18,341 |
176,734 |
|
Servicing
income, net of amortization and impairment |
— |
— |
43,958 |
(11,824) |
32,134 |
|
Gain
on sale of mortgage assets |
—
|
2,358 |
175 |
— |
2,533 |
|
Total
net revenues |
137,228 |
22,615 |
45,041 |
6,517 |
211,401 |
|
Operating
expenses |
(22,194) |
(72,963) |
(24,684) |
11,824 |
(108,017) |
|
Other
income (expense) |
(895) |
32,214 |
(1,324) |
(31,734) |
(1,739) |
|
Income
(loss) before taxes |
114,139 |
(18,134) |
19,033 |
(13,393) |
101,645 |
|
Income
tax (expense) benefit |
(40,996) |
6,513 |
(6,836) |
4,810 |
(36,509) |
|
Net
income (loss) |
$73,143 |
$(11,621) |
$12,197 |
$(8,583) |
65,136 |
| |
For
the Year Ended December 31, 2002 |
| |
Portfolio |
Mortgage
Loan
Production |
Servicing |
Eliminations |
Total |
| |
($
in thousands) |
|
Interest
income |
$186,355 |
$36,789 |
$1,714 |
$1,541 |
$226,399 |
|
Interest
expense |
(78,742) |
(10,399) |
(1,059) |
3,132 |
(87,068) |
|
Net
interest income |
107,613 |
26,390 |
655 |
4,673 |
139,331 |
|
Provision
for mortgage loan losses |
(18,731) |
(9,386) |
— |
— |
(28,117) |
|
Net
interest income after provision for mortgage loan losses |
88,882 |
17,004 |
655 |
4,673 |
111,214 |
|
Servicing
income, net of amortization and impairment |
— |
— |
28,508 |
(5,584) |
22,924 |
|
Gain
on sale of mortgage assets |
— |
365 |
— |
— |
365 |
|
Total
net revenues |
88,882 |
17,369 |
29,163 |
(911) |
134,503 |
|
Operating
expenses |
(21,046) |
(54,357) |
(20,946) |
5,584 |
(90,765) |
|
Other
income (expense) |
(30,267) |
59,181 |
24 |
(28,466) |
472 |
|
Income
(loss) before taxes |
37,569 |
22,193 |
8,241 |
(23,793) |
44,210 |
|
Income
tax (expense) benefit |
(14,304) |
(8,450) |
(3,138) |
9,059 |
(16,833) |
|
Net
income (loss) |
$23,265 |
$13,743 |
$5,103 |
$(14,734) |
$27,377 |
| |
December
31, 2004 |
December
31, 2003 |
December
31, 2002 |
|
Segment
Assets: |
|
|
|
|
Portfolio |
$6,184,859 |
$4,833,785 |
$3,971,002 |
|
Servicing |
212,124 |
139,843 |
127,529 |
|
Total
segment assets |
$6,396,983 |
$4,973,628 |
$4,098,531 |
| |
|
|
|
|
Corporate
assets |
142,148 |
85,453 |
64,631 |
|
Total
assets |
$6,539,131 |
$5,059,081 |
$4,163,162 |
(22) Regulatory
Requirements
The
Company and its wholly-owned subsidiaries are subject to a number of minimum net
worth requirements resulting from contractual agreements with secondary market
investors and state-imposed regulatory mandates. The most stringent net worth
requirement imposed upon the Company
is imposed by Ginnie Mae in connection with the Company being an approved
seller/servicer on behalf of Ginnie Mae. The table below summarizes the Ginnie
Mae net worth requirements as of December 31, 2004 and 2003,
respectively.
| |
2004 |
2003 |
| |
($
in thousands) |
|
Ginnie
Mae Net Worth Requirement |
$275 |
$275 |
|
Adjusted
Net Worth, as defined under contractual agreements with Ginnie
Mae |
$611,224 |
$304,531 |
|
Excess
Net Worth |
$610,949 |
$304,256 |
In the
event the Company becomes in default of these minimum net worth requirements,
Ginnie Mae maintains the contractual right to suspend
or terminate the Company’s status as a servicer.
* * * * * *
Supplementary
Data
Summary
of Selected Quarterly Results (unaudited)
| |
Saxon
Capital, Inc. |
| |
2004 |
2003 |
| |
Dec.
31 |
Sept.
30 |
June
30 |
March
31 |
Dec.
31 |
Sept.
30 |
June
30 |
March
31 |
| |
($
in thousands, except per share amounts) |
|
Net
interest income |
$56,980 |
$61,724 |
$63,006 |
$57,832 |
$54,237 |
$54,346 |
$52,584 |
$48,594 |
|
Provision
for loan losses |
(12,879) |
(14,730) |
(10,160) |
(3,878) |
(6,219) |
(8,517) |
(9,677) |
(8,614) |
|
Net
interest income after provision for loan losses |
44,101 |
46,994 |
52,846 |
53,954 |
48,018 |
45,829 |
42,907 |
39,980 |
| |
|
|
|
|
|
|
|
|
|
Net
income |
$30,140 |
$38,285 |
$17,448 |
$19,692 |
$20,202 |
$16,619 |
$15,431 |
$12,884 |
|
Basic
earnings per common share |
$0.60 |
$1.21 |
$0.61 |
$0.69 |
$0.71 |
$0.58 |
$0.54 |
$0.46 |
|
Diluted
earnings per common share |
$0.60 |
$1.14 |
$0.56 |
$0.63 |
$0.66 |
$0.55 |
$0.51 |
$0.44 |
|
Exhibit
Number |
|
Description
|
| |
|
|
|
3.1 |
|
Amended
and Restated Certificate of Incorporation of Saxon
Capital, Inc. |
|
3.2 |
|
Amended
and Restated Bylaws of Saxon Capital, Inc.
(1) |
|
4.1 |
|
Form
of Common Stock Certificate (2) |
|
4.2 |
|
Certain
instruments defining the rights of the holders of long-term debt of the
Company and certain of its subsidiaries, none of which authorize a total
amount of indebtedness in excess of 10% of the total assets of the Company
and its subsidiaries on a consolidated basis, have not been filed as
Exhibits. The Company hereby agrees to furnish a copy of any of these
agreements to the Securities and Exchange Commission upon
request. |
|
9 |
|
Voting
Agreement by and between Saxon Capital Acquisition Corporation and
Friedman, Billings, Ramsey & Co., Inc. dated July 6, 2001(3)
|
|
10.1* |
|
Form
of Saxon Capital, Inc. 2001 Stock Incentive Plan (3) |
|
10.2* |
|
Form
of Amended and Restated Employment Agreement of Michael L. Sawyer, dated
September 13, 2004(4) |
|
10.3 |
|
Residual
Assignment and Services Agreement, by and among Saxon Acquisition Corp.,
SCI Services, Inc., Saxon Mortgage, Inc., Meritech Mortgage
Services, Inc., and Dominion Capital, Inc. dated June 7,
2001(3) |
|
10.4 |
|
Registration
Rights Agreement by and between Saxon Capital Acquisition Corp. and
Friedman, Billings, Ramsey & Co., Inc. dated
July 6, 2001(3) |
|
10.5 |
|
FBR
Warrant Agreement by and between Saxon Capital Acquisition Corp. and
Friedman, Billings, Ramsey & Co., Inc. dated
July 6, 2001(3) |
|
10.6 |
|
Deed
of Lease between Innslake, L.P. and Resource Mortgage
Capital, Inc., dated September 15, 1994, as amended (3) |
|
10.7 |
|
Lease
Agreement by and between Reliance Insurance Company and Meritech Mortgage
Services, Inc. dated August 15, 1996, as amended (3) |
|
10.8* |
|
Form
of Saxon Capital, Inc. 2004 Employee Stock Purchase Plan, approved
September 13, 2004(2) |
|
10.9 |
|
Pooling
and Servicing Agreement, dated as of September 1, 2001, among Saxon Asset
Securities Company, as depositor, Saxon Mortgage, Inc., as master
servicer, Meritech Mortgage Services, Inc., as servicer and Bankers Trust
Company, as trustee. (5) |
|
10.10 |
|
Pooling
and Servicing Agreement, dated as of March 1, 2002, among Saxon Asset
Services Company, as depositor, Saxon Mortgage, Inc., as master servicer,
Meritech Mortgage Services, Inc., as servicer and Bankers Trust Company,
as trustee. (6) |
|
10.11* |
|
Form
of Amended and Restated Employment Agreement of Bradley D. Adams, dated
September 13, 2004(4) |
|
10.12 |
|
Pooling
and Servicing Agreement, dated as of July 1, 2002, among Saxon Asset
Services Company, as depositor, Saxon Mortgage, Inc., as master servicer,
Saxon Mortgage Services, Inc., as servicer and Deutsche Bank Trust Company
Americas, as trustee. (7) |
|
10.13 |
|
Pooling
and Servicing Agreement, dated as of November 1, 2002, among Saxon Asset
Securities Company, as depositor, Saxon Mortgage, Inc., as master
servicer, Saxon Mortgage Services, Inc., as servicer and Deutsche Bank
Trust Company Americas, as trustee. (8) |
|
10.14* |
|
Form
of Amended and Restated Employment Agreement of Robert B. Eastep, dated
September 13, 2004(4) |
|
10.15 |
|
Pooling
and Servicing Agreement, dated as of March 1, 2003, among Saxon Asset
Securities Company, as depositor, Saxon Mortgage, Inc., as master
servicer, Saxon Mortgage Services, Inc., as servicer and Deutsche Bank
Trust Company Americas, as trustee. (9) |
|
10.16 |
|
Pooling
and Servicing Agreement, dated as of May 1, 2003, among Saxon Asset
Securities Company, as depositor, Saxon Mortgage, Inc., as master
servicer, Saxon Mortgage Services, Inc., as servicer and Deutsche Bank
Trust Company Americas, as trustee. (10) |
|
10.17 |
|
Form
of First Amendment to Stock Option Agreement entered into with each of
Edward Harshfield, Richard Kraemer, Thomas Wageman, David D. Wesselink,
each a Non-Employee Director, dated September 4, 2003.
(11) |
|
10.18 |
|
Pooling
and Servicing Agreement, dated as of September 1, 2003, among Saxon Asset
Securities Company, as depositor, Saxon Mortgage, Inc., as master
servicer, Saxon Mortgage Services, Inc., as servicer and Deutsche Bank
Trust Company Americas, as trustee. (12) |
|
10.19 |
|
Sale
and Servicing Agreement, dated as of February 1, 2004, among Saxon Asset
Securities Trust 2004-1, as issuer, Saxon Asset Securities Company, as
depositor, Saxon Mortgage, Inc., as master servicer, Saxon Mortgage
Services, Inc., as servicer and Deutsche Bank Trust Company Americas, as
trustee. (13) |
|
10.20 |
|
Sale
and Servicing Agreement, dated as of July 1, 2004, among Saxon Asset
Securities Trust 2004-2, as issuer, Saxon Asset Securities Company, as
depositor, Saxon Mortgage, Inc., as master servicer, Saxon Mortgage
Services, Inc., as servicer and Deutsche Bank Trust Company Americas, as
trustee. (14) |
|
10.21 |
|
Sale
and Servicing Agreement, dated as of October 1, 2004, among Saxon Asset
Securities Trust 2004-3, as issuer, Saxon Asset Securities Company, as
depositor, Saxon Funding Management, Inc., as master servicer, Saxon
Mortgage Services, Inc., as servicer and Deutsche Bank Trust Company
Americas, as trustee. (15) |
|
10.22 |
|
Sale
and Servicing Agreement, dated as of January 1, 2005, among Saxon Asset
Securities Trust 2005-1, as issuer, Saxon Asset Securities Company, as
depositor, Saxon Funding Management, Inc., as master servicer, Saxon
Mortgage Services, Inc., as servicer and Deutsche Bank Trust Company
Americas, as trustee. (16) |
|
10.23* |
|
Form
of Notice of Restricted Stock Unit Grant for Employees and Restricted
Stock Unit Agreement under 2001 Stock Incentive Plan.
(17) |
|
10.24* |
|
Restricted
Stock Unit Agreement of James V. Smith dated January 27, 2005.
(17) |
|
10.25* |
|
Restricted
Stock Unit Agreement of Jeffrey A. Haar dated January 27,
2005.
(17) |
|
10.26* |
|
Form
of Notice of Restricted Stock Unit Grant for Employees with Employment
Agreement and Restricted Stock Unit Agreement under 2001 Stock Incentive
Plan.
(17) |
|
10.27* |
|
Restricted
Stock Unit Agreement of Michael L. Sawyer dated January 27,
2005.
(17) |
|
10.28* |
|
Restricted
Stock Unit Agreement of Robert B. Eastep dated January 27,
2005.
(17) |
|
10.29* |
|
Restricted
Stock Unit Agreement of Bradley D. Adams dated January 27,
2005.
(17) |
|
10.30* |
|
Form
of Notice of Restricted Stock Unit Grant for Non-Employee Directors and
Restricted Stock Unit Agreement under 2001 Stock Incentive
Plan.
(17) |
|
10.31* |
|
Restricted
Stock Unit Agreement of Richard A. Kraemer dated January 27,
2005.
(17) |
|
10.32* |
|
Restricted
Stock Unit Agreement of David D. Wesselink dated January 27,
2005.
(17) |
|
10.33* |
|
Restricted
Stock Unit Agreement of Thomas J. Wageman dated January 27,
2005.
(17) |
|
10.34* |
|
Form
of Employment Agreement of David L. Dill, dated March 2,
2005. |
|
10.35* |
|
Form
of Employment Agreement of James V. Smith, dated March 2,
2005. |
|
10.36 |
|
Lease
Agreement by and between Highwoods Realty Limited Partnership and SCI
Services, Inc. dated May 10, 2004, as amended |
|
21 |
|
List
of subsidiaries of Saxon Capital, Inc.
(18) |
|
23 |
|
Consent
of Deloitte & Touche LLP |
|
24 |
|
Power
of Attorney (included on signature page) |
|
31.1 |
|
Certification
of Chief Executive Officer pursuant to Section 302 |
|
31.2 |
|
Certification
of Chief Financial Officer pursuant to Section 302 |
|
32.1 |
|
Certification
of Chief Executive Officer and Chief Financial Officer pursuant to Section
906 |
__________________
|
(1) |
Incorporated
herein by reference to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on March 4, 2005.
|
|
(2) |
Incorporated
herein by reference to Amendment No. 3 to our registration statement on
Form S-4 (No. 333-112834) filed with the Securities and Exchange
Commission on June 18, 2004. |
|
(3) |
Incorporated
by reference from Old Saxon’s Registration Statement on Form S-1 (No.
333-71052), as amended, declared effective by the Securities and Exchange
Commission on January 15, 2002. Old Saxon is Saxon Capital, Inc., a
Delaware corporation that is our
predecessor. |
|
(4) |
Incorporated
herein by reference to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on September 30,
2004. |
|
(5) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated September 27, 2001. |
|
(6) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated March 14, 2002. |
|
(7) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K/A dated July 10, 2002. |
|
(8) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated November 8, 2002. |
|
(9) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated March 6, 2003. |
|
(10) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated May 29, 2003. |
|
(11) |
Incorporated
by reference from Old Saxon’s Quarterly Report on Form 10-Q for the
quarter ended September 30, 2003, filed with the Securities and Exchange
Commission on November 10, 2003. Old Saxon is Saxon Capital, Inc., a
Delaware corporation that is our
predecessor. |
|
(12) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated September 16, 2003. |
|
(13) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated February 19, 2004. |
|
(14) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated July 27, 2004. |
|
(15) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated October 27, 2004. |
|
(16) |
Incorporated
herein by reference to Saxon Asset Securities Company’s Current Report on
Form 8-K dated January 25, 2005. |
|
(17) |
Incorporated
herein by reference to our Current Report on Form 8-K filed with the
Securities and Exchange Commission on January 31,
2005. |
|
(18) |
Incorporated
herein by reference to Amendment No. 2 to our registration statement on
Form S-4 (No. 333-112834) filed with the Securities and Exchange
Commission on May 24, 2004. |
|
* |
Executive
Compensation Plan or Agreement. |
