Item 1. Business
General
AMRESCO, INC., a Delaware corporation (the "Company"), is a diversified financial services company specializing in real estate lending, commercial finance and the acquisition, resolution and servicing of performing, underperforming and nonperforming commercial loans. The Company began operations in 1987 providing asset management and resolution services to governmental agencies, financial institutions and others relating to nonperforming and underperforming commercial and real estate loans. In early 1994, the Company made the decision to diversify its business lines and build "franchise" business units that could use the Company's core real estate management and lending expertise to pursue growth in markets that were being underserved by traditional lenders. Since that time, the Company entered the commercial mortgage banking, commercial finance, residential mortgage lending and loan servicing businesses and oriented its asset management activities towards direct investments in asset portfolios and the special servicing of large portfolios of asset-backed securities.
Business Activities
During 1999, the Company's primary businesses were organized along the following lines: commercial finance, asset management, commercial mortgage banking, residential mortgage banking and home equity lending. Financial information regarding the Company's operating segments is presented in Note 15 of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data." Additional financial information regarding the Company's operating segments is presented in "Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations".
Recent Developments
Since December 31, 1998, the Company has entered into a number of transactions that will affect the Company's future operations, business strategy and operating results. The following is a summary of these events.
Formation of Home Equity Joint Venture With Lehman Brothers
Effective as of June 30, 1999, the Company formed a joint venture with Lehman Capital, a division of Lehman Brothers Holdings Inc., and various entities related to Lehman Capital (collectively, "Lehman"). Formation of the joint venture, now known as Finance America LLC ("Finance America"), represents the completion of the Company's previously announced plan to exit the home equity subprime mortgage finance business. Finance America took over the subprime home equity mortgage origination and sale business previously conducted by the Company's subsidiary, AMRESCO Residential Mortgage Corporation ("ARMC"), other than certain retail branches which have now been closed. The transaction allows the Company to cap its future investment in the home equity mortgage business, partner with a major investment bank that is substantially involved in the home equity mortgage business, both as a lender and as an investment banker, and retain an equity upside opportunity. As part of the transaction, the Company entered into a number of transaction agreements summarized below.
In connection with the formation of Finance America, the Company contributed substantially all of the operating assets of ARMC (but excluding working capital items) and cash aggregating $3.75 million. In addition, substantially all the persons employed by ARMC in connection with the origination and sale of loans were hired by Finance America. ARMC retained substantially all of its liabilities, other than certain contractual or other obligations associated with the assets conveyed to Finance America, and its loan servicing operations. Lehman agreed to fund various credit facilities, including a warehouse facility to finance loan originations and purchases by Finance America. The Company agreed not to engage in the business of wholesale origination, bulk purchase or securitization of subprime home equity mortgage loans for a period of five years after the closing. The parties also agreed to the winding down of ARMC following the organization of the joint venture. Finance America, the Company and ARMC also agreed to provide each other certain transitional services in respect to the initiation of operations by Finance America and the winding down of ARMC, including any future sale of the Company's remaining portfolio of subordinated certificates and other residual interests remaining from prior securitizations conducted by ARMC. During the first quarter 2000, the Company transferred net assets of $6.2 million of the home equity lending business to Finance America, a joint venture with Lehman Brothers for a 36% interest.
ARMC and Lehman, as owners of Finance America, entered into an agreement to govern their relationship and the management of Finance America. Various restrictions on transfers of the equity interest in Finance America held by each of ARMC and Lehman, as well as certain customary "drag along" and "tag along" rights and rights of first refusal with respect to any transfers of the equity interests in Finance America were agreed to.
Initially Lehman acquired a 60% equity interest in Finance America and the Company acquired the remaining 40% equity interest. Upon the Chief Executive Officer's hiring, he received a 10% restricted equity interest in the Company, with that dilution being borne ratably by Lehman and the Company (accordingly, the Company's equity interest is currently 36%). No further equity contributions by the owners are required, other than the Company has agreed to contribute $1.2 million to Finance America on June 30, 2000 if the Chief Executive Officer is still employed by Finance America at that date. If the Chief Executive Officer leaves or is terminated by Finance America prior to June 30, 2002, the Company would receive a rebate of its contribution equal to $50,000 for each month during the 24 month period between July 1, 2000 and June 30, 2002 that the Chief Executive Officer did not remain with Finance America.
Working Capital Facility. Lehman and the Company also agreed to provide up to $20 million of working capital to Finance America. Lehman agreed to provide the first $10 million; the Company agreed to provide the next $5 million (after Lehman had funded the first $10 million of borrowings); and Lehman agreed to provide $5 million after the Company had fully funded its $5 million working capital commitment.
Lehman and Finance America entered into various financing arrangements including a warehouse facility and other similar and customary financing facilities to fund the operation of the Finance America's business. Lehman also agreed to provide certain management services at a fee of $3.15 million per annum for a period not to exceed 13 years from the closing date. This fee can be deferred for up to three years.
ARMC also agreed to provide certain transition and other services to Finance America. In exchange for these services, ARMC is to be paid $2.1 million per annum for a period not to exceed 13 years from the closing date. In addition, on each of December 31, 1999, June 30, 2000, December 31, 2000 and June 30, 2001, ARMC will be paid a "set up" fee aggregating $3.75 million in equal installments. These fees can be deferred under certain conditions for up to three years.
Sale of Assets to Lend Lease (US) Services, Inc.
General. On December 8, 1999, the Company and certain of its subsidiaries, as sellers, and Lend Lease (US) Services, Inc. ("Lend Lease"), as purchaser, entered into an Asset Purchase Agreement, which agreement was amended on March 17, 2000 (as amended, the "Purchase Agreement"), pursuant to which the Company agreed to sell to Lend Lease the Company's commercial mortgage banking business (including commercial mortgage servicing, commercial mortgage brokerage and commercial loan origination (excluding the Company's conduit lending programs)) and asset management and real estate structured finance platforms (collectively, the "Businesses"). The transaction encompassed both the domestic and international operations of the Businesses, other than those Business operations conducted in Europe. This sale was completed on March 17, 2000.
Purchase Price. The gross, unadjusted purchase price for the Businesses was approximately $248.6 million (the "Consideration"). The Consideration was increased by amendment to the Purchase Agreement to reflect certain additional investments made prior to closing that inure to the benefit of Lend Lease. The Consideration is comprised of approximately $223.6 million of cash payable at closing (subject to certain adjustments and holdbacks described below) and an unsecured, non-negotiable promissory note of Lend Lease (the "Note") in the principal amount of $25.0 million. The Consideration received at closing was adjusted for an estimated increase in the net working capital of the Businesses, decreases in the estimated revenues to be received by Lend Lease pursuant to certain servicing agreements as a result of pre-closing asset sales and estimated enumerated expenditures and investments made by the Company prior to closing that inure to Lend Lease's benefit. The cash paid at closing, after adjustments of $1.2 million, and holdbacks of $50.0 million was $202.7 million (including an advance by Lend Lease of $4.0 million against the holdbacks, which was repaid on March 22, 2000). After closing, the actual amount of these adjustments will be calculated as of the closing date, and the parties will promptly compensate each other for any difference with the estimated adjustments. Additionally, the amount of Consideration paid was reduced on an item-by-item basis for certain significant consents or approvals not obtained by the Company at the time of closing. If any of these consents or approvals are obtained within one year of the closing and certain other conditions are satisfied, the amount of the corresponding closing reduction will be repaid to the Company. The purchase price was the result of arms- length negotiations between the parties.
Interest on the Note accrues at a rate of 7.5% per annum. The initial principal payment under the Note is due on the second anniversary of closing. Payment of the principal is subject to and may be offset by any obligation of the Company owed to Lend Lease under the Purchase Agreement or other agreements related to the Purchase Agreement, including the Company's indemnity obligations thereunder. The Note will not be paid in full until all indemnity claims of Lend Lease or other permitted holdbacks have been finally resolved.
Purchased Assets. Lend Lease acquired substantially all of the assets (the "Purchased Assets") used in the Businesses. The Purchased Assets include the Businesses' real property, real property leases, fixtures and improvements, furniture, office equipment and similar tangible personal property, permits (to the extent transferable), intellectual property, various servicing and other agreements, accounts receivable, earned and unearned fees and cash. In addition, certain computer hardware and software were also conveyed as well as the equity interests of certain co-investments related to the Businesses and certain foreign subsidiaries. With certain exceptions, Lend Lease did not acquire the loans and other financial-type assets of the Company, whether or not originated by the Businesses.
Lend Lease assumed certain pre-closing liabilities relating to the Businesses and the Purchased Assets, including certain accounts payable accrued in the ordinary course of business and included in the net working capital of the Businesses, obligations under assumed leases and contracts, and certain obligations to employees hired by Lend Lease to the extent included in the net working capital of the Businesses. Outside of enumerated liabilities or obligations expressly assumed by Lend Lease, all pre-closing liabilities and obligations related to the Businesses remain with the Company.
Representations and Warranties. The Purchase Agreement contains various representations and warranties customary for asset purchase transactions. The representations and warranties address various matters, including the authorization of the Purchase Agreement, required consents, power and authority, litigation, compliance with laws, title to the assets being conveyed, intellectual property rights and software matters, accuracy of the information supplied to Lend Lease by the Company, absence of changes and undisclosed liabilities, and servicing contract matters.
Covenants. Following closing, the Company may neither compete, directly or indirectly, in any manner with the Businesses nor solicit employees, customers, clients, suppliers, or licensors with respect to any business conducted by the Company substantially similar to the Businesses.
Survival and Indemnification. Generally, the representations and warranties survive until the second anniversary of closing. Certain representations and warranties survive indefinitely or until expiration of the applicable statute of limitations. The Purchase Agreement provides that the respective parties will indemnify the other for certain breaches, actions or other claims, including claims arising with respect to liabilities to be assumed by Lend Lease or retained by the Company. The indemnities made by each of the Company and Lend Lease are subject to a basket or floor of $750,000 before any claim can be pursued against the indemnifying party. The indemnity of the Company is subject to a cap of $100 million for breaches of representations and warranties claimed through the first anniversary of closing and, thereafter, $50 million (plus claims made during the first year). Lend Lease's indemnity is limited to $25 million in the aggregate.
Management Agreement. At closing, Lend Lease entered into an Asset Management and Servicing Agreement (the "Management Agreement") with the Company. Pursuant to the Management Agreement, Lend Lease will manage for the Company various financial and other assets held by the Company, including commercial and industrial loans, commercial and multi-family real estate (including partnership and other equity interests therein) and commercial and multi-family real estate loans. The assets were originated and managed by the Businesses acquired by Lend Lease. The services provided by Lend Lease include advisory, consultation, management, servicing and disposition services. The Management Agreement is similar in its terms to the management agreements that the Company previously entered into with third parties in respect of the same type of assets. The Management Agreement has an initial term of three years subject to automatic annual renewals at the Company's election.
Mortgage Investors Corporation
On August 11, 1998, the Company acquired Mortgage Investors Corporation and an affiliated entity ("MIC"), a privately held producer of Veteran's Administration ("VA") streamlined re-financed loans, by merging a wholly-owned subsidiary of the Company with MIC. The initial Agreement and Plan of Merger (the "Original Agreement") to purchase MIC, provided for an acquisition price of approximately 1.8 million shares of the Company's common stock and $2.6 million in cash. Also, the former owners were to receive an earn-out payment of between $70.0 million and $105.0 million over a three-year period with the payments structured to be paid 82% in the Company's common stock and 18% in cash. Effective April 12, 1999, the Original Agreement was amended (the "Amended Agreement") to provide the Company an option to effect redemption of the stock portion of the earn-out for cash subject to certain market conditions and restrictions, and to fix the earn-out payment at $105.0 million. During 1999, the Company made an earn-out payment of $9.7 million in cash and advanced $9.2 million, the balance of the cash portion of the earn-out. Also, the Company extended $17.0 million to the previous owners of MIC in exchange for a note receivable to be repaid upon issuance of the stock portion of the earn-out. The Company did not exercise its option to effect redemption of the stock portion of the earn-out prior to December 31, 1999. The issuance of the stock portion of the earn-out has been extended until at least March 31, 2000, but no later than June 30, 2000. At December 31, 1999, $86.1 million was recorded as common stock to be issued for the portion of the earn-out related to the Amended Agreement.
During January 2000, the Company obtained an option to return MIC and its related assets and liabilities to its previous owners for a cash payment of $25.0 million and forgiveness of the $17.0 million note in exchange for cancellation of the $86.1 million stock obligation currently owed to the previous owners. The option expires April 30, 2000. The Company expects to exercise its option with regard to MIC if sufficient cash is available to do so; as such, the Company recorded an impairment charge of $103.3 million on the intangible assets related to the MIC acquisition.
Sale of Communications Loans and Shutdown of Communications Loan Origination Business
On November 5, 1999, the Company sold nine of the Company's ten communications loans with an aggregate book value of $132.0 million for $131.8 million, the proceeds of which were used to pay down indebtedness outstanding under the Company's credit facility. As part of this transaction, the Company entered into an agreement with the lenders to permanently reduce the long-term credit facility by $84.4 million to $448.1 million and to reduce the term loan commitment amount by $10.6 million to $56.9 million. The Company has stopped making communications loans and has closed its communications loan origination business.
Sale of Real Estate Structured Finance
In January 2000, the Company sold approximately $182.4 million of real estate structured finance loans, resulting in approximately $170.2 million in cash proceeds. Consistent with the Company's strategy to de-leverage its balance sheet, the proceeds were used to pay down indebtedness outstanding under its credit facility. The Company has ceased making real estate structured finance loans. Pursuant to the Purchase Agreement, the Company has sold its real estate structured finance business to Lend Lease. See "Business - Recent Developments - Sale of Assets to Lend Lease (US) Services, Inc."
Restructuring of CLC Earn-out
In March 2000, the Company and the former shareholders of Commercial Finance Corporation ("CLC") agreed to amend the Asset Purchase Agreement pursuant to which the Company acquired CLC. This amendment provides that the amount of the final earn-out payment due on June 30, 2000 is fixed at $37.5 million and that, if the Company credit facility is paid in full, the Company must issue to such former CLC shareholders promissory notes in the aggregate principal amount of $37.5 million in exchange for shares of the Company's common stock having such value. Such notes would bear interest at the rate of 8% per annum, would be secured by certain residuals interests from previous securitizations of CLC and would provide for principal payments of $12.5 million on each of June 30, September 30 and December 29, 2000. The notes could be prepaid at any time without penalty. In the event that the Company is unable to issue such notes, the June 30, 2000 earn- out payment will be payable in the Company's common stock having a value of $37.5 million based upon the average of the closing price of such common stock for the 20 trading days prior to May 31, 2000.
Sale of Asset Management operations in the United Kingdom
On March 22, 2000, the Company sold its United Kingdom asset management assets and operations for $160.0 million. The Company received cash proceeds of $47.0 million and a note receivable for $25.0 million. Cash proceeds of the sale were used to reduce non- recourse and bank debt.
Commercial Finance Business
General. In 1996, the Company formally organized the commercial finance group which has grown through a combination of corporate acquisitions and business development to provide financing to commercial borrowers in various targeted lending markets. The commercial finance group is divided into two operating units: business lending and builder finance. The Company closed its activities in connection with real structured finance and communications lending, see "Recent Developments - Sale of Loans and Shut-down of Communication Loan Origination Business" and "Recent Developments - Sale of Real Estate Structured Finance."
Business Lending. The business lending group, which essentially began operations through the 1997 acquisition of Commercial Lending Corporation ("ACLC"), focuses on three lending sub-markets; conventional small business loans, government guaranteed SBA loans ("Program 7A") and telephone and equipment financing.
Conventional small business lending concentrates on the origination, securitization and servicing of loans made to small business owners. Borrower profiles emphasize, among other things, the borrower's experience with the particular operating concept and cash flow of the respective operating units. Typically, loans are for refinance, construction, remodeling or purchase of existing facilities. The loans are funded primarily by a dedicated warehouse facility until they are securitized and sold.
The SBA lending group was formed by the July 1998 acquisition of Independence Funding Company, LLC ("IFC"). As one of only 14 non-bank SBA lenders in the United States, the SBA lending group makes loans under SBA Program 7A to qualifying small business owners. A portion, typically 75%, of the principal balance is guaranteed by the SBA and sold at a premium to individual investors via a bid process approximately two to three weeks after the loan is closed. The remaining non-guaranteed portion of the loan is retained for future securitization along with the interest spread between the contractual rate and the investor pass-through rate on the guaranteed portion. The SBA loans are funded primarily by a warehouse debt facility.
The telephone equipment finance group was formed by the July 1998 acquisition of TeleCapital, L.P. ("TeleCapital"). The group's primary focus is the origination and servicing of loans which are collateralized by privately owned and operated payphone routes and related equipment. The loans are primarily accumulated for the purpose of securitization and sale and they are funded largely through a warehouse debt facility.
The equipment finance group also provides lease financing for business equipment, primarily restaurant equipment, based on referrals from business lending borrowers. Typically this group will fund the individual equipment purchases during installation and then sell the lease to a third party once fully funded and installed. The total leasing advances in 1999 and 1998 were $7.4 million and $5.8 million, respectively, and sales of completed leases were $7.4 million and $5.6 million, respectively.
The business lending group processes, underwrites, sells, securitizes and services loans originated from producers. The producers solicit business using a combination of marketing efforts that include direct solicitation, convention attendance and referrals from previous borrowers. The following table summarizes loan origination volumes for the years ended December 31, 1999 and 1998, respectively (dollars in thousands):
1999 % 1998 % Conventional lending $553,636 71.7% $392,303 82.2% SBA lending (1) 166,403 21.6 59,228 12.4 Telephone equipment lending (1) 51,525 6.7 25,920 5.4 Total $771,564 100.0% $477,541 100.0%
(1) Acquired July 16, 1998.
Since the acquisition of ACLC in 1997, the Company has completed eight securitizations aggregating $1.3 billion. The loans included in each securitization are grouped according to type of borrower consisting of either (i) loans to franchisees of nationally recognized concepts or (ii) loans to owners of other independent small businesses. The securitization structure consists of (a) multiple classes of investment grade certificates that are sold via private placement to investors and (b) an equity interest and subordinated certificate retained by the Company.
Investment grade ratings for the securities are achieved by (i) limited cross-guarantee loan provisions for the various borrowers within the securitization and (ii) financial guarantee insurance. In the limited cross-guarantee arrangement, each borrower signs a Note for an amount greater than their net loan proceeds and makes payments based on the higher Note amount. This increment above the loan amount, known as the credit enhancement amount, is rebated to the borrower after they make their monthly payment assuming no deficiency exists in the securitization pool. Should a deficiency occur within the pool, the rebates of the performing loans have been pledged to cure such deficiency and are applied in an amount to bring the loan pool to a non-delinquent status. Once the deficiency is cured, the recovered rebates are returned to the appropriate borrowers.
As noted above, the business lending group retains a subordinated interest in the securitization. The certificate's value at any point in time is based on the projected future cash flow spread between the interest collected from borrowers and interest paid to certificate holders, discounted to present value. The following table depicts the business lending group's retained interests in securitizations balances and related portfolio delinquency percentages (including an SBA residual acquired as a result of the purchase of IFC) as of December 31, 1999 and 1998 (dollars in thousands):
The business lending group retains the servicing rights to loans following sale or securitization. Due primarily to the cross- guarantee credit enhancement feature of the securities described above, the Company has developed a specialized servicing process for these loans. In addition, loan servicing utilizes a third party software system customized for the servicing of SBA loans. The following table summarizes the loan servicing portfolio and related delinquency profile as of December 31, 1999 and 1998, respectively (dollars in thousands):
1999 % 1998 % Conventional lending $1,367,736 77.4% $ 898,505 74.4% SBA lending 388,360 22.0 267,830 22.2 Telephone equipment lending 10,562 0.6 41,054 3.4 Total $1,766,658 100.0% $1,207,389 100.0%
Delinquencies (1): 31-60 Days $13,843 $ 6,616 61-90 Days 3,586 1,145 90+ Days 25,474 11,870 Total $42,903 $19,631
Total delinquencies as a percentage of total loan balances (2): 2.43% 1.63%
(1) The period of delinquency is based on the number of days payments are contractually past due. (2) Reflects contractual delinquencies. At December 31, 1999 and 1998, all borrower delinquencies related to business lending loans were paid by borrower cross guarantees. See Note 5 of the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data" for a discussion of borrower cross guarantees.
Real Estate Lending. Until the Company ceased its real estate lending origination activities in January 1999, the Company provided mid-to-high yield financing to borrowers in special situations that generally preclude financing from traditional funding sources. In these transactions, the Company funded senior and subordinated indebtedness generally ranging from $2 to $15 million for terms of one to four years to borrowers with an established management record. Borrowers targeted by the Company usually had a reputation for enhancing value, but may have lacked the financial capacity to qualify for bank financing beyond a certain level. Typically these loans have a defined exit strategy such as bridge loans, mezzanine debt or construction loans and are often extended for the purpose of turning around or repositioning assets to maximize their value. Loan structures varied as they were usually customized to fit the characteristics and purpose of the loans. Income is generally derived by a combination of interest, fees and (in some cases) a net profit interest tied to the performance of the collateral at loan payoff. Also, the Company made limited equity investments in ventures where they are also a lender. The Company had loan balances outstanding of $229.0 million and equity investments of $10.5 million as of December 31, 1999 and loan balances of $195.1 million as of December 31, 1998. The following table shows the combined real estate loan and joint venture equity balances as of December 31, 1999 and 1998 by collateral type (dollars in thousands):
1999 1998 Delinquency Delinquency Percentage Percentage Balance % 90+ days Balance % 90+ days Multi-family $ 56,705 23.7% 0.0% $ 57,474 29.5% 0.0% Office 64,416 26.9 0.0 52,371 26.8 0.0 Industrial 31,588 13.2 2.1 26,911 13.8 0.0 Hospitality 27,350 11.4 0.0 19,584 10.0 0.0 Retail 22,588 9.4 0.0 19,356 9.9 0.0 Land 2,664 1.1 0.0 Mixed Use 13,040 6.7 0.0 Other 34,158 14.3 0.0 6,396 3.3 0.0 Total $239,469 100.0% 0.4 $195,132 100.0% 0.0
The Company ceased originating real estate structured loans in 1999. During January 2000, the Company sold $182.4 million principal amount of such real estate loans for $170.2 million and ceased its real estate lending operations.
Communications Lending. Through November 1999, the Company also specialized in mid-to-high yield lending in the communications industry to operators that could not obtain traditional bank financing. Loan amounts range from $3 million to $40 million, though loans in the upper half of this range typically were participated to other lenders. Borrowers generally used proceeds to acquire radio and television stations, provide working capital and refinance existing third party debt. In November 1999, the Company sold substantially all of its communication loans and ceased all communication lending. The Company had loan balances outstanding of $5.9 million and $144.8 million as of December 31, 1999 and 1998, respectively. The following table depicts the collateral distribution of the communications portfolio as of December 31, 1999 and 1998 (dollars in thousands):
1999 1998 Delinquency Delinquency Percentage Percentage Balance % 90+ days Balance % 90+ days Radio $ - - % - % $112,940 78.0% 0.0% Television 5,893 100.0 0.0 31,872 22.0 0.0 Total $5,893 100.0% 0.0 $144,812 100.0% 0.0
Builder Finance Group. In January 1997, the Company established the builder finance group to provide construction financing to builders of first time and first move-up homes. To facilitate this effort, the Company hired an experienced lending and servicing team formerly associated with a Texas financial institution. Builder finance targets experienced homebuilders that are starting anywhere from 100 to 1,500 units per year in the $90,000 to $200,000 price range. Prospective borrowers must also have a minimum of three years proven experience in building and selling homes, satisfactory financial condition and acceptable credit history. Builder finance also provides a limited amount of acquisition and development lending for residential lots that are ready for home building which will serve as feeder stock for the construction loan program. Funding for these loans is provided by a warehouse debt facility.
Based in Houston, Texas with a state of the art loan servicing facility, the builder finance group currently has eight loan production offices in the United States. Producers are (and will be) located in markets that have large or growing populations of home buying age with qualifying incomes. These markets must also have a good balance of housing inventory as well as acceptable lot and home absorption patterns. General economic and employment conditions must be positive as well.
As of December 31, 1999 and 1998, loan balances outstanding were $218.9 million and $129.6 million on year-to-date advances of $325.0 million and $268.9 million, respectively.
Asset Management Business
General. The Company manages, owns and resolves portfolios of performing, underperforming and nonperforming loans ("asset portfolios") and provides special servicing for nonperforming or underperforming loans in commercial mortgage-backed bond trusts and similar securitized commercial asset-backed loan portfolios. As previously discussed under "Recent Developments - Sale of Assets to Lend Lease (US) Services, Inc." the Company has sold to Lend Lease the Company's asset management operations, other than its operations in Europe, asset portfolios and mortgage backed securities. Lend Lease will manage these assets for the Company. The Company has sold its asset management operations in Europe. See "Business - Recent Developments - Sale of Asset Management Operations in the United Kingdom."
Asset Portfolio Management. The Company manages and resolves asset portfolios which have been acquired at a discount to Face Value by the Company alone and by the Company with co-investors. During the latter part of 1999, the Company ceased acquiring for its own account asset portfolios or interests therein. The Company also manages and resolves asset portfolios owned by third parties.
Management of asset portfolios includes managing and resolving loans and providing routine accounting servicing functions. Asset portfolios generally include secured loans of varying qualities and collateral types. The majority of the loans in which the Company has invested were in payment default at the time of acquisition. Asset portfolios purchased by the Company are comprised of secured loans and real estate loans, the resolution of which may be based either on cash flow of a business or on real estate and other collateral securing the loan. The Company has not invested in loans with known environmental liabilities, unless the environmental risks can be quantified and discounted appropriately.
The Company obtains information on available asset portfolios from many sources, including banks, insurance companies and other lenders. Repeat business and referrals from asset portfolio sellers with whom the Company previously has transacted business are an important and frequent source of business. The Company believes that it receives many asset portfolio solicitations that result primarily from the Company's reputation as an active portfolio purchaser. Other important sources of business include referrals from co-investors who seek the Company's participation in asset portfolio purchases, contacts initiated by senior management, public advertising of asset portfolios for sale and the Company's nationwide presence.
The Company believes that opportunities for the acquisition, management and resolution of asset portfolios are becoming increasingly evident in certain international markets and that lenders in these markets are adopting many of the asset portfolio management and resolution outsourcing techniques currently utilized in the United States. Accordingly, the Company opened offices in Toronto (August 1994), employing seven persons, and London (October 1995), employing 13 persons, each at December 31, 1999, in order to take advantage of both investment and servicing opportunities in Canada, the United Kingdom and certain other Western European nations. During 1998 and 1999, the Company began providing asset management services in Mexico, Japan, South Korea and Thailand employing 55 persons in Mexico, 19 persons in Japan, two persons in South Korea and 13 persons in Thailand, each at December 31, 1999. The Company believes that the international markets are less competitive and, as a result, provide more attractive investments and greater profit margins. The Company had $55.4 million (Face Value) in Canadian asset portfolios, $392.9 million (Face Value) in United Kingdom asset portfolios and $199.5 million (Face Value) in Mexican asset portfolios and $1.2 billion (Face Value) in Asian asset portfolios under management as of December 31, 1999.
The Company has gained its market share in the asset portfolio acquisition, management and resolution business through its experience in managing and resolving asset portfolios and its national reputation and strategic relationships with sellers and purchasers of asset portfolios, including financial institutions, large corporate buyers, investment banking firms and sophisticated private investors.
Asset Portfolio Investment. Prior to making an offer to purchase an asset portfolio, whether for its own account or for the account of third parties, the Company conducts an extensive investigation and evaluation of the individual loans generally comprising 100% of the aggregate Face Value of all the loans therein, except in rare instances where an unusually large number of smaller assets are being purchased. This examination typically consists of analyzing the information made available by the seller (generally, the respective credit and collateral files for the loans), reviewing other relevant material that may be available (including tax and judgment records), and analyzing the underlying collateral (including conducting site inspections, obtaining value opinions from third parties and consulting with any of the Company's asset managers who have experience with the local market for such assets). The Company also reviews information on the local economy and real estate markets in the area in which the loan collateral is located. Because of its broad, nationwide experience in managing assets, the Company has been able to draw on its asset management experience in the specific market in which an asset is located. Unlike the original lender, the Company values loans based on the present value of estimated total cash flow from resolution, with the expectation that the loans will be resolved prior to scheduled maturity. Generally, the Company does not refinance or renew purchased loans or grant new credit.
Asset portfolio evaluations are conducted almost exclusively by the Company's employees who specialize in analysis of nonperforming and underperforming loans, often with further specialization based on geographic or collateral-specific factors. Most of these employees have previously served the Company (and some continue to serve) as asset managers with responsibility for resolving such loans. Their asset management experience aids these individuals, working together in teams, in making informed judgments about the status of each loan and the underlying collateral, the probable cash flows from the loan, the likely resolution of the loan and the time and expense required for resolution.
Loan resolutions are typically accomplished through (i) negotiating a discounted payoff with debtors, which may be accomplished through a refinancing by the obligor with a lender other than the Company, or (ii) foreclosure and sale of the collateral. The Company generally seeks consensual resolution of each loan, having found that a negotiated resolution usually maximizes the Company's or investor's rate of return. Historically, the Company has resolved the majority of the assets in an asset portfolio within 18 months of acquisition. The goal of the Company's loan resolution process is to maximize the cash recovery in a timely manner on each loan in an asset portfolio.
The Company's investment in asset portfolios is comprised of collateralized business loans and real estate collateralized loans. At December 31, 1999, the Face Value of the Company's wholly-owned asset portfolios aggregated approximately $852.5 million, which was composed of approximately $604.3 million (70.9%) of collateralized business loans, approximately $59.0 million (6.9%) of asset-backed securities and approximately $189.2 million (22.2%) of real estate.
For the years ended December 31, 1999, 1998 and 1997, $106.8 million (24.8%), $111.9 million (23.7%) and $90.5 million (28.2%), respectively, of the Company's revenues were attributable to its asset management business. The following table reflects the ownership composition of the asset portfolios (based on their face value) under management by the Company as of December 31, 1999, 1998 and 1997. Certain reclassifications of prior period amounts have been made to conform to the current year presentation (dollars in millions).
The following table reflects the book value of the Company's investment in asset portfolios as of December 31, 1999, 1998 and 1997:
1999 1998 1997 (dollars in millions) Wholly-owned by the Company $384.0 $573.0 $494.9 Owned by the Company with co-investors 50.2 17.1 22.8 Total $434.2 $590.1 $517.7
Special Servicing. As part of its third-party asset management and resolution business, the Company aggressively pursues contracts to serve as the designated special servicer for pools of securitized commercial mortgages. The competitive bidding process generally requires that the Company agree to purchase an interest (a "servicing strip") in the securitized portfolio in order to secure the servicing contract. In the latter part of 1999, the Company ceased the purchase of servicing strips, thereby substantially decreasing the ability of the Company to be a special servicer for additional pools of securitized commercial mortgages. After a loan within a securitized pool of performing loans becomes delinquent or nonperforming, the master servicer or primary servicer of the pool will contractually transfer responsibility for resolution of that loan to the pool's designated special servicer. Special servicers earn an annual fee (typically approximately 50 basis points of the Face Value of the delinquent or nonperforming loans subject to special servicing), plus a 50 to 200 basis points resolution fee based on the total cash flow from resolution of each such loan as it is received. As of December 31, 1999, the Company was the designated special servicer for securitized pools holding approximately $17.4 billion (Face Value) of loans, $491.1 million (Face Value) of which had been assigned to the Company for resolution in its capacity as special servicer.
Commercial Mortgage Banking Business
General. The Company performed a wide range of commercial mortgage banking services, including originating, underwriting, placing, selling and servicing commercial real estate loans through Holliday Fenoglio Fowler, AMRESCO Capital and AMRESCO Services. As previously discussed under "Recent Developments - Sale of Assets to Lend Lease (US) Services, Inc.", the Company sold to Lend Lease all of the assets and operating platforms of its commercial mortgage banking businesses.
Real Estate Capital Markets. The Company provides a wide range of real estate capital markets services to lenders on, and owners and developers of, commercial real estate properties. The typical consumers of commercial real estate mortgage banking services are both real estate developers and owners (as borrowers) and investor/lenders (as funding sources). Due to the specialized nature of commercial mortgage lending, borrowers rely on commercial mortgage bankers to find competitive lenders, and these lenders (particularly insurance companies and pension plans, which do not generally have origination staffs located in multiple branches) rely on commercial mortgage bankers to source potential borrowers. Lenders generally include banks, pension funds and insurance companies. In arranging loans, the Company works closely with both the borrower and potential lenders from the time a loan prospect is first contacted, through the application and proposal process and throughout the documentation of the loan to final funding.
Holliday Fenoglio Fowler was one of the largest commercial mortgage bankers in the United States in 1999 (based on origination volume) and primarily serves commercial real estate developers and owners by arranging commercial real estate loans and providing brokerage and other real estate capital markets services for commercial real estate transactions. Holliday Fenoglio Fowler arranged approximately $10.8 billion, $7.3 billion and $4.7 billion of commercial real estate loans during 1999, 1998 and 1997, respectively. Holliday Fenoglio Fowler principally targets developers and owners of commercial and multifamily real estate properties. Holliday Fenoglio Fowler serves prospective borrowers through its own commission-based mortgage bankers in 19 nationwide offices. The loans arranged by Holliday Fenoglio Fowler generally are funded by institutional lenders, primarily insurance companies, and by Conduit Purchasers. The Company estimates that Holliday Fenoglio Fowler has retained the servicing rights on approximately 20% of such loans over the last three years. The Company believes that Holliday Fenoglio Fowler's relationship and credibility with its institutional lender network provide the Company a competitive advantage in the commercial mortgage banking industry.
The Company provided brokerage and other real estate capital markets services on commercial real estate sales and other real estate transactions, including joint ventures and participating mortgages of approximately $13.2 billion, $9.8 billion and $6.1 billion during 1999, 1998 and 1997, respectively. For the years ended December 31, 1999, 1998 and 1997, Holliday Fenoglio Fowler earned gross fees of $71.4 million, $69.8 million and $44.0 million, respectively, for brokerage services.
Holliday Fenoglio Fowler generally earns a fee of between 35 and 100 basis points of the loan amount for originated or underwritten loans, plus certain additional processing fees. From time to time, Holliday Fenoglio Fowler also originates nontraditional financing involving hybrid forms of debt, equity participation's and other creative financing structures. Fees for equity or joint venture structures are typically higher.
Holliday Fenoglio Fowler has established relationships with over 290 institutional lenders that include insurance companies, pension plans and Conduit Purchasers. In 1999, 1998 and 1997, Holliday Fenoglio Fowler placed 862, 1,109 and 709 loans with approximately 174, 198 and 128 different lenders, respectively. Twenty-five institutional lenders have retained Holliday Fenoglio Fowler as their exclusive or semi-exclusive loan originator in selected cities and regions.
Commercial Real Estate Lending. AMRESCO Capital is a commercial real estate lender, which has originated, underwritten and closed long term fixed rate commercial mortgages for sale to various investors. During 1999, 1998 and 1997, AMRESCO Capital closed approximately $1.2 billion, $2.4 billion and $1.7 billion, respectively, of commercial real estate mortgages. AMRESCO Capital serves its market directly through seven offices located in seven states as well as through a network of independent mortgage brokers located throughout the United States. These independent mortgage brokers serve AMRESCO Capital on a nonexclusive basis and receive fees and commissions based on transaction size, type and complexity. For years ended December 31, 1999 and 1998, approximately 53% and 45% of the loans, respectively, underwritten by AMRESCO Capital were originated by Holliday Fenoglio Fowler.
During the fourth quarter of 1998, AMRESCO Capital suffered significant losses related to its commercial mortgage conduit operation. As a result, AMRESCO Capital made the strategic decision to exit the commercial mortgage conduit business. AMRESCO Capital's business is now focused on commercial mortgage lending through agency programs, such as the Fannie Mae DUS and Freddie Mac Program Plus programs and a private securitization program.
AMRESCO Capital is approved by Fannie Mae to participate in its DUS program. An approved DUS lender is delegated the authority to approve, commit and close loans for multifamily mortgages on a national basis with the assurance that Fannie Mae will purchase the loans with the lender retaining the servicing. In return for the delegated authority to make loans and the subsequent purchase of such loans by Fannie Mae, DUS lenders must maintain a minimum capital base, and retain a certain level of credit risk on the loans they make. The DUS lender takes first loss risk up to 5% of the loan amount, and above 5% of the loan amount Fannie Mae and the DUS lender share the loss, with the DUS lender's maximum loss capped at 20% of the loan amount. As of December 31, 1999, AMRESCO Capital, as a DUS lender, had experienced no losses on its portfolio of sold DUS loans, but had a reserve of $10.8 million as of December 31, 1999 included in other liabilities. AMRESCO Capital is one of only 27 currently approved DUS lenders. While all DUS lenders operate on a national basis, the Company believes that ten such lenders (including AMRESCO Capital) account for the majority of DUS volume.
AMRESCO Capital is also a member of the Freddie Mac Program Plusr multifamily seller/servicer program. Through this program, the Company is authorized to originate multi-family mortgages for Freddie Mac in 17 states and the District of Columbia.
The Company believes that AMRESCO Capital, as an authorized Fannie Mae DUS and Freddie Mac Program Plusr lender, has certain competitive advantages in the multifamily mortgage origination business. These advantages include the competitive pricing afforded by Fannie Mae's and Freddie Mac's positions as the largest purchasers of housing related mortgages in the nation and AMRESCO Capital's affiliation with Holliday Fenoglio Fowler, one of the largest mortgage banking company's in the nation. For these reasons, the Company expects Fannie Mae and Freddie Mac loan originations to become a larger portion of its commercial mortgage banking activities. Holliday Fenoglio Fowler has been and is expected to be a significant source of such loan originations.
During February 1999, AMRESCO Capital entered into strategic alliances with two entities in which commercial mortgage loans originated for a fee by AMRESCO Capital would be funded or purchased by such entities. These arrangements were mutually terminated in December, 1999. AMRESCO Capital also originates commercial mortgages for a private securitization program under which the investor purchases all of the resulting commercial mortgage-backed securities. This program does not expose the Company to capital markets or credit risk. For the years ended December 31, 1999, 1998 and 1997, approximately $485 million, $450 million and $220 million, respectively, of commercial mortgage loans were funded under this program.
Commercial Loan Servicing. AMRESCO Services is a servicer for securitized pools of commercial mortgages and whole loans. The average life of these securitized pools is expected to be approximately eight years. At December 31, 1999, 1998 and 1997, AMRESCO Services acted as servicer with respect to approximately $33.6 billion, $31.0 billion and $25.9 billion of loans, respectively. The dominant users of commercial loan servicers are commercial mortgage- backed bond trusts and other owners of commercial real estate loans, including lenders accumulating loans for securitization or sale that contract for servicing on an interim basis. Historically, the revenue stream from servicing contracts on commercial mortgages has been relatively predictable as prepayment penalties in commercial mortgages tend to discourage early loan payoffs.
Primary servicing of whole loans involves collecting monthly mortgage payments, maintaining escrow accounts for the payment of ad valorem taxes and insurance premiums on behalf of borrowers, remitting payments of principal and interest promptly to investors in the underlying mortgages, reporting to those investors on financial transactions related to such mortgages and generally administering the loans. The servicer of whole loans also must cause properties to be inspected periodically, determine the adequacy of insurance coverage on each property and monitor delinquent accounts for payment. Servicer rates are determined by a bidding and negotiating process. AMRESCO Services is approved as a primary servicer by all four rating agencies.
Master servicing involves providing administrative and reporting services to securitized pools of mortgage-backed securities. Typically, mortgages underlying mortgage-backed securities are serviced by a number of primary servicers. In fact, AMRESCO Services is a primary servicer for many of the loans for which it is also a master servicer. Under most master servicing arrangements, the primary servicers retain principal responsibility for administering the mortgage loans and the master servicer acts as an intermediary in overseeing the work of the primary servicers, monitoring their compliance with the issuer's standards and consolidating their respective periodic accounting reports for transmission to the securitization trustee in respect of the related securities. The Company frequently is designated as the full servicer for a pool of mortgages, in which case the Company acts as master, primary, and, in some cases, special servicer for the pool. Master/full servicers are typically paid fees based on the Face Value of loans under management, and the compensation is determined by a bidding and negotiating process. AMRESCO Services is approved as a master servicer by all four rating agencies.
Residential Mortgage Banking
General. Through its August 11, 1998 acquisition of MIC, the Company acquired the business of refinancing and selling Veteran's Administration ("VA") residential mortgage loans under the VA's interest rate reduction refinance loan ("IRRRL") program. During 1999, MIC began refinancing Federal Home Loan ("FHA") mortgages as well. All loans refinanced under the IRRRL program are guaranteed or insured, usually within 61 days of funding. MIC's loan refinancings aggregated $1.8 billion during 1999 compared to $1.6 billion from August 11, 1998 through December 31, 1999. Loan Product. Typically, the refinanced loans have a well- seasoned pay history and are refinanced at below market interest rates. Management believes that these loans are attractive to investors and servicers because of the historically low prepayment and default rates and the below market interest rates offered. Prepayment and default rates on these loans tend to be low due to the lower monthly payment as a result of the refinance and the underlying guarantee which limits exposure to losses.
Loan Sources. The Company obtains its refinanced loans through its own focused telemarketing database and related loan officers, of which the primary operating expense of MIC is commissions to the loan officers which vary with production. The loan officers are located throughout the United States. The telemarketing and loan processing functions are centralized in St. Petersburg, Florida, thus allowing the loan officers to focus solely on selling.
Sales of Loans and Servicing. Throughout 1999, MIC sold all loans on a servicing released basis. The Company typically enters into forward sale agreements in the 30-year fixed rate GNMA market for a portion of its production. The production is typically sold at a discount due to the below market interest rates on the refinanced loans. MIC sells the loans to the entity that will be the ultimate servicer of the loans and the servicer assumes the Company's obligation to deliver on the GNMA forward sale commitment. The servicer pools the loans and creates a 30-year fixed rate GNMA security, delivers on the forward sale commitment, and retains the servicing.
Home Equity Lending Business
General. Until the transfer of its assets and operations to Finance America, as described under "Recent Developments - Formation of Residential Finance Joint Venture with Lehman Brothers", the Company originated, acquired, warehoused, serviced and sold home equity loans. Home equity lending's loan production was $0.9 billion, $3.5 billion and $3.6 billion for the years ended December 31, 1999, 1998 and 1997, respectively. In late 1998, the Company suffered significant losses related to home equity loans accumulated and held for subsequent securitization. As a result, the Company discontinued its "bulk" purchase of home equity loans and origination of home equity loans through correspondent channels, which collectively accounted for approximately $2.4 billion and $2.7 billion of loan volumes for the years ended December 31, 1998 and 1997, respectively and ceased its securitization activities. During 1999, all loans originated by the Company were sold in "whole loan" sale transactions.
Borrower Profile and Underwriting. The Company targeted borrowers that had credit profiles that precluded their loans from being sold in the government agency secondary markets. Such credit profiles included consumer or mortgage loan delinquencies, high debt- to-income ratios, previous bankruptcy or inability to provide income documentation. Borrowers in the Company's targeted market typically had significant equity in their homes and were charged higher interest rates for loans than more creditworthy borrowers.
Loan Products. The home equity loans originated and acquired by the Company consisted of fixed and adjustable rate conventional, nonconforming mortgage loans with remaining terms to maturity of not more than 360 months and secured by deeds of trust, security deeds or mortgages. The properties securing the home equity loans consisted primarily of single family residences (which may be attached, detached, part of a two-to-four-family dwelling, a condominium unit or a unit in a planned unit development). The properties securing the home equity loans were owner occupied or non-owner occupied investment properties. The Company's home equity loan products included fixed rate loans that bear a fixed rate of interest for the life of the loan, adjustable rate loans that bear interest at rates that adjust, along with related monthly payments, periodically (generally semiannually) based on a specified financial index or quoted rate and loans that bear a fixed rate of interest for a specified period following origination (generally two, three or five years) with periodic rate adjustments thereafter based on a specified financial index or quoted rate. In a majority of cases, the home equity loans can be prepaid by the mortgagor in whole or in part at any time, although the mortgagor may be required to pay a fee in connection with certain prepayments.
Loan Sources. During the period between restructuring its operations in October 1998 and transferring its operations to Finance America, the Company obtained home equity loans through its wholesale broker operations and through various retail channels, including telemarketing, direct mail and retail branches. Wholesale operations involved the origination of loans through the Company's network of branch offices. Retail operations involved consumer direct mail, a retail sales center and retail branch operations. In its retail operations the Company worked directly with consumers to originate, underwrite and close mortgage loans (see "Item 1. Business Activities- Recent Developments).
Portfolio Performance. The following table provides information with respect to prepayments, delinquencies and net losses, prior to any potential recoveries for each of the Company's home equity securitizations as of December 31, 1999:
(1) The Constant Prepayment Rate ("CPR") represents the rate of prepayment experienced by the referenced securitized pool of mortgage loans, expressed as an annual rate, relative to the outstanding principal balance over the life of mortgage loans. CPR is equal to Pure Prepayment ("PPR") (5) + Liquidation Proceeds + Realized Losses + Buyouts + Scheduled Principal Payments.
(2) The period of delinquency is based on the number of days payments are contractually past due. The delinquency statistics for the 90+ days data includes loans in foreclosure.
(3) Net losses represents the aggregate amount, expressed as a percentage of the original balance, which has been determined to be uncollectible relating to mortgage loans, less recoveries from liquidation proceeds and deficiency judgments.
(4) Based on the balance outstanding at December 31, 1999.
(5) "PPR" is equal to voluntary borrower payoffs plus curtailments.
Home Equity Loan Servicing. From October 1996 through December 1999, the Company performed delinquency management and related servicing functions for the asset portfolios acquired and for loans originated by the Company after October 1, 1997 or acquired by it on a servicing released basis. At year end 1999, the Company transferred to unaffiliated third parties all of its loan servicing operations.
Competition
General. The Company's competition varies by business line and geographic market. Generally, competition within each of the business lines in which the Company competes is fragmented, with national, local and regional competitors, none of which dominates a particular business line. Certain of the Company's competitors within each of its business lines are larger and have greater financial resources than the Company.
Asset Management. The Asset Management business is a nationwide (and increasingly international) business with numerous financially strong and experienced competitors. The Company continues to encounter increased competition in the market for asset portfolios which could cause the Company to experience decreasing profit margins in this business line in order to remain a competitive bidder for asset portfolios. In addition, declining profit margins presented by current bidding opportunities has caused the Company to re-deploy its capital in more profitable product lines.
Commercial Mortgage Banking. The Company's commercial mortgage banking business consists of real estate capital markets, commercial real estate lending and commercial loan servicing business lines. In each of these business lines, the Company competes on a nationwide basis. The real estate capital markets and commercial real estate lending businesses are fragmented, composed primarily of small local or regional firms. The Company believes that the commercial mortgage banking industry is moving toward greater consolidation and that well capitalized, full service, nationwide mortgage banking firms will emerge from this consolidation.
The commercial loan servicing business is highly competitive. Distinct markets have developed for the servicing of performing loan pools, under-performing loan pools and non-performing loan pools. The Company has focused its commercial loan servicing business on the market for performing loan pools, the servicing market that management believes has the greatest potential for growth.
Home Equity Lending. The Company has encountered increased competition in the market for conventional, nonconforming home equity loans as more originators enter this market which could impact origination volume and profit margins. In addition, certain of the Company's larger, national competitors have access to greater financial resources and lower costs of capital.
Commercial Finance. The markets in which the Commercial Finance business operates are highly competitive and are characterized by competitive factors that vary based upon product and geographic region. The Commercial Finance Group's competitors include captive and independent diversified finance companies, specialty finance companies (including specialty franchise finance companies), commercial banks, thrift institutions, asset-based lenders, real estate investment trusts and leasing companies. Many of the competitors of the Commercial Finance Group are large companies that have substantial capital, technological and marketing resources, and some of these companies may have lower costs of capital than is available to the Commercial Finance business.
Residential Mortgage Banking. The market in which the Residential Mortgage Banking business operates is characterized by few originators of streamlined FHA and VA refinanced loans. The Company believes that it is an effective competitor in this market.
Employees
At December 31, 1999, the Company and its subsidiaries employed 2,572 persons. Of that total, 160 were employed in the asset management group, 712 in the commercial mortgage banking group, 381 persons in the home equity lending group, 261 in the commercial finance group, 847 in the residential mortgage banking group and 211 in general corporate administration. The Company believes that its employee relations are generally good. The Company has no collective bargaining arrangements.
Certain Definitions
The following are certain defined terms used herein:
"ACLC" means AMRESCO Commercial Lending Corporation, a subsidiary of the Company.
"AMRESCO Capital" means AMRESCO Capital L.P., a limited partnership.
"AMRESCO Funding" means AMRESCO Funding Corporation, a subsidiary of the Company.
"AMRESCO Services" means AMRESCO Services L.P., a limited partnership.
"Company" means, unless otherwise stated herein or unless the context otherwise requires, the Company and each of its subsidiaries.
"Conduit Purchasers" means investment bankers and other financial intermediaries who purchase or otherwise accumulate pools or portfolios of loans having common features (e.g., real estate mortgages, etc.), with the intent of securitizing such loan assets and selling them to a trust that secures its funds by selling ownership interests in the trust to public or private investors.
"DUS" means the Delegated Underwriting and Servicing program established by Fannie Mae that permits a DUS approved lender to commit and close loans for multifamily mortgages for resale to Fannie Mae without Fannie Mae's prior approval of such loans.
"Face Value" means, with respect to any loan or asset portfolio, the aggregate unpaid principal balance of a loan or loans.
"Fannie Mae" means the Federal National Mortgage Association.
"Freddie Mac" means the Federal Home Loan Mortgage Corporation.
"Holliday Fenoglio Fowler" means Holliday Fenoglio Fowler, L.P., a limited partnership.
"MIC" means Mortgage Investors Corporation, a subsidiary of the Company.
"securitization" and "securitized" mean a transaction in which loans originated or purchased by an entity are sold to special purpose entities organized for the purpose of issuing asset-backed securities.
Item 2.
Item 2. Properties
The Company leases approximately 200,000 square feet in the North Tower of the Plaza of the Americas in Dallas, Texas for its centralized corporate functions including executive, business development and marketing, accounting, legal, human resources and support and also certain line of business operations. This lease has an initial termination date of October 31, 2001 and has an annual base rent of approximately $2.6 million during 1999. The Company also leases space for branch offices pursuant to leases with varying terms. Effective March 17, 2000, in conjunction with the sale to Lend Lease of the commercial mortgage banking business and the asset management and real estate structured finance platforms, Lend Lease assumed approximately 50% of the leased space in the North Tower of the Plaza of the Americas in Dallas. The Company retained the balance of the space. The lease has the same terms as before with an annual base rent of approximately $1.6 million. Also in conjunction with the sale to Lend Lease, a substantial number of branch office leases were assigned or assumed by Lend Lease.
The Company believes that its facilities are adequate for its immediate needs or substitute space is available, if needed.
Item 3.
Item 3. Legal Proceedings
The Company is involved from time to time in various legal proceedings arising in the ordinary course of business. In connection with the Company's loan servicing, asset management and resolution activities, the Company is indemnified to varying degrees by the party on whose behalf the Company is acting. The Company also maintains insurance that management believes is adequate for the Company's operations. None of the legal proceedings in which the Company is currently involved, either individually or in the aggregate (and after consideration of available indemnities and insurance), is expected to have a material adverse effect on the Company's business or financial condition.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's security holders during the fiscal quarter ended December 31, 1999.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
The Company's common stock (Symbol: AMMB) is listed on the Nasdaq Stock Market. At March 22, 2000, there were approximately 2,600 stockholders of record of the Company's common stock. Presented below are the high and low last sale prices per share for 1999 and 1998, as reported by NASDAQ. The Company discontinued declaring dividends beginning with the fourth quarter of 1995 and the Company does not expect to declare dividends on its common stock in the foreseeable future.
High Low First Quarter $33.7500 $23.2500 Second Quarter 38.7500 29.1250 Third Quarter 30.1250 7.2500 Fourth Quarter 8.9375 2.0313 First Quarter $12.1325 $7.6875 Second Quarter 7.9375 4.0625 Third Quarter 7.8750 3.0000 Fourth Quarter 3.1875 1.4062
Item 6.
Item 6. Selected Financial Data
The selected financial data set forth below for the five years ended December 31, 1999 has been derived from the Company's audited consolidated financial statements. This information should be read in conjunction with "Item 1. Business" and "Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The Company began the year as a diversified financial services company with five principal lines of business: commercial finance, asset management, residential mortgage banking, home equity lending, and commercial mortgage banking. In its commercial finance business, the Company focuses on (i) loans to franchisees of nationally recognized restaurant, hospitality and service organizations, (ii) loans to small business owners, (iii) real estate structured finance, (iv) communications finance and (v) single family residential construction lending. The asset management business involves acquiring asset portfolios at a discount to Face Value and managing and resolving such asset portfolios to maximize cash recoveries. In addition, in its asset management business, the Company provides special servicing for non-performing and under-performing loans in commercial mortgage-backed bond trusts and similar securitized commercial asset-backed loan portfolios. The residential mortgage banking business originates and sells streamlined refinanced Federal Housing Administration ("FHA") and, to a lesser extent, Veterans Administration ("VA") loans. The home equity lending business involves originating, selling and servicing nonconforming first mortgage loans. The commercial mortgage banking business, which was discontinued during the year, involved fee-based origination and servicing of commercial real estate mortgages and commercial real estate brokerage
During the latter part of 1998, the capital markets experienced rapid and extreme changes evidenced by a decline of investor demand for corporate fixed income investments, including mortgage-backed securities ("MBS"), and a widening of spreads between interest rates on treasury securities and interest rates on MBS. This trend continued throughout 1999 and the market for MBS remained depressed. The Company also experienced a lack of available capital for new investments. Capital constraints particularly impacted the Company's ability to make new investments in asset management, real estate structured finance, communications lending and commercial mortgage servicing. These areas are highly dependent on capital in order to grow. Facing a lack of capital, the Company decided in 1999 to exit its capital intensive businesses and sought partners or buyers for these businesses.
During the year, the Company also entered into an agreement to transfer its interest in its home equity lending subsidiary to a joint venture with Lehman Brothers. During the first quarter 2000, the Company transferred its home equity business to Finance America, a joint venture partnership with Lehman Brothers and retained a 36% interest. At year-end 1999, the Company's investment in the joint venture was $6.2 million.
In the fourth quarter of 1999, the Company recorded a $103.3 million non-cash impairment charge on MIC, a $9.6 million mark to market on real estate structured finance assets transferred from loans held to maturity to loans held for sale, and a $56.4 million non-cash loss on retained interests in securitizations related to its home equity retained interests in securitizations.
In November 1999, the Company sold nine of the Company's ten communication loans with a book value of $132.0 million for $131.8 million, exiting from that capital intensive activity. The proceeds of the sale were used to pay down bank debt.
In December, the Company announced that it had signed a definitive agreement with Lend Lease (US) Services, Inc. to sell the commercial mortgage banking, asset management and real estate structured lending platforms. In anticipation of the pending sale and management's decision to exit this business, the commercial mortgage banking line of business is deemed a discontinued operation and is recorded as such in the financial statements. On March 17, 2000, the Company completed the sale of the commercial mortgage banking business and asset management and real estate structured finance platforms for cash of $202.7 million and a $25.0 million promissory note. Additional payments of up to $21.0 million are payable upon receipt of certain consents. The cash proceeds of the sale were used to reduce bank debt.
On January 18, 2000, the Company sold $182.4 million of its real estate structured finance portfolio for $170.2 million and recognized a loss in the accompanying 1999 financial statements in the line item, gain on sale of loans and investments, net. Proceeds from the sale were used to reduce bank debt.
During January 2000, the Company obtained an option to return Mortgage Investors Corporation ("MIC"), its residential mortgage banking subsidiary and pay cash of $25.0 million to the former owners of MIC and forgive $17.0 million of notes receivable from such owners in exchange for cancellation of an $86.1 million stock obligation currently owed to the former owners. The option can be extended to April 30, 2000. The Company expects to exercise its option with regard to MIC if sufficient cash is available to do so. This business will be treated as a discontinued operation beginning in 2000 if the option is exercised.
In March 2000, the Company and the former shareholders of Commercial Finance Corporation ("CLC") agreed to amend the Asset Purchase Agreement pursuant to which the Company acquired CLC. This amendment provides that the amount of the final earn-out payment due on June 30, 2000 is fixed at $37.5 million and that, if the credit facility with the Bank of America, N.A., as Administrative Agent, is paid in full, the Company must issue to such shareholders promissory notes in the aggregate principal amount of $37.5 million in exchange for shares of the Company's common stock having a value of $37.5 million. Such notes would bear interest at the rate of 8% per annum, would be secured by certain retained interests from previous securitizations of CLC and would provide for principal payments of $12.5 million on each of June 30, September 30 and December 29, 2000. The notes could be prepaid at any time without penalty. In the event that the Company is unable to issue such notes, the June 30, 2000 earn-out payment will be payable in the Company's common stock having a value of $37.5 million based upon the average of the closing price of such common stock for the 20 trading days prior to May 31, 2000.
On March 22, 2000, the Company sold its United Kingdom asset management assets and operations for $160.0 million. The Company received cash proceeds of $47.0 million and a note receivable for $25.0 million. Cash proceeds of the sale were used to reduce non- recourse and bank debt.
The Company is continuing to evaluate opportunities to further de- leverage its balance sheet. Sales of additional assets and/or businesses or the entire Company may be considered.
Continuing Operations Overview
Following the sale of the commercial mortgage banking line of business to Lend Lease, the expected exercise of its option regarding MIC and the sale of the United Kingdom asset management assets and operations, the Company's operations are now centered around the commercial finance line of business which includes small business lending, franchise lending, loans to residential home builders and equipment lending. The commercial finance line of business earned $66.7 million in operating profit in 1999 and grew revenues by $54.2 million over 1998, an increase of 44.4%.
Revenues from the Company's commercial finance business are primarily earned from (i) interest and fees on real estate structured and communications lending activities, loans to franchisees of nationally recognized restaurant, hospitality, service organizations and other small business owners and loans to single family residential contractors, (ii) accrued earnings on retained interests in securitizations and (iii) gains on the securitization and sale of loans. Revenues from the Company's asset management activities primarily consist of earnings on asset portfolios, fees charged for the management of asset portfolios and for the successful resolution of the assets within such asset portfolios and gains on sale of investments. Revenues from the Company's residential mortgage banking activities consist primarily of cash gains from sales of FHA and VA streamlined re-financed loans. Revenues from the Company's home equity lending activities primarily consist of interest earned on originated and purchased home equity loans, accrued earnings on retained interests in securitizations, gains on the securitization and sale of home equity loans and other related securities and fees generated by the origination, underwriting and servicing of home equity loans.
Retained interests in securitizations are classified as trading and are carried at estimated fair value. Changes in such market value are included in earnings. Cash flows for retained interests in securitizations are generally subordinated to other security holders in a securitization trust. The retained interests in securitizations are valued at the discounted present value of the cash flows based upon the expected timing of the release of the cash by the securitization trust ("cash-out method") over the anticipated life of the assets sold after estimated future credit losses, estimated prepayments and normal servicing and other related fees. The discounted present value of such retained interests is computed using management's assumptions of market discount rates, prepayment rates, default rates, credit losses and other costs. The carrying value of the retained interests in securitizations is determined by the Company on a disaggregated basis and considers historical prepayment and loss experience, economic conditions and trends, collateral values and other relevant factors. The actual weighted average annual prepayment rate on the Company's retained interests in securitizations from inception to December 31, 1999 was 31.3%. For additional information regarding the Company's retained interests in securitizations see "Item 1. Business" and Notes 1 and 6 to the Notes to Consolidated Financial Statements included in "Item 8. Financial Statements and Supplementary Data."
Results of Operations
The following discussion and analysis presents the significant changes in financial condition and results of operations of the Company by primary business line for the years ended December 31, 1999, 1998 and 1997. The results of operations of acquired businesses are included in the consolidated financial statements from the date of acquisition. This discussion should be read in conjunction with "Item 1. Business" and "Item 8. Financial Statements and Supplementary Data" (in thousands, except per share data).
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
The Company reported (i) revenues of $429.9 million, a decrease from $472.0 million, or 9%, from the year ended December 31, 1998, (ii) an operating loss from continuing operations of $291.1 million as compared to 1998 operating income from continuing operations of $2.5 million and (iii) a net loss of $220.8 million as compared to a 1998 net loss of $69.2 million. The losses were due primarily to home equity lending non-cash write-downs of retained interests on securitization, non-cash impairments on MIC and home equity retail operations, impairment of the Company's investment in AMRESCO Capital Trust, mark-to-market losses and operating losses resulting from a low volume of home equity originations and a residential mortgage banking operating loss in 1999 driven by lower VA and FHA refinance originations and pricing pressure on loan sales. Diluted weighted average common shares outstanding increased 12% primarily due to CLC earn-out payments and restricted stock grants.
Commercial Finance. Revenues for the year ended December 31, 1999 primarily consisted of $117.3 million of interest and other investment income and $62.4 million of gain on securitization and sale of loans and investments offset, in part, by a $9.6 million unrealized loss on the sale of certain real estate loans in January 2000. The $54.2 million increase in revenues from $122.0 million for the prior year period to $176.2 million for the year ended December 31, 1999 relates primarily to a $36.8 million increase in interest and other investment income generated by higher average balances of real estate structured finance, communication, small business and franchise loans held for sale held during 1999 and increased balances of retained interests. The net gain on sale increased $14.2 million due primarily to the securitization and sale of approximately $547.8 million of small business and franchise loans by business lending during 1999 as compared to $375.8 million of securitization and sales in 1998, offset, in part, by the previously mentioned $9.6 million unrealized loss on the sale of a substantial part of the real estate structured finance portfolio.
Operating expenses for the year ended December 31, 1999 primarily consisted of $62.3 million in interest expense, $29.9 million in personnel cost, $13.5 million in other general and administrative expenses, offset, in part, by reversing a $5.5 million of provision for loan losses. The $34.0 million increase in expenses from $75.5 million for the prior year to $109.5 million for the year ended December 31, 1999 was due primarily to an increase of $23.6 million in interest expense related to the financing for increased levels of investments and loans held for sale from 1998, $12.3 million in personnel expense related to expanded operations and $5.6 million in other general and administrative expenses primarily related to expanded operations, offset by the aforementioned reversal of $5.5 million of provision for loan losses.
Asset Management. Revenues for the year ended December 31, 1999 were $106.5 million and primarily consisted of $66.6 million in interest and other investment income, $19.8 million in asset management and resolution fees and $18.7 million of gains on sales of loans and investments. The $5.4 million decrease in revenues from $111.9 million for 1998 to $106.5 million for the year ended December 31, 1999 was primarily comprised of a $15.6 million decrease in interest and other investment income offset, in part, by a $6.5 million increase in gain on sale of loans and investments, and a $4.3 million increase in management and resolution fees. Interest and other investment income decreased due primarily to a decrease in aggregate investments for the Company's own account. Gain on sale of loans and investments increased due primarily to a decrease in impairment and hedging losses on Mortgage Backed Securities (MBS) in 1999 as compared to the prior period.
Operating expenses for the year ended December 31, 1999 primarily consisted of $30.0 million in interest expense, $16.8 million in other general and administrative expenses and $20.0 million in personnel expenses. The $5.0 million increase in expenses from $65.3 for the prior year to $70.3 million for the year ended December 31, 1999 was due primarily to a $6.0 million increase in personnel costs, a $1.7 million increase in other general and administrative costs, and a $1.5 million impairment on the Company's investment on AMRESCO Capital Trust offset, in part, by a $3.2 million decrease in interest expense related to the financing of decreased levels of investments.
Residential Mortgage Banking. Revenues for the year ended December 31, 1999 primarily consisted of $63.9 million in gain on sale of loans and investments and $2.7 million in interest and other investment income. The $8.1 million decrease in revenues to $66.6 million for the year ended December 31, 1999 from $74.7 the period from inception (August 11, 1998) to December 31, 1998, primarily consisted of a $8.2 million decrease in gain on sale resulting from decreased originations as a result of higher interest rates and the Company re-focusing its primary operation from re-financing Veteran's Administration ("VA") loans to re-financing Federal Housing Administration ("FHA") loans.
Operating expenses of $193.9 million primarily consisted of a $103.3 impairment charge, $52.1 million in personnel expense (primarily commissions), $21.0 million in other general and administrative expense and $14.3 million in depreciation and amortization. The $152.1 million increase in operating expenses from $41.8 million in the prior period to $193.9 million for the year ended December 31, 1999 was primarily comprised of a $103.3 million impairment charge of the residential mortgage banking operations in 1999, a $21.6 million increase in personnel expense, and a $14.3 million increase in general and administrative expenses. The other increases are primarily the result of a full year of operating expenses in 1999 as compared to shorter period from inception to year end 1998.
Home Equity Lending. Revenues for the year ended December 31, 1999 primarily consisted of $56.9 million of interest and other investment income, a $18.0 million gain on sale of loans and other investments and $8.7 million in mortgage banking and servicing fees. The $76.0 million decrease in revenues to $85.2 million for the year ended December 31, 1999 from $161.2 million for the year ended December 31, 1998 primarily consisted of a $111.9 million decrease in interest and other investment income offset, in part, by an increase of $34.6 million in gain on sale of loans and investments.
Operating expenses for the year ended December 31, 1999 consisted of $146.4 non-cash loss on retained interests in securitization, $40.3 million in interest expense, $42.3 million in personnel expense, $43.5 million in other general and administrative expense, $9.3 million in depreciation and amortization, a $8.7 million non-cash impairment of assets related to closing the retail branches, and a $3.3 million in provision for loan and asset portfolio losses. Operating expenses increased by $57.9 million from $235.9 million for the prior year period to $293.8 million for the year ended December 31, 1999. The largest component of the increase is a $130.3 million increase in losses on retained interests in securitizations partly due to changes in prepayment and loss assumptions and other assumptions influenced by market conditions and mark-to-market charges, a reduction in origination volume, soft pricing for sub-prime product and underwriting issues. Operating expenses also increased $8.7 million impairment on assets, $6.1 million in other general and administrative expenses and $2.9 million in depreciation and amortization. The increases in operating expenses were offset by a $58.9 million decrease in interest expense related to lower average balances of warehouse debt supporting higher average balances of loans held for sale, a $18.5 million decrease in provision for loan and asset portfolio losses from the prior year and a $12.7 million decrease in personnel expenses due primarily to closing retail operations during the year and other staffing reductions in the wholesale and home office operations.
Corporate, Other and Intercompany Eliminations. Operating loss of $58.1 million for the year ended December 31, 1999 increased $9.2 million over the operating loss of $48.9 million for the prior year. The increased loss consisted of a decrease of $4.4 million in interest and other investments, a decrease of $2.2 million in revenues from the pension advisory business resulting from the sale of this business in 1998, $4.7 million in increased personnel costs and $3.4 million in increased interest expenses, offset, in part, by a decrease of $6.2 million in general and administrative costs as these expenses were allocated to the lines of business.
Income Taxes. As of December 31, 1999, the Company had a net federal income tax receivable due primarily to the 1999 net loss. In addition, as of December 31, 1999, the Company had a deferred tax asset for which the Company must have future taxable income to realize. Certain of these benefits begin to expire in 2002 and are subject to annual utilization limitations. Management believes that recorded net deferred tax assets will be realized in the normal course of business. The decrease in the 1999 effective tax rate to 22% from 152% in 1998 was due primarily to a minimum level of net income in 1998 which results in taxes at statutory rates being increased dramatically by non-deductible goodwill and state taxes.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
The Company reported revenues of $472.0 million, an increase from $320.8 million, or 47%, from the year ended December 31, 1997, operating income from continuing operations of $2.5 million as compared to 1997 operating income from continuing operations of $64.9 million, and a net loss of $69.2 million as compared to net income of $56.2 million in 1997. The decrease in operating income from continuing operations was due primarily to the sale of $1.4 billion of home equity lending loans held for sale, which occurred in response to unprecedented capital market conditions that caused spreads on MBS and related instruments to widen. The loss in discontinued operations was due to the $1.0 billion sale of commercial mortgage conduit loans and also due to unprecedented capital market conditions. Diluted weighted average common shares outstanding increased 17% due primarily to the early 1998 offering of 5.2 million of the Company's common shares and new shares issued in business acquisitions.
Commercial Finance. Revenues for the year ended December 31, 1998 primarily consisted of $80.5 million of interest and other investment income and $38.6 million of gain on securitization and sale of loans and investments. The $70.8 million increase in revenues from $51.2 million for the prior year period to $122.0 million for the year ended December 31, 1998 relates primarily to a $50.1 million increase in interest and other investment income generated by higher average balances of small business and franchise loans held for sale held during 1998 and increased balances of retained interests. Gain on sale increased $22.8 million due primarily to the securitization and sale of approximately $375.8 million of small business and franchise loans by business lending (formerly known as commercial lending corporation) during 1998 as compared to $265.4 million of securitization and sales in 1997.
Operating expenses for the year ended December 31, 1998 primarily consisted of $38.7 million in interest expense, $17.6 million in personnel cost, $7.9 million in other general and administrative expenses and $5.8 million of provision for loan losses. The $43.4 million increase in expenses from $32.1 million for the prior year to $75.5 million for the year ended December 31, 1998 was due primarily to an increase of $25.5 million in interest expense related to the financing for increased levels of investments and loans held for sale from 1997, $9.4 million in personnel expense related to expanded operations and $3.8 million in other general and administrative expenses primarily related to expanded operations.
Asset Management. Revenues for the year ended December 31, 1998 primarily consisted of $82.2 million in interest and other investment income, $15.5 million in asset management and resolution fees and $12.2 million of gains on sales of loans and investments. The $21.4 million increase in revenues from $90.5 million for 1997 to $111.9 million for the year ended December 31, 1998 was primarily comprised of a $28.3 million increase in interest and other investment income offset, in part, by a $5.7 million decrease in gain on sale of loans and investments. Interest and other investment income increased due primarily to a significant increase in aggregate investments for the Company's own account. Gain on sale of loans and investments decreased due primarily to impairment and hedging losses on MBS in 1998 as opposed to MBS sale gains in 1997.
Operating expenses for the year ended December 31, 1998 primarily consisted of $33.2 million in interest expense, $15.1 million in other general and administrative expenses and $14.0 million in personnel expenses. The $18.8 million increase in expenses from $46.5 million for the prior year to $65.3 million for the year ended December 31, 1998 was due primarily to a $13.8 million increase in interest expense related to the financing of increased levels of investments and a $6.8 million increase in other general and administrative expenses offset, in part, by a $2.4 million decrease in provision for loan loss expense resulting from fewer assets being managed.
Residential Mortgage Banking. The residential mortgage banking line of business is comprised of the operations of MIC, acquired on August 11, 1998. Revenues for the period from inception (August 11, 1998) through December 31, 1998 primarily consisted of $72.1 million of gain on sale of VA streamlined re-financed loans. Operating expenses of $41.8 million primarily consisted of $30.4 million in personnel expense (primarily commissions) and $6.7 million in other general and administrative expense.
Home Equity Lending. Revenues for the year ended December 31, 1998 were $161.2 million, a decrease of $5.2 million from the prior year period. Revenues for the year ended December 31, 1998 primarily consisted of $168.9 million in interest and other investment income and reflect a $78.7 million increase in interest income, generated by higher average balances of mortgage loans held for sale during 1998 offset, in part, by $16.6 million of net loss on sale of loans held for sale. The decrease in revenues and the $16.6 million net loss on sale is primarily attributable to a $101.6 million loss on sale of loans held for sale as described below.
In October 1998, due to the market turmoil caused by the widening of spreads in the MBS market and in response to the Company's rapidly changing liquidity needs, the Company decided to sell its portfolio of performing home equity loans aggregating approximately $1.4 billion. The Company also decided to negotiate the termination of a commitment to purchase approximately $260.0 million of home equity loans. As of December 31, 1998, a $19.4 million retained interest (of which $15.0 million was collected subsequent to December 31, 1998) was carried on the Company's balance sheet representing the Company's interest in a subsequent securitization or sale of the home equity loans sold and also represents the Company's remaining maximum exposure related to the home equity loan sale.
Operating expenses for the year ended December 31, 1998 primarily consisted of $99.2 million in interest expense, $55.0 million in personnel expense, $37.4 million in other general and administrative expense, $21.7 million in provisions for loan losses and $16.1 million loss on residuals. Operating expenses increased by $115.6 million from $120.2 million for the prior year period to $235.9 million for the year ended December 31, 1998. This increase primarily consisted of $45.3 million in interest expense related to higher average balances of warehouse debt supporting higher average balances of loans held for sale, $20.1 million in other general and administrative expenses due primarily to AMRESCO Residential Mortgage Corporation ("ARMC") expansion, $17.2 million in personnel expense, $16.1 million in mark-to-market reductions on retained interests in securitizations, and $14.1 million in provisions for investment and loan losses primarily related to delinquent loans.
Corporate, Other and Intercompany Eliminations. Operating loss for the year ended December 31, 1998 increased $4.7 million due primarily to a $8.8 million loss on sales of RMBS, a decrease of $5.6 million of asset management fees and an increase of $6.3 million in interest expense related to the $330.2 subordinated debt issuance early in 1998 offset, in part, by a $10.6 million decrease in personnel costs related primarily to reduced incentive compensation accruals due to 1998 losses and a $3.7 million increase in interest and other investments.
Income Taxes. As of December 31, 1998, the Company had a net federal income tax receivable due primarily from the 1998 net loss of which $34.8 million was received in January 1999 and $44.5 million was received in March 1999. The higher effective tax rate in 1998 was due primarily to the 1998 losses occurring in subsidiary entities which had less efficient tax structures compared to a 40% tax rate in 1997.
Liquidity and Funding
Liquidity is a measure of a company's ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund investment and lending activities and for general business purposes. Cash for investing, originating and underwriting loans, general operating expenses and business acquisitions is primarily obtained through cash flow from operations and credit facilities, including advances on the corporate and portfolio credit lines, mortgage warehouse lines, non-recourse debt and other financing sources.
The Company has significant ongoing liquidity needs to support its existing business and continued growth in commercial finance. The Company's liquidity is actively managed on a daily basis and the Company's financial status, including its liquidity, is reviewed periodically by the Board of Directors. This process is intended to ensure the maintenance of sufficient funds to meet the needs of the Company.
Cash and cash equivalents totaled $42.4 million and $50.3 million at December 31, 1999 and 1998, respectively. Cash flows from operating activities plus principal cash collections on loans, asset portfolios and asset-backed securities totaled $876.5 million for the year ended December 31, 1999 compared to $499.4 million for 1998. The increase in cash flows from these activities resulted primarily from collections on loans and asset portfolios. The following is a summary of certain cash flow data (dollars in thousands):
(1) Excludes indebtedness under warehouse lines of credit. (2) EBITDA is calculated as income from continuing operations before interest, income taxes, depreciation and amortization. The Company has included information concerning EBITDA because EBITDA is one measure of an issuer's historical ability to service its indebtedness. EBITDA should not be considered as an alternative to, or more meaningful than, net income as an indicator of the Company's operating performance or to cash flows as a measure of liquidity. (3) Interest coverage ratio means the rolling twelve month ratio of earnings before interest, taxes, depreciation and amortization to interest expense.
The following table shows the components of the Company's capital structure, including certain short-term debt, as of December 31, 1999 and 1998 (dollars in millions):
1999 1998 Amount % Amount % Shareholders' equity $ 459.7 25% $ 585.4 24% Senior notes 57.5 2 Senior subordinated notes 580.0 31 580.2 24 Mortgage warehouse loans 101.9 6 276.3 11 Notes payable 708.6 38 957.9 39 Total $1,850.2 100% $2,457.3 100%
Total assets decreased $0.7 billion to $1.9 billion at December 31, 1999 from $2.6 billion at December 31, 1998. This decrease was due primarily to decreased loans and asset portfolios and decreased retained interests in securitization and the impairment write down on the residential mortgage banking operations.
Senior Credit Facility
Effective August 12, 1998 the Company entered into a Credit Agreement (the "Credit Agreement") with a syndicate of lenders led by Bank of America, N.A., as administrative agent, and Credit Suisse First Boston, as syndication agent, replacing the Third Amended and Restated Loan Agreement (as modified and amended) dated as of September 30, 1997. The Credit Agreement provides for a total commitment of $504.3 million with a revolving loan commitment of $448.1 million and a term commitment of $56.2 million. Both facilities terminate as of June 30, 2000. As of November 26, 1999 the total maximum amount available under the Credit Agreement was reduced to $460.3 million, subject to certain requirements such as contractually determined advance percentage applied to each asset that is pledged as collateral ("asset coverage test"). At December 31, 1999, $384.7 million was outstanding under the Credit Agreement.
The Credit Agreement was amended and restated as of January 18, 2000. The amended and restated Credit Agreement provides for a revolving commitment of $92.0 million and a two term commitments of $56.2 million (Term Loan A) and $320.4 million (Term Loan B). In conjunction with the sale of a substantial part of the real estate structured finance portfolio, the revolving commitment was reduced by $10.0 million to $82.0 million, Term Loan A commitment was reduced $22.4 million to $33.8 million and Term Loan B commitment was reduced $133.0 million to $187.4 million. On February 8, 2000, Term Loan A was further reduced by $0.7 million to $33.1 million and Term Loan B was further reduced by $5.7 million to $181.7 million. Upon completion of the Lend Lease transaction and the sale of the United Kingdom asset management operations and other asset sales, Term Loan B was paid off and the revolver commitment reduced to $30.3 million. On March 30, 2000, the Credit Agreement was amended and restated. In conjunction with the amendment and restatement, the outstanding balance of Term Loan A was repaid with an advance from the revolving credit facility. The amended and restated Credit Agreement provides for a revolving commitment of $75.0 million through May 31, 2000 and $55.0 million thereafter to maturity on August 15, 2000. As of March 30, 2000, the revolver debt was $24.8 million.
Commercial Finance Facilities
The Interim Warehouse and Security Agreement (the "Small Business Facility") dated February 26, 1998, between a wholly-owned subsidiary of the Company and Prudential Securities Credit Corporation ("Prudential") provides financing in an amount not to exceed $200.0 million for the origination and purchase of small business loans. On March 1, 2000, the Small Business Facility was amended to extend the Maturity Date to March 31, 2001. At December 31, 1999, $34.7 million was outstanding under the Commercial Concepts Agreement.
The Interim Warehouse and Security Agreement (the "Franchise Agreement") dated March 17, 1998, between a wholly-owned subsidiary of the Company and Prudential provides financing in an amount not to exceed $150.0 million for the origination and purchase of certain franchise and construction loans. On March 1, 2000, the Franchise Facility was amended to extend the Maturity Date to March 31, 2001. At December 31, 1999, $3.4 million was outstanding under the Franchise Facility.
The Loan Agreement ("Loan Agreement") dated August 31, 1998, between a wholly-owned subsidiary of the Company and Salomon Brothers Realty Corporation provides financing in an amount not to exceed $200.0 million to provide financing for the origination of commercial mortgage loans secured by certain real estate properties originated or acquired. At December 31, 1999, $15.2 million was outstanding under the Loan Agreement. The maturity date of the Loan Agreement is April 30, 2000.
The Loan Agreement ("Transamerica Loan Agreement"), dated December 18, 1998 between a wholly-owned subsidiary of the Company and Transamerica Business Credit Corporation provides a working capital facility in the maximum aggregate principal amount of up to $75.0 million for the purpose of funding new Small Business Administration ("SBA") loans. On November 30, 1999, an amendment of the Transamerica Loan Agreement changed the mandatory repayment period applicable to advances from one year to 359 days from the date of advance. At December 31, 1999, $47.2 million was outstanding under the Transamerica Loan Agreement. The Transamerica Loan Agreement has a Maturity Date of December 31, 2001.
On May 1, 1999, a wholly-owned subsidiary of the Company entered into a Financing Agreement (the "Financing Agreement") in which approximately $111.4 million of loans made by such subsidiary to small- to-medium sized local and regional home building companies were financed by Adjustable Rate Home Builder Loan Notes issued through the means of a private securitization. The Financing Agreement's final maturity is May 25, 2007. At December 31, 1999, $111.4 million was outstanding under the Financing Agreement.
A wholly owned subsidiary of the Company entered into a Transfer and Administration Agreement (the "Transfer and Administration Agreement") with Kitty Hawk Funding Corporation and Bank of America, N.A., as agent on June 26, 1998, which was subsequently amended on November 26, 1999. As of December 31, 1999, the Transfer and Administration Agreement provides financing in an amount not to exceed $55.0 million for construction financing to various home builders and is secured by the specific assets funded by such debt. At December 31, 1999, $31.1 million was outstanding under the Transfer and Administration Agreement. The Transfer and Administration Agreement commitment terminates on April 30, 2000.
Home Equity Lending Facilities
During the year ended December 31, 1998, the Company financed its home equity lending operations with warehouse lines of credit with aggregate credit limits of $2.9 billion. As a result of the restructuring of the home equity lending business described above, the Company's financing requirements and financing sources have been significantly reduced.
The Master Repurchase Agreement ("the Agreement") dated October 17, 1996, between a wholly owned subsidiary of the Company and Donaldson Lufkin & Jenrette, provides financing for certain retained interests purchased or created during the Company's securitization process. As of December 31, 1999, $7.6 million was outstanding under the Agreement.
On June 30, 1999, a wholly-owned subsidiary of the Company entered into a Master Repurchase Agreement Governing Purchases and Sales of Mortgage Loans (the "Master Agreement") with Lehman Commercial Paper Inc., ("Lehman") for the sale and repurchase of certain mortgage loans. On September 20, 1999, the Master Agreement was modified by a Letter Agreement ("Letter Agreement") to provide financing for certain exception loans, as defined in the Letter Agreement. At December 31, 1999, $1.4 million was outstanding related to the Letter Agreement.
General
Current liquidity, unused revolver availability and cash available, as of March 30, 2000, was approximately $48.0 million. The primary sources of liquidity currently include the Credit Agreement and, to the extent described above, the Warehouse Facilities, and internally generated funds. In addition to the loan sales and other matters described above, the Company expects to manage its liquidity from cash flows generated from its existing operations, and returns of and on investments in the ordinary course of business.
The Credit Agreement, the Warehouse Facilities and the indentures under which the senior subordinated notes are issued contain certain financial covenants relating to among other things, interest coverage, leverage and tangible net worth. If the Company experiences additional losses it may be in default under the financial covenants. Any such default could materially impact the Company's financial condition and prospects. The Company does not anticipate that it will be in default under any of its credit agreements and facilities in the foreseeable future. Although the Company is in compliance with all its respective debt agreements, these debt agreements contain restrictions on the incurrence of additional debt. These restrictions currently preclude the incurrence of additional long term debt, other than under the Credit Agreement (or any replacement or successor thereto) and pursuant to warehouse lines of credit, asset-based financings and other similar arrangements designed to support its various lines of business.
The Company has historically accessed the capital markets as an important part of its capital raising activities, including to raise funds in debt and equity offerings, to finance the acquisition of assets and the origination and accumulation of loans, and to securitize and sell loans originated by its different business lines. The Company anticipates that its access to the capital markets will be significantly limited for the foreseeable future and that other sources of third party financing will also be limited.
Other Matters
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires the Company to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value depending upon the Company's rights or obligations under the applicable derivative contract. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for- sale security, or a foreign-currency-denominated forecasted transaction. In June 1999, The FASB issued SFAS No. 137 which deferred the effective date of the SFAS No. 133 for one year. The Company will adopt SFAS No. 133 on January 1, 2001, as required. The Company has not yet determined the impact on the Consolidated Financial Statements upon adoption of this standard.
In October 1998, the Financial Accounting Standards Board issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise," which establishes accounting and reporting standards for certain activities of mortgage banking enterprises and other enterprises that conduct operations that are substantially similar to the primary operations of a mortgage banking enterprise. SFAS No. 134 requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities based upon its ability and intent to sell or hold those investments. The Company applied the new rules of SFAS 134 on January 1, 1999. The adoption of SFAS 134 did not have a material impact on the Company's results of operations or financial position.
Year 2000 Issue Update
The Company did not experience any significant malfunctions or errors in its operating or business systems when the date changed from 1999 to 2000. Based upon operations since January 1, 2000, the Company does not expect any significant impact to its ongoing business as a result of the "Year 2000 issue". However, it is possible that the full impact of the date change, which was of concern due to computer programs that use two digits instead of four digits to define years, has not been fully recognized. For example, it is possible that Year 2000 or similar issues such as leap year-related problems may occur with billing, payroll or financial closings at month, quarter, or year-end. The Company believes that any such problems are likely to be minor and correctable. In addition, the Company could still be negatively affected if its borrowers, significant business partners, lenders, vendors and other service providers are adversely affected by Year 2000 or similar issues. The Company is not currently aware of any significant Year 2000 or similar problems that have arisen for its borrowers, significant business partners, lenders or vendors or other service providers.
The Company expended $1.0 million on Year 2000 readiness efforts from 1997 to 1999. These efforts included assessing, remediating or replacing, testing and upgrading the Company's business critical systems with the assistance of a consulting firm that specializes in Year 2000 readiness. These costs do not include costs associated with internal resources assigned to the initiative.
Private Litigation Securities Reform Act of 1995
This report contains forward-looking statements based upon current expectations that involve a number of risks and uncertainties. The forward-looking statements are made pursuant to safe harbor provisions of the Private Litigation Securities Reform Act of 1995. The factors that could cause actual results to differ materially include the following: industry conditions and competition, interest rates, business mix, availability of additional financing, and the risks described from time to time in the Company's reports to the Securities and Exchange Commission.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest and currency exchange rates and in equity and commodity prices. Market risk is inherent to both derivative and non-derivative financial instruments, and accordingly, the scope of the Company's market risk management procedures extends beyond derivatives to include all market risk sensitive financial instruments.
The following is a discussion of the Company's primary market risk exposures as of December 31, 1999, including a discussion of how those exposures are managed.
Interest Rate Risk
The Company is subject to interest rate risk through its normal operating activities. The Company generates fixed rate loans and investments through its origination and asset management activities. A substantial portion of these fixed rate loans and investments are financed by LIBOR based notes payable and warehouse loans payable. In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments help to hedge against changes in interest rates. The Company may reduce its exposure to fluctuations in interest rates by creating offsetting positions through the use of derivative financial instruments. Derivatives are used to lower funding costs, to diversify sources of funding, or to alter interest rate exposures arising from mismatches between assets and liabilities. The Company does not use derivative financial instruments for trading or speculative purposes, nor is the Company party to highly leveraged derivatives. These financial instruments include interest rate cap agreements, put options and forward and futures contracts. The instruments involve, to varying degrees, elements of risk in excess of the amount recognized in the consolidated statements of financial condition. The Company controls the risk of its hedging agreements, interest rate cap agreements and forward and futures contracts through approvals, limits and monitoring procedures.
The Company purchases interest rate cap agreements to reduce the impact of changes in interest rates on its floating rate debt. The Company enters into these agreements to change the fixed/variable interest rate mix of the debt portfolio to reduce the Company's aggregate risk to movements in interest rates. Accordingly, the Company enters into agreements to effectively convert variable-rate debt to fixed-rate debt to reduce the Company's risk of incurring higher interest costs due to rising interest rates. The cap agreements entitle the Company to receive from the counterparties the amounts, if any, by which an interest rate index exceeds agreed-upon thresholds. The potential loss in fair value related to such cap agreements resulting from a 10% adverse change in interest rates is not material.
Futures and forward contracts are commitments to either purchase or sell designated financial instruments at a future date for a specified price and may be settled in cash or through delivery. The Company enters into these contracts to reduce the risk of loss in value on certain investments and loan portfolios due to changes in interest rates and currency exchange rates. Initial margin requirements are met in cash or other instruments. Futures contracts have little credit risk because futures exchanges are the counterparties. Forward agreements and interest rate swaps and caps are subject to the creditworthiness of the counterparties, which are principally large financial institutions.
Interest rate sensitivity analyses are used to measure the Company's interest rate risk related to its trading and other than trading portfolios by computing hypothetical changes in fair values of interest rate sensitive assets, liabilities and off balance sheet items in the event of a hypothetical changes in interest rates. The following are the Company's interest rate sensitivity analyses as of December 31, 1999 (dollars in millions):
Retained Interests in Securitization (trading):
Change in Hypothetical Hypothetical Interest Rates Fair Value Change ($) Change (%) 10% $310.0 $10.7 3.6% 0 299.3 - - (10)% 290.0 (9.3) (3.1)
A hypothetical increase in interest rates is projected to decrease loan pre-payments increasing the fair value of the retained interests. This increase is projected to more than offset a decrease in fair value of the retained interests caused by higher market interest rates.
Other than Trading:
Change in Hypothetical Hypothetical Interest Rates Fair Value Change $ Change % 10% $375.7 $(4.9) (1.3)% 0 380.6 - - (10)% 386.2 5.6 1.5
The other than trading category includes loans held for sale, loans and asset portfolios, asset backed securities, derivative positions, senior subordinated notes and the amount outstanding under the Company's Credit Agreement to the extent the fair value could be affected by a widening of spreads. In an increasing interest rate environment, the Company projects the fair value of its debt obligations to decrease offset, in part, by a fair value reduction in its asset and derivative portfolio.
Any market interest rate change would adjust the Company's projected cash flows from its variable rate assets and liabilities. Such changes in cash flows are not reflected in the above analysis as the fair values of variable assets and liabilities would not materially be affected by a 10% change in interest rates. As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to re-pricing, they may react in different degrees to changes in interest rates. Changes in interest rates related to certain types of assets and liabilities may fluctuate in advance of changes in market interest rates while changes in interest rates related to other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as variable rate loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Additionally, changes in market interest rates may increase or decrease due to pre- payments and defaults influenced by changes in market interest rates affecting the valuation of certain assets. Accordingly, the data presented in the above table should not be relied upon as indicative of actual results in the event of changes in interest rates.
Foreign Exchange Risk
Foreign exchange risk arises from the possibility that changes in foreign exchange rates will impact the value of financial instruments. The Company is subject to foreign exchange risk to the extent its income bearing assets exceeds its related foreign denominated debt. At December 31, 1999, the Company had one forward contract in place to hedge against a portion of its foreign exchange rate exposure. The following table summarizes the hypothetical impact to the Company's financial position due to changes in foreign currency exchange rates (dollars in millions):
Change in Foreign Exchange Rates Hypothetical Hypothetical per Dollar Fair Value Change Change 10% $16.0 $ (1.4) (8.0)% 0 17.4 - - (10)% 19.0 1.6 9.2%
Other Market Risks
As with any entity's investment or asset portfolio, the Company is subject to the risk that certain unpredictable conditions can exist which combine to have the effect of limiting the Company's ability to liquidate its assets through sale or securitization. As was the case in late 1998 when unprecedented market conditions caused a widening of interest rate spreads resulting in losses to the Company and substantial requirements on the Company's liquidity position, certain events, however remote a possibility, can again exist reducing the Company's ability to liquidate certain assets. The Company believes its liquidity risk would not be materially impacted solely by a 10% change in interest rates without a more substantial change in spreads.
Item 8.
Item 8. Financial Statements and Supplementary Data
See Index to Financial Statements on Page of this Annual Report on Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information required by this Item is set forth under the caption "Management" in the Company's definitive Proxy Statement (the "Proxy Statement"), which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required by this Item is set forth under the caption "Executive Compensation" in the Proxy Statement, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this Item is set forth under the caption "Certain Relationships and Related Transactions" in the Proxy Statement, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated herein by reference.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(1) Financial Statements
See Index to Financial Statements on page of this Annual Report on Form 10-K.
(2) Financial Statement Schedules
Financial statement schedules under the applicable rules and regulations of the Securities and Exchange Commission have been omitted as the schedules are not applicable or the information required thereby is included in the Company's consolidated financial statements or notes thereto.
(3) Exhibits
The following instruments are included as exhibits to the report. Exhibits incorporated by reference are so indicated.
Exhibit Number Description of Exhibit
3.(a) Restated Certificate of Incorporation, filed as exhibit 3(a) to Registrant's Form 10K for the fiscal year ended December 31, 1997, which is incorporated herein by reference. (b) Amended and Restated Bylaws effective as of February 25, 1997 filed as exhibit 3 (b) to Registrant's Form 10-K for the fiscal year ended December 31, 1996, which is incorporated herein by reference. 4.(a) See Exhibits 3(a) and (b). (b) Indenture, dated as of January 15, 1996, between the Registrant and Bank One, Columbus, N.A., as trustee, filed as Exhibit 4.1 to the Registrant's Form 8-K dated February 2, 1996, which exhibit is incorporated herein by reference. (c) Indenture, dated as of March 1, 1997, between the Company and Bank One, Columbus, N.A., as trustee, filed as Exhibit 4.1 to the Registrant's Form 8-K dated March 12, 1997, which exhibit is incorporated herein by reference. (d) Officers' Certificate and Company Order dated as of March 12, 1997, establishing the terms of the Company's Senior Subordinated Notes, Series 1997-A due 2004, filed as Exhibit 4.2 to the Registrant's Form 8-K dated March 12, 1997, which exhibit is incorporated herein by reference. (e) Officers' Certificate and Company Order dated as of February 23, 1998, establishing the terms of the Company's Senior Subordinated Notes, Series 1998-A due 2005, filed as exhibit 4(e) to Registrant's Form 10K for the fiscal year ended December 31, 1997, which is incorporated herein by reference. (f) Specimen Common Stock Certificate, filed as Exhibit 4.4 to the Company's Registration Statement on Form S-3 (No. 33- 63683), which exhibit is incorporated herein by reference. 10.(a) Form of Indemnification Agreement together with a list of all officers and directors who have signed such agreement, filed as Exhibit 10(g) to the Registrant's Annual Report on Form 10-K for the year ended October 31, 1987, which exhibit is incorporated herein by reference. (b) Form of Indemnification Agreement dated as of August 24, 1993, together with a list of all officers and directors who have signed such agreement, filed as Exhibit 10(g) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 31, 1993, which exhibit is incorporated herein by reference. (c) Fifth Amended and Restated Incentive Stock Option Plan dated as of November 20, 1990, filed as Exhibit 10(h) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, which exhibit is incorporated herein by references.(2) (d) Fourth Amended and Restated Stock Option Plan dated as of November 20, 1991, filed as Exhibit 10(i) to the Registrants Annual Report on Form 10-K for the year ended December 31, 1991, which exhibit is incorporated herein by reference.(2) (e) Stock Option Agreement, dated as of April 17, 1990, between the Registrant and Bruce W. Schnitzer, and Termination of Warrant between Mr. Schnitzer and the Registrant, filed as Exhibit 10(s) to the Registrant's Annual Report on Form 10-K for the year ended October 31, 1990, which exhibit is incorporated herein by reference.(2) (f) Promissory Note dated October 31, 1990 issued by James P. Cotton, Jr. to the Registrant, filed as Exhibit 10(s) to the Registrant's Annual Report on Form 10-K for the year ended October 31, 1990, which exhibit is incorporated herein by reference. (g) Promissory Note dated October 31, 1990 issued by Gerald E. Eickhoff to the Registrant, filed as Exhibit 10(w) to the Registrant's Annual Report Form 10-K for the year ended October 31, 1990, which exhibit is incorporated herein by reference. (h) Registrant's 1993 Key Individual Stock Option Plan filed as Exhibit 10(z) to the Registration Statement of Registrant on Form S-4 under the Securities Act of 1993 (File No. 33-72732), which exhibit is incorporated herein by reference.(2) (i) Indemnification Agreement, dated March 30, 1993, between AMRESCO Holdings, Inc. and Richard L. Cravey, filed as Exhibit 10(ab) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, which exhibit is incorporated herein by reference. (j) The Registrant's Retirement Savings and Profit Sharing Plan and Trust filed as Exhibit 10(ag) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, which exhibit is incorporated herein by reference.(2) (k) The Registrant's Severance Pay Plan filed as Exhibit 10(ai) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, which exhibit is incorporated herein by reference.(2) (l) Employment Agreement, dated as of May 31, 1994, between Registrant and Robert H. Lutz, Jr., filed as Exhibit 10(y) to the Registrant's Form 10-K for the fiscal year ended December 31, 1994, which exhibit is incorporated herein by reference.(2) (m) Amendment to Stock Option Agreement, dated as of April 1, 1995, between the Registrant and Bruce W. Schnitzer filed as Exhibit 10(an) to the Registrant's Form 10-K for the fiscal year ended December 31, 1995, which exhibit is incorporated herein by reference. (2) (n) Office Lease, dated as of February 9, 1996, between K-P Plaza Limited Partnership and the Registrant filed as Exhibit 10(ao) to the Registrant's Form 10-K for the fiscal year ended December 31, 1995, which exhibit is incorporated herein by reference. (o) First Amendment to Office Lease dated July 17, 1996, filed as exhibit 10(r) to Registrant's Form 10K for the fiscal year ended December 31, 1997, which is incorporated herein by reference. (p) Second Amendment to Lease Agreement dated May 27, 1997, filed as exhibit 10(s) to Registrant's Form 10K for the fiscal year ended December 31, 1997, which is incorporated herein by reference. (q) Third Amendment to Lease Agreement dated September 22, 1997, filed as exhibit 10(t) to Registrant's Form 10K for the fiscal year ended December 31, 1997, which is incorporated herein by reference. (r) Lease Expansion and Fourth Amendment to Lease Agreement dated January 6, 1998, filed as exhibit 10(u) to Registrant's Form 10K for the fiscal year ended December 31, 1997, which is incorporated herein by reference. (s) Form of Severance Agreement, dated as of May 29, 1996, with Robert H Lutz, Jr., Robert L. Adair, Barry L. Edwards, L. Keith Blackwell, Ronald B. Kirkland and Ronald Castleman filed as exhibit 10(x) to the registrants Form 10-K for the fiscal year ended December 31, 1996, which is incorporated herein by reference. (2) (t) Form of Letter Agreement, dated as of March 20, 1997, with Harold E. Holliday, Jr. filed as exhibit 10(y) to the registrants Form 10-K for the fiscal year ended December 31, 1996, which is incorporated herein by reference. (2) (u) AMRESCO, INC. 1997 Stock Option Plan filed as exhibit 10 (ac) to the registrants Form 10-K for the fiscal year ended December 31, 1996, which is incorporated herein by reference. (2) (v) AMRESCO, INC. 1995 Stock Option and Award Plan, as amended and restated. (2) (w) AMRESCO, INC. 1998 Stock Option and Award Plan filed as Exhibit 10 to the registrants' Form 10-Q for the fiscal quarter ended June 30, 1998, which is incorporated herein by reference. (2) (x) Credit Agreement entered into as of August 12, 1998 among AMRESCO, INC., as borrower, NationsBank, N.A. as administrative agent and Credit Suisse First Boston as syndication agent for the "Lenders" filed as Exhibit 10 to the registrant's Form 10-Q for the fiscal quarter ended September 30, 1998, which is incorporated herein by reference. (y) The First Modification of Credit Agreement entered into as of September 17, 1998 among AMRESCO, INC., as borrower, and NationsBank, N.A. as administrative agent for the "Lenders", filed as exhibit 10(ac) to Registrant's Form 10K for the fiscal year ended December 31, 1998, which is incorporated herein by reference. (z) The Second Modification of Credit Agreement entered into as of November 30, 1998, among AMRESCO, INC., as borrower, and NationsBank, N.A. as administrative agent for the "Lenders", filed as exhibit 10(ad) to Registrant's Form 10K for the fiscal year ended December 31, 1998, which is incorporated herein by reference. (aa) The Third Modification of Credit Agreement and Consent entered into as of February 28, 1999 among AMRESCO, INC., as borrower, and NationsBank, N.A. as administrative agent for the "Lenders", filed as exhibit 10(ad) to Registrant's Form 10K for the fiscal year ended December 31, 1998, which is incorporated herein by reference. (ab) Amendment No.1 to Rights Agreement, dated as of March 2, 1999, executed by and between AMRESCO, INC. and The Bank of New York, as Rights Agent (attached as Exhibit 1a to the Registrants Form 8-A [Amendment No.1] filed as of March 24, 1999, which is incorporated herein by reference. (ac) Amended and Restated Credit Agreement, dated January 18, 2000, among AMRESCO, INC. and its subsidiaries, as borrowers, and Bank of America, N. A. as Administrative Agent, and certain financial institutions and Funds, as Lenders. (1) (ad) First Modification of Amended and Restated Credit Agreement, dated as of February 25, 2000, by and among AMRESCO, INC. and the subsidiaries of AMRESCO listed as borrowers and Bank of America, N.A., as Administrative Agent, for and on behalf of the Lenders. (1) (ae) Asset Purchase Agreement, dated December 8, 1999, by and among, AMRESCO, INC. and certain of its subsidiaries, as Sellers and Lend Lease (US) Services, Inc., as Purchaser, filed as Exhibit 2.1 to the Registrant's Form 8-K dated December 8, 1999 which exhibit is incorporated herein by reference. 11. Statement re: Computation of Per Share Earnings. (1) 21. Subsidiaries of the Registrant. (1) 23. Consent of Independent Auditors-Deloitte & Touche LLP. (1) 27.(a) Financial Data Schedule- Fiscal year end 1999. (1) (b) Financial Data Schedule- Fiscal year ends 1997, 1998 and Quarters 1, 2 and 3 of 1998. (1) (c) Financial Data Schedule- Quarters 1, 2 and 3 of 1999. (1)
(1) Filed herewith.
(2) Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of this Report.
Reports on Form 8-K
The Registrant filed a Current Report on Form 8-K, dated December 8, 1999, reporting pursuant to Items such Form the entering into an Asset Purchase Agreement dated December 8, 1999, by and among AMRESCO, INC. and certain of its subsidiaries, as Sellers, and Lend Lease (US) Services, Inc., as Purchasers.
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 on the 30th day of March, 2000.
AMRESCO, INC.
By /s/ ROBERT H. LUTZ, JR. Robert H. Lutz, Jr.
Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the 30th day of March, 2000:
Signature Title Chairman of the Board and Chief Executive /s/ ROBERT H. LUTZ, JR. Officer Robert H. Lutz, Jr. Director, President and Chief Operating Officer Robert L. Adair III Executive Vice President and Chief Financial /s/ BARRY L. EDWARDS Officer (Principal Financial Officer) Barry L. Edwards Director /s/ JAMES P. COTTON, JR. James P. Cotton, Jr. Director /s/ RICHARD L. CRAVEY Richard L. Cravey Director /s/ AMY J. JORGENSEN Amy J. Jorgensen Director /s/ BRUCE W. SCHNITZER Bruce W. Schnitzer Senior Vice President and Chief Accounting /s/ RON B. KIRKLAND Officer (Principal Accounting Officer) Ron B. Kirkland (Principal Accounting Officer)
Page I. Financial Statements of AMRESCO, INC. and Subsidiaries
Consolidated Balance Sheets, December 31, 1999 and 1998 F- 2 Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997 F- 3 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1999, 1998 and 1997 F- 4 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 F- 5 Notes to Consolidated Financial Statements F- 6 Independent Auditors' Report
AMRESCO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1999 and 1998 (In thousands, except for share amounts)
See notes to consolidated financial statements.
AMRESCO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1999, 1998 and 1997 (In thousands, except per share data)
See notes to consolidated financial statements.
AMRESCO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Years Ended December 31, 1999, 1998 and 1997 (In thousands)
See notes to consolidated financial statements.
AMRESCO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1999, 1998 and 1997 (In thousands)
See notes to consolidated financial statements.
AMRESCO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
AMRESCO, INC. (the "Company") is engaged primarily in the business of real estate lending, commercial finance and the acquisition, resolution and servicing of nonperforming and underperforming commercial loans. The Company's business may be affected by many factors, including real estate and other asset values, the level of and fluctuations in interest rates, changes in the small business and franchise loan securitization market, and competition. In addition, the Company's operations require continued access to short term sources of financing. As further described in Notes 3 and 17, the Company has discontinued its commercial mortgage banking line of business and will concentrate its efforts on its commercial finance line of business in the future.
Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.
Interest and Other Investment Income. The Company's interest income consists of interest earned on loans and asset portfolios and accrued earnings on securities purchased or retained from securitization trusts. Interest income on loans and retained interests in securitizations is recorded as earned. Interest income represents the interest earned on the loans during the warehousing period (the period prior to their securitization), as well as loans held on the balance sheet on a long-term basis, and the recognition of interest income on the securities retained after securitization. Interest and other investment income is recognized using the effective yield method and includes accretion of discounts, amortization of premiums and market valuation adjustments for securities classified as trading.
Gain (Loss) on Sale of Loans and Investments. The Company computes a gain or loss on the sale and/or securitization of loans and investments based on the fair value of proceeds received over the allocated basis (between the assets sold and any retained interests) based upon their relative fair values at the date of sale. Retained interests in assets sold are initially recorded at their allocated basis and are classified as trading securities which are carried at estimated fair value.
Mortgage Banking and Servicing Fees. Loan placement fees, commitment fees, loan servicing fees and real estate brokerage commissions are recognized as earned. Placement and servicing expenses are charged to expense as incurred.
Asset Management and Resolution Fees. Asset management and resolution fees from management contracts are based on the amount of assets under management and the net proceeds from the resolution of such assets, respectively, and are recognized as earned. Expenses incurred in managing and administering the assets subject to management contracts are charged to expense as incurred. The Company provides asset management and resolution services primarily for private investors. Generally, the contracts provide for the payment of a fixed management fee which is reduced proportionately as managed assets decrease, a resolution fee using specified percentage rates based on net cash collections and an incentive fee for resolution of certain assets. Asset management and resolution contracts are of a finite duration, typically three to five years. Unless new assets are added to these contracts during their terms, the amount of total assets under management decreases over the terms of these contracts.
Cash and Cash Equivalents. Cash and cash equivalents include all highly liquid investments with a maturity of three months or less when purchased.
Accounts Receivable. Accounts receivable primarily represent receivables related to certain contracts. Receivables are recorded as the related revenues are earned according to the respective contracts. The Company's exposure to credit loss in the event that payment is not received for revenue recognized equals the balance of accounts receivable on the balance sheet.
Loans Held for Sale. Loans held for sale are carried at the lower of cost or market, net of deferred loan origination fees and associated direct costs and an allowance for loan loss. Loan origination fees and associated direct costs are deferred and recognized upon sale. Market value is determined based upon the estimated fair value of similar loans for the month of expected delivery.
Loans and Asset Portfolios. Loans are stated at face value, net of deferred loan origination fees and associated direct costs and net of an allowance for loan losses. Loan origination fees and incremental direct costs are deferred and recognized over the life of the loan as an adjustment to yield, using the interest method. Asset portfolios consist of pools of loans or real estate acquired at significant discounts to face value. The Company classifies its asset portfolios as loan portfolios, partnerships and joint ventures and real estate. The original cost of an asset portfolio is allocated to individual assets within that portfolio based on their relative fair value to the total purchase price. The difference between gross estimated cash flows from loans and its cost is accrued using the level yield method. The Company accounts for its investments in partnerships and joint ventures using the equity method which generally results in the pass-through of the Company's pro rata share of earnings as if the Company had a direct investment in the underlying assets. Loan portfolios, partnerships and joint ventures, and real estate are carried at the lower of cost, adjusted for equity earnings, or estimated fair value.
Allowances for Loan and Asset Portfolio Losses. The Company provides for estimated loan and asset portfolio losses by establishing allowances for losses through a charge to earnings. Actual losses reduce, and subsequent recoveries increase, each allowance. Management's periodic evaluation of each allowance for estimated losses is based upon an analysis of the portfolio, historical loss experience, economic conditions and trends, collateral values and other relevant factors.
Asset-Backed Securities. The Company's investments in asset- backed securities are classified as available for sale and are carried at estimated fair value determined by quoted market rates when available, otherwise by discounting estimated cash flows at current market rates. Any unrealized gains or losses on asset-backed securities are excluded from earnings and included in accumulated other comprehensive income, a separate component of shareholders' equity. Any realized gains or losses are included in earnings and are calculated based upon the specific identification method. Any impairment, other than temporary, in the value of a security is included in earnings.
Retained Interests in Securitizations. Retained interests in securitizations are classified as trading and are carried at estimated fair value. The carrying value of the retained interests in securitizations is analyzed by the Company on a disaggregated basis to determine whether historical prepayment and loss experience, economic conditions and trends, collateral values and other relevant factors have had an impact on the carrying value. Changes in market value are included in earnings. Cash flows for retained interests in securitizations are generally subordinated to other security holders in a securitization trust. The retained interests in securitizations are valued at the discounted present value of the cash flows based upon the expected timing of the release of cash by the securitization trust ("cash-out method") over the anticipated life of the assets sold after estimated future credit losses, estimated prepayments and normal servicing and other related fees. The discounted present value of such retained interests is computed using management's assumptions of market discount rates, prepayment rates, default rates, credit losses and other costs.
Premises and Equipment. Premises and equipment, primarily building and improvements, are stated at cost less accumulated depreciation. The related assets are depreciated using the straight- line method over their estimated service lives, which range from one to fifteen years. Improvements to leased property are amortized over the life of the lease or the life of the improvement, whichever is shorter.
Intangible Assets. Intangible assets represent the excess of purchase price over the fair value of tangible net assets acquired in connection with the purchases of other businesses. These intangible assets, principally goodwill, are amortized using the straight-line method over periods ranging from one to twenty-two years.
Long-Lived Assets. The Company reviews the carrying value of long-lived assets, such as intangibles and premises and equipment, used in operations when changes in events or circumstances indicate that the assets might have become impaired. The Company evaluates any possible impairment of long-lived assets using estimates of undiscounted cash flows. In addition, the Company periodically assesses the recoverability of intangible assets and estimates the remaining useful life by reviewing projected results of acquired operations, servicing rights and contracts. If this evaluation indicates that an asset is impaired, the Company records a charge to operations to reduce the asset's carrying value to fair value (see Note 2).
Mortgage Servicing Rights. The Company recognizes as separate assets the rights to service mortgage loans for others, whether the servicing rights are purchased or obtained through loan originations and contractually separated from the underlying loans by sale or securitization, by allocating total costs incurred between the loan sold and the servicing rights retained based upon their relative fair values. Amortization of mortgage servicing rights ("MSRs") is based upon the ratio of net servicing income received in the current period to total net servicing income projected to be realized from the MSRs. Projected net servicing income is in turn determined on the basis of the estimated future balance of the underlying mortgage loan portfolio, which declines over time from pre-payments and scheduled loan amortization. The Company estimates future pre-payment rates based upon current interest rate levels, other economic conditions and market forecasts, as well as relevant characteristics of the servicing portfolio, such as loan types, interest rate stratification and recent prepayment experience. MSRs are periodically assessed for impairment which would be recognized in the consolidated statement of operations. The Company evaluates impairment through stratification of its loan portfolio based upon certain risk characteristics including loan type (commercial or residential) and contractual interest rate (fixed or adjustable).
Investment in AMRESCO Capital Trust. The Company currently owns approximately 1.5 million common shares, or 15%, of the outstanding common stock of AMRESCO Capital Trust ("ACT"), which is a real estate investment trust. The Company also acts as manager of ACT for which it receives a management fee from ACT for performing asset management services. Fees and reimbursable expenses recognized by the Company for such services totaled $2.3 million and $1.0 million for 1999 and 1998, respectively. During the fourth quarter 1999, the Company recorded an impairment of $1.5 million in its investment in ACT. The Company concluded that a loss in value, other than temporary, occurred regarding its investment in ACT as the Company would not be able to recover its recorded investment. At December 31, 1999, the Company's investment in ACT was approximately $20.0 million, which is included in other assets, and is accounted for under the equity method of accounting. The fair value of the ACT common stock held by the Company at December 31, 1999 is $12.8 million, based upon the quoted market price.
Income Taxes. The Company and its subsidiaries file consolidated tax returns. Deferred income taxes are recorded for temporary differences between the bases of assets and liabilities as recognized by tax laws and their carrying value as reported in the financial statements.
Earnings per Share. Basic earnings per share is calculated by dividing income available to common shareholders by the weighted- average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing income available to common shareholders plus the number of additional common shares that would have been outstanding if any dilutive potential common shares had been issued during the period.
Foreign Currency Translation. Assets and liabilities of foreign subsidiaries are translated into United States dollars at the prevailing exchange rate on the balance sheet date. Revenue and expense accounts for these subsidiaries are translated using the weighted-average exchange rate during the period. Equity accounts are translated at the historical exchange rate. These translation methods give rise to cumulative foreign currency translation adjustments, which are reported as a component of accumulated other comprehensive income.
Derivative Financial Instruments. Derivative financial instruments are utilized by the Company to reduce interest rate risk. Derivative financial instruments include interest rate swaps and caps and futures and forward contracts. The Company does not hold or issue derivative financial instruments for speculative or trading purposes. Gains and losses resulting from the termination of derivative financial instruments are recognized over the shorter of the remaining original contract lives of the derivative financial instruments or the lives of the related hedged positions or, if the hedged positions are sold, are recognized in the current period as gain or loss on sale (see Note 16).
New Accounting Standards. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for stand-alone derivative instruments and for derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires the Company to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value depending upon the Company's rights or obligations under the applicable derivative contract. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. In June 1999, the FASB issued SFAS No. 137 which deferred the effective date of SFAS No. 133 for one year. The Company will adopt SFAS No. 133 on January 1, 2001, as required. The Company has not yet determined the impact on the Consolidated Financial Statements upon adoption of this standard.
In October 1998, the Financial Accounting Standards Board issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise," which establishes accounting and reporting standards for certain activities of mortgage banking enterprises and other enterprises that conduct operations that are substantially similar to the primary operations of a mortgage banking enterprise. SFAS No. 134 requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities based upon its ability and intent to sell or hold those investments. The Company applied the new rules of SFAS 134 on January 1, 1999. The adoption of SFAS No. 134 did not have a material impact on the Company's results of operations or financial position.
Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of certain assets, liabilities, revenues and expenses and disclosures of contingent assets and liabilities. Significant estimates include the valuation of retained interests in securitizations, asset-backed securities and the allowances for loan and asset portfolio losses. Actual results could differ significantly from such estimates.
Reclassifications. Certain reclassifications of prior year amounts have been made to conform to the current year presentation (see Note 3).
2. Acquisitions
All of the Company's acquisitions have been accounted for as purchases. Operations of acquired companies are included with those of the Company after the acquisition date. Goodwill related to the following acquisitions is amortized using the straight-line method over 11 to 22 years. Stock issued in connection with acquisitions was valued at the price of the stock at the time of the agreements.
On August 11, 1998, the Company acquired Mortgage Investors Corporation and an affiliated entity ("MIC"), a privately held producer of Veteran's Administration ("VA") streamlined re-financed loans, by merging a wholly-owned subsidiary of the Company with MIC. The initial Agreement and Plan of Merger (the "Original Agreement") to purchase MIC provided for an acquisition price of approximately 1.8 million shares of the Company's common stock and $2.6 million in cash. Also, the former owners were to receive an earn-out payment of between $70.0 million and $105.0 million over a three-year period with the payments structured to be paid 82% in the Company's common stock and 18% in cash. Effective April 12, 1999, the Original Agreement was amended (the "Amended Agreement") to provide the Company an option to effect redemption of the stock portion of the earn-out for cash subject to certain market conditions and restrictions, and to fix the earn-out payment at $105.0 million. During 1999, the Company made an earn-out payment of $9.7 million in cash and advanced $9.2 million, the balance of the cash portion of the earn-out. Also, the Company extended $17.0 million to the previous owners of MIC in exchange for a note receivable to be repaid upon issuance of the stock portion of the earn-out. The Company did not exercise its option to effect redemption of the stock portion of the earn-out prior to December 31, 1999. The issuance of the stock portion of the earn-out has been extended until at least March 31, 2000, but no later than June 30, 2000. At December 31, 1999, $86.1 million was recorded as common stock to be issued for the portion of the earn-out related to the Amended Agreement.
During January 2000, the Company obtained an option to return MIC and its related assets and liabilities to its previous owners for a cash payment of $25.0 million and forgiveness of the $17.0 million note in exchange for cancellation of the $86.1 million stock obligation currently owed to the previous owners. The option expires April 30, 2000. The Company expects to exercise its option with regard to MIC if sufficient cash is available to do so; as such, the Company recorded an impairment charge of $103.3 million on the intangible assets related to the MIC acquisition.
On July 16, 1998, the Company purchased the assets of Independence Funding Company L.L.P. ("IFC") and TeleCapital L.P. ("TeleCapital") for approximately 1.3 million shares of the Company's common stock and cash of $44.0 million. IFC's primary line of business is providing long term financing to small businesses and TeleCapital's primary line of business is providing financing to the pay phone industry.
On January 29, 1998, the Company acquired the home equity lending business and operations of City Federal Funding & Mortgage Corp. and its affiliate, Finance America Corporation (collectively "City Federal") for 286,996 shares of the Company's common stock. In addition to the common stock, the Company paid $2.0 million in cash in connection with such acquisition and was to pay up to an additional $8.5 million in cash and stock over the next three years in the event certain performance goals were met or exceeded during the fiscal years 1998, 1999 and 2000. At December 31, 1999 and 1998, such performance goals were not attained requiring no performance accrual by the Company. The purchase agreement included a provision to further compensate the sellers if the price of the Company's common stock on the one-year anniversary date of the purchase was less than the price of the stock on the purchase date. During 1999, the Company negotiated a settlement of $4.0 million for the change in stock price that was recorded as a reduction of shareholders'equity. Future obligations regarding the City Federal acquisition have been cancelled. During 1999, the Company closed all the retail branches included in the City Federal operations and recorded an impairment charge of $8.7 million on the intangible assets related to the City Federal acquisition. The 1998 acquisitions (before earn-outs) were allocated as follows (in thousands):
On March 31, 1997, the Company purchased the stock of Commercial Lending Corporation and the operations and specific assets of certain of its affiliates ("CLC"). CLC's primary line of business is originating, securitizing, selling and servicing small business loans. The purchase price consisted of approximately 2.1 million shares of the Company's common stock valued at $34.3 million, the assumption of certain liabilities and contingent earn-out payments of additional shares of the Company's common stock based upon a percentage of adjusted net income of the acquired entities through March 31, 2000. Approximately 3.4 million shares of the Company's common stock were issued in 1998 and an additional 27,289 shares were issued in 1999 based on performance targets (see Note 17).
3. Discontinued Operations
In December 1999, the Company announced that it had reached an agreement to sell its Commercial Mortgage Banking business to Lend Lease (US) Services, Inc. subject to normal closing and other conditions (see Note 17). Accordingly, the results from the Commercial Mortgage Banking segment are shown as discontinued operations with all prior years restated. Components of amounts reflected in the statement of operations and balance sheets of the discontinued operations are presented in the following table (in thousands):
1999 1998 1997 Operations Statement Data: Revenues $150,050 $ 71,018 $97,503 Gain (loss) on sale of loans and investments 6,069 (101,042) Interest expense 6,304 40,619 3,202 Depreciation and amortization 15,282 7,540 4,491 Operating income (loss) 11,428 (104,371) 27,163 Income tax (benefit) 4,000 (36,530) 10,050 Income (loss) from discontinued operations 7,428 (67,841) 17,113 Balance Sheet Data: Cash and equivalents $ 11,898 $ 16,084 Loans held for sale, net 11,513 343,897 Loans and asset portfolios, net 9,771 5,735 Retained interests in securitization 23,204 Income tax receivable 248 43,727 Intangibles 57,771 51,694 Mortgage servicing rights 69,708 35,656 Other assets 10,704 9,263 Accounts and other payables (12,416) (11,900) Warehouse loans (12,675) (311,142) Other liabilities (18,769) (8,323) Net assets of discontinued operations $127,753 $ 197,895
4. Loans Held for Sale
Loans held for sale were originated or acquired by the Company and are held for future sale or securitization. Such loans have mortgages on the underlying real estate or first liens on the related property and equipment. All of the Company's loans held for sale are pledged as collateral under the Company's various debt facilities. The maximum accounting loss if the borrower fails to pay is the carrying value. The Company's lending operations are diversified across the United States. Loans held for sale at December 31, 1999 and 1998 consisted of the following (in thousands):
1999 1998 Real estate structured finance loans $162,361 $ - Franchise and small business loans 131,749 176,700 Single family home equity loans 2,864 175,928 296,974 352,628 Allowance for loan losses (1,933) (2,128) Balance, end of year, net $295,041 $350,500
As of December 31, 1999 and 1998, the Company was committed to sell approximately $25.0 million and $45.4 million of small business loans, respectively, that were part of December 1999 and December 1998 securitizations.
The activity in the allowance for loan losses on loans held for sale for the years ended December 31, 1999 and 1998 is summarized as follows (in thousands):
1999 1998 Balance, beginning of year $ 2,128 $ 6,739 Provision for loan losses 4,539 15,467 Charge-offs (4,734) (20,078) Balance, end of year $ 1,933 $ 2,128
5. Loans and Asset Portfolios
The Company's loans consist primarily of high yield loans to businesses and projects that were unable to access traditional lending sources and loans for single family residential construction. Asset portfolios consist of loans purchased at a substantial discount from their principal amount, real estate and investments in partnerships and joint ventures that invest in such assets and an investment in preferred stock. Substantially all of the Company's loan and asset portfolios are backed by commercial mortgage real estate. All of the Company's loans and asset portfolios are collateral under the Company's various debt facilities. The Company's lending operations are diversified across the United States. The maximum accounting loss if the borrower fails to pay is the carrying value. Loans and asset portfolios at December 31, 1999 and 1998 consisted of the following (in thousands):
1999 1998 Loans: Commercial loans $101,265 $353,410 Residential construction loans 218,859 129,613 Total loans 320,124 483,023 Asset portfolios: Commercial real estate mortgages 140,381 216,276 Real estate 191,400 223,126 Partnerships, joint ventures and other 62,589 31,376 Total asset portfolios 394,370 470,778 Allowance for loan and asset portfolio losses (9,141) (16,417) Balance, end of year, net $705,353 $937,384
The activity in the allowance for loan and asset portfolio losses for the years ended December 31, 1999 and 1998 is summarized as follows (in thousands):
1999 1998 Balance, beginning of year $16,417 $ 8,502 Provision (credit) for loan and asset portfolio losses (5,626) 7,971 Charge-offs (1,650) (56) Balance, end of year $ 9,141 $16,417
During 1999, there was a negative provision for loan and asset portfolio losses as a result of management's regular assessment of the estimated losses in the portfolio. Such estimate of losses is based, in part, on individual assets and their related cash flow forecasts, sales values, independent appraisals and the volatility of certain real estate markets.
6. Retained Interests in Securitizations
The Company's retained interests in securitizations consist primarily of interest only certificates retained in the Company's securitizations of home equity, franchise and small business loans and are generally subordinated to other security holders in a securitization trust. The retained interests are classified as trading securities and are carried on the Company's balance sheets at fair value, with the change in fair value during the period being included in earnings. The timing and amount of cash flows on these securities are significantly influenced by prepayments on the underlying loans, estimated foreclosure losses to the extent the Company has retained the risk of such losses, and normal servicing and other related fees. The carrying value of the retained interests in securitizations at December 31, 1999 was determined by the Company on a disaggregated basis by discounting future cash flows using a weighted average discount rate of approximately 16.2%. The discount rate used to value the retained interests is influenced primarily by the underlying loan rate and the volatility and predictability of the underlying cash flows which generally become more certain as the securities season and prepayments and credit losses are more known.
The Company did not securitize any home equity loans in 1999 that generated retained interests. The actual weighted average annual prepayment rate on the Company's home equity securitizations was 31.3% for the period from inception of each security through December 31, 1999, which is higher than originally projected, and is modeled to be 25.2% for the next twelve months. The actual weighted average constant default rate on the Company's home equity securitizations was 1.4% from inception of each security through December 31, 1999 and is modeled to be 2.8% for the next twelve months. The actual weighted average loss severity from inception of each security through December 31, 1999 is 38.8% and is modeled to be 33.3% over the next twelve months. During 1999 changes were made in our projected prepayments, default rates and loss severity assumptions which resulted in increased home equity retained interests in securitization losses. New assumptions were based upon the current interest rate environment, recent industry trends and our recent portfolio history.
The Company has utilized, for initial valuation purposes in 1999, a discount rate of 18% for its commercial finance franchise loan securitizations and a 14% to 15% discount rate on its commercial finance small business loan securitizations. Prepayment rates on the Company's franchise and small business loan securitizations are in line with expectations. Current valuations take into account the change in prepayment assumptions as well as other assumptions influenced by market conditions.
The Company structures its franchise and small business loans with limited cross guarantees between borrowers such that the borrowers within a defined pool of loans absorb the first 5% - 10% of net losses. At the present time, the Company considers it unlikely that net losses on such loan portfolios will exceed the 5% - 10% range. Accordingly, losses are assumed to be zero. The Company has assumed no prepayments on its franchise and small business loan securitizations based on the significant prepayment penalties applicable to the loans and historical prepayment experience.
The following table summarizes the significant assumptions used by the Company regarding its retained interests in securitizations:
Net proceeds from sale of retained interests in securitizations were $174.6 million and $102.2 million in 1999 and 1997, respectively. There were no sales of retained interests in securitizations in 1998.
The Company's retained interests in securitizations were measured by allocating the previous carrying amount between the assets sold and the interests retained (including mortgage servicing rights, if any) based on their relative fair values at the date of transfer. The interests retained were marked-to-market which resulted in $146.4 million and $16.1 million decreases in the value of retained interests in securitization during 1999 and 1998, respectively. In all of the Company's securitization transactions completed in 1999 and 1998, the Company has not retained any recourse obligation, other than retained interests, with respect to the assets sold other than standard representations and warranties. As of December 31, 1998, the Company had $19.4 million of retained interests related to the Company's remaining interest from sales of home equity loans in October 1998 that were collected in the first half of 1999. Retained interests in securitizations at December 31, 1999 and 1998 consisted of the following (dollars in thousands):
1999 1998 Home equity loan interests $155,250 $413,412 Conventional small business and franchise interests 124,328 69,892 Home equity whole loan sale interest 19,440 SBA interests 16,315 7,612 Other 3,418 5,417 Total $299,311 $515,773
7. Asset-backed Securities
Asset-backed securities available for sale, carried at estimated fair value, at December 31, 1999 and 1998, were as follows (in thousands):
Gross Gross Amortized Unrealized Unrealized Estimated Cost Gain Loss Fair Value 1999 $124,079 $30,842 $(47,916) $107,005 1998 $160,351 $18,173 $(37,343) $141,181
Net proceeds from sales of asset-backed securities aggregated $20.7 million, $18.5 million and $52.3 million for the years ended December 31, 1999, 1998 and 1997, respectively, which resulted in gross realized gains of $8.0 million and $2.1 million in 1998 and 1997, respectively, and gross realized losses of $10.6 million and $6.7 million in 1999 and 1998, respectively. Maturities of securities available for sale are not presented because the loans underlying such securities are subject to prepayment. All of the Company's asset- backed securities are collateral under the Company's various debt facilities.
8. Mortgage Servicing Rights
The activity in mortgage servicing rights for the years ended December 31, 1999 and 1998 was as follows (in thousands):
1999 1998 Balance at beginning of year $13,731 $ - Purchased 254 5,957 Originated 3,994 9,363 Sales and transfers (6,139) Amortization (5,557) (1,589) Balance at end of year $ 6,283 $13,731
9. Notes Payable and Other Debt
The Company's notes payable and other debt at December 31, 1999 and 1998 consisted of the following (in thousands):
1999 1998 Notes payable: Revolving loan agreements $384,716 $640,198 Non-recourse debt 173,870 176,960 Commercial paper conduit and builder note payable 142,457 85,434 Retained interest financing 7,568 54,411 Other 868 Total notes payable $708,611 $957,871
Warehouse loans payable: Home equity lending facilities $ 1,373 $136,051 Commercial finance facilities 100,521 140,233 Total warehouse loans payable $101,894 $276,284
8.75% senior notes due July 1, 1999 $ - $ 57,500
Senior subordinated notes: 10.0% notes due January 15, 2003 $ 57,383 $ 57,500 10.0% notes due March 15, 2004 192,500 192,500 9.875% notes due March 15, 2005 330,150 330,179 Total senior subordinated notes $580,033 $580,179
Revolving Loan Agreements. Effective August 12, 1998, the Company entered into a Credit Agreement (the "Credit Agreement") with a syndicate of lenders led by Bank of America, N.A., as administrative agent, and Credit Suisse First Boston, as syndication agent, which replaced the Third Amended and Restated Loan Agreement (as modified and amended) dated as of September 30, 1997. The Credit Agreement was entered into in order to increase the Company's borrowing limits, among other things.
The Credit Agreement constitutes senior debt and provides for a revolving loan commitment of $448.1 million, and a term commitment of $56.2 million. Interest is payable quarterly and at the end of each advance period. The Credit Agreement is secured by substantially all of the assets of the Company not pledged under other credit facilities, including stock of a majority of the Company's subsidiaries. Indebtedness under the Credit Agreement generally bears interest at a rate based on the lower of (i) the applicable rate (as defined in the Credit Agreement) selected by the borrower between a variable rate (as defined in the Credit Agreement) or a London Interbank Offered Rate ("LIBOR") based rate (as defined in the Credit Agreement) or (ii) the maximum lawful rate (as defined in the Credit Agreement). Both facilities terminate as of June 30, 2000. The debt offering costs were included in other assets and are amortized over the life of the debt using the effective interest method. On November 26, 1999, the Credit Agreement was modified to, among other things, reduce by $44.0 million the total amount available for Advances under the Revolving Credit Facility. As of December 31, 1999, a total of $384.7 million was outstanding under the Credit Agreement bearing interest at 9.1% with availability under the Credit Agreement of approximately $75.6 million. At December 31, 1999, the Company had outstanding $10.2 million in face amount of letters of credit pursuant to such facility (see Note 17).
Non-recourse Debt, Commercial Paper Conduit and Builder Note Payable, Retained Interest Financing and Warehouse Loans Payable. Non- recourse debt is used primarily to fund purchases of real estate mortgage backed securities and under-performing loan portfolios and is secured by the specific assets purchased totaling $180.4 million at December 31, 1999. The commercial paper conduit and builder note payable is used primarily to provide construction financing to various home builders and is secured by the specific assets funded with such debt totaling $173.7 million at December 31, 1999. Retained interest financing is used primarily to finance certain retained interests purchased or created during the Company's securitization process and is secured by the specific assets funded with such debt totaling $17.0 million at December 31, 1999. The Warehouse debt is used primarily to fund purchases and originations of commercial finance and home equity loans and is secured by the specific assets funded with such debt totaling $121.3 million at December 31, 1999. The following table summarizes the Company's non-recourse debt, commercial paper conduit and builder note payable, retained interest financing and warehouse loans payable at December 31, 1999 (in thousands of dollars):
__________
(1) The maximum aggregate amount outstanding under the Prudential warehouse facility may not exceed $250.0 million. (2) There is no stated maturity date for this obligation as the underlying securities, which provide the cash flows to service the debt, have the ability to prepay.
8.75% Senior Notes Due July 1, 1999. On July 1, 1999 the Company repaid the entire $57.2 million balance of its 8.75% Senior Notes.
10% Senior Subordinated Notes Due January 15, 2003. On January 30, 1996, the Company issued $57.5 million principal amount of senior subordinated notes with net proceeds of approximately $54.9 million. There is no sinking fund or amortization of principal prior to maturity and the senior subordinated notes are not redeemable prior to January 15, 2001. The debt offering costs are included in other assets and are amortized over the life of the debt using the effective interest method. The senior subordinated notes are unsecured general obligations of the Company and subordinated to all existing and future senior indebtedness (as defined in the Indenture) of the Company.
10% Senior Subordinated Notes Due March 15, 2004. On March 12, 1997, the Company issued $192.5 million aggregate principal amount of senior subordinated notes with net proceeds of approximately $186.6 million. The senior subordinated notes are unsecured obligations of the Company and are subordinated to prior payment of all existing and future senior debt and to indebtedness and other liabilities of the Company's subsidiaries. The debt offering costs are included in other assets and are amortized over the life of the debt using the effective interest method. The notes are not redeemable prior to maturity.
9.875% Senior Subordinated Notes Due March 15, 2005. On February 24, 1998 and March 10, 1998, the Company issued $290.0 million and $40.2 million, respectively, aggregate principal amount of senior subordinated notes with total net proceeds of approximately $320.7 million. The senior subordinated notes are unsecured obligations of the Company and are subordinated to all existing and future senior debt and to indebtedness and other liabilities of the Company's subsidiaries. The debt offering costs are included in other assets and are amortized over the life of the debt using the effective interest method. The notes are redeemable prior to maturity at 104.938% of their principal amount, plus accrued interest, any time after March 15, 2002, declining ratably to 100% of their principal amount, plus accrued interest, on or after March 15, 2004.
Covenants. Each of the Company's notes payable and other debt agreements has certain covenants which include financial tests, including minimum consolidated tangible net worth, maximum consolidated funded debt to consolidated capitalization ratio, minimum fixed payment ratio, minimum interest coverage ratio, maximum debt to net worth ratio and minimum asset coverage ratio. The agreements also contain covenants that, among other things, limit incurring additional indebtedness, investments, asset sales, loans to shareholders, dividends, transactions with affiliates, acquisitions, mergers and consolidations, liens and encumbrances and other matters customarily restricted. At December 31, 1999, the Company was in compliance with all covenants.
Aggregate amounts of notes payable and other debt that mature during the next five years are as follows (in thousands):
10. Income Taxes
Income tax expense (benefit) consisted of the following for the years ended December 31, 1999, 1998 and 1997 (in thousands):
1999 1998 1997 Current: Federal $(14,342) $ 2,887 $ 37,913 State (3,936) 2,619 2,473 Total current tax expense (benefit) (18,278) 5,506 40,386 Deferred tax expense (benefit): Federal (44,179) (1,849) (13,673) State (317) 211 (891) Total deferred tax benefit (44,496) (1,638) (14,564) Income tax expense (benefit) from continuing operations $(62,774) $ 3,868 $ 25,822
A reconciliation of income taxes on reported pretax income at statutory rates to actual income tax expense for the years ended December 31, 1999, 1998 and 1997, is as follows (dollars in thousands):
The net deferred tax assets at December 31, 1999 and 1998, consisted of the tax effects of temporary differences related to the following (in thousands):
1999 1998 Reserves for loan and asset portfolio losses $25,439 $12,534 Net operating loss carryforwards 22,990 6,976 Accrued employee compensation 3,311 4,469 Foreign tax credit carryforward 6,351 3,592 Intangible assets 5,877 2,850 AMT credit carryforwards 2,123 602 Investment in subsidiaries 426 426 Securitized loans and investments 1,989 (5,972) Other 7,977 5,185 Deferred tax asset before valuation allowance 76,483 30,662 Valuation allowance (2,500) (1,175) Net deferred tax assets $73,983 $29,487
Realization of deferred tax assets is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset, net of applicable valuation allowance, will be realized. The amount of the deferred tax asset considered realizable could be reduced or increased if estimates of future taxable income during the carryforward period are reduced or increased. As a result of acquisitions and operations, the Company has net operating loss carryforwards available for its use. The Company is subject to certain annual limitations on the utilization of such losses. The following were the expiration dates and the approximate net operating loss carryforwards at December 31, 1999 (in thousands):
Expiration Date Amount 2002 $ 874 2003 1,459 2006 372 2007 2,867 2008 3,838 2011 9,283 2018 12,109 2019 55,758 Total $86,560
11. Employee Stock Compensation
The Company has stock option and award plans for the benefit of key individuals, including its directors, officers and key employees. The plan is administered by a committee of the Board of Directors.
On October 20, 1998, the Board of Directors adopted a resolution to exchange approximately 5.7 million options to purchase the Company's common shares at exercise prices ranging from $7.50 to $34.56 per common share for approximately 4.0 million options having an exercise price of $7.44 per common share, representing fair value at date of grant, which had no impact on the Company's financial statements. Stock option activity under the plans for the years ended December 31, 1999, 1998 and 1997 was as follows:
The following table summarizes information about stock options outstanding at December 31, 1999:
At December 31, 1999, the Company has reserved a total of 4,582,167 shares of common stock for exercise of stock options.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for its stock option and award plans. Under the terms of the plans, the exercise price of each option is equal to the market price of the Company's stock on the date of grant. Accordingly, no compensation expense has been recognized under these plans. Income (loss) and earnings (loss) per share from continuing operations on a pro forma basis as if the Company had utilized fair value accounting methodology would have been as follows (in thousands, except per share data):
For the Years Ended December 31, 1999 1998 1997 Income (loss) from continuing operations: As reported $(228,277) $(1,330) $39,111 Pro forma (231,455) (7,589) 31,205
Basic earnings (loss) per share from continuing operations: As reported $(4.77) $(0.03) $1.11 Pro forma (4.83) (0.18) 0.88
Diluted earnings (loss) per share from continuing operations: As reported $(4.77) $(0.03) $1.07 Pro forma (4.83) (0.18) 0.85
The estimated fair value of options granted during 1999, 1998 and 1997 was $2.90, $4.21 and $11.08 per share, respectively. For purposes of determining fair value of each option, the Company used the Black-Scholes model with the following assumptions:
1999 1998 1997 Risk-free interest rate 4.80% - 6.45% 4.19% - 4.50% 5.82% - 6.26% Expected life 7 years 5 years 7 years Expected volatility 55% - 60% 54% 43% - 46% Expected dividends - - -
During 1999, the Company issued 707,641 shares of restricted common stock at prices ranging from $6.38 per share to $9.52 per share, with a weighted average price of $9.37 per share, under one of the Company's stock option and award plans. Although the Company's restricted stock typically vests over a period of five years, the 1999 grants vest over periods of two and three years and certain 1998 grants vest in a lump sum in the year 2001. During 1999, 1998 and 1997, $6.9 million, $2.5 million and $1.7 million in unearned stock compensation was amortized as compensation expense, respectively. At December 31, 1999 and 1998 shareholders' equity includes unearned stock compensation of $4.0 million and $4.9 million, respectively.
12. Common Stock
During July and August 1998, the Company repurchased 1.0 million shares of the Company's outstanding common stock at an average price of $17.20 per common share.
On February 24, March 4, May 18, and July 28, 1998, the Company issued options to purchase approximately 331,000, 15,000, 152,000 and 2,629,000 shares, respectively, of common stock. On February 24, July 17, and July 22, 1998, the Company issued approximately 166,000, 34,000 and 21,000 restricted shares, respectively, of the Company's common stock to certain key employees.
On February 23, 1998, the Company completed a registered public offering of 5.2 million shares of common stock, including the underwriters' over-allotment option. The net proceeds from such offering, after underwriter's discount and offering expenses, aggregated approximately $147.2 million. The price to the public was $30.00 per share and the proceeds to the Company were $28.56 per share, after underwriting discounts.
On May 28, 1997, the Company adopted a Stockholders Rights Plan pursuant to which rights were distributed to stockholders of record as of June 9, 1997. This Stockholders Rights Plan was amended as of March 2, 1999. The Stockholders Rights Plan, as amended, provides, among other things, that if a person (or group of affiliated or associated persons) acquires (or ten days after the commencement of a tender offer to acquire) "beneficial ownership" of 15% or more of the outstanding shares of common stock, the rights previously distributed to stockholders, other than those owned by such acquiring person or group, will become exercisable. Under the Stockholders Rights Plan, as amended, the acquisition of 15% or more of the outstanding common stock or the completion of the tender offer will entitle the holder to purchase shares of common stock having a market value equal to twice the purchase price of the right.
A reconciliation of the numerators and denominators used in the basic and diluted earnings (loss) per share computations for net income (loss) is as follows (in thousands):
1999 1998 1997 Income (loss) from continuing operations basic and diluted $(228,277) $(1,330) $39,111
Weighted average shares outstanding (basic) 47,879 42,846 35,412 Dilutive stock options 958 Contingently issuable shares 293 Weighted average shares outstanding (diluted) 47,879 42,846 36,663
As the Company posted a net loss for the years ended December 31, 1999 and 1998, the effects of dilutive stock options and contingently issuable shares for the years ended December 31, 1999 and 1998 are anti-dilutive and not included in the computation of diluted loss per share. As of December 31, 1999 and 1998, the Company had 19,582,000 and 1,159,000 anti-dilutive options and contingently issuable shares, respectively.
At December 31, 1999, the Company had 20,000 stock appreciation rights outstanding related to the market value of the Company's common stock which were granted to certain non-employees of the Company. The stock appreciation rights have an award value of $13.125 and an automatic conversion into cash on February 20, 2006.
13. Employee Compensation and Benefits
Accrued employee compensation and benefits at December 31, 1999 and 1998 included amounts for incentive compensation, severance and benefits. Certain employees are eligible to receive a bonus from a pool computed on pretax income over predetermined minimum earning levels within operating units.
The AMRESCO Retirement Savings and Profit Sharing Plan ("Plan") qualifies under Section 401(k) of the Internal Revenue Code and incorporates both a savings component and a profit sharing component for eligible employees. As determined each year by the Board of Directors, the Company may match the employee contribution up to 6% of their base pay based on the Company's performance. For 1999, 1998 and 1997, the matching contribution was set at $0.50 for each $1.00 contributed by the employees. In addition to the matching savings contribution in 1997, the Company provided an annual contribution to the profit sharing retirement component of the Plan on behalf of all eligible employees. No such contributions were made in 1999 or 1998 due to the Company's net losses. For the year ended December 31, 1997, the Company accrued a profit sharing contribution of $3.1 million. Allocation of the Company's contribution is based on a percentage of an employee's weighted total pay. Weighted total pay places a stronger emphasis on the age of the employee and provides an increasingly larger profit sharing contribution as an employee nears retirement.
14. Commitments and Contingencies
The Company has entered into non-cancelable operating leases covering office facilities which expire at various dates through 2009. Certain of the lease agreements provide for minimum annual rentals with provisions to increase the rents to cover increases in real estate taxes and other expenses of the lessor. The Company also has leases on equipment, some of which are non-cancelable, which expire on various dates through 2002. The total rent expense for the years ended December 31, 1999, 1998 and 1997, was approximately $21.4 million, $17.7 million and $9.9 million, respectively. The future minimum annual rental commitments under non-cancelable operating lease agreements having a remaining term in excess of one year at December 31, 1999 were as follows (in thousands):
Year Ended December 31, 2000 $13,899 2001 12,393 2002 9,683 2003 7,341 2004 6,798 Thereafter 16,959
The Company is a defendant in various legal actions. In the opinion of management, such actions will not materially affect the financial position, results of operations or cash flows of the Company (see Note 17).
15. Segment and Related Information
The Company has four reportable segments which have separate management teams and infrastructures that engage in different investments and offer different services: commercial finance, asset management, home equity lending and residential mortgage banking. In its commercial finance business, the Company focuses on (i) loans to franchisees of nationally recognized restaurant, hospitality and service organizations, (ii) loans to small business owners, (iii) real estate structured finance, (iv) communications finance and (v) single family residential construction lending. The asset management business involves acquiring asset portfolios at a discount to face value and managing and resolving such asset portfolios to maximize cash recoveries. In addition, in its asset management business, the Company provides special servicing for nonperforming and underperforming loans in commercial mortgage-backed bond trusts and similar securitized commercial asset-backed loan portfolios. The home equity lending business involves originating, selling and servicing nonconforming residential mortgage loans. The residential mortgage banking line of business originates and sells FHA and VA streamlined re-financed loans.
The accounting policies are the same as those described in the summary of significant accounting policies with the exception of interest expense incurred by the Company being allocated to the subsidiaries in 1999, 1998 and 1997 based upon the subsidiaries' combined balance of common stock, paid in capital and intercompany accounts. The Company evaluates performance based upon operating income which is determined by adjusting operating profit to include intangible amortization expense.
The following represents the Company's reportable segment position as of and for the years ended December 31, 1999, 1998 and 1997 (in thousands):
16. Financial Instruments and Risk Management
In the normal course of business, the Company is a party to financial instruments with off-balance sheet interest rate and currency exchange rate risk. The Company may reduce its exposure to fluctuations in interest rates and currency exchange rates by creating offsetting positions through the use of derivative financial instruments. Derivatives are used to lower funding costs, to diversify sources of funding, or to alter interest rate and currency exchange rate exposures arising from mismatches between assets and liabilities. The Company does not use derivative financial instruments for trading or speculative purposes, nor is the Company party to highly leveraged derivatives. These financial instruments include interest rate cap agreements, put options and forward and futures contracts. The instruments involve, to varying degrees, elements of risk in excess of the amount recognized in the consolidated statements of financial condition. The Company controls the risk of its hedging agreements, interest rate cap agreements and forward and futures contracts through approvals, limits and monitoring procedures.
Futures and forward contracts are commitments to either purchase or sell designated financial instruments at a future date for a specified price and may be settled in cash or through delivery. Initial margin requirements are met in cash or other instruments. Futures contracts have little credit risk because futures exchanges are the counterparties. Forward agreements and interest rate swaps and caps are subject to the creditworthiness of the counterparties, which are principally large financial institutions.
The notional amounts of derivatives do not represent amounts exchanged by the parties and, thus, are not a measure of the exposure of the Company through its use of derivatives. The amounts exchanged are calculated on the basis of the notional amounts and the other terms of the derivatives, which relate to interest rates, exchange rates, securities prices, or financial or other indices. Market values of derivative transactions fluctuate based upon movements in underlying financial indices such as interest rates. Market values are monitored on a continual basis through external pricing mechanisms and internal calculations. The Company's objective measurement system together with risk limits and timely reporting to senior management help to mitigate the risks associated with market fluctuations. In the event that a derivative product were terminated prior to its contractual maturity, it is the Company's policy to recognize the resulting gain or loss over the shorter of the remaining original life of the derivative financial instrument or the life of the underlying hedged asset or liability. If the item being hedged is sold, settled or terminated, the derivative financial instrument is marked-to-market and any gain (loss) is recognized in earnings. No such terminations of derivative transactions prior to contractual maturity occurred during 1999 or 1998. If the derivative fails to effectively perform as a hedge and/or does not qualify as a hedge, it is marked-to-market and any gain (loss) is recognized in earnings.
From time to time the Company uses forward contracts to hedge interest rate and currency exchange risk. At December 31, 1999, the Company has (i) one U.S. Treasury forward contract with a total notional amount of $20 million related to hedging approximately $20.7 million in loans held for sale with a settlement date of January 2000 and (ii) one Japanese Yen forward contract to deliver 490 million Yen with a settlement of February 2000. As of December 31, 1998, the Company held (i) two (U.S. Treasury and Federal National Mortgage Association ("Fannie Mae")) forward security contracts with a total notional amount of $63.8 million hedging $82.9 million of loans held for sale, with settlement dates of January and February 1999, (ii) two Government National Mortgage Association thirty-year 6.0% contracts to sell approximately $65.0 million of residential mortgage banking loans to be delivered in February 1999 and (iii) one U.S. Treasury forward contract with a notional amount of $33.5 million which hedged approximately $35.3 million of residential mortgage backed securities ("MBS") with a settlement date of January 1999. Any gain or loss on a forward contract is deferred and recognized when the related assets are sold.
At December 31, 1999, the Company has no open option contracts. As of December 31, 1998, the Company had one option contract to sell (put option) ten-year U.S. Treasury securities at contracted forward prices. The contract matured in March 1999 and hedged two commercial MBS with a carrying value of $25.6 million.
As of December 31, 1999, the Company has no open futures contracts. As of December 31, 1998, the Company had one ten-year treasury note Fannie Mae futures contract with a notional amount of $21.4 million related to hedging approximately $18.9 million of loans.
The Company purchases interest rate swap and cap agreements to reduce the impact of changes in interest rates on its floating rate debt. The Company enters into these agreements to change the fixed/variable interest rate mix of the debt portfolio to reduce the Company's aggregate risk to movements in interest rates. Accordingly, the Company enters into agreements to effectively convert variable- rate debt to fixed-rate debt to reduce the Company's risk of incurring higher interest costs due to rising interest rates. The cap agreements entitle the Company to receive from the counterparties the amounts, if any, by which an interest rate index exceeds agreed-upon thresholds. The premiums paid for interest rate cap agreements purchased are included in other assets in the consolidated balance sheets and are amortized to interest expense over the terms of the agreements. Amounts received under cap agreements are recognized as yield adjustments to the related debt. As of December 31, 1999, the Company has two such agreements outstanding with a total notional amount of $10.6 million and a carrying balance of zero in its accounting records. The contracts have cap rates ranging from 6.375% to 6.4375% based upon one month LIBOR and have expiration dates between February and April 2000. As of December 31, 1998, the Company had four such agreements outstanding with a total notional amount of $31.7 million which hedge floating rate debt related to the Company's balances of residential MBS with a carrying value of $37.5 million. The contracts had cap rates ranging from 6.375% to 6.875% based upon one month LIBOR and had various expiration dates between November 1999 and April 2000.
As of December 31, 1998, the Company had an amortizing interest rate cap with a notional amount of $1.0 billion hedging approximately $384.9 million of retained interests in securitizations. The cap required monthly payments from the counterparty when one month LIBOR exceeds 5.9375%. The notional amount amortized monthly based upon levels agreed to with the counterparty through the expiration of the agreement on July 26, 1999. The Company paid an initial premium of approximately $3.2 million for the cap.
Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. Concentrations of credit risk that arise from financial instruments exist for counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The Company uses commercial rating agencies to evaluate the credit quality of the counterparties, all of whom are major international financial institutions. The Company does not have a significant exposure to any individual counterparty and does not anticipate a loss resulting from any credit risk of these institutions.
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
The fair value of loans, asset portfolios, asset-backed securities, retained interests in securitizations, notes payable and other debt, senior notes and senior subordinated notes were estimated based on quoted market prices when available, otherwise, they were based on present values of estimated cash flows using current entry- value interest rates applicable to each category of such financial instruments (which notes reflect the credit risk applicable to the instruments). Mortgage loans held for sale were valued at their contracted sales prices. The carrying amount of cash and cash equivalents, accounts receivable, net of reserves, and accounts payable approximated fair value. The Company has reviewed its exposure on standby letters of credit and has determined that the fair value of such exposure is not material. The fair values of the interest rate cap agreements, forward and futures contracts and put options were estimated using market quotes. The fair value estimates presented herein were based on pertinent information available to management as of December 31, 1999 and 1998. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since the date presented, and therefore, current estimates of fair value may differ significantly from the amounts presented herein
17. Subsequent Events
On January 18, 2000, the Company sold $182.4 million of its real estate structured finance portfolio for $170.2 million and recognized a loss in the accompanying 1999 financial statements in the line item, gain on sale of loans and investments, net. Proceeds from the sale were used to reduce bank debt.
During the first quarter 2000, the Company transferred net assets of $6.2 million of home equity lending business to Finance America, a joint venture with Lehman Brothers in exchange for a 36% interest.
In March 2000, the Company and the former shareholders of Commercial Finance Corporation ("CLC") agreed to amend the Asset Purchase Agreement pursuant to which the Company acquired CLC. This amendment provides that the amount of the final earn-out payment due on June 30, 2000 is fixed at $37.5 million and that, if the credit facility with the Bank of America, N.A., as Administrative Agent, is paid in full, the Company must issue to such former CLC shareholders promissory notes in the aggregate principal amount of $37.5 million in exchange for shares of the Company's common stock having a value of $37.5 million. Such notes would bear interest at the rate of 8% per annum, would be secured by certain retained interests from previous securitizations of CLC and would provide for principal payments of $12.5 million on each of June 30, September 30 and December 29, 2000. The notes could be prepaid at any time without penalty. In the event that the Company is unable to issue such notes, the June 30, 2000 earn-out payment will be payable in the Company's common stock having a value of $37.5 million based upon the average of the closing price of such common stock for the 20 trading days prior to May 31, 2000.
On March 17, 2000, the Company completed its sale of the commercial mortgage banking, asset management, and real estate structured finance platforms, to Lend Lease (US) Services, Inc. for cash of $203.0 million and a $25.0 million promissory note. Additional payments of up to $21.0 million are payable upon receipt of certain consents. The cash proceeds of the sale were used to reduce bank debt. In conjunction with this transaction, a substantial number of leases were assigned or assumed by Lend Lease.
On March 22, 2000, the Company sold its United Kingdom asset management assets and operations for $160.0 million. The Company received cash proceeds of $47.0 million and a note receivable for $25.0 million. Cash proceeds of the sale were used to reduce non- recourse and bank debt.
On March 30, 2000, the Credit Agreement was amended and restated. The amended and restated Credit Agreement provides for a revolving commitment of $75.0 million through May 31, 2000 and $55.0 million thereafter to maturity on August 15, 2000.
18. Quarterly Financial Data (Unaudited)
The following is a summary of unaudited quarterly results of operations for the years ended December 31, 1999 and 1998 (in thousands, except per share amounts):
Earnings (loss) per common share calculation for each of the quarters were based on the basic and diluted weighted average number of shares outstanding for each quarter. As a result, the sum of the quarters may not necessarily be equal to the full year earnings (loss) per common share amount.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of AMRESCO, INC.:
We have audited the accompanying consolidated balance sheets of AMRESCO, INC. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of AMRESCO, INC.'s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 AMRESCO, INC. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP Dallas, Texas March 30, 2000