An
investment in our securities involves a high degree of risk. You
should carefully consider the risk factors discussed in this section, as
well as
those contained in any filing that we make with the SEC after the date of
this
prospectus, before making your investment decision.
Risks
Related to Recent Adverse Conditions in the Sub-Prime Mortgage Industry,
as Well
as the Mortgage Industry and the Capital Markets Generally
We
face significant challenges due to adverse conditions in the sub-prime mortgage
and overall mortgage industries, as well as the capital markets
generally.
In
2006,
the sub-prime mortgage market in which we operate was characterized by increased
competition for loans and customers. The extensive competition
lowered profit margins on loans and caused lenders to be more aggressive
in
making loans to less qualified customers. By the end of 2006, the
sub-prime mortgage industry was negatively impacted. The sustained
pricing competition and higher risk portfolios of these loans reduced the
demand
for loans among potential buyers of whole-loan sales, who offered lower prices
for loans, reducing profit margins for sub-prime lenders, and increased costs
in
the securitization market. In addition, the higher levels of credit
risk assumed by many sub-prime lenders resulted in higher rates of delinquency
in these loans and an increase in the frequency of early payment defaults
and
repurchase demands on these loans.
These
trends accelerated during the first quarter of 2007; the industry experienced
a
period of turmoil in February and March of 2007, during which the securitization
market sustained significant disruption and dozens of lenders failed or faced
many other serious operating and financial challenges. Among the most
notable of these failures during this period was New Century Mortgage
Corporation, one of the largest sub-prime originators in recent years, which
announced in early April 2007 that it would file for bankruptcy protection
and
has since closed its operations.
Although
the sub-prime and securitization markets seemed to improve somewhat during
the
second quarter of 2007, this improvement was relatively minimal and apparently
short-lived. By July 2007, the sub-prime market had experienced even
more severe turmoil, which has continued through the date of this
prospectus. In response to higher rates of delinquencies and
defaults, a large number of mortgage-backed securities have been placed on
“credit watch,” and in some cases, downgraded, by the major U.S. rating
agencies. In addition, in the third quarter of 2007, Bear Stearns
announced the collapse of two of its hedge funds that had invested in sub-prime
mortgage securities. Other investors have either been experiencing,
or are expected to experience, problems arising from their investments in
sub-prime mortgage securities. Also, during the third quarter of
2007, the major U.S. rating agencies that rate sub-prime securitizations
have
increased reserve requirements for the securitizations to provide additional
credit support. The magnitude of these increased reserve requirements
was unanticipated.
The
combination of these significant industry events – including relatively poor
performing collateral primarily from 2006 securitizations, ratings agencies
downgrades, changes in credit enhancement levels required by rating agencies,
issues with investors in sub-prime mortgage securities, and mortgage companies
failing – has resulted in what has been characterized as unprecedented
disruption in the securitization market upon which we and others in the
sub-prime industry rely for long-term financing, further exacerbating the
operating environment. With this extremely limited secondary market,
in which few transactions have been consummated in recent months, warehouse
line
providers have significantly marked down the value of the collateral of loans
against which they provide financing and, as a result, placed margin calls
and
reduced advance rates on sub-prime and other lenders. These increased
margin calls and lower advance rates have required us and other lenders to
utilize large amounts of capital to make up the shortfall and have resulted
in
more distressed sales which, in turn, put further downward pressure on whole
loan sale prices, regenerating the cycle with escalating negative
results.
Throughout
the third quarter of 2007, a greater number of mortgage companies operating
in
the sub-prime (as well as prime and Alt-A) mortgage industry have failed
or
ceased operations, including mortgage companies or divisions of mortgage
companies owned and operated by more diversified financial services firms,
such
as HSBC and Lehman Brothers. All of these general market conditions
may affect the performance of the mortgage loans originated by us and have
and
may continue to adversely affect our operations, as described in more detail
in
this section.
Our
inability to access the securitization market or realize cash proceeds from
securitizations and whole-loan sales in excess of our operating costs could
harm
our financial position and results of operations.
We
rely,
and expect to continue to rely, significantly upon our ability to securitize
our
mortgage loans - and, to a lesser extent, the premiums we receive on whole-loan
sales - to generate cash for repayment of our short-term credit and warehouse
credit facilities and to finance mortgage loans for the remainder of each
mortgage loan’s life.
Since the end of the second
quarter of
2007, the market for securitizations of sub-prime mortgage loans has been
severely constrained, with only a small number of transactions coming to
market.
We
may
not be successful in securitizing mortgage loans that we accumulate in the
future.
Our most recent
securitization, completed in September 2007, was completed on materially
less
favorable terms to us than our other recent
securitizations.
We structured this
securitization
transaction to be accounted for as a sale (and not a financing, as we have
with
other securitizations since 2004) and also sold the residual interest to
a
third-party for cash. We expect to incur a loss in the third quarter
of 2007 with respect to this transaction, and in light of the significant
market
disruption that has occurred throughout the third quarter of
2007.
Our
ability to complete securitizations of our loans at favorable prices or at
all
in the future will depend on a number of factors, including:
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conditions
in the securities markets generally;
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conditions
in the asset-backed securities market specifically;
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the
availability of credit enhancement on acceptable economic terms
or at
all;
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credit
enhancement levels required by the U.S. rating agencies that rate
sub-prime mortgage securitizations;
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the
quality and characteristics of our newly originated loans that
we may seek
to securitize;
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investor
demand for securitizations we may seek to issue; and
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the
performance of our portfolio of securitized
loans.
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Additionally, we may not receive premiums on our future whole-loan sales
transactions, and may sell loans at a discount, affecting the amount of cash
proceeds we realize. If we are unable to realize proceeds that are
approximately equal to or greater than the full economic value of the mortgage
loans we securitize or sell on a whole-loan basis, our operations will be
adversely impacted. We cannot assure you that we will continue to be
successful in doing so in the future. As a result of conditions
within the sub-prime mortgage industry, rating agencies, financial guarantee
insurers and investors have recently required, and may continue to require
in
the future, additional credit enhancement to support the securities sold
in
securitizations of sub-prime mortgage loans. This requirement
generally has the effect of reducing the proceeds we may receive from, and
increasing the overall expense of, executing securitizations. The
rating agencies that rate sub-prime securitizations have recently increased
reserve requirements, the magnitude of which was unanticipated, which has
affected and may continue to affect the amount of proceeds we can expect
to
receive in future securitizations. We have recently raised our
mortgage rates and modified our product offerings and underwriting guidelines
in
an effort to mitigate the effects of these changes. There can be no
assurance, however, that we will be successful in doing so. In
addition, we expect to receive lower proceeds from any future securitization
that contains collateral that was originated based upon our previous guidelines
and rates.
Each
of the
securitizations we issue includes a series of asset-backed securities with
various credit ratings.
Unexpected
changes in ratings or rating methodology by the rating agencies
,
including, without limitation, the required levels of over-collateralization
on our newly
issued or
existing securitization transactions may have an adverse impact on our cash
position and may affect the prices we receive on all or certain portions
of the
asset-backed securities we issue.
The required
over-collateralization
and
sizing of each rated class of asset-backed securities
being offered are generally
determined
solely by the rating agencies.
We
depend on third-party financing sources, which may be unavailable to us in
the
future.
To
accumulate loans for
securitization or sale, we borrow money on a short-term basis through warehouse
credit facilities. We have relied upon a limited number of lenders to
provide the primary credit facilities for our loan
originations.
At September 30, 2007, we had $2.0 billion of
borrowing capacity under four warehouse credit facilities ($1.25 billion
of
which is committed), down from $2.5 billion of borrowing capacity at June
30,
2007 ($1.5 billion of which was committed), as we did not renew our warehouse
credit facility with Bank of America when it expired in September
2007. Also at September 30, 2007, we had $406.7 million of mortgage
loans outstanding on these warehouse credit facilities.
These facilities
are
due to expire between October 2007 and May 2008. We may not be able
to renew or replace any or all of these warehouse facilities at their respective
maturities, at terms satisfactory to us or at all.
Any
failure to renew or obtain adequate funding under these warehouse credit
facilities or other financing arrangements, or any reduction in the size
of, or
increase in the cost of, these types of facilities could increase our interest
expense or reduce the number of loans that we can originate. If we
are not successful in maintaining adequate financing, we would not be able
to
hold a sufficient volume of loans pending securitization. As a
result, we would have to curtail our loan origination activities or sell
loans
either through whole-loan sales or in smaller securitizations, which could
render our operations unprofitable.
During
volatile times in the capital markets, our access to warehouse credit and
other
financing facilities have been severely limited. If we are unable to
maintain adequate financing and other sources of capital are not available,
we
would be forced to suspend or curtail our operations.
Our
warehouse credit facilities contain covenants that restrict our operations
and
may inhibit our ability to grow our business and increase
revenues.
Our
warehouse credit facilities contain restrictions and covenants that, among
other
things, require us to satisfy financial, asset quality and loan performance
tests. If we fail to satisfy any of these covenants, we would be in
default under these agreements and our lenders could elect to declare all
amounts outstanding under the agreements to be immediately due and payable,
enforce their interests against collateral pledged under these agreements
and
restrict our ability to make additional borrowings. These agreements
also contain cross-default provisions, so that if a default occurs under
any one
agreement, the lenders under our other agreements could also declare a
default.
The
covenants and restrictions in our warehouse credit facilities may restrict
our
ability to, among other things:
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finance
loans which do not have specified attributes;
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reduce
our liquidity below minimum levels; and
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hold
loans for longer than established time
periods.
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These
restrictions may interfere with our ability to enter into other financing
arrangements or to engage in other business activities, such as selling new
types of loan products.
Our
warehouse financing is subject to margin calls based on our lender’s opinion of
the value of our collateral. Unanticipated margin calls could harm
our liquidity.
The
amount of financing we receive under our warehouse credit facilities depends
in
large part on our lenders’ valuation of the mortgage loans securing the
financings. Each credit facility provides the lender the right to
re-evaluate the loan collateral that secures our outstanding borrowings at
any
time. If the lender determines that the value of the collateral has
decreased, the lender has the right to initiate a margin call. A
margin call would require us to provide the lender with additional collateral
or
to repay a portion of our outstanding borrowings.
Any
significant change in the credit quality or fair market value of our loan
portfolio would have a significant effect on our financial position both
as to
profitability and cash flows, the amount of borrowings we can generate from
our
warehouse credit facilities, results of operations and our ability to securitize
or sell our loans. Declines in the fair market value of the mortgage
loans held as collateral under our warehouse credit facilities may subject
us to
margin calls. A substantial number of margin calls could cause us to
breach the required capital or other covenants under our warehouse credit
facilities. Any breach of this kind could trigger a default of our
other facilities under their respective cross-default provisions. Any
margin call could force us to redeploy our assets in a manner which may not
be
favorable to us, and if we are not able to satisfy a margin call, could result
in the loss of the related warehouse credit facility and cause a default
under
any other credit facility. As of September 30, 2007, we have
delivered $28.0 million of mortgage loans as additional collateral on $406.7
million of outstanding warehouse borrowings in response to margin calls by
our
warehouse providers.
To
date, we have been able to satisfy these margin calls from our existing
liquidity. However, we may be subject to increased margin calls in
the future, and may be unable to satisfy our obligations under these
calls.
Our
$60.0 million repurchase financing facility with Angelo, Gordon & Co., L.P.
(“Angelo Gordon”) requires the use of excess cash flows that we had heavily
relied upon in the recent past to help offset our operating costs to re-pay
the
facility.
In
August
2007, we entered into a $60.0 million repurchase facility (the “Repurchase
Facility”) financing transaction with Angelo Gordon to increase our available
liquidity. The Repurchase Facility is collateralized by our owner
trust certificates (or securitization certificates), which entitle the holder
to
receive the excess cash flow, if any, remaining in each payment period under
the
applicable securitization, after payments have been made in respect of the
asset-backed notes and certificates, the contractual servicing fee and other
fees, costs and expenses of administering the securitization
trust. Under the terms of the Repurchase Facility, the cash flows
from our securitization certificates will be applied to pay down the principal
of the Repurchase Facility. We are also obligated to make monthly
interest payments on the then-existing principal balance of the Repurchase
Facility. Although the Repurchase Facility has permitted us to
monetize the securitization certificates’ excess cash flows up to bolster our
liquidity, it has also eliminated, for now, our receipt of cash flows from
these
securitization certificates until the facility has been re-paid in
full. The elimination of these cash flows, upon which we have relied
heavily over the past several quarters to help offset our operating costs,
can
have a negative effect on our financial condition.
In
addition, the Repurchase Facility matures in 12 months, if not sooner
repaid. There can be no assurance that we will be able to repay the
Repurchase Facility at that time, if at all.
Our
success is dependent on leverage, which may create other
risks
.
Our
success is dependent, in part, upon our ability to maintain and grow our
assets
through the use of leverage. Leverage creates an opportunity for
increased net income, but at the same time creates risks. For
example, leveraging magnifies both positive and negative changes in our net
worth. If we are unable to borrow funds, we will not be able to
execute our business strategy and our results of operations, financial condition
and liquidity will be adversely affected
. In addition, there
can be no assurance that we will be able to meet our debt service obligations
and, to the extent that we cannot, our financial condition will
be
materially and adversely affected. Furthermore, if we were to
liquidate, our debt holders and lenders will receive a distribution of our
available assets before any distributions are made to our preferred or common
shareholders.
Risks
Related to Our Business Operations
We
may operate on a negative cash flow basis and may not have sufficient capital
resources to satisfy our fixed obligations and fund our
operations.
We
require substantial amounts of cash to fund our loan originations and
operations. We have operated on a negative cash flow basis at times
during the past several years. We utilize cash proceeds from our
securitizations, including our sales of net interest margin (“NIM”) trust
certificates, as well as cash generated from our sales of mortgage servicing
rights (“MSRs”) and whole-loan sales, to help offset the costs to originate our
loans. We cannot assure you, however, that we will be able to earn a
sufficient spread between our cost of funds and our average mortgage rates,
or
that we will be able to utilize optimal securitization structures (including
the
sale of NIM notes, Class N Notes or interest-only certificates or bonds),
or be
able to securitize at all or at terms favorable to us, to generate sufficient
revenues and cash flows to offset our current cost structure and cash uses
or
generate sufficient cash flow from whole-loan sales to offset the cost to
originate our loans. Furthermore, we cannot assure you that we will
be able to continue to originate a sufficient number of loans, which could
also
impact our ability to generate enough cash from securitizations, whole-loan
sales and net interest income to offset our costs in the future.
In
addition, we cannot assure you that we will generate positive cash flow in
future periods, or at all, or that we will have sufficient working capital
to
fund our operations, which includes substantial fixed costs. If we do
not have sufficient working capital, we may need to reduce the scope of our
operations and may not be able to satisfy our obligations as they become
due.
Our
profitability has recently declined, and we cannot assure you that we will
be
profitable in future periods.
We
reported net income of $777,000 for the three months ended June 30, 2007,
compared to net income of $7.2 million for the same period of
2006. We reported net income of $5.7 million for the six months ended
June 30, 2007, compared to net income of $13.8 million for the same period
of
2006. We expect to report a loss in the third quarter of 2007 related
to the tumultuous market conditions and the execution we received and the
manner
in which we structured our September 2007 securitization. We do not
expect to have the same profitability in the foreseeable future that we had
in
prior periods, and we may incur losses. Our profitability for the
current fiscal year will be adversely affected by the fact that our results
of
operations for the nine months ended September 30, 2007 will include losses
related to the structuring and execution of our September 2007 securitization,
as well as losses arising from our August 2007 staff reduction (approximately
300 employees) and branch closings (3 locations).
We
may be required to repurchase mortgage loans or indemnify investors if we
breach
representations and warranties in our mortgage loan sales
agreements.
In
connection with the sale and securitization of our loans, we are required
to
make customary representations and warranties regarding us and the
loans. We are subject to these representations and warranties for the
life of the loans and they relate to, among other things:
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compliance
with laws;
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regulations
and underwriting standards;
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the
accuracy of information in the loan documents and loan files;
and
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the
characteristics and enforceability of the
loans.
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A
loan
that does not comply with these representations and warranties may not be
saleable or saleable only at a discount. If the loan is sold before
we detect non-compliance with these representations, we may be obligated
to
repurchase the loan and bear any associated loss, or we may be obligated
to
indemnify the purchaser against that loss. We believe that we have
qualified personnel and have established controls to help ensure that all
loans
will be originated to the market’s requirements; however, we cannot provide any
assurance that we will succeed in doing so. We seek to minimize
losses from defective loans by correcting flaws if possible and then
securitizing, selling or re-selling these loans. We also create
allowances in our financial statements to provide for defective
loans. However, we cannot provide any assurance that losses
associated with defective loans will not harm our business, or that the
allowances in our financial statements will be sufficient to reflect the
actual
losses that we may incur.
We
typically finance borrowers with lower credit ratings relative to those who
would otherwise qualify for prime mortgage loans. This strategy may
hinder our ability to obtain financing and to continue securitizing loans
or
selling loans on attractive terms in the future.
We
market
a significant portion of our loans to borrowers who are either unable or
unwilling to obtain financing from traditional sources, such as commercial
banks, credit unions, savings and loans, savings banks, and government-sponsored
entities. This type of borrower is commonly referred to as a
sub-prime or non-conforming borrower. Loans made to non-conforming
borrowers may entail a higher risk of delinquency and loss than loans made
to
borrowers who use traditional financing sources. This fact may hinder
our ability to obtain financing and to continue securitizing loans or sell
loans
on attractive terms in the future. A borrower’s delinquency in making
timely mortgage loan payment will interrupt the flow of projected interest
income from the mortgage loans we hold and can ultimately lead to a borrower’s
loan default and a loss to us if the net realizable value of the real property
securing the mortgage loan is insufficient to cover the principal and interest
due on the loan. In addition, our cost of financing a delinquent or
defaulted loan is generally higher than for a performing loan. We
bear the risk of delinquency and default on loans beginning at the time of
origination. We continue to bear this risk until we sell these loans
and, thereafter, we continue to bear this risk if we sell the loans with
a
retained interest or if we securitize the loans. We also reacquire
the risk of delinquency and default for loans that we are obligated to
repurchase in connection with a securitization or a loan
sale. Repurchase obligations are typically triggered in loan sale
transactions if the first payment due to the buyer following the loan sale
is
made more than 30 days after it is due or in any sale or securitization if
the
loan is not in compliance with the representations and warranties we provided
in
our sale documents. Higher than anticipated loan delinquencies,
including underestimating the extent of losses that our loans may incur,
could
cause us to incur substantial loan repurchase obligations, limit our ability
to
sell or securitize additional loans and limit the cash flow from our
securitizations.
Historically,
we have experienced higher rates of delinquency on loans made to these
credit-impaired, non-conforming borrowers compared to delinquency rates
experienced by other financial companies on loans to borrowers who are not
credit impaired. While we use underwriting standards designed to
mitigate the higher credit risk associated with lending to these non-conforming
borrowers, our standards and procedures may not offer adequate protection
against the risk of default. In addition, any deterioration of
prevailing economic conditions, such as higher unemployment rates, may further
increase the risks inherent in making loans to these types of
borrowers.
We
may change or eliminate the types of loan products we offer, which could
reduce
our origination levels.
Since
the
second quarter of 2007, in response to prevailing market conditions, we made
substantial changes to our products, inc
luding increasing our mortgage
rates,
modifying our underwriting guidelines, and discontinuing certain loan
products. We may make similar or other changes to our products in the
future.
Any
change to or elimination of loan products we offer (including the states
we
choose to originate loans in) may have a significant effect on, including
without limitation, the amount of loans we originate, our cost to originate,
the
size of our securitizations, the credit ratings of our asset-backed securities,
the amount of loans we sell and our overall financial results. The
changes or eliminations may also affect our ability to securitize or sell
our
loans.
Declines
in the housing or real estate market could cause us to incur
losses.
The
leveling off or decline in the value of residential properties could have
a
significant impact on our origination levels or cause us to incur
losses. The increase in home prices (generally from 2001 through
2005) contributed to the growth in our origination volume, as well as reducing
the risk of losses by improving loan-to-value (“LTV”) or combined LTV (“CLTV”)
ratios. The slowing of home-price growth, or decline in values in
some markets over the past several quarters, could have a significant impact
on
our mortgage loan origination growth, as well as impact our prepayment speed
and
credit loss assumptions on the mortgage loans held for investment and the
corresponding allowance for loan losses. Furthermore, any further
material decline in real estate values would weaken our collateral and LTV
and
CLTV ratios and increase the possibility of loss if a borrower
defaults. In such an event, we would be subject to the risk of loss
on our mortgage assets arising from borrower defaults.
We
depend heavily on independent mortgage brokers for the origination of our
wholesale mortgage loans.
Approximately
50% or more of our loan production is sourced from independent mortgage
brokers. These independent mortgage brokers have relationships with
multiple lenders and are not obligated by contract or otherwise to do business
with us. For the six months ended June 30, 2007 and 2006, 53.6% and
54.0%, respectively, of our loan originations were originated through
independent mortgage brokers. We compete with other lenders for the
independent mortgage brokers’ business on the basis of pricing, service, loan
fees, costs and other factors. Competition from other lenders could
harm the volume and pricing of our wholesale loans, which could reduce our
loan
production.
We
have
faced intense competition in the non-conforming mortgage loan
industry. The level of competition may result in reduced loan
production, reduced net income or in revised underwriting standards, which
could
harm our business.
As
an
originator of mortgage loans, we have faced intense competition, primarily
from
diversified consumer financial companies and other diversified financial
institutions, mortgage banking companies, commercial banks, credit unions,
savings and loans, savings banks, mortgage REITs and other finance
companies. Compared to us, many of these competitors are
substantially larger than we are, have greater access to capital at a lower
cost
than we do, have substantially greater resources than we do and have a more
established market presence than we have. In addition, we have
experienced increased competition over the Internet, where barriers to entry
are
relatively low. Competition can take many forms, including lower
interest rates and costs to the borrower, less stringent underwriting standards,
convenience in obtaining a loan, customer service, the amount and term of
a loan
and more desirable or effective marketing and distribution
channels. Furthermore, the entrance of additional competitors
into our market could adversely affect the overall execution of our
securitizations as well as reduce the gains that we may realize in future
whole-loan sales. In addition, during some prior periods,
efficiencies in the asset-backed securities market have created a desire
for
larger transactions, giving companies with greater volumes of originations
a
competitive advantage.
If
our
competitors increase their marketing efforts, we may be forced to expand
our
marketing efforts, reduce the rates and fees we currently charge or change
our
underwriting guidelines in order to maintain and expand our market
share. Any reduction in our rates or fees, or any change to our
underwriting guidelines, could reduce our profitability or the likelihood
that
our loans will be repaid. Any expansion of our marketing efforts
could result in higher costs.
We
are subject to losses due to fraudulent and negligent acts on the part of
loan
applicants, mortgage brokers, other vendors and our
employees.
At
the
time we originate mortgage loans, we rely heavily upon information supplied
to
us by third parties, including the information contained in the loan
application, property appraisal, title information and employment and income
documentation. If any of this information is intentionally or
negligently misrepresented and we do not detect the misrepresentation prior
to
funding the loan, the value of the loan may be significantly lower than
expected. Whether any misrepresentation or fraudulent act is made by
the loan applicant, the mortgage broker, another third party or one of our
employees, we may bear the risk of loss. A loan subject to such
misrepresentation or fraud is typically unsaleable or subject to repurchase
by
us if it is sold by us prior to detection of the misrepresentation or
fraud. Even though we may have rights against persons and entities
who made or knew about the misrepresentation or fraudulent act, these persons
and entities are often difficult to locate, making it difficult to collect
any
monetary losses we may have suffered.
We
have
controls and processes that are designed to help us identify misrepresentations
from our borrowers, mortgage brokers, other vendors and our
employees. However, we cannot assure you that we have detected or
will detect all misrepresentations or fraud in our loan
originations.
Some
of our loan products may require payment adjustments during the term of the
mortgage loan that may result in increased payment defaults by borrowers
and
higher losses to us.
Some
of
our loan products require payment adjustments during the term of the mortgage
loan. This can result in payment defaults by borrowers who are
unprepared or unable to meet higher payment requirements. In
addition, some of our loan products do not amortize evenly and generally
enable
the borrower to pay a reduced principal and interest payment for the first
10
years that the loan is outstanding. These loan products, in addition
to possibly having increased payment defaults, also may result in higher
losses
to us due to higher principal balances outstanding at the time of a borrower
default than would be the case for a loan that amortizes evenly throughout
its
term.
A
significant decline in the volume of cash-out refinancings could
reduce
our
origination levels
.
To
date,
a significant source of our mortgage loan production volume has consisted
of
cash-out refinancings. The demand for these types of loans generally
decreases as interest rates rise or as market values of homes
decline. The rise in interest rates generally reduces the number of
borrowers who would otherwise qualify for or elect to pursue a cash-out
refinancing. Similarly, the decline in the market value of homes
reduces the amount of equity available to be borrowed against in a cash-out
refinance.
We
depend on key personnel and the continued ability to attract and retain
qualified employees, the loss of which could disrupt our operations and result
in reduced revenues.
The
success of our operations depends on the continued employment of our senior
management. If key members of our senior management were unable to
perform their duties or were to leave us, we may not be able to find capable
replacements, which could disrupt operations and result in reduced
revenues. We have entered into employment, change-in control and
non-competition agreements with some members of our senior management; however,
these individuals may leave us or compete against us in the
future. In addition, a court might not enforce the non-competition
provisions of these agreements.
Even
if
we retain our current employees, our management must continually recruit
talented professionals in order to grow our business. These
professionals must have skills in business strategy, marketing, sales, finance
and underwriting loans. Moreover, we depend, in large part, upon our
wholesale account executives and retail loan analysts to attract borrowers
by,
among other things, developing relationships with financial institutions,
other
mortgage companies and brokers, real estate agents, borrowers and
others. The market for these skilled professionals is highly
competitive and may lead to increased hiring and retention costs. The
morale of our current employees may have been adversely affected by our August
2007 workforce reduction, in which we eliminated approximately 20% of our
workforce; these reductions could potentially impact our personnel’s performance
or their willingness to remain with us. An inability to attract,
motivate and retain qualified professionals could disrupt our operations
and
limit our growth.
Any
disruption to our Click and Close
®
system
could disrupt our
operations, expose us to litigation and require expensive investments in
alternative technology.
We
are
highly dependent upon our Click and Close
®
proprietary software to originate our mortgage loans. Any disruption
to this software would substantially curtail our ability to originate new
loans. The costs to replace this system may be extremely
large.
An
interruption in or breach of our information systems may result in lost
business.
We
rely heavily upon
communications and information systems to conduct our business. Any
failure or interruption or breach in security of our information systems
(including communication and computer systems) or the third party information
systems on which we rely could cause underwriting or other delays and could
result in fewer loan applications being received, slower processing of
applications and reduced efficiency in loan
servicing.
Additionally, in connection with our loan file due
diligence reviews, we have access to the personal financial information of
the
borrowers, which is highly sensitive and confidential, and subject to
significant federal and state regulation. If a third party were to
misappropriate this information, we potentially could be subject to both
private
and public legal actions. Our policies and safeguards may not be
sufficient to prevent the misappropriation of confidential information, or
prevent us from violating existing federal or state laws or regulations
governing privacy, or those laws or regulations that may be adopted in the
future.
Despite
our efforts to maintain Internet security, we may not be able to stop
unauthorized attempts to gain access to, or disrupt communications with,
our
brokers and our customers. Specifically, computer viruses, break-ins
and other disruptions could lead to interruptions, delays, and loss of data
or
the inability to accept and confirm the receipt of information. Any
of these events could substantially damage our reputation. We cannot
assure you that our current technology or future advances in this technology
or
other developments will be able to prevent security breaches. We may
need to incur significant costs or employ other resources to protect against
the
threat of security breaches or to alleviate problems caused by these
breaches.
The
success, growth and competitiveness of our business will depend upon our
ability
to adapt to and implement technological changes.
The
intense competition in the non-conforming mortgage industry over the past
several years has led to rapid technological developments, evolving industry
standards and frequent releases of new products and enhancements. As
mortgage products are offered more widely through alternative distribution
channels, such as the Internet, we may be required to make significant changes
to our current wholesale and retail structure and information systems to
compete
effectively. The origination process is becoming more dependent upon
technological advancement, such as the ability to process applications over
the
Internet, accept electronic signatures, process status updates instantly
and
other conveniences that customers may expect. Implementing this new
technology and becoming proficient with it may also require significant capital
expenditures. Our inability to continue enhancing our current
Internet capabilities, or to adapt to other technological changes in the
industry, could reduce our ability to compete.
Unpredictable
delays or difficulties in the development of new loan products or loan programs
can harm our business.
We
and
our competitors often seek to develop new loan products and programs to gain
a
competitive advantage in the marketplace. New loan products and
programs can have the effect of obtaining more business in the wholesale
channel
from mortgage brokers and/or in the retail channel directly with consumers,
by
providing greater flexibility and more alternatives to meeting borrowers’
needs. Any unpredictable delays or difficulties in developing and
introducing new loan products or programs can result in the loss of business
to
competitors.
Our
use of Insured Automated Valuation Models (“Insured AVMs”) in lieu of appraisals
could increase our losses.
We
use
Insured AVMs in lieu of appraisals for certain mortgage loans we originate
(totaling approximately 13.9% and 14.1% of our total loan production during
the
three and six months ended June 30, 2007, respectively). An Insured
AVM is the coupling of a third-party valuation estimate and insurance on
that
value. The third-party AVM providers have created computer programs
that use relevant real estate information, such as sales prices, property
characteristics and demographics, to calculate a value for a specific
property. Public records are the primary data source for an AVM, and
the quality of the values that they generate varies depending upon the data
they
use and their design. AVMs are complex programs incorporating a
variety of forecasting techniques. The different methodologies,
algorithms and variables used by the third-party AVM providers may vary greatly
and affect their reliability and accuracy.
One
of
the weaknesses in using an AVM to value a property is the lack of a physical
exterior or interior inspection of the property. To mitigate some of
this inherent weakness, we require a property condition report to be completed
for each AVM considered for use. A property condition report is a
limited physical external inspection of the property. There can be no
assurance, however, that these property inspections will uncover all potential
issues with a property that a full appraisal might uncover.
At
the
closing of the loan, we purchase insurance that insures the value of the
property. In the event the borrower defaults upon their loan,
resulting in the liquidation of the property, the insurance company may have
to
pay a portion of any losses incurred by the applicable securitization trust
resulting from incorrect values. However, there can be no assurance
that the securitization trust will be able to collect any insurance in the
event
of a loss, which would affect the interest income we earn from that
trust.
Current
loan performance data may not be indicative of future
results.
When
making capital budgeting and other decisions, we use projections, estimates
and
assumptions based on our experience in the mortgage lending
industry. Actual results and the timing of certain events could
differ materially in adverse ways from those projected, due to factors including
changes in general economic conditions, real estate values, interest rates,
mortgage loan prepayment rates and in losses due to defaults on mortgage
loans. These differences and fluctuations could rise to levels that
may adversely affect our profitability and financial condition.
If
we make any acquisitions, we will incur a variety of costs and may never
realize
the anticipated benefits, which can harm our business.
If
appropriate opportunities become available, we may attempt to acquire businesses
that we believe are a strategic fit with our business. We currently
have no agreements to consummate any acquisitions. If we pursue any
transaction, the process of negotiating the acquisition and integrating an
acquired business may result in operating difficulties and expenditures,
and may
require significant management attention that would otherwise be available
for
ongoing development of our business, whether or not the relevant transaction
is
ever consummated. Moreover, we may never realize the anticipated
benefits of any acquisition. Future acquisitions could result in
potentially dilutive issuances of equity securities, the incurrence of debt,
contingent liabilities and/or the recording of goodwill and other intangible
assets, which could increase our expenses.
If
any of our assumptions used to determine the fair value of our stock-based
awards change significantly, future share-based compensation expense may
differ
materially from that recorded currently.
In
2006
we adopted
Statement of Financial
Accounting Standards (“SFAS”)
No. 123(R), “Share-Based Payment,” which
required us to measure compensation cost for stock awards at fair value and
recognize compensation over the service period in which the awards are expected
to vest. The determination of compensation cost requires us to make
many assumptions regarding volatility, expected option life and forfeiture
rates. In addition, changes in our stock price or prevailing interest
rates will also impact the determination of fair value and compensation
cost. If any of our assumptions used to determine fair value change
significantly, future share-based compensation expense may differ materially
from the amounts that we currently record.
We
are subject to risks in connection with the level of our allowance for loan
losses.
A
variety
of factors could cause our borrowers to default on their loan payments and
the
collateral securing such loans to be insufficient to pay any remaining
indebtedness. In such an event, we could experience significant loan
losses. Our provision for loan losses increased to $13.3 million for
the three months ended June 30, 2007, compared to $7.0 million for the three
months ended June 30, 2006.
In
the
process of originating a loan, we make various assumptions and judgments
about
the ability of the borrower to repay it, based on the creditworthiness of
the
borrower and the value of the real estate, among other factors. We
establish an allowance for loan losses through an assessment of probable
losses
in our loan portfolio. Several factors are considered in this
process, including historical and projected default rates and loss
severities. If our assumptions and judgments regarding these matters
are incorrect, our allowance for loan losses might not be sufficient, and
additional loan loss provisions might need to be made. Depending on
the amount of such loan loss provisions, the adverse impact on our earnings
could be material.
If
the total amount of excess inclusion income exceeds our regular taxable income,
our liquidity would be impacted as our cash payments for federal income taxes
would exceed the amount that would otherwise be required.
A
portion
of the income we received from our ownership interests in a “REMIC”
securitization is referred to as “excess inclusion” Income. In
addition, all or a portion of the dividends we receive from our REIT subsidiary
is considered excess inclusion income, resulting from the subsidiary’s ownership
of the securitization trusts, which are classified as a taxable mortgage
pool. With limited exceptions, excess inclusion income is always
subject to tax because it cannot be offset by other deductions or by net
operating losses.
Our
previous financial statements are not indicative of our future financial
results.
Our
most recent securitization,
completed in September 2007, was completed on materially less favorable terms
to
us than our other recent securitizations.
In addition, we structured
the
securitization transaction to be accounted for as a sale, and not a financing,
as we have with other securitizations since 2004. We also sold the
residual interest in that securitization to a third party for a cash purchase
price. We expect to incur a loss in the third quarter of 2007 with
respect to this transaction, and in light of the aforementioned significant
market disruption that has occurred throughout the third quarter of
2007.
In
March
2004, we began using a securitization structure that we account for as a
secured
financing, also known as portfolio accounting. Portfolio accounting
recognizes the related revenue as net interest income over the life of the
securitized loans. In contrast, our prior securitization structures
required us to record virtually all of the income received upfront as a gain
on
sale of mortgage loans. We structured all of our 2006, 2005 and 2004
securitizations (as well as those throughout 2007, other than our September
2007
securitization) as secured financings and plan to continue to utilize this
structure, and portfolio accounting, for our future securitization
transactions. As a result, income that would have otherwise been
recognized upfront as gain-on-sale revenue at the time of a securitization
is
now typically recognized over the life of the loans.
As
a
result of these changes, our results of operations during the six months
ended
June 30, 2007 and the years ended December 31, 2006, 2005 and 2004 were recorded
on a basis that is substantially different from years prior to
2004. We recorded increased quarterly income during 2006, as compared
to the same quarter in 2005. The increasing trend in same quarter
over same quarter income we experienced from the first quarter of 2004 through
the fourth quarter of 2006 largely reflects the time it took to build our
loan
portfolio to a size that generated sufficient net interest income to offset
our
operating expenses. Accordingly, our financial statements from years
prior to 2004, and to a certain extent in 2004 and 2005 when we started building
up our loan portfolio, will be of limited use to you in evaluating our
performance in future periods. Likewise, because we structured our
September 2007 securitization as a sale and further sold the residual interest
for cash, our third quarter 2007 results will be substantially different
than
the past several quarters and may be of limited use to you in evaluating
our
performance in future periods.
Risks
Related to Our Financing Activities
We
are exposed to contingent risks and liabilities related to all of the loans
we
originate and either securitize or sell.
We
have
the following contingent risks with respect to loans that we originate and
either securitize or sell:
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We
retain some degree of credit risk on all loans we originate or
purchase
during the period of time that we hold loans before securitization
or
sale. This credit risk includes the risk of borrower default,
the risk of foreclosure and the risk that an increase in interest
rates
would result in a decline in the value of our loans to potential
purchasers.
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Our
securitizations generally require the use of the excess cash flow
distributions related to the owner trust certificates to accelerate
the
amortization of the securities balances relative to the amortization
of
the mortgage loans held by the trust, up to specified
over-collateralization (“O/C”) limits. The resulting O/C serves
as credit enhancement for the related securitization trust and,
therefore,
is available to absorb losses realized on loans held by that
securitization trust. Generally, the form of credit enhancement
entered into in connection with securitization transactions contains
limits on the delinquency, default and loss rates on the loans
included in
each securitization trust. If at any measuring date, the
delinquency, default or loss rate with respect to any trust exceeds
the
specified delinquency, default and loss rates, excess cash flow
from the
securitization trust, if any, would be used to fund the increased
O/C
limit instead of being distributed to the holder of the owner trust
certificate. For those securitizations where we hold the owner
trust (or similar) certificate, which includes all securitizations
since
the beginning of 2004 (other than the September 2007 securitization),
such
an occurrence would reduce our cash flow.
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When
we sell or finance mortgage loans, either through securitization
or on a
whole-loan basis, we make standard representations and warranties
regarding these loans and may be required to repurchase mortgage
loans
that are not in compliance with any one or more of these representations
and warranties. In addition, in the past, we also have sold
loans and/or pools of loans directly to commercial banks, consumer
finance
companies and accredited investors. In general, we sold these
pools of loans or individual loans with recourse, in which case
we are
obligated to repurchase any loan upon default and to acquire the
related
mortgage loan. This obligation is subject to various terms and
conditions, including, in some instances, a time limit. At June
30, 2007, we had reserved $115,000 in potential losses against
$343,000 in
aggregate principal amount of loans sold subject to future repurchase
should these loans meet the default provisions.
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A
decline in the quality of servicing could reduce our ability to sell or
securitize loans.
In
May
2001, we transferred our servicing portfolio to Ocwen Federal Bank FSB, a
subsidiary of Ocwen Financial
Corporation
and a
related predecessor entity to Ocwen Loan Servicing, LLC, which presently
services our loan portfolio.
Poor servicing by Ocwen Loan
Servicing, LLC (or its parent or subsidiaries) or any other third-party servicer
who services the loans we originate could harm our ability to sell or securitize
loans. Additionally, regulatory actions and class action lawsuits
against these servicers could harm the value of our securitized loans and
our
ability to sell or securitize loans. Ocwen Financial Corporation and
several of its affiliates have been named as defendants in a number of purported
class action lawsuits that challenge its servicing practices under applicable
federal and state laws. In addition, according to its public filings,
Ocwen Financial Corporation and its affiliates maintain high levels of
indebtedness.
Ocwen
Financial
Corporation, a non-investment grade company, terminated its banking subsidiary’s
status as a federal savings bank under supervision of the Office of Thrift
Supervision (“OTS”) and Federal Deposit Insurance Corporation (“FDIC”) and has
obtained necessary licensing at the state and local level. If Ocwen
Financial Corporation's operations are impaired as a result of litigation,
governmental investigations, its inability to repay its indebtedness when
due,
or further degradation of its capitalization or credit rating, our profitability
and operations may be harmed.
Risks
Related to Economic Factors, Market Conditions and Other Factors Beyond Our
Control
The
mortgage loans we originate are generally considered subprime mortgage loans,
and it is possible that we, due to our substantial economic exposure to the
subprime mortgage market, for financial or other reasons, may not be capable
of
repurchasing or providing a substitute mortgage loan for any defective mortgage
loans we previously securitized or sold.
Recently,
numerous residential mortgage
loan companies that originate subprime mortgage loans have experienced serious
financial difficulties and, in some cases, bankruptcy. Those
difficulties have resulted in part from declining markets for mortgage loans
as
well as from claims for repurchases of mortgage loans previously sold for
breaches of the representations and warranties made on the mortgage loans,
such
as fraud claims.
We cannot assure you that we will not face
similar circumstances in the future.
Recent
bankruptcies, and regulatory and legal actions affecting the subprime sector
may
cause our loans to be viewed as less desirable for
securitization.
Our
ability to securitize or sell certain of the mortgage loans we originate
depends
upon the acceptance of those products by various parties in the market,
including, among others, underwriters or purchasers of our asset-backed
securities, rating agencies, bond insurers and/or whole-loan
purchasers. Any one of these or other parties may determine that
certain of the loan products that we originate (now or in the future) are
undesirable or problematic, which can make it more difficult to securitize
these
loans or sell them at a price and on other terms acceptable to us in the
future. Our inability to securitize or sell certain types of loan
products may cause us to retain these loans in our portfolio, which may have
an
adverse impact on our cash position or generate losses, or sell them at a
significant discount, which may generate losses and adversely affect our
cash
flows.
Changes
in ratings or rating methodology by rating agencies may adversely impact
our
liquidity.
Each
of
our securitizations includes a series of asset-backed securities with various
credit ratings.
Unexpected changes
in ratings or rating methodology by the rating agencies (
S&P,
Moody's, Fitch and/or DBRS)
on our
newly
issued or existing securitization transactions may have an adverse
impact on our cash position and may affect the prices we receive on all or
certain portions of the asset-backed securities we issue.
The required O/C and sizing
of each
rated class of asset-backed securities
being offered are generally
determined
solely by the rating agencies
, which may make determinations that are
adverse to our interests. For example, as a result of recent
conditions within the sub-prime mortgage industry, rating agencies have begun
to, and may continue to in the future, require additional credit enhancement
to
support the securities sold in securitizations of sub-prime mortgage
loans. This requirement generally has the effect of reducing the
proceeds we may receive from, and increasing the overall expense of executing
securitizations. The rating agencies that rate subprime
securitizations have also recently increased reserve requirements, the magnitude
of which was unanticipated, which may affect the amount of proceeds we can
expect to receive in any future securitizations.
Interest
rate fluctuations may reduce our loan origination volume, increase our
prepayment, delinquency, default and foreclosure rates, and reduce the value
of
and income from our loans.
One
of
our primary market risks is interest rate risk. Our profitability may
be directly affected by the level of, and fluctuation in, interest rates,
which
affects our ability to earn a spread between the interest received on our
loans
and the cost of our borrowings, which are tied to various interest rate swap
maturities, commercial paper rates and the
London
Inter-Bank
Offered Rate (“LIBOR”)
. Our profitability is likely to be
harmed during any period of unexpected or rapid changes in interest
rates. A substantial and sustained increase in interest rates could
harm our ability to originate loans, because refinancing an existing loan
would
be less attractive to the borrower, and qualifying for a loan may be more
difficult for the borrower.
Risks
Associated
with Increased Interest Rates.
Some of the risks we face
relating to an increase in interest rates are:
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reduced
customer demand for our mortgage loan products;
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higher
delinquency and default rates on the adjustable-rate mortgage loans
that
we have originated;
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reduced
profitability on future securitizations due to wider investor spread
requirements or increased over-collateralization requirements for
securities issued in securitizations;
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increased
cost of funds on our warehouse credit financings or other corporate
borrowings, which may result in a reduced spread between the rate
of
interest we receive on loans and the interest rates we must pay
under our
credit facilities; and
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limited
access to borrowings in the capital
markets.
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Risks
Associated
with Lower Interest Rates.
A
decline
in market interest rates generally induces borrowers to refinance their loans,
and could reduce our long-term profitability. Because consumers in
the United States have recently experienced a prolonged period of low interest
rates (predominantly in late 2001 through mid-2004), many borrowers have
already
refinanced their existing debt, which could reduce the pool of borrowers
interested in our mortgage products. Furthermore, a material decline
in interest rates could increase the level of loan prepayments, which in
turn
could decrease the amount of collateral underlying our securitizations, and
cause us to earn less income in connection with these loans over
time.
Risks
Associated
with Fluctuating Interest Rates.
Periods
of unexpected or rapid changes in interest rates, and other volatility or
uncertainty regarding interest rates, also can harm us by increasing the
likelihood that asset-backed investors will demand higher than normal spreads
to
offset that volatility or uncertainty. In that event, the net
interest spread we can expect to receive from our securitized assets would
decrease.
Fluctuating
interest rates may affect the net interest income we earn, based upon the
difference between the yield we receive on loans held pending whole-loan
sale or
pre-securitization and the interest that we pay for funds borrowed under
our
warehouse credit facilities. A change in interest rates could reduce
the spread between the average coupon rate on fixed rate loans and the weighted
average pass-through rate paid to investors on the securities issued in
connection with a securitization. Although the average loan coupon
rate is fixed at the time the loan is originated, the pass-through rate to
investors in a securitization is not fixed until the pricing of the
securitization, which occurs shortly before our sale of the loans to the
securitization trust. Therefore, if the market rates required by
investors increase prior to securitization of the loans, the spread between
the
average coupon rate on the loans and the pass-through rate to investors may
be
reduced or eliminated, which would reduce or eliminate our net interest income
from our on-balance sheet loan portfolio. A portion of our
asset-backed securities are priced based on one-month LIBOR, but the collateral
that backs these securities is comprised of mortgage loans with either fixed
interest rates or “hybrid” interest rates — that is, fixed for the initial two
or three years of the mortgage loan, and adjusting afterwards every six months
thereafter. As a result, the cash flows that we receive from these
securitized mortgage loans are dependent upon the interest rate
environment. This is because “basis risk” exists between the assets
and liabilities of the securitization trusts that we create. For
example, the interest costs for that portion of our asset-backed securities
that
are priced on one-month LIBOR bears interest at a floating rate. As a
result, each month the interest rate received by the security holders will
adjust upwards or downwards as interest rates change. Therefore, as
interest rates rise, the spread we earn on these assets will fall, and as
interest rates fall, the spread we earn on these assets will
rise. The decrease in the interest rate spread we earn as a result of
rising interest rates will reduce our cash flow and harm our
profitability.
Our
hedging strategies may not be successful in mitigating our risks associated
with
interest rates.
Although
we may seek to mitigate or offset our exposure to interest rate risks by
using
various hedging strategies, including interest rate swaps and/or “corridors”
(corresponding purchase and sale of interest rate caps with similar notional
balances at different strike prices), these hedging strategies may not be
effective and involve risk. There have been periods, and it is likely
that there will be periods in the future, during which we will incur losses
after accounting for our hedging strategies. The hedging strategies
we select may not have the effect of reducing our interest rate
risk. In addition, the nature and timing of our hedging transactions
could actually increase our risk and losses. In addition, hedging
strategies involve transaction costs and other costs. Our hedging
strategies and the derivatives that we may use may not adequately mitigate
or
offset the risk of interest rate volatility, and our hedging transactions
may
result in losses.
Our
business may be harmed by economic difficulties in the eastern United States,
where we conduct a significant amount of our business.
We
lend
primarily to borrowers that secure their obligations to us with real property
located in the eastern half of the United States. Accordingly, an
economic downturn in the eastern half of the United States could negatively
impact our ability to meet our origination targets or harm the performance
of
our existing on-balance sheet loan portfolio.
An
economic slowdown or recession could cause us to experience losses, including
increasing delinquencies, decreasing real estate values and increasing
foreclosures on our loans.
Periods
of economic slowdown or recession may be accompanied by decreased demand
for
consumer credit, declining real estate values and an increased rate of
delinquencies, defaults and foreclosures, and may harm our
business. In the mortgage business, any material decline in real
estate values reduces the ability of borrowers to use the equity in their
homes
to support borrowings and increases the loan-to-value ratios of loans we
previously made. These factors weaken collateral coverage and
increase the possibility of a loss on the loan if a borrower
defaults. Delinquencies, foreclosures and losses on mortgage loans
generally increase during economic slowdowns or recessions. However,
delinquencies, foreclosures and losses on mortgage loans also have increased
during periods of economic growth. As a result, we cannot assure you
that any delinquencies, foreclosures and losses will not increase in the
future.
Because
of our focus on non-conforming credit-impaired borrowers in the home equity
loan
market, the actual rates of delinquencies, foreclosures and losses on the
loans
we hold is likely to be higher under adverse economic conditions than
delinquencies, foreclosures and losses currently experienced in the mortgage
loan industry in general. We are particularly subject to economic
conditions in the northeastern United States, where approximately 39.6% and
41.5% of our loans were originated during the three and six months ended
June
30, 2007, respectively. Any sustained period of increased
delinquencies, foreclosures, losses or increased costs could reduce our ability
to sell, and could increase the cost of selling, loans through securitization
or
on a whole loan basis. Any sustained increase in delinquencies,
defaults or foreclosures is likely to increase losses and harm the pricing
of
our future securitizations and whole-loan sales as well as our ability to
finance our loan originations.
Geopolitical
risks may harm our business.
Geopolitical
risks, such as terrorist attacks in the United States or other parts of the
world, conflicts involving the United States or its allies, or military or
trade
disruptions, may harm our business. These types of events could
cause, among other things, the delay or cancellation of plans to finance
a
mortgage with us on the part of our customers or potential customers, or
could
negatively impact the capital markets and the asset-backed market in
particular. Any of these events could cause business and consumer
confidence and spending to decrease further, resulting in increased volatility
in the United States and worldwide financial markets and potentially an economic
recession in the United States and internationally, which could harm our
business.
Additionally,
the economic impact of the United States’ military operations in Afghanistan,
Iraq and other countries, as well as the possibility of any terrorist attacks
in
response to these operations, is uncertain, but could have a material adverse
effect on general economic conditions, consumer confidence and market
liquidity. No assurance can be given as to the effect of these events
on consumer confidence and the performance of our mortgage
loans. United States military operations also may increase the
likelihood of shortfalls under the Servicemembers Civil Relief Act or similar
state laws, which provide for reduced interest payments for members of the
armed
forces while on active duty.
Natural
disasters may harm our business, causing us to experience losses, and increasing
delinquencies and foreclosures on our loans.
Natural disasters may adversely affect the performance of mortgage loans
in a
variety of ways, including but not limited to, impacting borrowers’ abilities to
repay their loans, displacing the homeowners due to severe damage to the
properties, and decreasing the value of the mortgaged property, which may
result
in increased losses to us. Additionally, claims for insurance
recoveries may be disputed if insured parties and their insurers disagree
in
their assessments or type of insurable damage, causing the timing and receipt
of
insurance payments for damages to be delayed or made at amounts lower than
expected, if at all. We may not be able to readily determine the
particular nature of such economic effects, how long any of these effects
may
last, or the impact on the performance of mortgage loans affected by the
natural
disaster.
Risks
Related to Laws, Regulations and Legal Actions
The
scope of our business exposes us to risks of noncompliance with an increasing
and, in some cases, inconsistent body of complex laws, rules and regulations
at
the federal, state and local levels.
We
must
comply with the laws, rules and regulations, as well as judicial and
administrative decisions, in all of the jurisdictions in which we are licensed
to originate mortgage loans, as well as an extensive body of federal laws,
rules
and regulations. Moreover, our lending business is subject to
extensive government regulation, supervision and licensing requirements by
various state departments of banking or financial services, and the cost
of
compliance with such regulations may hinder our ability to operate
profitably. Also, individual cities and counties have begun to enact
laws that restrict non-conforming loan origination activities in those cities
and counties. The laws, rules and regulations of each of these
jurisdictions are different, complex and, in some cases, in conflict with
each
other. As new laws, rules and regulations are added or amended, it
may be more difficult to comprehensively identify, accurately interpret,
properly program our technology systems and effectively train our personnel
with
respect to all of these laws, rules and regulations. Our inability to
properly manage regulatory compliance could increase our potential exposure
to
the risks of noncompliance with these laws, rules and regulations.
Our
failure to comply with these laws, rules and regulations may lead
to:
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civil
and criminal liability, including potential monetary
penalties;
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loss
of state licenses or other approved status required for continued
lending
operations;
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legal defenses
delaying or otherwise harming the servicers’ ability to enforce loans, or
giving the borrower the right to rescind or cancel the loan transaction,
or remove the
security
interest in the property;
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demands
for indemnification or loan repurchases from purchases of our
loans;
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difficulty
in securitizing or selling our mortgage loans;
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our
choosing or being forced to severely limit, or even cease our lending
activities in a particular area;
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class
action lawsuits; or
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administrative
enforcement actions.
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Any
of
these results could harm our business.
Compliance
with a variety of potentially inconsistent federal, state and local laws,
rules
and regulations has increased our compliance costs, as well as the risk of
litigation or administrative action associated with complying with these
proposed and enacted federal, state and local laws, particularly those aspects
of proposed and enacted laws that contain subjective requirements, with which
it
may be difficult to ensure compliance. In addition, federal, state
and local laws, rules and regulations could impact over-collateralization
requirements set by the rating agencies, which could decrease the cash proceeds
we may receive from our securitizations. In some cases, rating
agencies may refuse to rate securitization transactions that contain loans
covered by laws, rules and regulations that they determine create too much
risk
or uncertainty.
The
federal government and many states and local municipalities have adopted
and/or
are considering adopting laws that are intended to further regulate our
industry. We anticipate that the level of regulatory activity at the
federal and state level is likely to increase in the short term, in light
of
higher defaults and reports of unprecedented numbers of U.S. consumers at
risk
to lose their homes. Many of these laws and regulations seek to
impose broad restrictions on certain commonly accepted lending practices,
including some of our practices.
If
we do not comply with the Federal Truth-in-Lending Act (“TILA”), aggrieved
borrowers could have the right to rescind their loans.
TILA
and
Regulation Z under TILA contain disclosure requirements designed to provide
consumers with uniform and understandable information regarding the terms
and
conditions of loans and credit transactions in order that consumers may compare
proposed credit terms. TILA also guarantees consumers a three-day
right to cancel certain loan transactions and imposes specific loan feature
restrictions on some loans, including the type of loans that we
originate. If we do not comply with these requirements, in addition
to fines and penalties, aggrieved borrowers could have the right to rescind
their loans or to demand, among other things, the return of finance charges
and
fees paid to us at the time of the loan, as well as statutory, actual and
other
damages.
If
we do not comply with Regulation X under the Real Estate Settlement Procedures
Act (“RESPA”), we could be subject to substantial fines and potential
limitations upon future business activities.
We
also
are subject to the RESPA, and Regulation X under RESPA. These laws
and regulations, which are administered by
the Department
of
Housing and Urban Development, (“HUD”)
, impose limits on the amount of
funds a lender can require a borrower to deposit in any escrow account for
the
payment of taxes, insurance premiums or other charges; limits the types of
fees
which may be paid to third parties; and imposes various disclosure requirements
on the lender. If we do not comply with these requirements, we could
be subject to refunding unearned fees, imposition of substantial fines and
potential limitations upon future business activities.
The
increasing number of federal, state and local “anti-predatory” lending laws may
restrict our ability to originate, or increase our risk of liability with
respect to, some types of mortgage loans and could increase our cost of doing
business.
In
recent
years, several federal, state and local laws, rules and regulations have
been
adopted, or are under consideration for adoption, that are intended to eliminate
so-called “predatory” lending practices. These laws, rules and
regulations impose restrictions on mortgage loans on which certain points
and
fees, interest rate, or the annual percentage rate (“APR”) exceed specified
amounts. Some of these restrictions expose lenders to risks of
litigation and penalties no matter how carefully a loan is
underwritten. In addition, an increasing number of these laws, rules
and regulations seek to impose liability for violations on purchasers of
loans,
regardless of whether a purchaser knew of or participated in the violation.
It
is against our policy to engage in predatory lending practices.
In May
2007, the
U.S. Federal Reserve Board announced that it would hold hearings to consider
new
regulations in the subprime mortgage sector, and the U.S. Congress has also
announced that it is conducting hearings to consider new legislation as
well. Other federal regulatory agencies have introduced guidance
restricting certain products offered by depository institutions that state
banking regulators may adopt and require non-depository mortgage lenders
to
follow as well. As the result of these laws, we may choose to
severely limit, or even cease, our lending activities in particular
jurisdictions. In addition, we may find it difficult, if not
impossible, to sell or securitize loans since purchasers and secondary market
participants may be reluctant to risk such liability.
We
have
decided not to originate loans that exceed the interest rate, APR or “points and
fees” thresholds of these laws, rules and regulations, because the companies
that buy our loans and/or provide financing for our loan origination operations
generally do not want to buy or finance those types of loans. The
continued enactment of these laws, rules and regulations may prevent us from
making these loans and may cause us to reduce the interest rate, APR or the
points and fees on loans that we do make. In addition, the difficulty
of managing the risks presented by these laws, rules and regulations may
decrease the availability of warehouse financing and the overall demand for
non-conforming loans, making it difficult to fund, sell or securitize any
of our
loans. If we decide to originate loans that are subject to these
laws, rules and regulations, we will be exposed to greater risks for actual
or
perceived non-compliance with them. This could lead to demands for
indemnification or loan repurchases from our lenders and loan purchasers,
class
action lawsuits, increased defenses to foreclosure of individual loans in
default, individual claims for significant monetary damages and administrative
enforcement actions. In any event, the growing number of these laws,
rules and regulations will increase our cost of doing business as we are
required to develop systems and procedures to ensure that we do not violate
any
aspect of these requirements.
We
are no longer able to rely on the Federal Alternative Mortgage Transactions
Parity Act (“Parity Act”) to preempt certain state law restrictions on
prepayment penalties, which could harm our business.
The
value
of a mortgage loan depends, in part, upon the expected period of time that
the
mortgage loan will be outstanding. If a borrower pays-off a mortgage
loan in advance of this expected period, the holder of the mortgage loan
does
not realize the full value expected to be received from the loan. A
prepayment penalty payable by a borrower who repays a loan earlier than expected
helps offset the reduction in value resulting from the early
pay-off. Consequently, the value of a mortgage loan is enhanced to
the extent the loan includes a prepayment penalty, and a mortgage lender
can
offer a lower interest rate and/or lower loan fees on a loan which has a
prepayment penalty. Prepayment penalties are an important feature to
obtain value on the loans we originate.
Several
state laws restrict or prohibit prepayment penalties on mortgage loans, and
we
have relied on the federal Parity Act and related rules issued in the past
by
the OTS, to preempt state limitations on prepayment penalties for certain
types
of loans. The Parity Act was enacted to extend to financial
institutions, other than federally chartered depository institutions, the
federal preemption that federally chartered depository institutions
enjoy. However, in September 2002, the OTS released a new rule that
reduced the scope of the Parity Act preemption. As a result, since
July 1, 2003, we have no longer been able to rely on the Parity Act to preempt
state restrictions on prepayment penalties and have been required to comply
with
state restrictions on prepayment penalties. We believe that these
restrictions prohibit us from charging any prepayment penalty in eight states
and restrict the amount or duration of prepayment penalties that we may impose
in an additional 14 states. This may place us at a competitive
disadvantage relative to financial institutions that will continue to enjoy
federal preemption of these state restrictions. These institutions
will be able to charge prepayment penalties without regard to state restrictions
and, as a result, may be able to offer loans with interest rates and loan
fee
structures that are more attractive than the interest rates and loan fee
structures that we are able to offer. In addition, the lack of
prepayment penalties on loans could harm our ability to complete securitizations
and NIM transactions.
We
are a defendant in litigation relating to consumer lending practices, including
class actions, and we may not prevail in these matters.
We
are a
defendant in several class action lawsuits that are pending in courts in
the
states of New York and Illinois. These actions allege that we engaged
in improper practices in connection with our origination of mortgage loans,
including fraud, unjust enrichment, charging improper fees and making firm
offers under the fair credit reporting act. These actions generally
seek unspecified compensatory damages, statutory damages, punitive damages
and
the return of allegedly improperly collected fees. It is difficult to
predict how these matters will be ultimately determined. We believe
that we have meritorious defenses to these actions, and we intend to vigorously
defend these actions. However, an adverse judgment in any of these
matters could require us to pay substantial amounts.
Changes
in the mortgage interest deduction could decrease our loan production and
harm
our business.
Members
of Congress and government officials have from time to time suggested the
elimination of the mortgage interest deduction for federal income tax purposes,
either entirely or in part, based on borrower income, type of loan or principal
amount. The competitive advantages of tax deductible interest, when
compared to alternative sources of financing, could be eliminated or seriously
impaired by this change. Accordingly, the reduction or elimination of
these tax benefits could reduce the demand for our mortgage loans.
The
“Do Not Call Registries” administered by federal and state authorities, and
other regulations affecting our telemarketing activities could reduce our
loan
production, increase our costs, or result in claims and/or
penalties.
To
date,
a substantial portion of our retail loans have been generated through
telemarketing. The federal “Do Not Call Registries” and similar
registries that various state authorities may now or in the future administer,
along with federal and state telemarketing laws, rules and regulations
restricting the means, methods and timing of telemarketing, have reduced,
and in
the future will continue to reduce, our ability to use telemarketing to generate
retail leads and originate retail loans. We may not be able to offset
any loss of business through alternative means, and our ability to effectively
market our products and services to new customers may be
harmed. Furthermore, compliance with these Do No Call Registries and
telemarketing laws, rules and regulations may prove costly and difficult,
and we
may incur penalties or be subject to claims or lawsuits, including class
actions, for improperly conducting our marketing activities.
We
have been, and in the future may be, subject to various settlement agreements
arising from legal issues, and we may be subject to substantial claims and
legal
expenses if we do not comply with these agreements, or if allegations are
made
that we are not in compliance with them.
The
non-conforming mortgage market in which we operate has been the subject of
significant scrutiny by various federal and state governmental agencies and
legislators. In particular, in 1999, the lending practices we
utilized were the subject of investigations by
the New
York State
Banking Department (“NYSBD”),
the New York Office of the Attorney General
(“NYOAG”) and the Department of Justice (“DOJ”). The investigations
centered on our compliance with various federal and state laws. In
September 1999 and March 2000, we entered into related settlement agreements
with these regulatory agencies, joined by the HUD and the Federal Trade
Commission (“FTC”), which provided for changes to our lending practices on a
prospective basis, and retrospective relief to some borrowers. If
similar claims are made in the future, defending those claims may result
in
significant legal expenses to us, which will reduce our
profitability. A finding against us, or any settlement we may enter
into, may result in our payment of damages, which may be costly to
us.
We
may be subject to fines or other penalties based upon the conduct of the
independent mortgage brokers who place loans with us.
The
independent mortgage brokers through which we source mortgage loans have
legal
obligations to which they are subject. Although these laws may not
explicitly hold the originating lenders responsible for the legal violations
of
mortgage brokers, federal and state agencies have increasingly sought to
impose
liability upon assignees, as well as wholesale lenders. For example,
the FTC has in the recent past entered into a settlement agreement with a
mortgage lender in which the FTC characterized a broker that had placed all
of
its loan production with a single lender as the “agent” of the lender; the FTC
imposed a fine on the lender in part because, as “principal,” the lender was
legally responsible for the mortgage broker’s unfair and deceptive acts and
practices. Moreover, in the past, the DOJ has sought to hold
non-conforming mortgage lenders responsible for the pricing practices of
their
mortgage brokers, alleging that the mortgage lenders were directly responsible
for the total fees and charges paid by the borrower under the Fair Housing
Act
even if the lenders neither dictated what the mortgage broker could charge
nor
kept the money for its own account. This was one of the DOJ’s primary
allegations against us at the time of our aforementioned settlement with
the DOJ
in 2000.
Accordingly,
we may be subject to fines or other penalties in the future based upon the
conduct of our independent mortgage brokers.
Regulatory
actions and/or class actions against servicers who service the loans we
originate could lower the value of our securitized mortgage loans and our
ability to sell or securitize our loans.
Federal
agencies, including the FTC, the HUD and the DOJ, have in the recent past
investigated, and/or commenced regulatory actions against, several servicers
who
specialize in servicing nonconforming loans. Similarly, numerous
class actions have been brought against servicers alleging improper servicing
policies and procedures. Any regulatory actions and/or class actions
of these kinds brought against any of the servicers who service the loans
we
originate could harm our ability to sell or securitize our loans.
Other
legal actions that are pending against us, if successful, could expose us
to
substantial liability.
Because
the nature of our business involves the collection of numerous accounts,
the
validity of liens and compliance with federal, state and local lending laws,
we
are subject to numerous claims and legal actions in the ordinary course of
our
business. Generally, we are subject to claims made against us by
borrowers and investors arising from, among other things:
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Losses
that are claimed to have been incurred as a result of alleged breaches
of
fiduciary obligations, misrepresentation, errors and omissions
by our
employees, officers
and
agents;
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incomplete
documentation; and
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failure
to comply with various laws, rules and regulations applicable to
our
business.
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An
adverse outcome in any potential litigation matters could subject us to
significant monetary damages and legal fees. While it is impossible
to estimate with certainty the ultimate legal and financial liability with
respect to claims and actions, regardless of the merits of a claim and
regardless of the outcome, defending against these claims is expensive and
time
consuming. In addition, these cases could divert management’s
attention from our business.
Our
inability to comply with REIT qualification tests for our REIT subsidiary
may
result in our securitization trusts being taxed as a taxable mortgage pool,
which would reduce our earnings and cash flow.
Our
inability to comply with REIT qualification tests for our REIT subsidiary
(Renaissance REIT Investment Corp.) on a continuous basis would subject our
securitization, trusts issued by our REIT subsidiary to federal income tax
as a
corporation as a taxable mortgage pool, and not allow it to be filed as part
of
consolidated income tax return with any other corporation. The REIT
rules require compliance with asset, income, distribution and ownership
tests. The ownership test prohibits five or fewer stockholders from
owning more than 50% of our common stock. As of June 30, 2007,
members of the Miller family (considered one stockholder under the attribution
rule applicable to the ownership of REIT stock) owned approximately 33.7%
of the
common stock (including employee stock options as required by the Internal
Revenue Code of 1986 (the "Code") and related rules and
regulations). There can be no assurance that we will be able to
comply with these tests or remain compliant.
Failure
to remain compliant would result in the imposition of a tax upon our
securitization trusts and would reduce the cash flow that would otherwise
be
available to make payments on the offered asset-backed securities and reduce
the
amount that we would receive from the securitization trusts. A
failure of this kind would cause us to breach our representation, under each
of
our securitizations issued since the first quarter of 2005, that we would
maintain Renaissance REIT Investment Corp. as a real estate investment
trust. In addition, it would result in an event of default, unless
waived, under our warehouse facilities. Accordingly, a failure to
remain compliant with the REIT qualification tests may reduce our profitability
and cash flow and have a material adverse impact on us.
We
may be subject to claims under federal and state environmental
laws.
To
date,
we have not been required to perform any environmental investigation or clean-up
activities, nor have we been subject to any environmental
claims. However, there can be no assurance that this will remain the
case in the future. Although we primarily lend to owners of
residential properties, in the course of our business, we may acquire properties
securing loans that are in default. There is a risk that we could be
required to investigate and clean-up hazardous or toxic substances or chemical
releases at these properties, and we may be held liable to a governmental
entity
or to third parties for property damage, personal injury and investigation
and
clean-up costs incurred in connection with the contamination. In
addition, the owner or former owners of a contaminated site may be subject
to
common law claims by third parties based on damages and costs resulting from
environmental contamination emanating from the property.
Complying
with the Sarbanes-Oxley Act of 2002, as well as other recently-enacted and
proposed changes to applicable securities laws, are likely to increase our
costs
and make it more difficult for us to attract directors, officers and other
personnel.
The
Sarbanes-Oxley Act of 2002, and the related regulations of the SEC and U.S.
stock exchanges, has substantially increased the complexity and cost of
corporate governance, financial reporting and disclosure practices for public
companies such as ours. These rules and regulations could also make
it more difficult for us to attract and retain qualified executive officers
and
members of our board of directors, particularly to serve in our finance
department and on our audit committee.
The
value of our deferred tax asset and our ability to use such deductions/losses
may be significantly limited.
At
June 30, 2007, we have recorded a deferred tax asset of $36.1 million,
all of
which relates to future tax deductions/losses ("built in losses"). These
built in losses could provide significant future tax savings to us if we
are
able to use them. However, our ability to use these tax benefits may
be impacted, restricted or eliminated by a number of factors including,
but not
limited to:
•
our ability to generate sufficient net income to utilize these built in
losses;
•
a future ownership change of us within the meaning of Section 382 of the
Code;
and
•
future changes in laws or regulations, which changes may have retroactive
effect, relating to the use of these built in losses.
To the extent that we are unable to utilize these built in losses, our
results
of operations, liquidity and financial condition could be adversely affected
in
a significant manner.
Pursuant to Section 382 of the Code, a corporation is limited in its ability
to
use existing net operating losses carryforwards and net unrealized built
in
losses once that corporation experiences an "ownership change" (as that
term is
defined in the Code and regulations thereunder). More specifically,
corporations are limited in their ability to use net built in losses and
net
operating losses carryforwards that are in existence prior to an "ownership
change" to offset taxable income they receive after an "ownership
change".
Any
future
equity offering(s) and/or changes in our major stockholders during the
look back
period resulting in a change in ownership within the meaning of Section
382 of the Code may limit the amount of net built in losses and net operating
loss carryforwards that exist as of the date of change that we may claim
in
future periods which may result in higher taxable income for the company
(and a
significantly higher tax cost to us as compared to the situation where
these tax
benefits are preserved).
Risks
Related to Our Capital Structure
We
are controlled by principal stockholders, some of whom are also members of
our
senior management, who may have the ability to influence fundamental corporate
changes if they act in concert.
As
of
August 31, 2007, our principal stockholders, including members of the Miller
family, entities controlled by Angelo Gordon, and entities controlled by
Mr.
Mohnish Pabrai, beneficially owned approximately 50.0% of the outstanding
shares
of our common stock, including shares issued or issuable as a result of our
August 2007 financing. Accordingly, if these stockholders were to act
in concert, they would have the ability to exercise significant control over
us
with respect to matters submitted to a stockholder vote, including the approval
of fundamental corporate transactions, such as mergers and acquisitions,
consolidations and asset sales, and electing all members of our Board of
Directors. As long as these stockholders control such a substantial
percentage of our shares, third parties may not be able to gain control of
us
through purchases of our common stock. In addition, members of the
Miller family hold positions as executive officers of our company, including
Chairman, Chief Executive Officer, Executive Vice President (Chief Credit
Officer) and Executive Vice President (General Counsel). Angelo
Gordon also has the right to appoint two members of our board of directors
if it
exercises its warrants for at least 5.0 million shares of our common
stock.
Our
stock price is volatile.
The
trading price of our stock is volatile, and this volatility will likely continue
in the future. Wide fluctuations in our trading price or volume can
be caused by:
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quarterly
variations in our operating results;
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variations
in the size and terms of our securitizations;
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conditions
in the real estate industry and in the asset-backed securities
market;
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announcements
by significant investors of their intention to sell our
shares;
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investor
perception of our company and our business generally;
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announcements
or implementation by us or our competitors of new products or
services;
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financial
estimates by securities analysts; and
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general
economic and financial services market conditions, including changes
in
interest rates.
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In
addition, the stock market in general has experienced extreme price and volume
fluctuations that have often been unrelated or disproportionate to the operating
performance of companies. If investor interest in financial services
companies declines, the price for our common stock could drop suddenly and
significantly, even if our operating results are positive. Our common
stock has historically traded at low volumes compared to many other financial
services companies, which may increase the potential illiquidity of an
investment in our common stock. If the trading volume of our common
stock experiences significant changes, the price of our common stock could
also
be adversely affected. Furthermore, declines in the trading or price
of our common stock could harm employee morale and retention, our access
to
capital and other aspects of our business.
Our
common stock commenced trading on the
NASDAQ Global Market in March
2007 and
traded on the
American Stock Exchange (“AMEX”) from May 2003 until March
2007. However, we cannot assure you that an active public trading
market for our common stock will be sustained. If active trading in
our common stock does not continue, the price that you may receive in connection
with any sale of your shares may be substantially less than the price that
you
paid for them.
Our
financial results or condition in any period may not meet market expectations,
which could adversely affect our stock price.
The
public trading of our stock is based in large part on market expectations
as to
our future business and financial performance. If the securities
analysts that follow our stock lower their rating or lower their projections
for
future growth and financial performance, the market price of our stock is
likely
to drop significantly. In addition, if our quarterly financial
performance does not meet the expectations of securities analysts, our stock
price would likely decline. The decrease in the stock price may be
disproportionate to the shortfall in our financial performance.
We
may need additional capital, which may be dilutive to our stockholders or
impose
burdensome financial restrictions on our business.
We
may
seek to raise additional funds through public or private debt or equity
offerings. Additional equity financing may be dilutive to the holders
of our common stock. If we obtain funds through a bank credit
facility or by issuing debt securities or preferred shares, the indebtedness
or
preferred shares would have rights senior to the rights of holders of our
common
stock, and their terms could impose significant restrictions on our
operations. If we need to raise additional funds, we may not be able
to do so on favorable terms, or at all. If we cannot obtain adequate
funds on acceptable terms, we may not be able to implement our business strategy
as planned, or at
all.
Future
sales of our common stock in the public market could adversely affect our
stock
price.
Future
sales of shares of our common stock, including shares of common stock held
by
our directors, officers and principal stockholders, or the availability for
future sale of shares of our common stock may reduce the market price of
our
common stock prevailing from time to time. The market price of our
common stock may decline if a substantial number of shares of our common
stock
is sold, or the perception that those sales might occur. We are
unable to predict whether significant numbers of shares will be sold in the
open
market in anticipation of or following a sale by insiders.
Our
current stockholders hold a substantial number of shares of our common stock,
which they are able to sell in the public market today to some
extent. In addition, certain of our principal stockholders, including
entities controlled by Mr. Mohnish Pabrai and affiliates of Angelo Gordon
have
agreements that require us to register for resale a substantial number of
their
shares of our common stock. In addition, as of June 30, 2007, we had
approximately 1.7 million shares of our common stock issuable upon exercise
of
options, approximately 1.4 million of which were currently exercisable, and
257,900 shares of restricted common stock granted and outstanding.
We
have implemented anti-takeover provisions which could discourage or prevent
a
takeover, even if an acquisition would be beneficial to our
stockholders.
Provisions
of our certificate of incorporation and our bylaws could make it more difficult
for a third-party to acquire us, even if doing so would be beneficial to
our
stockholders. These provisions include:
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establishing
a classified Board of Directors of which approximately one-third
of the
members of the board are elected each year, and lengthening the
time
needed to elect a new majority of the board;
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authorizing
the issuance of “blank check” preferred stock that could be issued by our
Board of Directors to increase the number of outstanding shares
or change
the balance of voting control and prevent a takeover attempt;
and
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prohibiting
stockholder action by written consent and requiring all stockholder
actions to be taken at a meeting of our
stockholders.
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We
also are
subject to the anti-takeover provisions of Section 203 of the
DGCL. Subject to specified exceptions, this section provides that a
corporation may not engage in any business combination with any interested
stockholder during the three-year period following the time that such
stockholder becomes an interested stockholder. This provision could
have the effect of delaying or preventing a change in control of our
company. These factors could also limit the price that investors or
an acquirer might be willing to pay in the future for shares of our common
stock.
Description
of Debt
Securities
As
used in this prospectus, the term
“debt securities” means the debentures, notes, bonds and other evidences of
indebtedness that we may issue from time to time. The debt securities
will either be senior debt securities or subordinated debt securities and
they
may be secured or unsecured. Senior debt securities will be issued
under an indenture to be entered into between us and an indenture trustee,
or
another trustee to be named in a prospectus supplement. The
subordinated debt securities will be issued pursuant to an indenture to be
entered into between us and an indenture trustee to be named in a prospectus
supplement. The senior indenture and the subordinated indenture are
collectively referred to in this prospectus as the
“indentures.”
The
senior indenture and the
subordinated indenture are expected to be substantially similar, except that
(1)
the subordinated indenture, unlike the senior indenture, will provide for
debt
securities that are specifically made junior in right of payment to our other
specified debt and (2) the senior indenture, unlike the subordinated indenture,
may restrict our ability and the ability of certain of our subsidiaries to
issue
any secured debt and may contain additional negative
covenants.
General
Terms of the Debt
Securities
The
debt securities of any series will
be our
direct,
secured or unsecured
obligations.
Senior debt securities of any series
will be our unsubordinated obligations and rank equally with all of our other
unsecured and unsubordinated debt, including any other series of debt securities
issued under the senior indenture.
Subordinated debt securities of any
series will be junior in right of payment to our senior indebtedness
,
as defined in the applicable indenture.
In
the event that our secured creditors,
if any, exercise their rights with respect to our assets pledged to them,
our
secured creditors would be entitled to be repaid in full from the proceeds
of
those assets before those proceeds would be available for distribution to
our
other creditors, including the holders of debt securities of any
series.
Our
$60
.0
million repurchase
facility
dated
August 13, 2007
with
Angelo
Gordon restricts the debt that
we, as guarantor of the facility, may create. This facility and our
warehouse credit facilities also may restrict the debt that we may create
by
requiring us to maintain certain debt or total liabilities to equity ratios,
as
well as certain net worth and liquidity ratios at the end of each fiscal
quarter
that these facilities are in effect.
Our
subsidiaries are separate and
distinct legal entities and
will
have
no obligation, contingent or
otherwise, to pay
any
amounts due under the debt securities of any series or to make any funds
available to us, whether by dividend, loans or other
payments. Therefore, the assets of our subsidiaries will be subject
to the prior claims of all creditors of those subsidiaries. The
payment of dividends or the making of loans or advances to us by our
subsidiaries may be subject to contractual, statutory or regulatory
restrictions, are contingent upon the earnings of those subsidiaries and
are
subject to various business considerations.
The
indentures may issue debt securities
from time to time in one or more series. We may, from time to time,
without giving notice to, or seeking the consent of, the holders of any debt
securities of any series
offered by this prospectus
,
issue additional debt securities
having the same ranking, interest rate, maturity and other terms as the debt
securities of that series. Any additional debt securities having such
similar terms, together with the outstanding debt securities of that series,
will constitute a single series of debt securities under the applicable
indenture.
Unless
otherwise specified in the
applicable prospectus supplement, the debt securities will not be listed
on any
securities exchange.
Specific
Terms of the Debt
Securities
We
will provide a prospectus supplement
to accompany this prospectus for each series of debt securities we offer.
In the
prospectus supplement, we will describe the following terms of the series
of
debt securities which we are offering, to the extent
applicable:
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the
title of the debt securities of the series;
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whether
the debt securities of the series are senior or subordinated;
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the
subordination provisions that will apply to any subordinated
debt
securities of the series;
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any
limit upon the aggregate principal amount of the debt securities
of the
series;
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the
date or dates on which the principal of the debt securities of
the series
is payable;
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the
place or places where payments will be made;
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the
rate or rates at which the debt securities of the series shall
bear
interest or the manner of calculation of such rate or rates,
if
any;
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the
date or dates from which any interest shall accrue, the interest
payment
dates on which any interest will be payable or the manner of
determination
of such interest payment dates and the record date for the determination
of holders to whom interest is payable on any interest payment
dates;
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the
right, if any, to extend the interest payment periods and the
duration of
an extension;
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the
period or periods within which, the price or prices at which
and the terms
and conditions upon which debt securities of the series may be
redeemed,
in whole or in part, at our option;
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the
obligation, if any, of us to redeem or purchase debt securities
of the
series under any sinking fund or analogous provisions, including
payments
made in cash in participation of future sinking fund obligations,
or at
the option of a holder, and the period or periods within which,
the price
or prices at which and the terms and conditions upon which debt
securities
of the series shall be redeemed or purchased, in whole or in
part, under
such obligation;
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the
form of the debt securities of the series, including the form
of the
certificate of authentication for the series;
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if
other than denominations of one thousand U.S. dollars ($1,000)
or any
integral multiple thereof, the denominations in which the debt
securities
of the series shall be issuable;
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whether
the debt securities are issuable as global securities and, in
such case,
the identity of the depositary for such series;
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if
other than the principal amount thereof, the portion of the principal
amount of debt securities of the series which shall be payable
upon
declaration of acceleration of maturity in connection with an
event of
default (as described below);
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any
additional or different events of default or restrictive covenants
provided for with respect to the debt securities of the
series;
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any
provisions granting special rights to holders when a specified
event
occurs;
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if
other than such coin or currency of the United States of America
as at the
time of payment is legal tender for payment of public or private
debts,
the coin or currency or currency unit in which payment of the
principal
of, or premium, if any, or interest on the debt securities of
the series
shall be payable;
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the
application, if any, of the terms of the indentures relating
to defeasance
or covenant defeasance (as described below); and
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any
and all other terms with respect to the debt securities of the
series,
including any terms which may be required by or advisable under
any laws
or regulations or advisable in connection with the marketing
of debt
securities of the series.
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Unless
we state otherwise in a
prospectus supplement, we will issue debt securities only as registered
securities, which means that the name of the holder will be entered in a
register which will be kept by the trustee or another agent of
ours. Unless we state otherwise in a prospectus supplement, we will
make principal and interest payments at the office of the paying agent or
agents
we name in the prospectus supplement or by mailing a check to you at the
address
we have for you in the register.
Unless
we state otherwise in a
prospectus supplement, you will be able to transfer registered debt securities
at the office of the transfer agent or agents we name in the prospectus
supplement. You may also exchange registered debt securities at the
office of the transfer agent for an equal aggregate principal amount of
registered debt securities of the same series having the same maturity date,
interest rate and other terms as long as the debt securities are issued in
authorized denominations.
Neither
we nor the trustee will impose
any service charge for any transfer or exchange of a debt security; however,
we
may ask you to pay any taxes or other governmental charges in connection
with a
transfer or exchange of debt securities.
If
the debt securities are redeemable
and we redeem less than all of the debt securities of a particular series,
we
may block the transfer or exchange of debt securities during a specified
period
of time in order to freeze the list of holders to prepare the
mailing. The period begins 15 days before the day we mail the notice
of redemption and ends on the day of that mailing. We also may refuse
to register transfers or exchanges of debt securities selected for
redemption. However, we will continue to permit transfers and
exchanges of the unredeemed portion of any debt security being partially
redeemed.
Debt
securities may be sold at a
substantial discount below their stated principal amount, bearing no interest
or
interest at a rate which at the time of issuance is below market
rates. The applicable prospectus supplement will describe the federal
income tax consequences and special considerations applicable to any such
debt
securities. The debt securities may also be issued as indexed
securities or securities denominated in foreign currencies, currency units
or
composite currencies, as described in more detail in the prospectus supplement
relating to any of the particular debt securities.
Global
Debt
Securities
We
may issue registered debt securities
in global form. This means that one “global” debt security would be
issued to represent a number of registered debt securities. The
denomination of the global debt security would equal the aggregate principal
amount of all registered debt securities represented by that global debt
security.
We
will deposit any registered debt
securities issued in global form with a depositary, or with a nominee of
the
depositary, that we will name in the applicable prospectus
supplement. Any person holding an interest in the global debt
security through the depositary will be considered the “beneficial” owner of
that interest. A “beneficial” owner of a security is able to enjoy
rights associated with ownership of the security, even though the beneficial
owner is not recognized as the legal owner of the security. The
interest of a beneficial owner in the security is considered the “beneficial
interest.” We will register the debt securities in the name of the
depositary or the nominee of the depository, as appropriate.
Each
person owning a beneficial interest
in a registered global security must rely on the procedures of the depositary
for the registered global security and, if that person owns through a
participant, on the procedures of the participant through which that person
owns
its interest, to exercise any rights of a holder under the applicable
indenture.
We
understand that under existing
industry practices, if we request any action of holders of debt securities
or if
an owner of a beneficial interest in a registered global security desires
to
give or take any action which a holder of debt securities is entitled to
give or
take under the applicable indenture, the depositary for the registered global
security would authorize the participants holding the relevant beneficial
interests to give or take the action, and the participants would authorize
the
beneficial owners owning through participants to give or take the action
or
would otherwise act upon the instructions of the beneficial owners owning
through them.
We
will make payments of principal, any
premium and any interest on a registered global security to the depositary
or
its nominee. We expect that the depositary or its nominee for any
registered global security, upon receipt of any payment of principal, any
premium or any interest in respect of the registered global security, will
immediately credit participants’ accounts with payments in amounts proportionate
to their respective beneficial interests in the registered global security
as
shown on the records of the depositary. We also expect that standing
customer instructions and customary practices will govern payments by
participants to owners of beneficial interests in the registered global security
owned through participants.
Under
the terms of the indentures, we
and the applicable trustee will treat the depositary or its nominee as the
owner
of the registered global security for the purpose of receiving payments and
for
all other purposes. Consequently, neither we, the trustee under the
applicable indenture nor any of our agents will have any responsibility or
liability for:
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any
aspect of the records of the depositary, its nominee or any direct
or
indirect participant relating to, or payment made on account of,
beneficial ownership interests in the registered global security
or for
maintaining, supervising or reviewing any records of the depositary,
its
nominee or any direct or indirect participant relating to, or payments
made on account of, the beneficial ownership interests; or
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the
depositary, its nominee or any direct or indirect
participants.
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If
(1) the depositary for any series of
debt securities notifies us that it is no longer willing or able to act as
a
depositary or clearing system for the debt securities or the depositary ceases
to be registered or in good standing under the Securities Exchange Act of
1934,
as amended (the “Exchange Act”) and a successor depositary or clearing system is
not appointed within 90 days after we have received notice or become aware
of
this condition, (2) we, at our option, notify the applicable trustee in writing
that we elect to cause the issuance of debt securities in certificated form
under the applicable indenture or (3) upon the occurrence and continuation
of an
event of default under an indenture, then, upon surrender of the depositary
of
the registered global debt securities, certificated debt securities will
be
issued to each person that the depositary identifies to us as the owner of
the
debt securities represented by the global debt securities. Upon any
such issuance, the applicable trustee is required to register the certificated
notes in the name of the person or persons or the nominee of any of these
persons and cause the same to be delivered to these persons. Neither
we, the applicable trustee nor our agents will be liable for any delay by
the
depositary, its nominee or any direct or indirect participant in identifying
the
beneficial owners of the debt securities, and each such person may conclusively
rely on, and will be protected in relying on, instructions from the depositary
for all purposes, including with respect to the registration and delivery,
and
the respective principal amounts of, the certificated debt securities to
be
issued.
Unless
certificated notes are issued, a
global security of a series may be transferred, in whole but not in part,
only
to another nominee of the depositary for the series, or to a successor
depositary for the series selected and approved by us or to a nominee of
such
successor depositary.
Covenants
Applicable to the Debt
Securities
Other
than as described below, the
indentures are not expected to contain any provisions that would offer
protection to holders of the debt securities in the event of a takeover,
recapitalization or similar occurrence.
Merger,
Consolidation or Sale of
Assets
Nothing
contained in the indentures
prevents any consolidation or merger of
our company
with or into any other entity or
entities (whether or not affiliated with
us
),
or successive consolidations or
mergers in which we or any of our successors is a party, or will prevent
any
sale, conveyance, lease, transfer or other disposition of all or substantially
all of our property or any of our successors, to any other entity (whether
or
not affiliated with us or our successors) authorized to acquire and operate
the
same; provided, however, that upon any such consolidation, merger, sale,
conveyance, lease, transfer or other disposition, the due and punctual payment
of the principal of, premium, if any, and interest on all of the debt securities
and the due and punctual performance and observance of all the covenants
and
conditions of the indentures with respect to the debt securities or established
with respect to any series of debt securities to be kept or performed by
us (or
such successor) will be expressly assumed by supplemental indentures
satisfactory in form to the applicable trustee executed and delivered to
such
trustee by the entity formed by such consolidation (if other than
us
),
or into which we (or such successor)
will have been merged, or by the entity which will have acquired such
property.
In
case of any such consolidation,
merger, sale, conveyance, lease, transfer or other disposition and upon the
assumption by the successor entity, by supplemental indenture, executed and
delivered to the applicable trustee and satisfactory in form to such trustee,
of
the due and punctual payment of the principal of, premium, if any, and interest
on all of the debt securities outstanding and the due and punctual performance
of all of the covenants and conditions of the indentures or established with
respect to any series of debt securities
under
the indentures to be performed by us,
such successor entity will succeed to and be substituted for us with the
same
effect as if it had been named as
obligor
in the indentures, and the predecessor
entity will be relieved of all obligations and covenants under the indentures
and the debt securities.
After
that time, all of our obligations
under the debt securities and the indentures
will
terminate.
If,
as a result of any such
consolidation, merger, sale, conveyance, lease, transfer or other disposition,
our properties or assets or the properties or assets of certain of our
subsidiaries would become subject to any lien which would not be permitted
under
the applicable indenture without equally and ratably securing the senior
debt
securities, we or our subsidiaries or successor person, as the case may be,
will
take the steps as are necessary to secure effectively the senior debt securities
equally and ratably with, or prior to, all indebtedness secured by those
liens.
Please
note that
under our
$60.0 million
repurchase
facility
dated
August 13, 2007 with Angelo
Gordon, without Angelo Gordon
’
s
prior written consent,
we
may not consummate any merger or
consolidation with any person or sell all or substantially all of its assets,
unless the surviving entity by law or by agreement
assumes our obligations
under the
repurchase agreement. Furthermore, such a merger or consolidation may
not result in or cause a default or an event of default under the repurchase
agreement.
Events
of
Default
The
following are the expected events of
default under the indentures with respect to a series of debt
securities:
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we
default in the payment of any installment of interest upon any
of the debt
securities of that series, as and when the same shall become due
and
payable, and such default continues for a period of 30 days; provided,
however, that a valid extension of an interest payment period in
accordance with the terms of the debt securities of that series
shall not
constitute a default in the payment of interest for this
purpose;
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we
default in the payment of the principal of, or premium, if any,
on, any of
the debt securities of that series as and when the same shall become
due
and payable whether at maturity, upon redemption, by declaration
or
otherwise, or in any payment required by any sinking or analogous
fund
established with respect to that series; provided, however, that
a valid
extension of the maturity of such debt securities in accordance
with the
terms of the debt securities of that series shall not constitute
a default
in the payment of principal or premium, if any, for this
purpose;
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we
fail to observe or perform any other of its covenants or agreements
with
respect to that series of debt securities contained in the applicable
indenture or otherwise established with respect to that series
of debt
securities (other than a covenant or agreement that has been expressly
included in the applicable indenture solely for the benefit of
one or more
series of debt securities other than such series) for a period
of 60 days
after the date on which written notice of such failure shall have
been
received from the applicable trustee or from the holders of at
least 25%
in principal amount of the debt securities of that series; or
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certain
events of our bankruptcy, insolvency or reorganization, whether
voluntary
or not.
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If
an event of default with respect to
any series of debt securities occurs and is continuing, the applicable trustee
or the holders of at least 25% in aggregate principal amount of the outstanding
debt securities of that series may declare that series of debt securities
due
and payable immediately. In case of an event of default with respect
to any series of debt securities resulting from certain events of bankruptcy,
insolvency or reorganization, the principal (or such specified amount) and
premium, if any, of all outstanding debt securities of any series will become
and be immediately due and payable without any declaration or other act by
the
applicable trustee or any holder of outstanding debt securities of any
series. Under certain circumstances, the holders of a majority in
principal amount of the outstanding debt securities of any series may rescind
any such acceleration with respect to the debt securities of that series
and its
consequences.
The
holders of a majority in principal
amount of the outstanding debt securities of any series may waive any default
or
event of default with respect to any series of debt securities and its
consequences, except defaults or events of default regarding payment of
principal, any premium or interest. A waiver will eliminate the
default.
If
an event of default with respect to
any series of debt securities occurs and is continuing, the applicable trustee
will be under no obligation to exercise any of its rights or powers under
the
applicable indenture, unless the holders of the debt securities of that series
have offered the applicable trustee reasonable indemnity. The holders
of a majority in principal amount of debt securities of any series will have
the
right to direct the time, method and place of conducting any proceeding for
any
remedy available to the applicable trustee, or exercising any trust or power
conferred on such trustee, provided that:
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such
proceeding or exercise is not in conflict with any law or the
applicable
indenture;
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the
applicable trustee may take any other action deemed proper by
it that is
not inconsistent with directions from the holders; and
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unless
otherwise provided under the Trust Indenture Act of 1939, or
the “TIA,”
the applicable trustee need not take any action that might involve
it in
personal liability or might be unduly prejudicial to the holders
not
involved in the proceeding.
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A
holder of debt securities of any
series will only have the right to institute a proceeding under the applicable
indenture or to appoint a receiver or trustee, or to seek other remedies
if:
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the
holder has given written notice to the applicable trustee of
a continuing
event of default;
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the
holders of at least 25% in aggregate principal amount of the
outstanding
debt securities of that series have made written request;
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those
holders have offered reasonable indemnity to the applicable trustee
to
institute proceedings as trustee; and
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the
applicable trustee does not institute a proceeding and does not
receive
conflicting directions within 60
days.
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These
limitations do not apply to a suit
brought by a holder of debt securities of any series if we default in the
payment of the principal, any premium or interest on such debt
securities. Any right of a holder of the debt securities of that
series to receive payments of the principal of, and premium, if any, and
any
interest on debt securities of that series on or after the due dates expressed
in the debt securities of that series and to institute suit for the enforcement
of any such payment on or after such dates will not be impaired or affected
without the consent of such holder.
We
will periodically file statements
with the trustees regarding our compliance with the covenants in the
indentures.
Modification
of
Indentures
We
and the applicable trustee may change
either indenture without the consent of any holder of debt securities
to:
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fix
any ambiguity, defect or inconsistency in the applicable
indenture;
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evidence
the succession of another entity to us and the assumption by
such party of
our obligations under the successor obligor provisions of either
indenture;
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provide
for uncertificated debt securities in addition to or in place
of
certificated debt securities;
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add
to our covenants for the benefit of all or any series of debt
securities;
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add
to, delete from, or revise the conditions, limitations and restrictions
on
the authorized amount, terms, or purposes of issue, authentication,
and
delivery of debt securities set forth in either indenture;
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change
anything that does not materially and adversely affect the interests
of
the holders of debt securities of any series;
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provide
for the issuance of and establish the form and terms and conditions
of the
debt securities of any series, establish the form of any certifications
required or add to the rights of any holders of any series of
debt
securities;
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secure
the senior debt securities in accordance with the limitations
on lien
covenant;
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add
any additional events of default;
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change
or eliminate any of the provisions of either indenture; provided
that any
such change or elimination shall become effective only when there
are no
debt securities of any series outstanding under the applicable
indenture
created prior to such change or elimination which is entitled
to the
benefit of such provision;
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provide
for the appointment of a successor trustee with respect to the
debt
securities of one or more series; or
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comply
with the requirements of the SEC in order to effect or maintain
the
qualification of the indentures under the
TIA.
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In
addition, with the consent of the
holders of not less than a majority in aggregate principal amount of the
debt
securities of each series affected, we and the applicable trustee may add
to,
change or eliminate any provisions of the applicable
indenture. However, the following changes may only be made with the
consent of each affected holder: