Item
1. – Financial
Statements
DELTA
FINANCIAL CORPORATION AND
SUBSIDIARIES
(Dollars
in thousands, except for share
data)
|
|
At
September
30,
2007
|
|
|
At
December
31,
2006
|
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
Cash
and cash
equivalents
|
|
$
|
4,207
|
|
|
$
|
5,741
|
|
|
|
|
|
|
|
|
|
|
Mortgage
loans held for
investment, net of discounts and deferred
origination
fees
|
|
|
7,046,272
|
|
|
|
6,413,687
|
|
Less: Allowance
for loan losses
|
|
|
(75,878
|
)
|
|
|
(55,310
|
)
|
Mortgage
loans held for investment, net
|
|
|
6,970,394
|
|
|
|
6,358,377
|
|
|
|
|
|
|
|
|
|
|
Trustee
receivable
|
|
|
32,152
|
|
|
|
73,361
|
|
Accrued
interest
receivable
|
|
|
52,823
|
|
|
|
41,684
|
|
Excess
cashflow
certificates
|
|
|
--
|
|
|
|
1,209
|
|
Equipment,
net
|
|
|
7,212
|
|
|
|
8,287
|
|
Accounts
receivable
|
|
|
17,792
|
|
|
|
4,872
|
|
Prepaid
and other
assets
|
|
|
79,609
|
|
|
|
49,836
|
|
Deferred
tax
asset
|
|
|
59,339
|
|
|
|
45,760
|
|
Total
assets
|
|
$
|
7,223,528
|
|
|
$
|
6,589,127
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’
Equity
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Bank
payable
|
|
$
|
1,797
|
|
|
$
|
1,557
|
|
Warehouse
financing
|
|
|
406,675
|
|
|
|
335,865
|
|
Financing
on mortgage loans held
for investment, net
|
|
|
6,514,154
|
|
|
|
6,017,947
|
|
Other
borrowings
|
|
|
68,582
|
|
|
|
5,970
|
|
Accrued
interest
payable
|
|
|
28,701
|
|
|
|
25,052
|
|
Accounts
payable and other
liabilities
|
|
|
88,323
|
|
|
|
53,160
|
|
Total
liabilities
|
|
|
7,108,232
|
|
|
|
6,439,551
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
Equity:
|
|
|
|
|
|
|
|
|
Common
stock, $.01 par value.
Authorized 49,000,000 shares;
23,725,661and
23,607,611 shares
issued and 23,608,861 and
23,490,811
shares
outstanding at September 30, 2007 and December 31,
2006,
respectively
|
|
|
235
|
|
|
|
234
|
|
Additional
paid-in
capital
|
|
|
148,289
|
|
|
|
141,984
|
|
(Accumulated
deficit)
retained
earnings
|
|
|
(26,125
|
)
|
|
|
10,180
|
|
Accumulated
other comprehensive
loss
|
|
|
(5,785
|
)
|
|
|
(1,504
|
)
|
Treasury
stock, at cost (116,800
shares)
|
|
|
(1,318
|
)
|
|
|
(1,318
|
)
|
Total
stockholders’ equity
|
|
|
115,296
|
|
|
|
149,576
|
|
Total
liabilities and
stockholders’ equity
|
|
$
|
7,223,528
|
|
|
$
|
6,589,127
|
|
The
accompanying notes are an integral
part of these consolidated financial statements.
DELTA
FINANCIAL CORPORATION AND
SUBSIDIARIES
(Dollars
in thousands, except share and
per share data)
|
|
For
the Three
Months
Ended
September
30,
|
|
|
For
the Nine
Months
Ended
September
30,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
$
|
154,744
|
|
|
$
|
122,313
|
|
|
$
|
444,359
|
|
|
$
|
337,022
|
|
Interest
expense
|
|
|
117,041
|
|
|
|
84,734
|
|
|
|
327,201
|
|
|
|
228,294
|
|
Net
interest income
|
|
|
37,703
|
|
|
|
37,579
|
|
|
|
117,158
|
|
|
|
108,728
|
|
Provision
for loan
losses
|
|
|
21,471
|
|
|
|
6,874
|
|
|
|
45,392
|
|
|
|
20,276
|
|
Net
interest income after provision for loan losses
|
|
|
16,232
|
|
|
|
30,705
|
|
|
|
71,766
|
|
|
|
88,452
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(loss)
gain on sale of mortgage loans
|
|
|
(48,343
|
)
|
|
|
9,501
|
|
|
|
(32,476
|
)
|
|
|
23,601
|
|
Other
income
|
|
|
23
|
|
|
|
1,815
|
|
|
|
2,108
|
|
|
|
9,447
|
|
Total
non-interest
income
|
|
|
(48,320
|
)
|
|
|
11,316
|
|
|
|
(30,368
|
)
|
|
|
33,048
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payroll
and related costs
|
|
|
14,467
|
|
|
|
16,505
|
|
|
|
49,249
|
|
|
|
50,098
|
|
General
and administrative
|
|
|
17,908
|
|
|
|
12,390
|
|
|
|
46,825
|
|
|
|
35,974
|
|
Loss
(gain) on derivative instruments
|
|
|
197
|
|
|
|
262
|
|
|
|
210
|
|
|
|
(161
|
)
|
Total
non-interest expense
|
|
|
32,572
|
|
|
|
29,157
|
|
|
|
96,284
|
|
|
|
85,911
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
income before income tax
(benefit) expense
|
|
|
(64,660
|
)
|
|
|
12,864
|
|
|
|
(54,886
|
)
|
|
|
35,589
|
|
Provision
for income tax (benefit) expense
|
|
|
(25,024
|
)
|
|
|
4,904
|
|
|
|
(20,914
|
)
|
|
|
13,802
|
|
Net
(loss)
income
|
|
$
|
(39,636
|
)
|
|
$
|
7,960
|
|
|
$
|
(33,972
|
)
|
|
$
|
21,787
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
(Loss)
Income
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive loss
|
|
|
(4,522
|
)
|
|
|
(7,649
|
)
|
|
|
(4,281
|
)
|
|
|
(2,570
|
)
|
Comprehensive
(loss) income
|
|
$
|
(44,158
|
)
|
|
$
|
311
|
|
|
$
|
(38,253
|
)
|
|
$
|
19,217
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per
Share
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
-
weighted average number of shares
outstanding
|
|
|
23,347,304
|
|
|
|
23,213,262
|
|
|
|
23,324,493
|
|
|
|
22,214,538
|
|
Diluted
-
weighted average number of shares
outstanding
|
|
|
23,347,304
|
|
|
|
23,978,901
|
|
|
|
23,324,493
|
|
|
|
23,021,825
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(loss)
income applicable to common shares
|
|
$
|
(39,636
|
)
|
|
$
|
7,960
|
|
|
$
|
(33,972
|
)
|
|
$
|
21,787
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
earnings per share – net (loss) income
|
|
$
|
(1.70
|
)
|
|
$
|
0.34
|
|
|
$
|
(1.46
|
)
|
|
$
|
0.98
|
|
Diluted
earnings per share – net (loss) income
|
|
$
|
(1.70
|
)
|
|
$
|
0.33
|
|
|
$
|
(1.46
|
)
|
|
$
|
0.95
|
|
The
accompanying notes are an integral
part of these consolidated financial statements.
DELTA
FINANCIAL CORPORATION AND
SUBSIDIARIES
For
the Nine Months Ended September 30,
2007
(Dollars
in
thousands)
|
|
Common
Stock
|
|
|
Additional
Paid-in
Capital
|
|
|
(Accumulated
Deficit) Retained
Earnings
|
|
|
Accumulated
Other Comprehensive
Loss
|
|
|
Treasury
Stock
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at December 31,
2006
|
|
$
|
234
|
|
|
$
|
141,984
|
|
|
$
|
10,180
|
|
|
$
|
(1,504
|
)
|
|
$
|
(1,318
|
)
|
|
$
|
149,576
|
|
Stock
options
exercised
|
|
|
1
|
|
|
|
136
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
137
|
|
Excess
tax benefit related to
share-based compensation
|
|
|
--
|
|
|
|
121
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
121
|
|
Share-based
compensation
expense
|
|
|
--
|
|
|
|
998
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
998
|
|
Cash
dividend
paid
|
|
|
--
|
|
|
|
--
|
|
|
|
(2,333
|
)
|
|
|
--
|
|
|
|
--
|
|
|
|
(2,333
|
)
|
Change
in net unrealized
losses
from
derivatives, net of
tax
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
(4,281
|
)
|
|
|
--
|
|
|
|
(4,281
|
)
|
Issuance
of warrants,
net
|
|
|
--
|
|
|
|
5,050
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
5,050
|
|
Net
loss
|
|
|
--
|
|
|
|
--
|
|
|
|
(33,972
|
)
|
|
|
--
|
|
|
|
--
|
|
|
|
(33,972
|
)
|
Balance
at September 30,
2007
|
|
$
|
235
|
|
|
$
|
148,289
|
|
|
$
|
(26,125
|
)
|
|
$
|
(5,785
|
)
|
|
$
|
(1,318
|
)
|
|
$
|
115,296
|
|
The
accompanying notes are an integral
part of these consolidated financial statements.
DELTA
FINANCIAL CORPORATION AND
SUBSIDIARIES
(Dollars
in
thousands)
|
|
Nine
Months Ended
September
30,
|
|
|
|
2007
|
|
|
2006
|
|
Cash
flows from operating
activities:
|
|
|
|
|
|
|
Net
(loss)
income
|
|
$
|
(33,972
|
)
|
|
$
|
21,787
|
|
Adjustments
to reconcile net
(loss) income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
Provision
for loan
losses
|
|
|
45,392
|
|
|
|
20,276
|
|
Provision
for recourse loans,
premium recapture and secondary marketing losses
|
|
|
1,475
|
|
|
|
1,118
|
|
Depreciation
and
amortization
|
|
|
2,801
|
|
|
|
2,518
|
|
Deferred
tax (benefit)
expense
|
|
|
(10,881
|
)
|
|
|
6,760
|
|
Deferred
origination
income
|
|
|
(16,852
|
)
|
|
|
(11,836
|
)
|
Gain
on change in fair value of
excess cashflow certificates
|
|
|
(1,560
|
)
|
|
|
(9,184
|
)
|
Loss
(gain) on sale of mortgage
loans
|
|
|
42,074
|
|
|
|
(18,543
|
)
|
Gain
on sale of mortgage servicing
rights
|
|
|
(491
|
)
|
|
|
(144
|
)
|
Amortization
of deferred debt
issuance costs and premiums
|
|
|
(337
|
)
|
|
|
(8,878
|
)
|
Cash
flows received from excess
cashflow certificates, net of accretion
|
|
|
1,719
|
|
|
|
15,016
|
|
Proceeds
from sale of excess
cashflow certificates
|
|
|
1,050
|
|
|
|
1,500
|
|
Proceeds
from sale of mortgage
servicing rights, net
|
|
|
16,285
|
|
|
|
19,092
|
|
Stock-based
compensation
expense
|
|
|
998
|
|
|
|
615
|
|
Changes
in operating assets and
liabilities:
|
|
|
|
|
|
|
|
|
Increase
in accrued interest
receivable
|
|
|
(11,078
|
)
|
|
|
(11,174
|
)
|
Decrease
(increase) in trustee
receivable
|
|
|
41,209
|
|
|
|
(8,627
|
)
|
(Increase)
decrease in accounts
receivable
|
|
|
(12,920
|
)
|
|
|
440
|
|
Increase
in prepaid and other
assets
|
|
|
(36,001
|
)
|
|
|
(13,221
|
)
|
Increase
in accrued interest
payable
|
|
|
3,649
|
|
|
|
8,990
|
|
Increase
in accounts payable and
other liabilities
|
|
|
30,201
|
|
|
|
12,076
|
|
Net
cash provided by operating
activities
|
|
|
62,761
|
|
|
|
28,581
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing
activities:
|
|
|
|
|
|
|
|
|
Origination
of mortgage loans held
for investment
|
|
|
(3,402,604
|
)
|
|
|
(2,910,193
|
)
|
Repayment
of mortgage loans held
for investment
|
|
|
1,228,315
|
|
|
|
1,093,207
|
|
Proceeds
from sale of mortgage
loans (securitized)
|
|
|
839,870
|
|
|
|
--
|
|
Proceeds
from sale of mortgage
loans (whole-loan)
|
|
|
645,026
|
|
|
|
534,005
|
|
Purchase
of
equipment
|
|
|
(1,726
|
)
|
|
|
(3,851
|
)
|
Net
cash used in investing
activities
|
|
|
(691,119
|
)
|
|
|
(1,286,832
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing
activities:
|
|
|
|
|
|
|
|
|
Proceeds
from warehouse
financing
|
|
|
3,423,364
|
|
|
|
2,842,118
|
|
Repayment
of warehouse
financing
|
|
|
(3,352,554
|
)
|
|
|
(3,009,664
|
)
|
Proceeds
from financing on
mortgage loans held for investment, net
|
|
|
1,783,985
|
|
|
|
2,545,813
|
|
Repayment
of financing on mortgage
loans held for investment
|
|
|
(1,291,203
|
)
|
|
|
(1,136,936
|
)
|
Proceeds
from equipment financing,
net of repayments
|
|
|
118
|
|
|
|
322
|
|
Increase
(decrease) in bank
payable
|
|
|
240
|
|
|
|
(231
|
)
|
Proceeds
from residual financing,
net
|
|
|
54,225
|
|
|
|
--
|
|
Repayment
of residual
financing
|
|
|
(2,962
|
)
|
|
|
--
|
|
Proceeds
from issuance of
convertible notes, net
|
|
|
9,800
|
|
|
|
--
|
|
Proceeds
from issuance of
warrants, net
|
|
|
5,050
|
|
|
|
--
|
|
Cash
dividends paid on common
stock
|
|
|
(3,497
|
)
|
|
|
(3,236
|
)
|
Excess
tax benefit related to
stock-based compensation
|
|
|
121
|
|
|
|
872
|
|
Proceeds
from issuance of common
stock in secondary offering, net
|
|
|
--
|
|
|
|
19,329
|
|
Proceeds
from exercise of stock
options
|
|
|
137
|
|
|
|
298
|
|
Net
cash provided by financing
activities
|
|
|
626,824
|
|
|
|
1,258,685
|
|
|
|
|
|
|
|
|
|
|
Net
(decrease) increase in cash
and cash equivalents
|
|
|
(1,534
|
)
|
|
|
434
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at
beginning of period
|
|
|
5,741
|
|
|
|
4,673
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end
of period
|
|
$
|
4,207
|
|
|
$
|
5,107
|
|
|
|
Nine
Months Ended
September
30,
|
|
|
|
2007
|
|
|
2006
|
|
Supplemental
Information:
|
|
|
|
|
|
|
Cash
paid during the
period for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
316,555
|
|
|
$
|
219,322
|
|
Income
taxes
|
|
$
|
2,712
|
|
|
$
|
9,975
|
|
|
|
|
|
|
|
|
|
|
Non-cash
transactions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfer
of mortgage loans held
for investment to REO, net
|
|
$
|
61,753
|
|
|
$
|
21,364
|
|
Dividends
payable
|
|
$
|
--
|
|
|
$
|
1,169
|
|
The
accompanying notes are an integral
part of these consolidated financial statements.
DELTA
FINANCIAL CORPORATION AND
SUBSIDIARIES
(1)
Basis
of
Presentation
The
accompanying unaudited consolidated financial statements include the accounts
of
Delta Financial Corporation and its subsidiaries (collectively, the “Company,”
“we” or “us”). The consolidated financial statements reflect all
normal recurring adjustments that, in the opinion of management, are necessary
to present a fair statement of the financial position and results of operations
for the periods presented. Certain reclassifications have been made
to prior-period financial statements to conform to the 2007
presentation.
Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with United States generally accepted accounting
principles (“GAAP”) have been condensed or omitted in accordance with the rules
and regulations of the U.S. Securities and Exchange Commission
(“SEC”). The accompanying unaudited consolidated financial statements
have been prepared in conformity with the instructions to Quarterly Report
on
Form 10-Q and Article 10, Rule 10-01 of Regulation S-X for interim financial
statements. Accordingly, they do not include all of the information
and footnotes required by GAAP for complete financial statements
The
preparation of consolidated financial statements in conformity with GAAP
requires our management to make estimates and assumptions that affect the
reported amounts of assets, liabilities and stockholders’ equity and disclosure
of contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of income and expenses during the reporting
periods. Actual results could differ from those estimates and
assumptions.
These
unaudited consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto included in
our
Annual Report on Form 10-K for the year ended December 31, 2006. The
results of operations for the three and nine months ended September 30, 2007
are
not necessarily indicative of the results that should be expected for the entire
year.
(2) Bas
is
of
Consolidation
The accompanying consolidated financial statements are prepared on the accrual
basis of accounting and include our accounts and those of our
subsidiaries. All inter-company accounts and transactions have been
eliminated in consolidation.
(3)
Summary
of Significant Accounting
Policies
(a)
Cash and Cash
Equivalents
For cash flow reporting purposes, cash and cash equivalents include cash in
checking accounts, cash in interest bearing deposit accounts, amounts due from
banks, restricted cash and money market investments. Included in cash
and cash equivalents were $3.7 million and $5.1 million of interest-bearing
deposits with select financial institutions at September 30, 2007 and December
31, 2006, respectively.
Additionally, cash and cash equivalents as of September 30, 2007 and December
31, 2006 included restricted cash held for various reserve accounts totaling
$98,000 and $604,000, respectively.
(b) Mortgage Loans, Net
Mortgage
loans held for sale
- Mortgage loans held for sale represents mortgage
loans that have a contractual maturity of up to 30 years that we originate
specifically with the intent to sell. These mortgage loans are
secured by residential properties and are recorded at the lower of amortized
cost or market value. We typically hold our mortgage loans held for
sale for no more than 30 days before they are sold in the secondary
market. During the period in which the loans are held for sale, we
earn the coupon rate of interest paid by the borrower and pay interest to the
lenders that provide our warehouse credit facilities, to the extent that we
utilize such financing. We also pay a sub-servicing fee to a
third-party servicer during the period in which the loans are held for
sale. Loan origination fees, discount points and certain direct
origination costs associated with loans held for sale (as more fully described
below) are initially recorded as an adjustment of the cost of the
loan. Gains or losses on sales of mortgage loans are recognized based
upon the difference between the selling price and the carrying value of the
related mortgage loans being sold.
During
the three months ended September
30, 2007 we closed a securitization transaction totaling $846.5
million. The securitization was accounted for as a sale and
collateralized by $900.0 million of mortgage loans. The mortgage
loans sold in this transaction were reclassified from mortgage loans held for
investment at the lower of their amortized cost or market value on the date
we
determined that the securitization would be structured as a
sale.
For the
three and nine months ended September 30, 2007, we recorded interest income
related to our
mortgage
loans held for sale
of $2.0
million. For the three and nine months ended September 30, 2006, we
did not record any interest income, as we did not have any mortgage loans held
for sale during that period.
We held no mortgage loans
classified as held for sale at September 30, 2007 or December 31,
2006.
Mortgage loans held for investment -
Mortgage loans held for investment
represents mortgage loans that have a contractual maturity of up to 30 years
that are securitized through transactions structured and accounted for as
secured financings (mortgage loans held for investment – securitized) or held
pending securitization (mortgage loans held for investment –
pre-securitization). Mortgage loans held for investment are primarily
secured by residential properties and stated at amortized cost, including the
outstanding principal balance, net of the allowance for loan losses, net of
discounts and net of deferred origination fees or costs.
The
secured financing related to the mortgage loans held for investment -
securitized is included in our consolidated balance sheets as financing on
mortgage loans held for investment, net. Once the mortgage loans are
securitized, we earn the net pass-through rate of interest and pay interest
on
our financing on mortgage loans held for investment, net.
We typically hold our mortgage loans held for investment – pre-securitization
for no more than 120 days, and for 60 days on average, before they are
securitized, and from time-to-time sold on a whole-loan basis, in the secondary
market. During the period in which the loans were held pending
securitization or whole-loan sale, we earn the coupon rate of interest paid
by
the borrower and pay interest to the lenders that provide our warehouse
financing, to the extent that we utilized such financing. We also pay
a sub-servicing fee to a third-party during the period the loans are held
pending securitization or whole-loan sale.
Mortgage loan related discounts, deferred fees and costs
- In accordance with Statement
of
Financial Accounting Standards (“SFAS”) No. 91, “
Accounting for Nonrefundable
Fees and
Costs Associated with Originating or Acquiring Loans and Initial Direct Costs
of
Leases - an amendment of FASB Statements No. 13, 60, and 65 and a rescission
of
FASB Statement No. 17,”
the
net deferred origination fees or costs associated with our mortgage loans held
for investment are amortized to interest income on a level-yield basis over
the
estimated life of the related loans, on a homogeneous pool basis, using the
interest method calculation.
The
amount of deferred nonrefundable fees is determined based on the amount of
such
fees collected at the time of loan closing. We determine the amount
of direct loan origination costs to be deferred based on the amount of time
spent and actual costs incurred, including the cost of loan origination
personnel in the performance of specific activities, directly related to the
origination of funded mortgage loans for that period. These
activities include evaluating the prospective borrowers’ financial condition,
evaluating and recording collateral and security arrangements, negotiating
loan
terms, processing loan documents and closing the loan. Management
believes these estimates reflect an accurate cost structure related to
successful loan origination efforts. Management periodically reviews
its time and cost estimates to determine if updates and refinements to the
deferral amounts are necessary.
Discounts related to mortgage loans held for investment are recorded from the
creation of mortgage servicing assets. The allocated cost basis of
mortgage servicing rights (“MSRs”) is recorded as an asset with an offsetting
reduction (
i.e.
, discount) in the cost basis of the mortgage
loans. Under SFAS No. 140, “Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities - a replacement of FASB
Statement No. 125,” the discount is measured using the relative fair values of
the mortgage loans and MSRs to allocate the carrying value between the two
assets. The MSRs are generally sold to a third-party
servicer. The resulting discount is accreted to interest income on a
level-yield basis over the estimated life of the related loans, on a per
securitization basis, using the interest method calculation.
(c)
Allowance and Provision for Loan
Losses
In connection with our mortgage loans held for investment, excluding those
loans
which meet the criteria for specific review under SFAS No. 114, “Accounting by
Creditors for Impairment of a Loan - an amendment of FASB Statements No. 5
and
15,” we established an allowance for loan losses based on our estimate of losses
that we expect will arise within the next 18 to 24 months following the analysis
date of September 30, 2007. Provisions for loan losses are made for
loans to the extent that we bear probable losses on these
loans. Provision amounts are charged as a current period expense to
operations. We charge-off uncollectible loans at the time we deem
they are not probable of being collected. In order to estimate an
appropriate allowance for loan losses on mortgage loans held for investment
(both securitized and pre-securitization), we estimate losses using a detailed
analysis of historical loan performance by product type, origination year and
securitization issuance, which is updated each quarter. We stratify
the mortgage loans held for investment into separately identified loan pools
based upon seasoning criteria. In accordance with SFAS No. 5,
“Accounting for Contingencies,” we believe that pooling of mortgages with
similar characteristics is an appropriate methodology by which to calculate
or
estimate the allowance for loan losses. The results of that analysis
are then applied to the current long-term mortgage portfolio, and an allowance
for loan losses estimate is created to take into account both known and inherent
losses in the loan portfolio. Losses incurred are written-off against
the allowance for loan losses.
In analyzing the adequacy of this allowance, there are qualitative factors
and
estimates that must be taken into consideration when evaluating and measuring
potential expected losses on mortgage loans. These items include, but
are not limited to, current performance of the loans, economic indicators that
may affect the borrowers’ ability to pay, changes in the market value of the
collateral, political factors and the general economic
environment. As these factors and estimates are influenced by factors
outside of our control, there is inherent uncertainty in our
estimates. Accordingly, it is reasonably possible that they could
change. In particular, if conditions required us to increase the
provision for loan losses, our income for that period would
decrease. Management considers the current allowance for loan losses
to be adequate.
In accordance with SFAS No. 114, as amended by SFAS No. 118, “Accounting by
Creditors for Impairment of a Loan/Income Recognition and Disclosures,” a loan
is impaired when, based on current information and events, it is probable that
a
creditor will be unable to collect all amounts due according to the contractual
terms of the mortgage loan agreement. Based upon the analysis
performed, we identified certain mortgage loans in which the borrowers’ ability
to repay the loans in accordance with their contractual terms was
impaired. At September 30, 2007, we have a specific reserve of
$306,000 on impaired loans. As additional information is obtained and
processed over the coming months and quarters, we will continue to assess the
need for any adjustments to our estimates and the specific reserves related
to
the impaired mortgage loans.
(d)
Trustee
Receivable
Trustee receivable principally represents any un-remitted principal and interest
payments collected by the securitization trust’s third-party loan servicer
subsequent to the monthly remittance cut-off date on our mortgage loans held
for
investment – securitized portfolio. Each month, the third-party loan
servicer, on behalf of each securitization trustee, remits all of the scheduled
loan payments and unscheduled principal payoffs and curtailments generally
received through a mid-month cut-off date. We record unscheduled
principal and interest payments and prepaid principal loan payments received
after the cut-off date for the current month as a trustee receivable on our
consolidated balance sheets. The trustee or third-party loan servicer
retains these unscheduled principal and interest payments until the following
month’s scheduled remittance date, at which time they primarily will be used to
pay down financing on mortgage loans held for investment, net.
(e)
Excess Cashflow
Certificates
Prior to 2004, we structured our securitization transactions to be accounted
for
as sales. In these transactions, the excess cashflow certificates
represented one or more of the following assets: (1) residual interest (“BIO”)
certificates; (2) P certificates (prepayment penalty fees); (3) payments from
our interest rate cap providers; and (4) net interest margin (“NIM”) owner trust
certificates. Our excess cashflow certificates were classified as
“trading securities” in accordance with SFAS No. 115, “Accounting for Certain
Investments in Debt and Equity Securities.” The amount initially
recorded for the excess cashflow certificates at the date of a securitization
structured as a sale reflected their then allocated estimated fair
value. The amount recorded for the excess cashflow certificates was
reduced for cash distributions received, and adjusted for income accretion
and
subsequent changes in the fair value. Any changes in fair value were
recorded as a component of “other income” in our consolidated statements of
operations. During the three months ended March 31, 2007, we sold all
of our remaining excess cashflow certificates, and consequently, we no longer
record any interest income or other income related to changes in fair value
of
the excess cashflow certificates. For the three months ended
September 30, 2006, we recorded $1.7 million of other income due to an increase
in the fair value of excess cashflow certificates. For the nine
months ended September 30, 2007 and 2006, we recorded $1.6 million and $9.2
million, respectively, of other income due to an increase in the fair value
of
excess cashflow certificates.
(f)
Equipment, Net
Equipment,
including leasehold improvements, is stated at cost, less accumulated
depreciation and amortization. Depreciation of equipment is computed
using the straight-line method over the estimated useful lives of three to
seven
years. Leasehold improvements are amortized over the lesser of the
terms of the lease or the estimated useful lives of the
improvements. Ordinary maintenance and repairs are charged to expense
as incurred.
Depreciation
and amortization are included in “non-interest expense - general and
administrative” in our consolidated statements of operations, and amounted to
approximately $923,000 and $892,000 for the three months ended September 30,
2007 and 2006, respectively, and $2.8 million and $2.5 million for the nine
months ended September 30, 2007 and 2006, respectively. Accumulated
depreciation and amortization totaled $18.4 million and $16.0 million at
September 30, 2007 and December 31, 2006, respectively.
(g)
Real Estate
Owned
Real
estate owned (“REO”) represents properties acquired through, or in lieu of,
foreclosure. REO properties are recorded at the lower of cost or fair
value less estimated selling costs. The fair value of an REO property
is determined based upon values (
i.e
., appraisal or broker price
opinion) obtained by the third-party servicer. REO properties are
evaluated periodically for recoverability and any subsequent declines in value
are reserved for through a provision. Any costs incurred to maintain
the REO properties are expensed as incurred. Gains or losses on the
sale of REO properties are recognized upon disposition.
In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” we classify our REO as “held for sale” at the date of
foreclosure. The REO properties held are actively marketed for sale
by our third-party servicer at a price that is deemed reasonable in relation
to
the properties’ current fair value. We generally expect the REO
properties to be disposed of within six months to one year after being
acquired.
Included
in “prepaid and other assets”
on our consolidated balance sheets are $62.9 million and $29.6 million of REO
properties as of September 30, 2007 and December 31, 2006,
respectively. Included in
“general and administrative
expenses” on our statements of operations are
provisions for the decrease
in the fair
value of the REO properties of $4.1 million and $240,000 recognized during
the
three months ended September 30, 2007 and 2006, respectively. During
the nine months ended September 30, 2007 and 2006, we recorded a provision
for
the decrease in fair value of REO properties of $8.8 million and $786,000,
respectively.
During the nine months ended September 30, 2007
and the year ended December 31, 2006, we sold $20.2 million and $8.8 million,
respectively, of REO properties.
(h)
Warehouse Financing
Warehouse
financing represents the outstanding balance of our borrowings collateralized
by
mortgage loans held prior to securitization or sale. Generally,
warehouse financing facilities are used as short-term financing and bear
interest at a fixed margin over the one-month
London Inter-Bank Offered Rate
(“LIBOR”)
. The outstanding balance of our warehouse financings
will fluctuate based on our lending volume, cash flows from operations,
whole-loan sales activity, other financing activities and equity
transactions. Any commitment fees paid to obtain the warehouse
financing are capitalized and amortized to expense as a component of
“non-interest expense – general and administrative” over the term of the
warehouse agreement, which is normally a 12-month period.
(i)
Financing on Mortgage Loans Held for Investment, Net
Financing
on mortgage loans held for
investment, net represents the securitization debt (asset-backed certificates
or
notes, referred to as “asset-backed securities”) used to finance loans held for
investment - securitized, and the notes issued in connection with the issuance
of interest-only certificates and NIM securities, along with any discounts
on
the financing. The balance of this account will generally increase in
proportion to the increase in mortgage loans held for investment -
securitized.
Asset-backed
securities are secured, or
backed, by the pool of mortgage loans held by the securitization trust, which
are recorded as mortgage loans held for investment – securitized within our
consolidated balance sheets.
Generally, the asset-backed
security financing is comprised of a series of senior and subordinate securities
with varying maturities ranging generally from one to 20 years and bearing
either a fixed rate of interest or a variable rate of interest (representing
a
fixed margin over one-month LIBOR). The variable-rate asset-backed
securities adjust monthly.
Any securitization debt issuance costs are deferred and amortized, along with
any discounts on the financing, on a level-yield basis over the estimated life
of the debt issued. From time-to-time, we may utilize derivative
instruments, such as interest rate swap contracts and corridors (corresponding
purchases and sales of interest rate caps with similar notional balances at
different strike prices), as cash flow hedges as defined in SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities” in an effort to
maintain a minimum margin or to lock in a pre-determined base interest rate
on
designated portions of our prospective future securitization financing
(collectively, the hedged risk). (See – Note 3(o) – “Derivative
Instruments” and Note 11 – “Derivative Instruments” for further information
regarding hedging securitization financing).
All
of our securitizations, including
those structured as sales under SFAS No. 140, are structured legally as sales,
and
we are not legally required
to
make payments to the holders of the asset-backed securities. The only
recourse of the asset-backed securities holders for repayment is from the
underlying mortgages specifically collateralizing the debt. The
assets held by the securitization trusts are not available to our general
creditors. As with past securitizations, we have potential liability
to each of the securitization trusts for any breach of the standard
representations and warranties that we provided in connection with that
securitization.
Under
SFAS No. 140, the securitizations we completed from the first quarter of 2004
through the second quarter of 2007 are accounted for as
financings. The securitization trusts do not meet the qualifying
special purpose entity (“QSPE”) criteria under SFAS No. 140 and related
interpretations, because, after the loans are securitized, we have the option
to
either contribute a derivative instrument into the trust or
purchase
up to 1% of
the mortgage loans contained in the securitization mortgage pool
.Our
pre-2004 securitizations and the third quarter of 2007 securitization met the
sales criteria of SFAS No. 140, which required the securitizations to be
accounted for as a sale of mortgage loans.
(j)
Interest
Income
Interest
income primarily represents the
sum of (a) the gross interest, net of servicing fees, we earn on mortgage loans
held for investment - securitized; (b) the gross interest we earn on mortgage
loans held for investment - pre-securitization; (c) the gross interest we earn
on mortgage loans held for sale; (d) securitization accrued bond interest
(income received from the securitization trust for fixed-rate asset-backed
securities at the time of securitization settlement); (e) excess cashflow
certificate income (through the first quarter of 2007); (f) interest earned
on
bank accounts; (g) prepayment penalty fees; and (h) amortized discounts,
deferred costs and fees recognized on a level-yield basis.
Interest
on mortgage loans is recognized as revenue when earned according to the
contractual terms of the mortgages and when, in the opinion of management,
it is
deemed collectible. Mortgage loans are placed on non-accrual status
generally when the loan becomes 90 days past due, or earlier when concern exists
as to the ultimate collectability of principal or interest (
i.e.,
an
impaired loan), in accordance with the contractual terms of the
mortgage. A non-accrual loan will be returned to accrual status when
loan payments are no longer three months past due, and the loan is anticipated
to be fully collectible. Cash receipts on non-accrual loans,
including impaired loans, are generally applied to principal and interest in
accordance with the contractual terms of the loan.
(k)
Interest
Expense
Interest expense primarily represents the borrowing costs under (a) our
warehouse credit facilities to finance loan originations; (b) securitization
debt; (c) residual financing facility; (d) convertible notes; and (e) equipment
financing. Interest expense also reflects the impact of hedge
amortization and the amortization of discounts and deferred costs on a
level-yield basis.
(l)
(Loss) Gain on Sale of Mortgage Loans
Gains
and
losses on the sale of mortgage loans, on a whole-loan or securitization basis,
are recognized at settlement date and are determined by the difference between
the selling price (net of selling expenses) and the carrying value of the loans
sold. These transactions are treated as sales in accordance with SFAS
No. 140. Any unamortized deferred origination fees or costs at the date of
sale are reflected as an adjustment to loss or gain on sale.
We generally sell whole-loans on a servicing-released basis and as such, the
risk of loss or default by the borrower has generally been assumed by the
purchaser. During the quarter ended September 30, 2007, we
securitized loans and accounted for the securitization transaction on a sale
basis. Both our whole-loan sales and our securitizations (whether
accounted for as a financing or as a sale) are transacted on a non-recourse
basis. However, we are generally required to make certain
representations and warranties to these purchasers relating to borrowers’
creditworthiness, loan documentation and collateral. To the extent
that we do not comply with such representations, or there are early payment
defaults on whole-loans sold, we may be required to repurchase loans or
indemnify these purchasers for any losses from borrower defaults.
During
the three and nine months ended September 30, 2007 we securitized $900.0 million
of loans (in September 2007), which we accounted for as a
sale. During the three and nine months ended September 30, 2006, we
did not securitize any loans which we accounted for as a sale. During
the three months ended September 30, 2007 and 2006, we sold $244.5 million
and
$196.7 million, respectively, of whole-loans on a non-recourse
basis. During the nine months ended September 30, 2007 and 2006, we
sold $627.0 million and $515.5 million, respectively, of whole-loans on a
non-recourse basis.
Additionally,
when we sell loans on a whole-loan basis, we establish premium recapture and
secondary marketing (indemnification) reserves. We establish a
premium recapture reserve for the contractual obligation to rebate a portion
of
any premium paid by a purchaser when a borrower prepays a sold loan within
an
agreed period (generally a 3 to 12 month period). We also establish a
secondary marketing (indemnification) reserve
based upon our estimated exposure
to
losses arising from loan repurchases, or net settlements, related to
representation and warranty claims made by whole-loan sale investors.
The
premium recapture and secondary marketing (indemnification) reserves are
recorded as liabilities on our consolidated balance sheets when the mortgage
loans are sold,
based on our
historical experience,
coupled with our analysis
of current
market conditions
.
The provisions
recorded for the premium recapture and secondary marketing (indemnification)
reserves are recognized at the date of sale and are included in the consolidated
statements of operations as a reduction of gain on sale of mortgage
loans. The premium recapture reserve totaled $386,000 and $958,000 at
September 30, 2007 and December 31, 2006, respectively. The secondary
marketing (indemnification) reserve totaled $744,000 and $512,000 at September
30, 2007 and December 31, 2006, respectively.
(m)
Mortgage Servicing Rights
Sales
We generally sell the MSRs to a third-party as of the securitization
date. Upon the sale of the MSRs, we allocate a portion of the
accounting basis of the mortgage loans to the MSRs based upon the relative
fair
values of the mortgage loans and the MSRs, which results in a discount to the
mortgage loans. That discount is either (a) accreted as an adjustment
to yield on the mortgage loans held for investment – securitized over the
estimated life of the related loans, on a pool-by-pool basis, using the interest
rate method, or (b) becomes a component of the calculated gain or loss on sale
of mortgage loans. For the three months ended September 30, 2006, we
received $6.4 million from a third-party servicer for the right to service
the
mortgage loans collateralizing the securitization that we structured to be
accounted for as a secured financing. Due to the structure of third
quarter 2007 securitization, we had no separately identifiable residual
interests (i.e., MSRs) and therefore had no sales of MSRs during the three
months ended September 30, 2007. For the nine months ended September
30, 2007 and 2006, we received $16.3 million and $19.1 million, respectively,
from a third-party servicer for the right to service the mortgage loans
collateralizing our securitizations structured as financings.
(n)
Stock-Based Compensation
We
have
various stock-based compensation plans for employees and outside directors,
which are described more fully in Note 5, “Stock-Based
Compensation.” We apply the fair value recognition provisions of SFAS
No. 123(R), “Share-Based Payment,” using the modified-prospective adoption
method. Under that method of adoption, the provisions of SFAS No.
123(R) generally are applied only to share-based awards granted subsequent
to
adoption. Additionally, under this method, compensation cost
recognized for the three and nine months ended September 30, 2007 and 2006
includes compensation cost for all options granted prior to, but not yet vested
as of January 1, 2006, and all options granted subsequent to January 1, 2006,
based on the grant date fair value estimated in accordance with the provisions
of SFAS No. 123(R).
For
purposes of calculating the pool of
excess tax benefits available to absorb tax deficiencies recognized subsequent
to the adoption of SFAS No. 123(R) (“APIC Pool”), we determined the net excess
tax benefits that would have qualified as such had we adopted SFAS No. 123
for
recognition purposes for all of our stock-based award grants made after December
31, 1994.
(o)
Derivative
Instruments
Our
hedging strategy revolves around two
principal activities: (a) the issuance of our prospective securitization
financing which is collateralized by the origination of mortgage loans, and
(b)
the issuance of variable-rate securitization debt (financing). As a
result of these activities, we are exposed to interest rate risk beginning
when
our mortgage loans close and are recorded as assets until permanent financing
is
arranged, such as when the asset-backed securities are issued. We
utilize derivative instruments as hedges to mitigate our interest rate
exposure. After we originate mortgage loans, our strategy is to
generally use a series of duration matched interest rate swap contracts (i.e.,
two, three and five-year contracts) in an effort to lock in a pre-determined
base interest rate on designated portions of our prospective future
securitization financing (i.e., the asset-backed securities that we expect
to
issue). We also use corridors (
corresponding purchases and
sales of interest rate caps with similar notional balances at different strike
prices
) and/or amortizing notional
balance interest rate swaps that are designed to limit our financing costs
on
the variable portion of the debt issued in the securitization. The
purpose of the hedge within the securitization is to maintain minimum margins
over specific periods of time, with the possibility of allowing us to increase
margins during periods in which prevailing interest rates are lower than
anticipated. Both the interest rate swaps (which generally have an
expected life of 36 months) and corridors (which have a range of expected lives)
are derivative instruments that trade in liquid markets, and we do not use
either of them for speculative purposes.
In
accordance with SFAS No. 133, all
derivatives are recorded on the balance sheet at fair value. When
derivatives are used as hedges, certain criteria must be met in order to qualify
for hedge accounting. Under SFAS No. 133, cash flow hedge accounting
is permitted only if a hedging relationship is properly documented and
qualifying criteria are satisfied. For derivative financial
instruments not designated as hedging instruments, all gains or losses, whether
realized or unrealized, are recognized in current period
earnings.
Cash
flow hedge accounting is
appropriate for hedges of forecasted interest payments associated with future
periods – whether as a consequence of interest to be paid on existing
variable-rate debt or in connection with future debt
issuances.
Under cash flow hedge accounting treatment, derivative results are divided
into
two portions, “effective” and “ineffective.” The effective portion of
the derivative's gain or loss is initially reported as a component of “other
comprehensive income or loss” (“OCI”) and subsequently reclassified into
earnings when the forecasted interest payments affect earnings or until the
sale
is consummated. The ineffective portion of the gain or loss is
reported in earnings immediately.
To qualify for cash flow hedge accounting treatment, all of the following
factors must be met:
|
·
|
Hedges
must be contemporaneously
documented, with the objective and strategy stated, along with an
explicit
description of the methodology used to assess effectiveness and measure
ineffectiveness;
|
|
·
|
Dates
(or periods) for the
expected forecasted events and the nature of the exposure involved
(including quantitative measures of the size of the exposure) must
be
explicitly documented;
|
|
·
|
Hedges
must be expected to be
“highly effective,” both at the inception of the hedge and on an ongoing
basis. Effectiveness measures must relate the gains or losses
of the derivative to the changes in cash flows associated with the
hedged
item;
|
·
Forecasted
transactions must be
probable; and
·
Forecasted
transactions must be made
with counterparties other than the reporting entity.
If and when a derivative no longer qualifies for hedge accounting because it
fails the test of hedge effectiveness (the ratio of the changes in the value
of
the hedging instrument to the changes in the value of the hedged item exceeds
125% or falls below 80%, and therefore the hedge is no longer “highly
effective”), hedge accounting is discontinued and any amounts previously
recorded in OCI are amortized into earnings over the remaining life of the
hedged asset or liability. As permitted by SFAS No. 133, when a hedge
relationship is discontinued for this reason, we will analyze the derivative
to
determine whether all or a portion of the derivative may be designated as a
hedge of a different transaction or item. If all or a portion of the
derivative qualifies for a new hedging relationship, hedge accounting is applied
to future changes in the fair value of that portion of the
derivative. The future changes for any portion of the derivative that
does not qualify for a new hedge relationship are included in income as they
occur.
The “new hedge relationship” is determined by re-aligning the hedge with the
projected remaining securitization debt as of the date the original hedge became
retrospectively ineffective. The ratio of the outstanding balance of
the debt to notional size of the revised hedge will then be 100% as of the
re-alignment date. The expected repayment pattern of the debt
associated to the original hedge is used as the basis to establish the “new
hedge relationship” future repayment pattern. The difference between
the fair value of the original hedge and the “new hedge relationship” hedge on
the re-alignment date is classified as a trading security. Once
classified as a trading security, any changes in the fair value are recorded
directly to the income statement as a component of “gain or loss on derivative
instruments.”
(p)
Earnings Per Share
Basic
earnings per share (“EPS”) excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of shares of
common stock outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock, or resulted in
the
issuance of common stock that then shared in the earnings of the
entity.
(q)
Income Taxes
On
January 1, 2007, we adopted FIN No. 48, “Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109.” FIN No. 48
provides guidance on financial statement recognition and measurement of tax
positions taken, or expected to be taken, in tax returns. The initial
adoption of FIN No. 48 did not have an impact on our consolidated financial
statements. As of January 1, 2007, the amount of gross unrecognized
tax benefits was approximately $2.5 million, including approximately $1.5
million of related accrued interest and penalties. The total amount
of unrecognized tax benefits that, if recognized, would affect the effective
tax
rate was $780,000 as of January 1, 2007. We do not anticipate that
the total amount of unrecognized tax benefits will significantly increase or
decrease within the next twelve months.
The
amount of unrecognized tax benefits may increase or decrease in the future
for
various reasons, including adding amounts for current tax year positions,
expiration of open income tax returns due to statutes of limitation, changes
in
management's judgment about the level of uncertainty, status of tax
examinations, litigation and legislative activity and the addition or
elimination of uncertain tax positions.
Our
policy is to report interest and penalties as a component of loss or income
before taxes. Penalties are recorded in “general and administrative
expense” and interest paid or received is recorded in “interest expense” or
“interest income” in the consolidated statements of
operations. During the three and nine months ended September 30,
2007, we recorded approximately $70,000 and $200,000, respectively, in interest
expense related to current audits. We have accrued interest and
penalties totaling approximately $1.7 million at September 30,
2007. During the nine months ended September 30, 2007, the
unrecognized tax benefit remained unchanged, except for the aforementioned
accrued interest.
Our
federal income tax returns are open and subject to examination from the 2004
tax
return year and forward. Our various state income tax returns are
generally open from the 2004 and subsequent tax return years, except for New
York State, which is open from the 1999 tax return year forward, based on
individual state statute of limitations.
(4)
Recent
Accounting
Developments
Fair
Value Measurement of Loan Commitments.
On November 5, 2007, the
SEC issued staff accounting bulletin ("SAB") No. 109, which provides guidance
regarding written loan commitments that are accounted for at fair value through
earnings under GAAP. The SEC had previously issued SAB No. 105,
"Application of Accounting Principles to Loan Commitments," which stated
that in
measuring the fair value of a derivative loan commitment, it would be
inappropriate to incorporate the expected net future cash flows related to
the
associated servicing of the loan. SAB No. 109 supersedes SAB No. 105
and expresses the current view of the SEC that, consistent with the guidance
in
SFAS No. 156, "Accounting for Servicing of Financial Assets," and SFAS No.
159,
“The Fair Value Option for Financial Assets and Financial Liabilities -
Including an amendment of FASB Statement No. 115,” the expected net future
cash flows related to the associated servicing of the loan should be included
in
the measurement of all written loan commitments that are accounted for at
fair
value through earnings. We will apply SAB No. 109 on a prospective
basis to derivative loan commitments issued or modified in fiscal quarters
beginning after December 15, 2007. We are currently evaluating SAB
No. 109, and have not yet determined the effect it will have on our consolidated
financial statements.
Offsetting
of Amounts Related to
Certain Contracts.
In
April 2007, the FASB issued FASB
Staff Position (“FSP”) No. FIN 39-1,
“Amendment of FASB Interpretation
No.
39,”
which amends FIN No.
39,
“Offsetting of Amounts
Related to Certain Contracts,”
to permit a reporting
entity to offset
fair value amounts recognized for the right to reclaim cash collateral (a
receivable) or the obligation to return cash collateral (a payable) against
fair
value amounts recognized for derivative instruments executed with the same
counterparty under the same master netting arrangement that have been offset
in
accordance with FIN No. 39. FSP No. FIN 39-1 also amends FIN No. 39
for certain terminology modifications. FSP No. FIN 39-1 is effective
for fiscal years beginning after November 15, 2007, with early application
permitted, and is applied retrospectively as a change in accounting principle
for all financial statements presented. Upon adoption of FSP No. FIN
39-1, we are permitted to change our accounting policy to offset or not offset
fair value amounts recognized for derivative instruments under master netting
arrangements. We are currently evaluating FSP No. FIN 39-1, and have
not yet determined the effect the adoption of FSP No. FIN 39-1 will have on
our
consolidated financial statements.
Fair
Value Option for Financial Assets and Financial Liabilities
. In
February 2007,
FASB issued SFAS No. 159, which permits entities to
elect to measure many financial instruments and certain other items at fair
value that are not currently required to be so measured. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently, without having to apply complex
hedge accounting provisions. SFAS No. 159 also establishes
presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types
of assets and liabilities. SFAS No. 159 does not affect any existing
accounting literature that requires certain assets and liabilities to be carried
at fair value, and does not eliminate disclosure requirements included in other
accounting standards, including requirements for disclosures about fair value
measurements included in SFAS No. 157, “Fair Value Measurements,” and SFAS No.
107, “Disclosures about Fair Value of Financial Instruments.”
SFAS
No. 159 is effective for our fiscal year beginning after November 15,
2007.
We are currently
assessing the impact that the adoption of SFAS No. 159 will have on our
consolidated financial statements
, but we do not expect that the adoption
during the first quarter of 2008 will have a material impact on our financial
condition or results of operations.
Fair
Value Measurements.
In September 2006, FASB issued SFAS No. 157,
which defines fair value, establishes a framework for measuring fair value
in
GAAP, and expands disclosures about fair value measurements. SFAS No.
157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal
years.
We are currently
assessing the impact that the adoption of SFAS No. 157 will have on our
consolidated financial statements, but
we do not expect that the adoption
during the first quarter of 2008 will have a material impact on our financial
condition or results of operations.
(5)
Stock-Based
Compensation
Stock
Options
- In accordance
with SFAS No. 123(R),
our loss before income tax benefit and net loss for the three months ended
September 30, 2007 included stock option compensation cost of $91,000 and
$56,000, respectively, which had no impact on basic and diluted earnings
per
share for the three-month period. Our income before income tax
expense and net income for the three months ended September 30, 2006 included
stock option compensation cost of $119,000 and $73,000, respectively, which
had
no impact on basic and diluted earnings per share for the three-month
period. Our loss before income tax benefit and net loss for the nine
months ended September 30, 2007 included stock option compensation cost of
$301,000 and $185,000, respectively, which had a $0.01 impact on basic and
diluted loss per share for the nine month period. Our income before
income tax expense and net income for the nine months ended September 30,
2006
included stock option compensation cost of $373,000 and $228,000, respectively,
which had a $0.01 impact on basic and diluted earnings per share for the
nine
month period.
No
stock options were granted during the
three or nine months ended September 30, 2007. When stock options are
awarded, the fair value of each option award is estimated on the date of
grant
using the Black Scholes Merton option pricing model. Under the Black
Scholes Merton option pricing model, the expected term of the options is
estimated based on historical option exercise activity and represents the
period
of time that options granted are expected to be outstanding. The
expected volatility is based on the historical volatility of our common
stock. The risk-free interest rate for periods within the contractual
life of the option is based on the U.S. Treasury yield curve in effect at
the
time of grant. The weighted-average assumptions used in the
valuations of the grants made during the nine months ended September 30,
2006
are summarized as follows:
|
|
|
For
the Nine Months
Ended
September
30,
2006
|
|
|
|
|
Expected
dividend
yield
|
|
|
2.2%
|
Expected
volatility
|
|
|
53.6%
|
Risk-free
interest
rate
|
|
|
4.9%
|
Expected
term
|
|
|
3.7
years
|
Annual
forfeiture
rate
|
|
|
7.9%
|
The
average grant date fair value of the
stock options granted during the three and nine months ended September 30,
2006
was $3.51 and $3.64, respectively.
The
following table summarizes the option activity regarding our stock-benefit
plans
for the nine months ended September 30, 2007:
(
Dollars
in thousands, except
weighted-average exercise price
)
|
|
Number
of
Options
|
|
|
Weighted-Average
Exercise
Price
|
|
Weighted-Average
Remaining
Contractual Term
|
|
Aggregate
Intrinsic
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
January
1, 2007
balance
|
|
|
1,781,750
|
|
|
$
|
3.23
|
|
|
|
|
|
Options
granted
|
|
|
--
|
|
|
|
--
|
|
|
|
|
|
Options
exercised
|
|
|
49,050
|
|
|
|
2.80
|
|
|
|
|
|
Options
expired
|
|
|
800
|
|
|
|
1.99
|
|
|
|
|
|
Options
forfeited
|
|
|
19,300
|
|
|
|
7.80
|
|
|
|
|
|
September
30, 2007
balance
|
|
|
1,713,400
|
|
|
$
|
3.20
|
|
2.0
years
|
|
$
|
4,546
|
|
Options
fully vested and
exercisable
|
|
|
1,470,950
|
|
|
$
|
2.40
|
|
1.6
years
|
|
$
|
4,546
|
|
The
intrinsic value of a stock option is the amount by which the fair value of
the
underlying stock exceeds the exercise price of the option. The total
intrinsic value of the stock options exercised during the three months ended
September 30, 2007 and 2006 was $55,000 and $259,000,
respectively. The total intrinsic value of the stock options
exercised during the nine months ended September 30, 2007 and 2006 was $366,000
and $2.2 million, respectively.
As of September 30, 2007 and
2006, there
was $511,000 and $863,000, respectively, of total unrecognized compensation
cost, net of estimated forfeitures, related to non-vested options under our
stock-benefit plans. The unrecognized compensation cost at September
30, 2007 is expected to be recognized over a weighted-average period of 1.3
years.
Cash
received from option exercises
under our stock-benefit plans for the three months ended September 30, 2007
and
2006 was $21,000 and $51,000, respectively. Cash received from option
exercises under our stock-benefit plans for the nine months ended September
30,
2007 and 2006 was $137,000 and $298,000, respectively. The actual tax
benefit for the tax deductions from option exercises totaled $19,000 and
$101,000, respectively, for the three months ended September 30, 2007 and
2006. The actual tax benefit for the tax deductions from option
exercises totaled $121,000 and $872,000, respectively, for the nine months
ended
September 30, 2007 and 2006. The fair value of the shares that vested
during the three months ended September 30, 2007 and 2006, totaled $130,000
and
$119,000, respectively. The fair value of the shares that vested
during the nine months ended September 30, 2007 and 2006 totaled $393,000
and
$431,000, respectively.
Restricted
Stock
- Our loss before
income tax benefit
and net loss for the three months ended September 30, 2007 included a restricted
stock award compensation cost (recorded as a component of non-interest expense
–
payroll and related costs) of $188,000 and $115,000, respectively, which had
no
impact on basic loss per share and diluted loss per share for the three-month
period. Our income before income tax expense and net income for the
three months ended September 30, 2006 included a restricted stock award
compensation cost of $80,000 and $48,000, respectively, which had no impact
on
basic and diluted earnings per share for the quarter. Our loss before
income tax benefit and net loss for the nine months ended September 30, 2007
included restricted stock award compensation cost of $661,000 and $405,000,
respectively, which increased by $0.02 our basic and diluted loss per share
for
the nine-month period. Our income before income tax expense and net
income for the nine months ended September 30, 2006 included restricted stock
award compensation cost of $242,000 and $147,000, respectively, which had a
$0.01 impact on basic earnings per share and diluted earnings per share for
the
nine-month period. The actual tax benefit for the tax deductions from
vested restricted stock awards totaled $60,000 for the nine months ended
September 30, 2007. We had no tax benefit for the three months ended
September 30, 2007 and the three and nine months ended September 30, 2006,
as we
had no restricted stock awards vesting during those periods.
The
status of our non-vested restricted
stock awards as of September 30, 2007, and the changes during the nine months
ended September 30, 2007, is set forth in the following
table:
|
|
Number
of
Shares
|
|
|
Weighted-Average
Grant Date Fair
Value Per Share
|
|
Non-vested
restricted stock awards
at January 1, 2007
|
|
|
203,775
|
|
|
$
|
8.05
|
|
Granted
|
|
|
77,500
|
|
|
|
8.72
|
|
Vested
|
|
|
18,125
|
|
|
|
8.53
|
|
Forfeited
|
|
|
8,500
|
|
|
|
8.02
|
|
Non-vested
restricted stock awards
at September 30, 2007
|
|
|
254,650
|
|
|
$
|
8.22
|
|
As
of
September 30, 2007 and 2006, there was $1.2 million and $869,000, respectively,
of total unrecognized compensation costs related to non-vested restricted stock
awards granted under our stock-benefit plans. The unrecognized
compensation cost at September 30, 2007 is expected to be recognized over a
weighted-average period of 2.1 years.
Restricted
Stock
Units
– During the
three months ended September 30, 2007, we issued 8,600 restricted stock units
to
our outside directors. Prior to the July 6, 2007 grant, we had no
outstanding restricted stock units. Our loss before income tax
benefit and net loss for the three months ended September 30, 2007 included
a
restricted stock unit compensation cost (recorded as a component of non-interest
expense – general and administrative expenses) of $36,000 and $22,000,
respectively, which had no impact on our basic and diluted loss per share for
the three-month period. Our loss before income tax benefit and net
loss for the nine months ended September 30, 2007 included a restricted stock
unit compensation cost of $36,000 and $22,000, respectively, which had no impact
on basic and diluted loss per share for the nine-month period. We had
no tax benefit for the three and nine months ended September 30, 2007, as we
did
not issue the vested restricted stock to the holders during those
periods.
The
status of our non-vested and vested
restricted stock units as of September 30, 2007, and the changes during the
nine
months ended September 30, 2007, is set forth in the following
table:
|
|
Number
of
Shares
|
|
|
Weighted-Average
Grant Date Fair
Value Per Share
|
|
Non-vested
restricted stock units
at January 1, 2007
|
|
|
--
|
|
|
$
|
--
|
|
Granted
|
|
|
8,600
|
|
|
|
11.58
|
|
Vested
|
|
|
2,150
|
|
|
|
11.58
|
|
Forfeited
|
|
|
--
|
|
|
|
--
|
|
Non-vested
restricted stock units
at September 30, 2007
|
|
|
6,450
|
|
|
$
|
11.58
|
|
Vested
restricted stock units at
September 30, 2007 (not issued)
|
|
|
2,150
|
|
|
$
|
11.58
|
|
As
of
September 30, 2007 there was $64,000 of total unrecognized compensation costs
related to non-vested restricted stock units granted under our stock-benefit
plans. The unrecognized compensation cost at September 30, 2007 is
expected to be recognized over a weighted-average period of 1.0
year.
(6)
Mortgage
Loans Held for Investment, Net
and Allowance for Loan Losses
Mortgage
loans held for investment
represents our basis in the mortgage loans that either were delivered to
securitization trusts (recorded as mortgage loans held for investment –
securitized) or are pending delivery into future securitizations (recorded
as
mortgage loans held for investment – pre-securitization), net of discounts,
deferred origination fees and allowance for loan losses. Mortgage
loans held for investment – securitized had a weighted-average interest rate of
8.31% and 8.19% per annum at September 30, 2007 and December 31, 2006,
respectively. Mortgage loans held for investment – pre-securitization
had a weighted-average interest rate of 9.81% and 8.73% per annum at September
30, 2007 and December 31, 2006, respectively.
Included in our
mortgage
loans held for investment –
pre-securitization at September 30, 2007 and December 31, 2006, was
approximately $433.9 million and $335.9 million, respectively, of mortgage
loans
that were pledged as collateral for our warehouse financings at those same
respective dates.
The
following table presents a summary
of mortgage loans held for investment, net at September 30, 2007 and December
31, 2006:
(Dollars
in
thousands)
|
|
At
September
30,
2007
|
|
|
At
December 31,
2006
|
|
Mortgage
loans held for investment
– securitized
(1)
|
|
$
|
6,629,892
|
|
|
$
|
6,051,996
|
|
Mortgage
loans held for investment
– pre-securitization
(2)
|
|
|
480,514
|
|
|
|
417,818
|
|
Discounts
(MSR
related)
|
|
|
(43,412
|
)
|
|
|
(36,933
|
)
|
Net
deferred origination
fees
|
|
|
(20,722
|
)
|
|
|
(19,194
|
)
|
Allowance
for loan
losses
|
|
|
(75,878
|
)
|
|
|
(55,310
|
)
|
Mortgage
loans
held for investment, net
|
|
$
|
6,970,394
|
|
|
$
|
6,358,377
|
|
(1)
Included
in the
outstanding
balance of the mortgage loans held for investment - securitized at September
30,
2007 and December 31, 2006 were $460,000 and $1.1 million, respectively, of
impaired loans.
(2)
Included
in the
outstanding
balance of the mortgage loans held for investment - pre-securitized at September
30, 2007 and December 31, 2006 were $433,000 and $1.5 million, respectively,
of
impaired loans.
For
the three months ended September 30,
2007 and 2006, we recorded interest income related to our
mortgage loans held for
investment –
securitized
of $128.1
million and $110.2 million, respectively. For the nine months ended
September 30, 2007 and 2006, we recorded interest income related to our
mortgage loans held for
investment – securitized
of
$377.6 million and $300.4 million, respectively. For the three months
ended September 30, 2007 and 2006, we recorded interest income related to our
mortgage loans held for
investment – pre-securitization
of $24.3 million and
$9.0 million,
respectively. For the nine months ended September 30, 2007 and 2006,
we recorded interest income related to our
mortgage loans held for
investment –
pre-securitization
of $58.3
million and $26.7 million, respectively.
The
following table presents a summary
of the activity for the allowance for loan losses on all mortgage loans held
for
investment for the three and
nine months ended September
30, 2007 and
2006
:
|
|
For
the Three
Months
Ended
September
30,
|
|
|
For
the Nine
Months
Ended
September
30,
|
|
(Dollars
in
thousands)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Beginning
balance
|
|
$
|
66,864
|
|
|
$
|
46,326
|
|
|
$
|
55,310
|
|
|
$
|
36,832
|
|
Provision
(1)
|
|
|
21,471
|
|
|
|
6,874
|
|
|
|
45,392
|
|
|
|
20,276
|
|
Charge-offs
|
|
|
(12,457
|
)
|
|
|
(2,367
|
)
|
|
|
(24,824
|
)
|
|
|
(6,275
|
)
|
Ending
balance
|
|
$
|
75,878
|
|
|
$
|
50,833
|
|
|
$
|
75,878
|
|
|
$
|
50,833
|
|
(1)
The
provision for loan losses for the
three months ended September 30, 2007 and 2006 includes a specific provision
of
$19,000 and $61,000, respectively,
related to probable losses
attributable to impaired loans.
The provision for loan losses
for the
nine months ended September 30, 2007 and 2006 includes a recovery of specific
provision of $333,000 and $351,000, respectively,
related to probable
losses attributable to impaired loans.
The
allowance for loan losses at September 30, 2007 and December 31, 2006 contains
$306,000 and $1.0 million, respectively, of specific reserves related to
impaired loans. Our recorded investment in impaired loans at
September 30, 2007 and December 31, 2006 was $893,000 and $2.5 million,
respectively. Additionally, the average recorded investment in
impaired loans for the three months ended September 30, 2007 and 2006 was $2.1
million and $3.2 million, respectively. The average recorded
investment in impaired loans for the nine months ended September 30, 2007 and
2006 was $2.7 million and $3.4 million, respectively. We recorded
$65,000 and $66,000 of interest income, based upon the cash received on the
loans classified as impaired during the three months ended September 30, 2007
and 2006, respectively. We recorded $104,000 and $187,000 of interest
income, based upon the cash received on the loans classified as impaired during
the nine months ended September 30, 2007 and 2006, respectively.
The
mortgage loans held for investment
portfolio at September 30, 2007 and December 31, 2006 are seasoned approximately
16.6 months and 12.2 months, respectively, on average. The
significant increase in seasoning is primarily due to the $900.0 million
securitization which we accounted for as a sale during the quarter ended
September 30, 2007. Seasoning refers to the length of time the loans have been
outstanding from their origination date. Historically,
as the
loan portfolio ages (becomes more seasoned), the delinquencies generally grow
until peaking at some point, generally within the 24
th
to 60
th
month, of the loan
pool’s life.
The
following table presents the
delinquency status of our mortgage loan held for investment portfolio
(securitized and pre-securitization) at September 30, 2007 and December 31,
2006:
|
|
At
September 30,
2007
|
|
|
At
December 31,
2006
|
|
(Dollars
in
thousands)
|
|
Amount
|
|
|
%
|
|
|
Amount
|
|
|
%
|
|
Delinquency
status:
|
|
|
|
|
|
|
|
|
|
|
|
|
0
- 29
days
|
|
$
|
5,903,604
|
|
|
|
83.0
|
%
|
|
$
|
5,792,563
|
|
|
|
89.5
|
%
|
30
- 59
days
|
|
|
363,482
|
|
|
|
5.1
|
|
|
|
237,059
|
|
|
|
3.7
|
|
60
- 89
days
|
|
|
197,978
|
|
|
|
2.8
|
|
|
|
116,332
|
|
|
|
1.8
|
|
90+
days
|
|
|
645,342
|
|
|
|
9.1
|
|
|
|
323,860
|
|
|
|
5.0
|
|
Total
|
|
$
|
7,110,406
|
|
|
|
100.0
|
%
|
|
$
|
6,469,814
|
|
|
|
100.0
|
%
|
As
of
September 30, 2007, December 31, 2006 and September 30, 2006, we had $645.9
million (including $533,000 of impaired loans that are less than 90 days
delinquent but on non-accrual status), $324.1 million (including $937,000 of
impaired loans that are less than 90 days delinquent but on non-accrual status)
and $255.2 million (including $1.3 million of impaired loans that are less
than
90 days delinquent but on non-accrual status), respectively, of mortgage loans
held for investment that were 90 days or more delinquent under their payment
terms, all of which were on non-accrual status. If the non-accrual
mortgage loans held for investment at September 30, 2007 and 2006 performed
in
accordance with their contractual loan terms, we would have recognized an
additional $10.1 million and $3.6 million of interest income during the three
months ended September 30, 2007 and 2006, respectively, and an additional $22.1
million and $7.8 million of interest income during the nine months ended
September 30, 2007 and 2006, respectively.
We expect the amounts of non-accrual
mortgage loans to change over time depending on a number of factors, such as
the
growth or decline in the size of our mortgage loans held for investment
portfolio, the maturity of the loan portfolio, the number and dollar value
of
problem loans that are recognized and resolved through collection efforts made
by our third-party servicer, and the amount of
charge-offs. Additionally, the performance of our mortgage loans can
be affected by external factors, such as economic and employment conditions,
or
other factors related to the individual borrower.
(7)
Excess
Cashflow
Certificates
The following table presents
the
activity related to our excess cashflow certificates for the nine months ended
September 30, 2007 and the year ended December 31, 2006:
(Dollars
in
thousands)
|
|
For
the
Nine
Months
Ended
September
30,
2007
|
|
|
For
the
Year
Ended
December
31,
2006
|
|
Balance,
beginning of
year
|
|
$
|
1,209
|
|
|
$
|
7,789
|
|
Excess
cashflow certificates
sold
|
|
|
(1,050
|
)
|
|
|
(1,500
|
)
|
Accretion
|
|
|
17
|
|
|
|
452
|
|
Cash
receipts
|
|
|
(1,736
|
)
|
|
|
(16,198
|
)
|
Net
change in fair
value
|
|
|
1,560
|
|
|
|
10,666
|
|
Balance,
end of
period
|
|
$
|
--
|
|
|
$
|
1,209
|
|
In
accordance with Emerging Issues Task
Force (“EITF”) 99-20, “Recognition of Interest and Impairment on Purchased and
Retained Beneficial Interests in Securitized Financial Assets,” we have
regularly analyzed and reviewed our assumptions to determine whether the actual
rate of return (interest income) on our excess cashflow certificates was within
our expected rate of return. The expected rate of return was recorded
as a component of interest income. Any return that either was greater
than or less than the expected rate of return was reflected as a fair value
adjustment and was recorded as a component of “other income” in the consolidated
statements of operations. During the three months ended March 31,
2007, we sold all of our remaining excess cashflow certificates at fair value
for $1.1 million, and consequently, no longer record any interest income or
other income related to changes in fair value of the excess cashflow
certificates. For the three months ended September 30, 2006, we
recorded interest income related to our excess cashflow certificates of
$53,000. For the nine months ended September 30, 2007 and 2006, we
recorded interest income related to our excess cashflow certificates of $17,000
and $433,000, respectively. For the three months ended September 30,
2006, we recorded a fair value gain in other income related to our excess
cashflow certificates of $1.7 million. For the nine months ended
September 30, 2007 and 2006, we recorded fair value gain in income related
to
our excess cashflow certificates of $1.6 million and $9.2 million,
respectively.
(8)
Warehouse
Financing
Our
warehouse credit facilities are collateralized by specific mortgage loans held
for investment – pre-securitization at September 30, 2007 and December 31, 2006,
the balances of which are equal to or greater than the outstanding balances
under the warehouse credit facility at any point in time. Mortgage
loans held for sale also collateralized our warehouse credit facilities
intra-quarter. The amounts available under these warehouse credit
facilities are based on the amount of the collateral pledged. The
amount we have outstanding on our warehouse credit facilities as of the end
of
any financial period generally is a function of the pace of mortgage loan
originations relative to the timing of our securitizations and whole-loan
sales.
Additionally,
the amounts we are able to borrow under our warehouse credit facilities are
dependent upon the valuations placed on the collateral by the warehouse
providers. The collateral is subject to re-valuation at any
time. Any downward re-valuations of the collateral may result in a
margin call, which will subject us to either making a cash payment or delivering
additional collateral to the warehouse provider, and result in the reduction
of
our available liquidity and can harm our results of operation and financial
condition.
The
following table summarizes
information regarding warehouse credit facilities at September 30, 2007 and
December 31, 2006:
(Dollars
in
thousands)
|
|
|
|
|
|
Balance
Outstanding
|
|
|
Warehouse
Credit
Facility
|
|
Facility
Amount
(1)
|
|
Interest
Rate
|
|
At
September
30,
2007
|
|
|
At
December
31,
2006
|
|
Expiration
Date
|
Deutsche
Bank
(2)
|
|
$
|
500,000
|
|
Margin
over
LIBOR
|
|
$
|
158,584
|
|
|
$
|
--
|
|
October
2007
|
RBS
Greenwich Capital
(3)
|
|
|
500,000
|
|
Margin
over
LIBOR
|
|
|
133,418
|
|
|
|
24,570
|
|
November
2007
|
JPMorgan
Chase
|
|
|
500,000
|
|
Margin
over
LIBOR
|
|
|
114,673
|
|
|
|
--
|
|
May
2008
|
Citigroup
|
|
|
500,000
|
|
Margin
over
LIBOR
|
|
|
--
|
|
|
|
234,578
|
|
May
2008
|
Bank
of America
(4)
|
|
|
--
|
|
Margin
over
LIBOR
|
|
|
--
|
|
|
|
76,717
|
|
N/A
|
Total
|
|
$
|
2,000,000
|
|
|
|
$
|
406,675
|
|
|
$
|
335,865
|
|
|
(1) The
warehouse facility amount shown is as of September 30, 2007, and was $1.75
billion as of December 31, 2006. The committed portion of the
warehouse facility amount totaled approximately $1.25 billion and $1.0 billion
at September 30, 2007 and December 31, 2006, respectively.
(2)
|
The
Deutsche Bank warehouse credit facility was extended to December
2007 in
October 2007.
|
(3)
|
The
RBS Greenwich Capital warehouse credit facility was extended to December
2007 in October 2007.
|
(4)
|
The
Bank of America warehouse credit facility was not renewed upon its
expiration in September 2007.
|
Our
warehouse financing costs are
determined based upon a margin over the one-month LIBOR rate, which is the
benchmark index used to determine our cost of borrowed funds. The
benchmark index increased 8 basis points to an average of 5.43% for the three
months ended September 30, 2007, compared to an average of 5.35% for the three
months ended September 30, 2006. The benchmark index increased 34
basis points to an average of 5.36% for the nine months ended September 30,
2007, compared to an average of 5.02% for the nine months ended September 30,
2006. Partially offsetting the increase in the benchmark rate during
the three and nine month periods was a decrease in the average margin over
the
benchmark index charged by our warehouse lenders during the same
periods. For the three months ended September 30, 2007 and 2006, we
recorded interest expense related to our warehouse financing of $15.3 million
and $7.6 million, respectively. For the nine months ended September
30, 2007 and 2006, we recorded interest expense related to our warehouse
financing of $41.0 million and $23.0 million, respectively.
(9)
Financing
on Mortgage Loans Held for
Investment, Net
For our securitizations, which were structured and accounted for as financings,
the securitization trust or special purpose entity (“SPE”) holds mortgage loans,
referred to as “securitization loans,” and issues debt represented by
securitization asset-backed securities. The securitization loans are
recorded as an asset on our consolidated balance sheets under “mortgage loans
held for investment, net” and the corresponding securitization debt is recorded
as a liability under “financing on mortgage loans held for investment,
net.” Under securitizations structured as financings, we record
interest income from the mortgage loans held for investment - securitized and
interest expense from the asset-backed securities issued (financing on mortgage
loans held for investment, net) in connection with each securitization over
the
life of the securitization. Deferred securitization debt issuance
costs are amortized on a level-yield basis over the estimated life of the
asset-backed securities. Any discounts on the financing are amortized
on a level-yield basis over the estimated life of the debt issued using the
interest method.
At September 30, 2007 and December 31, 2006, the outstanding financing on
mortgage loans held for investment, net consisted of $6.5 billion and $6.0
billion, respectively. The weighted-average interest rate of our
financing on mortgage loans held for investment, net increased 15 basis points
to 5.75% at September 30, 2007 from 5.60% at December 31, 2006.
The
following table summarizes the expected maturities on our secured financings
at
September 30, 2007:
(Dollars
in
thousands)
|
|
Total
|
|
|
Less
than
One
Year
|
|
|
One
to
Three
Years
|
|
|
Three
to
Five
Years
|
|
|
More
than
Five
Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financing
on mortgage loans held
for investment, net
(1)
|
|
$
|
6,514,154
|
|
|
$
|
2,153,017
|
|
|
$
|
2,380,857
|
|
|
$
|
1,005,556
|
|
|
$
|
974,724
|
|
(1)
The amounts in
the table do not include interest.
Amounts shown above reflect estimated repayments based on anticipated receipt
of
principal and interest on the underlying mortgage loan collateral using
prepayment assumptions. The assumed prepayment assumptions are
estimates based upon our historical loan performance and the performance of
similar mortgage pools from other lenders, and considering other public
information about market factors such as interest rates, inflation, recession,
unemployment and real estate values, among others. The funds used to
repay these securitization asset-backed securities are generated solely from
the
underlying mortgage loans held for investment for each particular securitization
trust. We have no recourse obligation to repay these securitization
asset-backed securities, except for the standard representations and warranties
typically made as part of a sale of loans on a non-recourse basis.
For
the three months ended September 30, 2007 and 2006, we recorded interest expense
related to our securitization debt of $99.6 million and $77.1 million,
respectively. For the nine months ended September 30, 2007 and 2006,
we recorded interest expense related to our securitization debt of $283.8
million and $204.7 million, respectively. Included in financing on
mortgage loans held for investment, net at September 30, 2007 and December
31,
2006, are $12.7 million and $6.3 million, respectively, of unamortized
discounts.
(10)
Other Borrowings
Other
borrowings are comprised of (1) a
residual financing facility, (2) convertible notes, and (3) capital leases
and
other arrangements related to our equipment financing. On August 13,
2007, we, together with certain of our subsidiaries, entered into agreements
providing for an aggregate of $70.0 million in liquidity, consisting of a $60.0
million residual financing facility and the issuance of $10.0 million in
convertible notes. The closing of these transactions took place on
August 14, 2007.
The
following table summarizes certain information regarding other borrowings at
September 30, 2007 and December 31, 2006:
(Dollars
in
thousands)
|
|
Range
of Interest Rates
(1)
|
|
|
Balance
at September 30,
2007
|
|
|
Balance
at
December
31,
2006
|
|
Range
of Expiration Dates
(1)
|
|
|
|
|
|
|
|
|
|
|
|
Residual
financing facility, net
(2)
|
|
600
basis points over one-month
LIBOR
|
|
|
$
|
52,494
|
|
|
$
|
--
|
|
August
2008
|
Convertible
notes
(3)
|
|
|
6.00%
|
|
|
|
10,000
|
|
|
|
--
|
|
August
2008
|
Equipment
financing
(4)
|
|
7.05%
to
8.95%
|
|
|
|
6,088
|
|
|
|
5,970
|
|
January
2008 to September
2010
|
Total
|
|
|
|
|
|
$
|
68,582
|
|
|
$
|
5,970
|
|
|
(1)
The
range of interest rates and
expiration dates are as of September 30, 2007.
(2)
The
balance at September 30, 2007 is net
of $4.5 million related to deferred warrant costs associated with the residual
financing facility.
(3)
The
convertible notes were converted
into 2.0 million shares of our common stock on October 4,
2007.
(4)
At
December 31, 2006, the outstanding
equipment financing had a range of interest rates of 6.26% to 8.95% and a range
of expiration of January 2007 to November 2009.
For
the three months ended September 30,
2007 and 2006, we recorded interest expense related to our other borrowings
of
$2.0 million and $107,000, respectively. For the nine months ended
September 30, 2007 and 2006, we recorded interest expense related to our other
borrowings of $2.3 million and $317,000, respectively.
Residual
financing facility
– In August 2007, we entered into a $60.0 million
residual financing facility with
an affiliate of Angelo,
Gordon & Co., L.P., (“Angelo Gordon”) an alternative asset management firm,
which is collateralized by all of our existing securitization Class P, Class
BIO
and owner trust certificates (the “residual certificates”), which entitle the
holder to receive the excess cash flows, 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. Holders of the certain classes of residual certificates are
also entitled to receive any prepayment penalties that are paid under the
applicable securitization. Under the terms of the residual financing
facility, the cash flows from the residual certificates will be applied to
pay
down the principal of the residual financing facility. The residual
financing facility bears interest at the rate of 600 basis points over one-month
LIBOR, and matures in 12 months (August 2008), if not sooner
repaid.
In
connection with the residual financing facility, we issued to affiliates of
Angelo Gordon (the “Angelo Gordon Entities”) warrants to purchase, in the
aggregate, up to 10.0 million shares of our common stock. The initial
exercise price of the warrants is $5.00 per share, and the exercise price is
subject to adjustment. In connection with the issuance of the
warrants, the Angelo Gordon Entities were granted certain rights as
investors. The warrants expire in February 2009. (See Note
15 – “Subsequent Events”).
In
accordance with Emerging Issues Task Force ("EITF") Issue 00-19, "Accounting
for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock," we measured the warrants based upon their fair value
at
the date of issuance, or $5.1 million. We classified the warrants as
a capital contribution (additional paid-in capital) and as a corresponding
discount on the associated debt on the date of issuance.
Convertible
notes
–
In August
2007, we issued $10.0
million of convertible notes to entities managed by Mr. Mohnish Pabrai (“PIF
Investors”). The notes are mandatorily convertible into an aggregate
of 2.0 million shares of our common stock, at a conversion price of $5.00 per
share, upon approval of our stockholders. The convertible notes
mature in August 2008, if not converted or redeemed earlier, and bear interest
at the rate of 6.0% per annum for the first 90 days, and thereafter at the
rate
of 12.0% per annum, until converted or redeemed. The convertible
notes converted into shares of our common stock in October 2007. (See
Note 15 – “Subsequent Events”).
Equipment
financing
– We generally enter into equipment financing arrangements on a
quarterly basis in order to fund our equipment needs. These
borrowings consist of
capital
leases and other arrangements that
are collateralized by pools of
equipment (i.e., computer equipment and furniture and fixtures). The
arrangements are made at market rates on the date entered into and generally
mature in two to three years from date of origination.
(11)
Derivative
Instruments
We account for our derivative financial instruments, such as corridors and
interest rate swaps (including amortizing notional balance interest rate swaps),
as cash flow hedges. We utilize both corridors and amortizing
notional balance interest rate swaps to hedge interest payments on
securitization variable-rate debt, while we utilize interest rate swaps to
hedge
uncertain cash flows associated with future securitization
financing. At September 30, 2007 and December 31, 2006, the fair
value of our corridors totaled $359,000 and $2.5 million, respectively, and
the
fair value of our interest rate swaps (including amortizing notional balance
interest rate swaps) totaled a loss of $1.8 million and gains of $942,000,
respectively. The fair value of our corridors and interest rate swaps
are recorded as a component of “prepaid and other assets” or “accounts payable
and other liabilities.”
As
of
September 30, 2007, the effective portion of the changes in fair value of the
corridors, interest rate swaps and any losses on terminated swaps are recorded
as components of accumulated OCI and totaled, net of tax, losses of $566,000,
losses of $2.9 million and losses of $2.4 million, respectively. As
of December 31, 2006, the effective portion of the changes in fair value of
the
corridors and interest rate swaps and any losses on terminated swaps are
recorded as components of accumulated OCI, and totaled, net of tax, losses
of
$155,000, gains of $575,000 and losses of $1.9 million,
respectively. Accumulated OCI or loss relating to cash flow hedging
is reclassified to earnings as a yield adjustment to interest expense as the
interest payments affect earnings. Hedge ineffectiveness associated
with hedges resulted in a loss of $154,000 and a loss of $99,000 for the three
months ended September 30, 2007 and 2006, respectively. Hedge
ineffectiveness associated with hedges resulted in a loss of $252,000 and a
gain
of $40,000 for the nine months ended September 30, 2007 and 2006,
respectively.
If
a
hedge fails the assessment of hedge effectiveness test (the ratio of the
outstanding balance of the hedged item (debt) to the notional amount of the
hedge exceeds 125% or falls below 80%, since the notional amount varies) at
any
time, and therefore is not expected to be “highly effective” at achieving
offsetting changes in cash flows, the hedge ceases to qualify for hedge
accounting. At September 30, 2007 and December 31, 2006, we
classified $179,000 and $227,000, respectively, of derivative instruments
(specifically corridors) as trading securities in prepaid and other assets
as
these instruments were no longer deemed “highly effective.” During
the three months ended September 30, 2007 and 2006, a loss of $43,000 and a
loss
of $163,000, respectively, was recorded to earnings on the changes in fair
value
of the hedges (specifically corridors) held as trading
securities. During the nine months ended September 30, 2007 and 2006,
a gain of $42,000 and a gain of $121,000, respectively, was recorded to earnings
on the changes in fair value of the hedges (specifically corridors) held as
trading securities.
The following table summarizes the notional amount, expected maturities and
weighted-average strike price or rate for the corridors (caps bought and caps
sold) and amortizing notional balance interest rate swaps that we held as of
September 30, 2007:
(Dollars
in
thousands)
|
|
Total
|
|
|
One
Year
|
|
|
Two
Years
|
|
|
Three
Years
|
|
|
Four
Years
|
|
|
Five
Years &
Thereafter
|
|
Caps
bought -
notional
|
|
$
|
430,636
|
|
|
$
|
270,984
|
|
|
$
|
39,803
|
|
|
$
|
30,157
|
|
|
$
|
23,245
|
|
|
$
|
66,447
|
|
Weighted-average
strike
rate
|
|
|
7.39%
|
|
|
|
7.31%
|
|
|
|
7.46%
|
|
|
|
7.46%
|
|
|
|
7.43%
|
|
|
|
7.42%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Caps
sold -
notional
|
|
$
|
430,636
|
|
|
$
|
270,984
|
|
|
$
|
39,803
|
|
|
$
|
30,157
|
|
|
$
|
23,245
|
|
|
$
|
66,447
|
|
Weighted-average
strike
rate
|
|
|
9.30%
|
|
|
|
9.33%
|
|
|
|
9.27%
|
|
|
|
9.27%
|
|
|
|
9.29%
|
|
|
|
9.32%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortizing
notional balance
interest rate swaps:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional
|
|
$
|
276,785
|
|
|
$
|
146,368
|
|
|
$
|
97,649
|
|
|
$
|
32,768
|
|
|
$
|
--
|
|
|
$
|
--
|
|
Weighted-average
rate
|
|
|
5.10%
|
|
|
|
5.11%
|
|
|
|
5.08%
|
|
|
|
5.00%
|
|
|
|
--
|
|
|
|
--
|
|
The
notional amount of the corridors
totaled $954.1 million at December 31, 2006. The notional amount of
the amortizing notional balance interest rate swaps totaled $274.7 million
at
December 31, 2006.
The
original stated maturities of our corridors on the date of purchase ranged
from
a low of 1.3 years to a maximum of 8.3 years. The original stated
maturities of our amortizing interest rate swaps on the date of purchase ranged
from a low of 3.0 years to a maximum of 3.1 years. The maturities of
our corridors as of September 30, 2007 ranged from October 2007 to July 2012
and
had weighted average strike prices of 6.94% to 8.20% for the caps bought and
9.15% to 9.47% for caps sold. The maturities of our notional balance
interest rate swaps as of September 30, 2007 ranged from October 2007 to June
2010 and had a weighted average rate of 4.96% to 5.12%.
(12)
Accumulated Other Comprehensive Loss
In
accordance with SFAS No. 130, “Reporting Comprehensive Income,” the components
of OCI for the three and nine months ended September 30, 2007 and 2006 are
as
follows:
(Dollars
in
thousands)
|
|
Before
Tax
Amount
|
|
|
Tax
Benefit
(Expense)
|
|
|
After
Tax
Amount
|
|
For
the three months ended
September 30, 2007:
|
|
|
|
|
|
|
|
|
|
Net
unrealized holding
losses on derivatives arising during the period
|
|
$
|
(7,351
|
)
|
|
$
|
2,849
|
|
|
$
|
(4,502
|
)
|
Reclassification
adjustment for losses on derivatives included in net (loss)
income
|
|
|
(32
|
)
|
|
|
12
|
|
|
|
(20
|
)
|
Other
comprehensive (loss)
income
|
|
$
|
(7,383
|
)
|
|
$
|
2,861
|
|
|
$
|
(4,522
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the three months ended
September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized holding
losses on derivatives arising during the period
|
|
$
|
(9,768
|
)
|
|
$
|
3,809
|
|
|
$
|
(5,959
|
)
|
Reclassification
adjustment for loss on derivatives included in net
income
|
|
|
(2,771
|
)
|
|
|
1,081
|
|
|
|
(1,690
|
)
|
Other
comprehensive (loss)
income
|
|
$
|
(12,539
|
)
|
|
$
|
4,890
|
|
|
$
|
(7,649
|
)
|
For
the nine months ended
September 30, 2007:
|
|
|
|
|
|
|
|
|
|
Net
unrealized holding
losses on derivatives arising during the period
|
|
$
|
(6,818
|
)
|
|
$
|
2,636
|
|
|
$
|
(4,182
|
)
|
Reclassification
adjustment for loss on derivatives included in net (loss)
income
|
|
|
(162
|
)
|
|
|
63
|
|
|
|
(99
|
)
|
Other
comprehensive (loss)
income
|
|
$
|
(6,980
|
)
|
|
$
|
2,699
|
|
|
$
|
(4,281
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the nine months ended
September 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
unrealized holding
gains on derivatives arising during the period
|
|
$
|
2,903
|
|
|
$
|
(1,132
|
)
|
|
$
|
1,771
|
|
Reclassification
adjustment for loss on derivatives included in net
income
|
|
|
(7,116
|
)
|
|
|
2,775
|
|
|
|
(4,341
|
)
|
Other
comprehensive (loss)
income
|
|
$
|
(4,213
|
)
|
|
$
|
1,643
|
|
|
$
|
(2,570
|
)
|
(13)
Earnings
Per
Share
EPS
is computed in accordance with SFAS
No. 128, “Earnings Per Share.”
Basic EPS is computed by
dividing net income by the weighted-average number of shares of common stock
outstanding during each period presented. The computation of diluted
EPS gives effect to stock options (except for those stock options with an
exercise price greater than the average market price of our common stock during
the period) and other share-based awards, warrants and convertible debt
outstanding during the applicable periods.
The following is a reconciliation
of the
denominators used in the computations of basic and diluted EPS. The
numerator for calculating both basic and diluted EPS is net
income.
|
|
Three
Months
Ended
September
30,
|
|
|
Nine
Months
Ended
September
30,
|
|
(Dollars
in thousands, except
share and
per
share
data)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Net
(loss) income, as
reported
|
|
$
|
(39,636
|
)
|
|
$
|
7,960
|
|
|
$
|
(33,972
|
)
|
|
$
|
21,787
|
|
Less
preferred stock
dividends
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
|
|
--
|
|
Net
(loss) income available to
common stockholders
|
|
$
|
(39,636
|
)
|
|
$
|
7,960
|
|
|
$
|
(33,972
|
)
|
|
$
|
21,787
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
- weighted-average
shares
|
|
|
23,347,304
|
|
|
|
23,213,262
|
|
|
|
23,324,493
|
|
|
|
22,214,538
|
|
Basic
EPS
|
|
$
|
(1.70
|
)
|
|
$
|
0.34
|
|
|
$
|
(1.46
|
)
|
|
$
|
0.98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
- weighted-average
shares
|
|
|
23,347,304
|
|
|
|
23,213,262
|
|
|
|
23,324,493
|
|
|
|
22,214,538
|
|
Incremental
shares-options
(1)
(2)
|
|
|
--
|
|
|
|
765,639
|
|
|
|
--
|
|
|
|
807,287
|
|
Diluted
- weighted-average
shares
|
|
|
23,347,304
|
|
|
|
23,978,901
|
|
|
|
23,324,493
|
|
|
|
23,021,825
|
|
Diluted
EPS
(1)
(2)
|
|
$
|
(1.70
|
)
|
|
$
|
0.33
|
|
|
$
|
(1.46
|
)
|
|
$
|
0.95
|
|
(1)
For
the
three and nine months ended September 30, 2007, the weighted average of
approximately 1.3 million and 1.7 million, respectively, in-the-money employee
stock options and approximately 263,000 and 237,000, respectively, restricted
stock awards/units, approximately 1.7 million and 827,000, respectively, of
warrants and 1.0 million and 352,000, respectively, of convertible note related
shares are excluded from the calculation of diluted EPS as they are
anti-dilutive due to the loss reported for the period. Also excluded
was 371,000 and 50,000 of out-of-the-money employee stock options, which have
been excluded since their effect is anti-dilutive, for the three and nine months
ended September 30, 2007, respectively.
(2)
For
each of the
three and nine months ended September 30, 2006, approximately 1.8 million
in-the-money employee stock options and approximately 155,000 restricted stock
awards are included in the calculation of diluted EPS, while approximately
25,000 of out-of-the-money employee stock options have been excluded
since their effect
is
anti-dilutive.
(14) Restructuring
Charge
On
August
22, 2007, we eliminated 313 employees, resulting in an approximate 20.1%
reduction in our nationwide workforce at that date. The majority of
the reductions related to the closing of our wholesale origination offices
located in Florida, Texas, and California, and the elimination of certain
employee positions involved in the originations process. The
positions and offices were eliminated in response to an unanticipated decrease
in our origination volume driven by the market conditions that existed during
July and August of 2007.
We
incurred a pre-tax charge of $1.4 million during the three months ended
September 30, 2007 as a result of the workforce reductions and office closing
related expenses. The following reconciles the activity of the types
of costs associated with the staff reduction and office closings:
(
Dollars
in
thousands
)
|
|
Termination
Date Amount
Incurred
|
|
|
Paid
or
Settled
|
|
|
Adjustments
|
|
|
Balance
at
September
30,
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance
benefits
|
|
$
|
775
|
|
|
$
|
775
|
|
|
$
|
--
|
|
|
$
|
--
|
|
Lease
terminations
|
|
|
572
|
|
|
|
37
|
|
|
|
--
|
|
|
|
535
|
|
Leasehold
improvements and
furniture and fixtures
|
|
|
80
|
|
|
|
55
|
|
|
|
--
|
|
|
|
25
|
|
Total
|
|
$
|
1,427
|
|
|
$
|
867
|
|
|
$
|
--
|
|
|
$
|
560
|
|
Included
in payroll and related costs during the three and nine months ended September
30, 2007 was $775,000 of the severance benefits related to the August 2007
staff
reduction. Additionally, included in general and administrative
expense during the three and nine months ended September 30, 2007 was $652,000
of office closing expenses related to the August 2007 office
closings.
(15)
Subsequent
Events
On November 8, 2007, we announced that, in response to the continued disruption
in the credit markets, we reduced our staff by approximately 470 employees
and closed 4 origination offices. We estimate that we will incur a
pre-tax charge of approximately $7.5 million, of which $1.4 million will
be paid
immediately in severance, during the fourth quarter of 2007 as a result of
the
workforce reductions and office closing related expenses.
On
October 4, 2007, we held a special
meeting of our stockholders
to approve the issuance of shares of our
common stock that are issuable upon exercise or conversion of securities that
we
issued in August 2007.
The
stockholders approved both of the following proposals presented: (1)
the
issuance of 5.4 million shares of our common stock that are issuable upon the
exercise of warrants held by affiliates of Angelo Gordon (in addition to the
4.6
million warrant shares that were not subject to stockholder approval), and
(2)
the issuance of an aggregate
of 2.0 million shares of our common stock that were issuable upon the conversion
of the convertible notes held by the PIF Investors
. As a result of the vote,
and in accordance with the terms of the convertible notes, the $10.0 million
of
convertible notes were automatically converted into 2.0 million shares of our
common stock on October 4, 2007, upon receipt of the stockholder
approval.
In October 2007, we extended our warehouse credit facilities with both Deutsche
Bank and RBS Greenwich Capital to December 2007. The material terms
and conditions of both facilities remained consistent with the terms and
conditions of the previous facilities.
This Quarterly Report on Form 10-Q (“Quarterly Report”) should be read in
conjunction with the more detailed and comprehensive disclosures included in
our
Annual Report on Form 10-K for the year ended December 31, 2006. In
addition, please read this section in conjunction with our Consolidated
Financial Statements and Notes to Consolidated Financial Statements herein,
and
please see “Part II – Item 1A.. - Risk Factors,” including the information with
respect to forward-looking statements that appear in this Report. As
discussed in Part II-Item 1A. of this Quarterly Report, there have been
substantial operating difficulties for us and for companies in our sector during
the three and nine months ended September 30, 2007 and in the weeks preceding
the filing of this Quarterly Report. Accordingly, our past
performance described in this section should not be construed to be indicative
of our future performance.
General
We are a national specialty consumer finance company that originates,
securitizes and sells non-conforming mortgage loans. Our loans are
primarily fixed rate and secured by first mortgages on one- to four-family
residential properties. Throughout our 25-year operating history, we
have focused on lending to individuals who generally do not satisfy the credit,
documentation or other underwriting standards set by more traditional sources
of
mortgage credit, including those entities that make loans in compliance with
the
conforming lending guidelines of Fannie Mae and Freddie Mac. We make
mortgage loans to these borrowers for purposes such as debt consolidation,
refinancing, education and home improvements. We provide our
customers with a variety of loan products designed to meet their needs, using
a
risk-based pricing strategy to develop products for different risk
categories. Historically, the majority of our loan production has had
amortization schedules ranging from five years to 30 years.
We make mortgage loans to individual borrowers, which are a cash outlay for
us. At the time we originate a loan, and prior to the time we
securitize or sell the loan, we either finance the loan by borrowing under
our
warehouse credit facilities or by utilizing our available working
capital. During the time we hold the loans prior to securitization or
whole-loan sale, we earn interest income from the borrower. The
income is partially offset by any interest we pay to our warehouse creditors
for
providing us with financing. Additionally, we pay a third-party
servicer a sub-servicing fee to perform the servicing of the mortgage loans
during this pre-securitization or pre-sale holding period.
Following this initial holding period, we either securitize our loans or sell
them on a whole-loan basis, using the net proceeds from these transactions
to
repay our warehouse credit facilities and for working
capital. Beginning in the first quarter of 2004 and through the
second quarter of 2007, we structured each of our securitizations to be
accounted for as on-balance sheet financings, in which we record interest income
on the outstanding portfolio of loans in each securitization trust and interest
expense from the asset-backed securities issued by each securitization trust
over time. During the third quarter of 2007 and for the periods prior
to 2004, we structured our securitizations to be accounted for as sales, which
required us to record cash and non-cash revenues as loss/gain-on-sale at the
time the securitizations were completed. Additionally, when we sell
loans on a whole-loan basis, we record the net proceeds received upon sale
as
revenue, net of any deferred fees, and premium recapture or secondary marketing
(indemnification) reserves. (See “- Origination of Mortgage Loans -
Securitizations and Whole-Loan Sales”).
Origination
of Mortgage
Loans
All of the mortgage loans we originate are originated using our underwriting
guidelines. The majority of the loans we originate represent loans
that we intend to place into our on-balance sheet
securitizations. These loans are originated with the intent to hold
the mortgage loans to maturity in our securitizations trusts. We
typically sell a small percentage of these mortgage loans on a whole-loan basis
each quarter, depending upon the potential economic benefit from the sale of
the
loans. The sale of these mortgage loans does not reflect on our intention
when the mortgage loans are originated, but rather reflects the fact that we
regularly review (generally on a monthly basis) our mortgage loans held for
investment – pre-securitization portfolio to determine which mortgage loans we
prefer to sell on a whole-loan basis, rather than
securitize. Beginning in the fourth quarter of 2007, we recommenced
originating Federal Housing Authority (“FHA”) loans (we have not originated FHA
loans in more than 10 years). Because these loans represent loans
that we originate with the intent to sell in the secondary market on a
whole-loan sales basis, they will be classified as “held for sale”
loans.
We originate mortgage loans through two distribution channels, wholesale and
retail. In the wholesale channel, we receive loan applications from
independent third-party mortgage brokers, who submit applications on a
borrower’s behalf. In the retail channel, we receive loan
applications directly from borrowers. We process and underwrite the
submission and, if the loan conforms to our underwriting criteria, approve
the
loan and lend the money to the borrower. We underwrite loan packages
for approval through our Woodbury, New York headquarters, our Cincinnati, Ohio
underwriting hub, and our regional office in Phoenix, Arizona. We
also purchase closed loans on a limited basis from other lenders.
For the three and nine months ended September 30, 2007 and 2006, we originated
the following loans by origination channel and by loan type:
|
|
For
the Three
Months
Ended
September
30,
|
|
|
For
the Nine
Months
Ended
September
30,
|
|
(Dollars
in
thousands)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Originations
by
channel:
|
|
|
|
|
|
|
|
|
|
|
|
|
Wholesale
|
|
$
|
412,291
|
|
|
$
|
505,728
|
|
|
$
|
1,802,295
|
|
|
$
|
1,539,113
|
|
Retail
|
|
|
396,704
|
|
|
|
489,204
|
|
|
|
1,600,309
|
|
|
|
1,371,155
|
|
Total
originations
|
|
$
|
808,995
|
|
|
$
|
994,932
|
|
|
$
|
3,402,604
|
|
|
$
|
2,910,268
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan
type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
rate
|
|
|
98.4
|
%
|
|
|
87.0
|
%
|
|
|
95.8
|
%
|
|
|
85.4
|
%
|
Adjustable-rate
|
|
|
1.6
|
|
|
|
13.0
|
|
|
|
4.2
|
|
|
|
14.6
|
|
Total
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
For
the three months ended September 30,
2007, we originated $809.0 million of loans, a decrease of 18.7% over the $994.9
million of loans originated during the three months ended September 30,
2006. Loan originations for the three months ended September 30, 2007
were comprised of approximately $412.3 million of wholesale loans, representing
51.0% of total loan production, and $396.7 million of retail loans, representing
49.0% of total loan production. This compares to originations for the
three months ended September 30, 2006 of $505.7 million of wholesale loans,
representing 50.8% of total loan production, and $489.2 million of retail loans,
representing 49.2% of total loan production.
For
the nine months ended September 30,
2007, we originated $3.4 billion of loans, an increase of 16.9% over the $2.9
billion of loans originated during the nine months ended September 30,
2006. Loan originations for the nine months ended September 30, 2007
were comprised of approximately $1.8 billion of wholesale loans, representing
53.0% of total loan production, and $1.6 billion of retail loans, representing
47.0% of total loan production. This compares to originations for the
nine months ended September 30, 2006 of $1.5 billion of wholesale loans,
representing 52.9% of total loan production, and $1.4 billion of retail loans,
representing 47.1% of total loan production.
During
the three months ended September 30, 2007 we continued to refine our
underwriting criteria. We raised the minimum required credit scores
on some loans, lowered the maximum loan-to-value (“LTV”) ratios on other loans
and eliminated certain product offerings, among other changes. During
the three months ended September 30, 2007, we ceased originating adjustable-rate
loans, such as “3/27” loans (loans that have a fixed rate of interest for the
first three years, and then adjusts thereafter for the remaining 27 years of
the
term) based upon changes in market conditions and because we did not believe
that they provided sufficient financial benefit to our prospective borrowers,
especially when compared to our fixed rate products. Collectively,
adjustable-rate loans represented only 1.6% and 4.2% of our total originations
for the three and nine months ended September 30, 2007,
respectively. Additionally, we commenced the origination of Section
203(b) FHA loans during October 2007. Section 203(b) FHA loans are
fixed rate mortgages with maturities of 15 or 30 years, and are insured by
the
U.S.
Department of Housing and
Urban Development (“HUD”).
Securitizations
and Whole-Loan
Sales.
As a
fundamental part of
our present business and financing strategy, we securitize the majority of
the
mortgage loans we originate. We generally structure our
securitization transactions as a financing, but may from time-to-time structure
a securitization as a “gain on sale” transaction, as we did in the third quarter
of 2007. Additionally, we also sell a portion of our loans (all of
the mortgage loans held for sale and a portion of the mortgage loans held for
investment – pre-securitized) on a whole-loan basis. We select the
outlet (securitization or whole-loan sale) depending on market conditions,
relative profitability and cash flows. For example, if all of the
mortgage loans we originated in a quarter were placed in the pool being
securitized at the end of that quarter, the pool would not have the optimal
average loan life, mix of interest rate terms, mix of and overall LTV ratio,
mix
of credit quality, or geographic mix to maximize profitability and cash flow
for
the securitization. Mortgage loans being held as mortgage loans held
for investment – pre-securitized that are determined to be left out of the pool
of mortgage loans collateralizing a securitization are typically sold shortly
thereafter. Additionally, in the fourth quarter of 2007, we began to
originate FHA loans with the intent to sell them on a whole-loan
basis.
During
the three months ended September
30, 2007 and 2006, whole-loan sales comprised approximately
21.4% and
19.3%
, respectively, of the total
amount of our combined securitizations and whole-loan sale
transactions. During the nine months ended September 30, 2007 and
2006, whole-loan sales comprised approximately
18.8% and 17.0%
, respectively, of the
total amount of
our combined securitizations and whole-loan sale
transactions.
The
following table sets forth certain information regarding loans sold through
our
securitizations and on a whole-loan basis during the three and nine months
ended
September 30, 2007 and 2006:
|
|
Three
Months
Ended
September
30,
|
|
|
Nine
Months
Ended
September
30,
|
|
(Dollars
in thousands)
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Loan
securitizations – structured as a
sale
|
|
$
|
899,999
|
|
|
$
|
--
|
|
|
$
|
899,999
|
|
|
$
|
--
|
|
Loan
securitizations – structured as a financing
|
|
|
--
|
|
|
|
824,999
|
|
|
|
1,799,998
|
|
|
|
2,524,977
|
|
Whole-loan
sales
|
|
|
244,510
|
|
|
|
196,744
|
|
|
|
626,971
|
|
|
|
515,462
|
|
Total
securitizations and whole-loan sales
|
|
$
|
1,144,509
|
|
|
$
|
1,021,743
|
|
|
$
|
3,326,968
|
|
|
$
|
3,040,439
|
|
We
apply the net proceeds from
securitizations and whole-loan sales to pay down our warehouse credit facilities
in order to make capacity available under these facilities to fund additional
mortgage loans and utilize any remaining funds for working
capital.
Securitizations.
Securitizations,
whether structured as a
sale or secured financing, effectively provide us with a source of long-term
financing.
In a securitization, we pool together loans,
typically each quarter, and convey these loans to a newly formed securitization
trust.
For
securitizations structured as a sale, the securitization trust is formed as
a
qualified special purpose entity (“QSPE”), which is not consolidated in our
financial statements for financial reporting purposes. For
securitizations structured as a financing, the securitization trust is formed
as
a special purpose entity (“SPE”), which is consolidated for financial reporting
purposes.
These trusts are established for the limited purpose
of receiving and holding our mortgage loans and issuing asset-backed securities,
and are bankruptcy remote – meaning that purchasers of asset-backed securities
may rely only on the cash flows generated from the assets held by the
securitization trust for payment, and may not rely upon us for payment;
likewise, the assets held by the securitization trust are not available to
our
general creditors, although when we utilized securitizations structured as
a
financing we record the securitized loans and the securitization financing
on
our consolidated financial statements. We carry no contractual
obligation related to these trusts or the loans sold to the trusts, nor do
we
have any direct or contingent liability related to the trusts, except for the
standard representations and warranties typically made as part of a sale of
loans on a non-recourse basis. Furthermore, we provide no guarantees
to investors with respect to the cash flow or performance of these
trusts.
Each
of our securitizations contains an
overcollateralization (“O/C”) provision, which is a credit enhancement
determined and required by the rating agencies and/or the bond insurer insuring
the securities. The required O/C can increase or decrease throughout
the term of the securities depending upon subordination levels, delinquency
and/or loss tests, and is subject to minimum and maximum levels. The O/C
provision is designed to provide additional credit support for the securities
sold from credit losses, which may arise principally from defaults on the
underlying mortgage loans. O/C occurs when the amount of collateral
(
i.e.
,
mortgage loans) owned by a
securitization trust exceeds the aggregate amount of asset-backed securities
(senior note portion only).
The
securitizations we completed during the nine months ended September 30, 2007
required an O/C ranging from 3.6% to 6.0%
of the initial mortgage loans
sold to
the securitization trust.
During the year ended December 31,
2006, our securitizations required a range of O/C from 2.7% to 3.1%
of the initial mortgage loans
sold to
the securitization trust. The level of O/C required for our
securitizations is driven by the ratings placed on our asset-backed securities
by the rating agencies, which are
Standard & Poor's Ratings Services
(“S&P”), Moody's Investors Service, Inc (“Moody’s”), Fitch Ratings, Inc.
(“Fitch”) and/or
Dominion Bond
Rating Service, Inc.
(“DBRS”). During the three months ended
September 30, 2007, several of the rating agencies announced substantial
changes
to their ratings criterion and methodologies which, among other things, raised
the level of O/C required on our third quarter 2007 securitization transaction
to a level above the levels we experienced during the first six months of
2007
(which ranged from 3.6% to 3.7%). We anticipate that the level of O/C
required on our future securitizations will also be directly affected by
the
market conditions present at the time of securitization, among other things,
which we currently expect to continue to substantially exceed the levels
we
experienced during the first six months of 2007.
For
securitizations structured to be
accounted for as secured financings, no up front gain (or loss) is recorded;
rather, the mortgage loans that collateralizes the financings are recorded
on
our balance sheet as mortgage loans held for investment - securitized, together
with the related financing on the mortgage loans held for
investment. For securitizations structured as sales, we record an
upfront loss or gain at the time of securitization, which is recorded in our
statements of operations as a component of net loss or gain on sale of mortgage
loans.
We
regularly issue net interest margin (“NIM”) securities (either NIM notes or
Class N Notes) simultaneously with the underlying securitization. In
a NIM transaction, the right to receive the excess cash flows generated by
the
pool of loans collateralizing the securitization structured as a financing,
or
from the excess cashflow certificates or residual securitization certificates
in
transactions structured as sales, is transferred to a NIM investor, in exchange
for an up front cash payment to us.
The
NIM note(s) or Class N Notes entitle
the holder to be paid a specified interest rate, and further provides for,
(1)
in the case of the Class N Notes, all remaining cash flows generated by the
trust after payment of senior payment priorities and expenses, or (2) in the
case of the NIM notes, the cash flows generated by the excess cashflow
certificates or residual securitization certificates, to be used to pay all
principal and interest on the NIM note(s) or the Class N Notes until paid in
full, which typically occurs approximately 15 to 24 months from the date the
NIM
note(s) or the Class N Notes are issued. We ultimately will hold the
excess cashflow, residual securitization or owner trust certificates after
the
holder(s) of the NIM note(s) or the Class N Notes has been paid in full, or
may
sell the certificates either at the time of securitization or when economically
beneficial to do so.
NIM
transactions generally enable us to generate upfront cash flow when the
securitization and related NIM transaction close, net of funding the upfront
O/C, securitization and NIM costs. Historically, NIM transactions
helped us offset a portion of our cost to originate the loans included in the
transaction, to the extent there are any excess proceeds. We intend
to continue to issue NIM notes or Class N Notes in connection with any
securitization transactions that we complete in the foreseeable
future.
Each
securitization trust also has the
additional credit benefit of either a financial guaranty insurance policy from
a
monoline insurance company or a “senior-subordinated” securitization structure,
or a combination of the two (referred to as a “hybrid”). In a
securitization trust with a financial guaranty insurance policy that is not
a
hybrid, all of the securities are senior securities. The monoline
insurance company guarantees the timely payment of principal and interest to
all
security holders in the event that the cash flows are not
sufficient. In “senior-subordinated” securitization structures, the
senior security holders are protected from losses (and payment shortfalls)
first
by the excess cash flows and the O/C, then by subordinated securities which
absorb any losses prior to the senior security holders. In a hybrid
structure, the senior securities generally have both the subordinated securities
to absorb losses and a monoline insurance company that guarantees timely
principal and interest payments with respect to the senior
securities.
Each
of our securitizations includes a
series of asset-backed securities with various credit ratings, maturities and
interest rates. The combined weighted average interest rate of the
asset-backed securities in each securitization generally will increase over
time
as the shorter-term asset-backed securities with higher credit ratings and
lower
interest costs mature, leaving the longer-term asset-backed securities with
lower credit ratings and higher interest costs remaining.
Securitizations
Structured as a
Financing
.
All
of our securitizations
completed since the beginning of 2004 through the end of the second quarter
of
2007 were structured and accounted for as secured financings, as they do not
meet the
QSPE
criteria
under SFAS No. 140 and related interpretations, because, after the loans are
securitized, we have the option to either contribute a derivative instrument
into the applicable trust or
purchase
up to 1% of
the mortgage loans contained in the securitization mortgage pool
. We refer to the recording
of these transactions
as “portfolio accounting.”
Securitization transactions
consummated
prior to 2004 and the third quarter of 2007 securitization transaction met
the
QSPE criteria under SFAS No. 140 and were accounted for, recognized and recorded
as sales.
With
portfolio accounting, (1) the
mortgage loans we originate remain on our consolidated balance sheets as
mortgage loans held for investment; (2) the securitization debt replaces the
warehouse debt associated with the securitized mortgage loans; and (3) we record
interest income on the mortgage loans and interest expense on the securities
issued in the securitization over the life of the securitization, instead of
recognizing a gain or loss upon completion of the
securitization.
We
believe that portfolio accounting treatment closely matches the recognition
of
income with the receipt of cash payments on the individual
loans.
We intend to continue to utilize portfolio accounting
in the foreseeable future.
The
following table sets forth
information about our securitized mortgage loan portfolio and the corresponding
securitization debt balance for each on-balance sheet asset-backed security
series completed since the first quarter of 2004, at September 30,
2007:
(Dollars
in
thousands
)
|
|
|
|
|
|
|
|
|
Asset-backed
Security
Series:
|
|
Issue
Date
|
|
Current
Loan Principal
Balance
(1)
|
|
|
Total
Securitization Debt
Balance
(2)
|
|
|
|
|
|
|
|
|
|
|
|
2004-1
|
|
March
30,
2004
|
|
$
|
158,311
|
|
|
$
|
153,878
|
|
|
2004-2
|
|
June
29,
2004
|
|
|
188,009
|
|
|
|
176,237
|
|
|
2004-3
|
|
September
29,
2004
|
|
|
223,263
|
|
|
|
206,135
|
|
|
2004-4
|
|
December
29,
2004
|
|
|
254,880
|
|
|
|
237,982
|
|
|
2005-1
|
|
March
31,
2005
|
|
|
349,646
|
|
|
|
327,340
|
|
|
2005-2
|
|
June
29,
2005
|
|
|
397,156
|
|
|
|
375,138
|
|
|
2005-3
|
|
September
29,
2005
|
|
|
481,984
|
|
|
|
453,658
|
|
|
2005-4
|
|
December
30,
2005
|
|
|
539,335
|
|
|
|
513,650
|
|
|
2006-1
|
|
March
30,
2006
|
|
|
575,211
|
|
|
|
554,663
|
|
|
2006-2
|
|
June
29,
2006
|
|
|
612,387
|
|
|
|
597,374
|
|
|
2006-3
|
|
September
29,
2006
|
|
|
674,254
|
|
|
|
663,803
|
|
|
2006-4
|
|
December
29,
2006
|
|
|
563,282
|
|
|
|
557,836
|
|
|
2007-1
|
|
March
29,
2007
|
|
|
904,299
|
|
|
|
889,613
|
|
|
2007-2
|
|
June
18,
2007
|
|
|
829,590
|
|
|
|
819,512
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
6,751,607
|
|
|
$
|
6,526,819
|
|
(1)
The
current loan principal balance shown
includes amounts reflected on the consolidated balance sheet as mortgage loans
held for investment - securitized (excluding discounts and net deferred
origination fees), REO (at its trust-basis value) and the principal portion
of
trustee receivables.
(2)
The
total securitization debt (financing on mortgage loans held for investment,
net)
balance shown excludes discounts of $12.7 million at September 30,
2007.
Securitizations
Structured as a
Sale.
During
the third quarter of 2007 and for
the period
prior to 2004, we structured our securitizations to be
accounted for as sales
under SFAS
No. 140
, which is known as “gain-on-sale accounting.”
In a securitization structured
as a
sale, or off-balance sheet, we sell a pool of loans to a trust for a cash
purchase price and we receive one or more excess cashflow certificates or
residual certificates evidencing our ownership in certain distributions from
the
trust. Prior to 2004, we recognized our securitizations on a
gain-on-sale basis, and we recorded an upfront gain at the time of
securitization and recorded the fair value of the excess cashflow certificates
on our balance sheet.
We allocated our basis in the
mortgage
loans and excess cashflow or residual certificate between the portion of the
mortgage loans and excess cashflow or residual certificate sold through
securitization and the portion retained based on the relative fair values of
those portions on the date of sale.
Our
net
investment in the pool of loans sold at the date of the securitization
represented the amount originally paid to originate the loans, adjusted for
the
following:
·
|
any
direct loan origination costs incurred (an increase in the investment)
and
loan origination fees received (a decrease in the investment) in
connection with the mortgage loans, which are treated as a component
of
the initial investment in the mortgage
loans;
|
·
|
the
principal payments received, and the amortization of the net loan
fees or
costs, during the period we held the mortgage loans prior to their
securitization; and
|
·
|
any
gains (a decrease in the investment) or losses (an increase in the
investment) we incurred on any hedging instruments that we may have
utilized to hedge against the effects of changes in interest rates
during
the period we held the loans prior to their
securitizations. (See “–Summary of Critical Accounting Policies
- Accounting for Hedging
Activities”).
|
The
excess cashflow or residual certificate retained in the transaction are
classified as trading securities and are carried at their fair
value. Any changes in their fair value were recognized through
earnings as a component other income.
The fair value of the excess
cashflow
certificates held at December 31, 2006 totaled $1.2 million. During the first
quarter of 2007, we sold all of our remaining excess cashflow certificates,
and
we no longer held any excess cashflow certificates at September 30,
2007.
In
the
securitization structured as a sale during the third quarter of 2007, we sold
the residual certificate and did not retain any economic interest in the
securitization.
Securitizations
Structured as
Real Estate Mortgage Investment Conduits and Owner-Trusts for Income Tax
Purposes
.
During
the third quarter of
2007, and for the periods prior to 2005,
we structured our
securitizations for tax purposes, as Real Estate Mortgage Investment Conduits
(“REMICs”) or “sale-for-tax” treatment. For federal tax purposes,
REMICs are accounted for as a sale, which required us to recognize a gain
or
loss at the time we securitized the mortgage loans. Beginning in
2005, and through the second quarter of 2007, we structured our securitizations
for tax purposes, as owner-trust transactions or “debt-for-tax” treatment and
issued our securitizations through our Real Estate Investment Trust (“REIT”)
subsidiary to avoid taxable mortgage pool issues (double
taxation). For federal tax purposes, owner-trust transactions are
accounted for as debt, which facilitates compliance with the applicable REIT
income and asset tests and allows us to recognize any taxable income associated
with the securitized mortgage loans and corresponding securitized debt over
time. Although we intend to continue to structure most of our
securitizations as owner-trust transactions, we may engage in REMIC
securitizations, as we did during the third quarter of 2007, in the
future. We have in the past, and may in the future, recognize excess
inclusion income attributable to the interests we retain in these securitization
transactions, including the owner trust certificates, which could have negative
tax consequences to us.
Whole-Loan
Sales
. Whole-loan sales are the sales of pools of mortgage
loans to banks, consumer finance-related companies and institutional investors
on a servicing-released basis. As discussed above, we sell a portion
of our mortgage loans on a whole-loan basis, without retaining servicing rights,
generally in private transactions to financial institutions or consumer finance
companies. We recognize a gain or loss when we sell loans on a
whole-loan basis equal to the difference between the cash proceeds received
for
the mortgage loans and our investment in the mortgage loans, including any
unamortized loan origination fees and costs. We generally sell these
mortgage loans without recourse, except that we provide standard representations
and warranties to the purchasers of these loans. During the three
months ended September 30, 2007 and 2006, we sold whole-loans without recourse
(with the exception of a premium recapture and secondary marketing
(indemnification) reserves described below) to third-party purchasers and on
a
servicing-released basis of $244.5 million and $196.7 million,
respectively. During the nine months ended September 30, 2007 and
2006, we sold whole-loans without recourse (with the exception of a premium
recapture and secondary marketing (indemnification) reserves described below)
to
third-party purchasers and on a servicing-released basis of $627.0 million
and
$515.5 million, respectively. The average gross premium we received
for the whole loans sold during the three months ended September 30, 2007 was
2.24%, compared to 3.79% for the three months ended September 30,
2006. The average gross premium we received for the whole loans sold
during the nine months ended September 30, 2007 was 2.88%, compared to 3.60%
for
the nine months ended September 30, 2006. The gross premium paid to
us by third-party purchasers in whole-loan sale transactions does not take
into
account premiums we pay to originate the mortgage loans, the origination fees
we
collect, premium recapture reserves or secondary marketing (indemnification)
reserves – each of which are components of the net gain on sale
calculation.
We
maintain a premium recapture reserve
related to our contractual obligation to rebate a portion of any premium paid
by
a purchaser when a borrower prepays a sold loan within an agreed period of
time. The premium recapture reserve is established at the time of the
whole-loan sale through a provision, which is reflected as a reduction of the
gain on sale of mortgage loans. During the three months ended
September 30, 2007 and 2006, we recorded a premium recapture reserve recovery
of
$117,000 and a provision of $248,000, respectively, for the refunding of
premiums to whole-loan sale investors. During the nine months ended
September 30, 2007 and 2006, we recorded a premium recapture reserve provision
of $179,000 and $732,000, respectively, for the refunding of premiums to
whole-loan sale investors. The premium recapture reserve is recorded
as a liability on our consolidated balance sheets. We estimate
recapture losses primarily based upon historical premium recaptures and by
reviewing the types of loan products, interest rates, borrower prepayment fees,
if any, and an estimate of the impact that future interest rate changes may
have
on early repayments. The premium recapture reserve totaled $386,000
and $958,000 at September 30, 2007 and December 31, 2006,
respectively.
We
also maintain a secondary market
(indemnification) reserve related to our estimated exposure to losses arising
from loan repurchases, or net settlements, related to claims by investors
relating to breaches of representations and warranties. The secondary
marketing reserve is established at the time of the whole-loan sale through
a
provision, which is reflected as a reduction of the gain on sale of mortgage
loans. During the three months ended September 30, 2007 and 2006, we
recorded a secondary market (indemnification) reserve provision of $502,000
and
$158,000, respectively, for losses that arise in connection with loans that
we
may be required to repurchase from whole-loan sale investors. During
the nine months ended September 30, 2007 and 2006, we recorded a secondary
market (indemnification) reserve provision of $1.2 million and $386,000,
respectively. We estimate the exposure primarily based upon
historical repurchases and we estimate losses using a detailed analysis of
historical loan performance by product type and origination year, similar to
the
analysis performed for the allowance for loan losses related to our mortgage
loans held for investment portfolio. The secondary market
(indemnification) reserve allowance totaled $744,000 and $512,000 at September
30, 2007, and December 31, 2006, respectively.
Summary
of Critical Accounting
Policies
An
appreciation of our critical accounting policies is necessary to understand
our
financial results. These policies may require management to make
difficult and subjective judgments regarding uncertainties, and as a result,
these estimates may significantly impact our financial results. The
accuracy of these estimates and the likelihood of future changes depend on
a
range of possible outcomes and a number of underlying variables, many of which
are beyond our control, and there can be no assurance that our estimates are
accurate.
Accounting
for Hedging
Activities.
Our hedging
strategy
revolves around two principal activities: (a) the issuance of our prospective
securitization financing which is collateralized by the origination of mortgage
loans, and (b) the issuance of variable-rate securitization debt
(financing). As a result of these activities, we are exposed to
interest rate risk beginning when our mortgage loans close and are recorded
as
assets until permanent financing is arranged, such as when the asset-backed
securities are issued. We utilize hedges to mitigate our interest
rate exposure. After we originate mortgage loans, our strategy is to
generally use a series of duration-matched interest rate swap contracts (i.e.,
two, three and five-year contracts) in an effort to lock in a pre-determined
base interest rate on designated portions of our prospective future
securitization financing (i.e., the asset-backed securities that we expect
to
issue). We also use corridors (
corresponding purchases and
sales of interest rate caps with similar notional balances at different strike
prices
) and/or amortizing notional
balance interest rate swaps that are designed to limit our financing costs
on
the variable portion of the debt issued in the securitization. The
purpose of the hedge within the securitization is to maintain minimum margins
over specific periods of time, with the possibility of allowing us to increase
margins during periods in which prevailing interest rates are lower than
anticipated. Both the interest rate swaps (which generally have an
expected life of 36 months) and corridors (which have a range of expected lives)
are derivative instruments that trade in liquid markets, and we do not use
either of them for speculative purposes.
In accordance with SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities,” we record all of our derivatives on our consolidated
balance sheets at fair value. For derivative financial instruments
not designated as hedging instruments, gains or losses resulting from a change
in fair value are recognized in current period earnings. When
derivatives are used as hedges, hedge accounting is permitted only if we
document the hedging relationship and its effectiveness at the time we designate
the derivative as a hedge instrument. If we meet certain requirements
under SFAS No. 133, we may account for the hedge instrument as a cash flow
hedge.
Cash
flow hedge accounting is appropriate for hedges of uncertain cash flows
associated with future periods – whether as a consequence of interest to be
received or paid on existing variable rate assets or liabilities or in
connection with intended purchases or sales.
Under
cash flow hedge accounting treatment, the changes in the fair value of the
derivative instruments are divided into two portions, “effective” and
“ineffective.” The effective portion of the derivative's gain or loss
initially is reported as a component of OCI and subsequently reclassified into
earnings when the forecasted transaction affects earnings. The
ineffective portion of the gain or loss is reported in earnings
immediately.
To qualify for cash
flow hedge accounting treatment, all of the following factors must be
met:
·
|
hedges
must be contemporaneously documented, with the objective and strategy
stated, along with an explicit description of the methodology used
to
assess and measure hedge
effectiveness;
|
·
|
dates
(or periods) for the expected forecasted events and the nature of
the
exposure involved (including quantitative measures of the size of
the
exposure) must be explicitly
documented;
|
·
|
hedges
must be expected to be “highly effective,” both at the inception of the
hedge and on an ongoing basis. Effectiveness measures must
relate the gains or losses of the derivative to changes in the cash
flow
associated with the hedged item;
|
·
|
forecasted
transactions must be probable; and
|
·
|
forecasted
transactions must be made with counterparties other than the reporting
entity.
|
If
and
when a derivative no longer qualifies for hedge accounting because it fails
the
test of hedge effectiveness (the ratio of the changes in the value of the
hedging instrument to the changes in the value of the hedged item exceeds 125%
or falls below 80%, and therefore the hedge is no longer “highly effective”),
hedge accounting is discontinued and any amounts previously recorded in OCI
are
amortized into earnings over the remaining life of the hedged asset or
liability. As permitted by SFAS No. 133, when a hedge relationship is
discontinued for this reason, we will analyze the derivative to determine
whether all or a portion of the derivative may be designated as a hedge of
a
different transaction or item. If all or a portion of the derivative
qualifies for a new hedging relationship, hedge accounting is applied to future
changes in the fair value of that portion of the derivative. The
future changes for any portion of the derivative that does not qualify for
a new
hedge relationship are included in net loss or income as they
occur.
The
“new
hedge relationship” is
determined by re-aligning the hedge with the projected remaining bond balances
(debt) as of the date the original hedge became retrospectively
ineffective. The ratio of the outstanding balance of the debt to
notional size of the revised hedge will then be 100% as of the re-alignment
date. The expected repayment pattern of the debt associated with the
original hedge is used as the basis to establish the “new hedge relationship”
future repayment pattern. The difference between the fair value of
the original hedge and the “new hedge relationship” hedge on the re-alignment
date is classified as a trading security. Once classified as a
trading security, any changes in the fair value are recorded directly to the
income statement as a component of “gain or loss on derivative
instruments.”
Accounting
for Income
Taxes.
Significant
management
judgment is required in developing our provision for income taxes, including
the
determination of deferred tax assets and liabilities and any valuation
allowances that might be required against the deferred tax
asset.
Management needs to consider the relative impact of
negative and positive evidence related to the ability to recognize a deferred
tax asset. This evaluation takes into consideration our recent
earnings history, current tax position and estimates of taxable income in the
near term. If actual results differ from these estimates, we may be
required to record a valuation allowance on our deferred tax assets, which
could
negatively impact our consolidated financial position and results from
operations. We recognize all of our deferred tax assets if we
believe, on a more likely than not basis, that all of the benefits of the
deferred tax assets will be realized. Management currently believes
that, based upon on the available evidence, it is more likely than not that
the results of future operations
will generate sufficient taxable income to realize the deferred tax
assets.
Therefore, at September 30, 2007 and December 31,
2006, we did not maintain a valuation allowance against our deferred tax
assets. Additionally, on January 1, 2007, we adopted FIN No. 48,
which clarified the accounting for uncertainty in income taxes recognized
in
an enterprise’s
financial statements in accordance with SFAS No. 109. Our adoption of
FIN No. 48 did not have a material effect on our consolidated financial
statements.
Allowance for Loan Losses on Mortgage Loans Held for Investment.
In connection with our mortgage loans held for investment,
excluding those loans which meet the criteria for specific review under SFAS
No.
114, “Accounting by Creditors for Impairment of a Loan - an amendment of FASB
Statements No. 5 and 15,” we established an allowance for loan losses that we
expect will arise within the next 18 to 24 months following the analysis date
of
September 30, 2007. Provisions for loan losses are made for
loans to the extent that we bear probable losses on these
loans. Provision amounts are charged as a current period expense to
operations. We charge-off uncollectible loans at the time we deem
that they are not probable of being collected.
In order to estimate an appropriate allowance for losses on mortgage loans
held
for investment (both securitized and pre-securitized), we estimate losses using
a detailed analysis of historical mortgage loan performance data, which is
updated each quarter. This data is analyzed for loss performance and
prepayment performance by product type, origination year and securitization
issuance. The results of that analysis are then applied to the
current long-term mortgage portfolio held for investment, excluding those loans
which meet the criteria for specific review under SFAS No. 114, and an estimate
is created. In accordance with SFAS No. 5, “Accounting for
Contingencies,” we believe that pooling of mortgages with similar
characteristics is an appropriate methodology by which to calculate or estimate
the allowance for loan losses. The results of that analysis are then
applied to the current long-term mortgage portfolio, and an allowance for loan
losses estimate is created to take into account both known and inherent losses
in the loan portfolio. Losses incurred will be written-off against
the allowance for loan losses.
While we will continually evaluate the adequacy of the allowance for loan
losses, we recognize that there are qualitative factors that must be taken
into
consideration when evaluating and measuring potential expected losses on
mortgage loans. These items include, but are not limited to, current
performance of the loans, economic indicators that may affect the borrowers’
ability to pay, changes in the market value of the collateral, political factors
and the general economic environment. As these factors and estimates
are influenced by factors outside of our control and there is inherently
uncertainty in our estimates, it is reasonably possible that they could
change. In particular, if conditions were such that we were required
to increase the provision for loan losses, our income for that period would
decrease.
In
accordance with SFAS No. 114, as amended by SFAS No. 118, a loan is impaired
when, based on current information and events, it is probable that a creditor
will be unable to collect all amounts due according to the contractual terms
of
the mortgage loan agreement. Based upon analyses performed, we
identified specific mortgage loans in which the borrowers’ abilities to repay
the loans in accordance with their contractual terms was impaired. We
assessed the extent of damage to the underlying collateral, and the extent
to
which the damaged collateral was not covered by insurance, in determining the
amount of specific reserves needed. We established specific reserves
for these affected mortgage loans based upon our estimates of loss
exposure. As additional information is obtained and processed over
the coming months and quarters, we will continue to assess the need for any
adjustments to our estimates and the specific reserves related to the impaired
mortgage loans.
Amortization
of Deferred Loan Origination Fees and Costs.
Interest income
is recorded on our mortgage loans held for investment portfolio based upon
a
combination of interest accruals on the outstanding balance and the contractual
terms of the mortgage loans, adjusted by the amortization of net deferred
origination fees or costs accounted for in accordance with SFAS No.
91. Our net deferred origination fees/costs consist principally of
origination fees, discount points, broker premiums, and payroll and commissions
associated with originating our mortgage loans. For our loans held
for investment, these net deferred fees or costs are accreted or amortized
as
adjustments to interest income over the estimated lives of the loans using
the
interest method. Our portfolio of mortgage loans held for investment
is comprised of a large number of homogeneous loans for which we believe some
prepayments are probable. The periodic amortization of our deferred
origination fees or costs is based on a model that considers actual prepayment
experience to date as well as forecasted prepayments based on the contractual
interest rate on the mortgage loans, loan age, loan type and prepayment fee
coverage, among other factors. Mortgage prepayments are affected by
the terms and credit grades of the loans, conditions in the housing and
financial markets and general economic conditions. Prepayment
assumptions are reviewed regularly to ensure that our actual experience, as
well
as industry data, is supportive of the prepayment assumptions used in our
model. Any changes to these estimates are applied as if the revised
estimates had been in place since the origination of the loans, and current
period amortization is adjusted to reflect the effect of the
changes. During the three months ended June 30, 2007, we revised the
prepayment assumptions utilized to accrete the deferred origination income
related to our fixed rate mortgage loans. The assumptions utilized
during the three months ended June 30, 2007 were not changed during the three
months ended September 30, 2007.
In general, prepayment speeds
are lowest
in the first month after origination, and generally increase until a peak speed
is reached. Generally, loans will continue to prepay at the peak
speed for some period of time, and then prepayment speeds typically begin to
decline. We use prepayment assumptions that reflect these
tendencies. The prepayment curve established during the second
quarter of 2007 lowered the prepayment speeds we expect over the next 12
months. As of June 30, 2007, the revised prepayment curve for fixed
rate loans seasoned less than 15 months ranged from 4.0% to 35.0% over the
next
12 months as compared to 4.0% to 43.0% on the previous prepayment
curve. As of June 30, 2007, the revised prepayment curve for fixed
rate loans seasoned 15 months or more is 24.0% over the next 12 months as
compared a range of 34.0% to 43.0% on the previous prepayment
curve. As of June 30, 2007, the prepayment curves for adjustable-rate
loans seasoned less than 15 months and 15 months or more ranged from 4.0% to
75.0% and 35.0% to 75.0%, respectively, over the next 12 months, which is
unchanged from the previous prepayment curves.
Amortization
of Deferred Debt Issue Discounts and Transaction
Costs.
Interest expense on our securitization and residual
financing is comprised of the accrual of interest based on the contractual
terms, and among other things, cash receipts and amortization related to our
cash flow hedges (interest rate swaps and corridors), the amortization of
deferred debt issue discounts and transaction costs. The deferred
debt issue discounts and transaction costs are amortized as an adjustment to
interest expense over the estimated lives of the related debt using the interest
method, and take into account the effect of estimated
prepayments. The deferred issuance discounts and transaction costs
related to our residual financing facility and convertible notes are amortized
as an adjustment to interest expense over the estimated lives of the related
debt using the interest method, and take into account the effect of estimated
prepayments. Any changes made to these estimates are applied as if
the revised estimates had been in place since the issuance of the related debt,
and result in adjustments to the period amortization recorded to interest
expense.
Stock-Based
Compensation Expense.
Effective January 1, 2006, we account
for stock-based compensation costs in accordance with SFAS No. 123(R), which
requires the measurement and recognition of compensation expense for all
stock-based payment awards made to our employees and directors. Under
the fair value recognition provisions of SFAS No. 123(R), stock-based
compensation cost is measured at the grant date based on the fair value of
the
award and is recognized as expense over the vesting
period. Determining the fair value of stock-based awards at the grant
date requires considerable judgment, including estimating expected volatility,
expected term and risk-free interest rate. Our expected volatility is
based upon the historical volatility of our common stock. The
expected term of the stock options is based on factors including historical
observations of employee exercise patterns and expectations of employee exercise
behavior in the future, giving consideration to the contractual terms of the
stock-based awards. The risk-free interest rate assumption is based
on the yield at the time of grant of a U.S. Treasury security with an equivalent
remaining term. If factors change and we employ different
assumptions, stock-based compensation expense may differ significantly from
the
amounts we have recorded or reported in the past.
Results
of
Operations
Three
Months Ended September 30, 2007
Compared to Three Months Ended September 30, 2006
General
The third quarter of 2007 witnessed a global credit market disruption that
dramatically affected the securitization and subprime markets, and virtually
every company that operates within the subprime market. The magnitude
and duration of the market disruption was greater than anyone predicted
and
resulted in companies in our sector scaling back or ceasing their
operations. Virtually every originator of subprime loans, as well as many
of those who purchase, securitize or buy asset-backed securities collateralized
by subprime mortgages, sustained substantial losses as a result of this
market
disruption. We were able to complete a securitization in early
September 2007 collateralized by $900.0 million of mortgage loans, but
received
adverse pricing on this transaction as a result of the global credit crisis
and
consequent highly illiquid securitization market conditions at that
time. We structured the transaction as a sale, and not a financing;
as a result, we incurred all of the losses associated with the transaction,
totaling $56.2 million, during the third quarter of 2007. Although
we reported a large loss for the quarter, by completing this
securitization, we significantly reduced our credit risk on our balance
sheet
and exposure to additional margin calls on warehouse lines. The effects of
these market disruptions negatively impacted our operating results for the
three and nine months ended September 30, 2007, as described
below.
Our
net loss for the three months ended
September 30, 2007 was $39.6 million, or $1.70 per share basic and diluted,
compared to net income of $8.0 million, or $0.34 per share basic and $0.33
per
share diluted, for the three months ended September 30, 2006. As
described in more detail below, the decrease in net income primarily related
to
(a) the $56.2 million loss incurred on the sale of mortgage loans we recorded
on
the securitization we structured as a sale during the third quarter of
2007, (b)
the $14.6 million increase in the provision for loan losses primarily related
to
the size and seasoning of the mortgage loans held for investment, net,
(c) the
$5.0 million increase in REO related expenses, (d) the $1.9 million of
interest
expense related to our August 2007 residual financing and convertible notes,
and
(e) the $1.4 million expense related to restructuring charges incurred
in
connection with the elimination of 313 positions and the closing of some
wholesale origination offices. Additionally, the net loss was generated by
the net effect of:
(1)
|
An
increase in net interest income
before the provision for loan losses of $37.7 million, or 0.3%, during
the
three months ended September 30, 2007 from $37.6 million recorded
during
the three months ended September 30, 2006. The increase in net
interest income before the provision for loan losses reflects the
net
effect of recognizing interest income on a 18.2% larger amount of
mortgage
loans held for investment and recognizing interest expense on a 17.3%
larger amount of mortgage loan related financing (including warehouse
credit financing) from September 30, 2006. Mitigating the
increase in interest income was the $6.4 million increase in non-accrual
interest (interest income not recorded on loans that are generally
90 days
or more delinquent) for the three months ended September 30, 2007
as
compared to the same period in 2006. The increase in net
interest income was also mitigated by a $2.7 million decrease in
prepayment penalty income during the three months ended September
30,
2007, compared to the three months ended September 30, 2006, due
to the
slower prepayments experienced during the three months ended September
30,
2007 compared to the same period in 2006
;
and
|
(2)
|
A
decrease in net gain on sale of
mortgage loans related to whole-loan sales of $1.7 million, or 17.4%,
to
$7.8 million on the sale of $244.5 million of mortgage loans on a
whole-loan basis during the three months ended September 30, 2007,
from a
$9.5 million gain during the three months ended September 30, 2006
on
sales on a whole-loan basis of $196.7 million of mortgage
loans. Whole loan sales represented 30.2% and 19.8% of total
loans originated for the three months ended September 30, 2007 and
2006,
respectively. The decrease in the gain primarily relates to the
155 basis point decrease in the premiums received, partially offset
by the
increase in the percentage of whole loan sales to loans originated
for the
three months ended September 30, 2007 as compared to the three months
ended September 30, 2006
.
|
We
originated $809.0 million of mortgage
loans during the three months ended September 30, 2007, representing a $185.9
million, or 18.7%, decrease from $994.9 million of mortgage loans originated
during the three months ended September 30, 2006. We sold $1.1
billion of loans during the three months ended September 30, 2007, an increase
of $122.8 million, or 12.0%, compared to the $1.0 billion of loans securitized
and/or sold during the three months ended September 30, 2006. The
increase in the total loans securitized and sold during the three months ended
September 30, 2007 as compared to the same period in 2006 was attained by
utilizing the mortgage loans held for investment – pre-securitized portfolio to
offset the effect of the reduced origination levels for the
period. We had a $341.3 million decrease in the amount of mortgage
loans held pre-securitization from June 30, 2007 to September 30,
2007.
Net
Interest
Income
We recorded net interest income of $37.7 million during the three months ended
September 30, 2007, an increase of $124,000, or 0.3%, from the $37.6 million
recorded during the three months ended September 30, 2006. The slight
increase in net interest income primarily reflects the net effect of the higher
average balance of mortgage loans held for investment and the related financing,
coupled with the net changes in the interest rates earned or incurred on those
balances, and the impact of the change in prepayment speeds on the
accretion/amortization of deferred income and expenses during the three months
ended September 30, 2007 compared to the three months ended September 30,
2006. Additionally offsetting net interest income during the three
months ended September 30, 2007 were: (1) the increase in non-accrual loans
-
which reduces the amount of interest income recognized for the period, and
(2)
the interest expense incurred on the August 2007 financings. Net
interest income represents the difference between our interest income and our
interest expense, each of which is described in the following
paragraphs.
Interest Income.
Interest income increased $32.4
million, or 26.5%, to $154.7 million for the three months ended September 30,
2007, from $122.3 million for the three months ended September 30,
2006. The increase was primarily due to (1) a $17.9 million increase
in interest income earned (including prepayment penalty income) on our loans
held for investment - securitized, which totaled $6.6 billion at September
30,
2007, compared to $5.9 billion at September 30, 2006, coupled with a 25 basis
point increase in the average interest rate over the same period, (2) a $15.4
million increase in interest income on mortgage loans held for investment –
pre-securitized due to an increase in the average amount of mortgage loans
we
held prior to securitization or sale during the three months ended September
30,
2007 compared to the three months ended September 30, 2006, coupled with a
41
basis point increase in the average interest rate over the same period, and
(3)
$2.0 million of interest income related to mortgage loans held for sale during
the three months ended September 30, 2007. These increases were
partially offset by (1) an increase in non-accrual loans for the quarter ended
September 30, 2007, representing $6.4 million less in interest income from
the
period one-year ago, (2) a $3.0 million decrease in securitization pass-through
interest received from securitization trusts on fixed-rate asset-backed
securities due to structuring the securitization as a sale during the three
months ended September 30, 2007 as compared to structuring the securitization
as
a financing during the comparable 2006 period, (3) a $2.7 million decrease
in
prepayment penalty income (despite a 18.2% increase in the size of our mortgage
loans held for investment, net at September 30, 2007, compared to September
30,
2006) due to the slower prepayments experienced during the three months ended
September 30, 2007 as compared to the same period in 2006.
The
following table is a summary of
interest income for the three months ended September 30, 2007 and
2006:
|
|
For
the Three Months
Ended
September
30,
|
|
(Dollars
in
thousands)
|
|
2007
|
|
|
2006
|
|
Interest
income on mortgage loans
held for investment - securitized, net
(1)
|
|
$
|
128,086
|
|
|
$
|
110,232
|
|
Interest
income on mortgage loans
held for investment - pre-securitization, net
|
|
|
24,343
|
|
|
|
8,966
|
|
Interest
income on mortgage loans
held for sale, net
|
|
|
2,014
|
|
|
|
--
|
|
Securitization
pass-through
interest
|
|
|
--
|
|
|
|
3,048
|
|
Interest
income on excess cashflow
certificates
|
|
|
--
|
|
|
|
53
|
|
Miscellaneous
interest
income
|
|
|
301
|
|
|
|
14
|
|
Total
interest
income
|
|
$
|
154,744
|
|
|
$
|
122,313
|
|
(1)
The
amounts for
the three months ended September 30, 2007 and 2006 include $3.3 million and
$6.0
million, respectively, of prepayment penalties.
Interest Expense.
Interest expense increased by $32.3
million, or 38.1%, to $117.0 million for the three months ended September 30,
2007, from $84.7 million for the three months ended September 30,
2006. The $22.6 million, or 29.3%, increase in interest expense on
mortgage loans held for investment financing was primarily due to the increase
in the weighted average cost of the financing, which increased by 22 basis
points from 5.51% during the three months ended September 30, 2006 to 5.73%
during the three months ended September 30, 2007, coupled with the increase
in
the average balance of the financing over the same period. The $7.7
million, or 100.3%, increase in interest expense on warehouse financing was
due
to the increase in the average balance of the loans held for investment -
pre-securitization and financed during the three months ended September 30,
2007
on our warehouse facilities, compared to the three months ended September 30,
2006, coupled with an increase in the average one-month LIBOR rate, which is
the
benchmark index used to determine the cost of our borrowed funds. The
index rate increased 8 basis points to an average of 5.43% for the three months
ended September 30, 2007, compared to an average of 5.35% for the three months
ended September 30, 2006. Also increasing interest expense during the
three months ended September 30, 2007 was the $1.9 million increase in interest
expense on our August 2007 financings (residual financing facility and
convertible notes). The increase in interest expense was somewhat
offset by a slowing in the recognition of the deferred debt issuance costs,
trustee expenses and hedging costs, as a result of the slower prepayments on
the
securitization debt (directly related to the slower prepayments on the mortgage
assets described above) extending the life of the financing on mortgage loans
held for investment.
The
following is a summary of the
components of interest expense for the three months ended September 30, 2007
and
2006:
|
|
For
the Three Months
Ended
September
30,
|
|
(Dollars
in
thousands)
|
|
2007
|
|
|
2006
|
|
Interest
expense on mortgage loans
held for investment financing
(1)
|
|
$
|
99,649
|
|
|
$
|
77,057
|
|
Interest
expense on warehouse
financing
|
|
|
15,310
|
|
|
|
7,645
|
|
Interest
expense on other
borrowings
(2)
|
|
|
2,012
|
|
|
|
107
|
|
Other
interest expense
(income)
|
|
|
70
|
|
|
|
(75
|
)
|
Total
interest
expense
|
|
$
|
117,041
|
|
|
$
|
84,734
|
|
(1)
The
amounts for the three months ended
September 30, 2007 and 2006 includes an expense of $2.5 million and income
of
$33,000, respectively, of securitization debt issuance cost amortization and
trustee expenses recognized during the period, net of hedge
amortization.
(2)
The
amount for the three months ended
September 30, 2007 includes an expense of $911,000 of debt issuance cost and
discount amortization related to the August 2007 financings (residual financing
facility and convertible notes).
Provision
for Loan
Losses
A
provision for loan losses on mortgage
loans held for investment is recorded to maintain the related allowance for
loan
losses at an appropriate level for currently existing probable losses of
principal. We recorded a provision for loan losses of $21.5 million
and $6.9 million for the three months ended September 30, 2007 and 2006,
respectively, related to mortgage loans held for investment. The
increase in the amount of the provision for loan losses, excluding the specific
provision related to impaired loans, corresponds to the performance and
seasoning of our mortgage loans held for investment during the respective
period, coupled with the impact of the declining real estate market during
the
three months ended September 30, 2007, which increased our loss
estimates.
Non-Interest
Income
Total
non-interest income decreased by
$59.6 million to a loss of $48.3 million for the three months ended September
30, 2007, from income of $11.3 million for the three months ended September
30,
2006. The decrease in non-interest income resulted from the $56.2
million of losses recorded on the securitization structured as a sale during
the
three months ended September 30, 2007 and, to a lesser extent, a $1.7 million
decrease in the gain recorded from the sale of mortgage loans on a whole-loan
basis and a $1.7 million decrease in the amount of fair value gains recorded
on
our excess cashflow certificates during the three months ended September 30,
2007 as compared to the three months ended September 30,
2006.
Net (Loss) Gain on Sale of Mortgage Loans.
The net loss
on the sale of mortgage loans recorded during the three months ended September
30, 2007 was comprised of (1) a loss from the securitization structured as
a
sale and (2) a gain from the sale of loans on a whole-loan
basis. During the three months ended September 30, 2007, we recorded
a $56.2 million loss on the sale of $900.0 million of mortgage loans related
to
the third quarter 2007 securitization. The third quarter 2007
securitization was structured to be accounted for as a sale under SFAS No.
140. The net loss on sale of mortgage loans related to the
securitization was comprised primarily of the basis differential between the
cash purchase price we received in connection with selling the asset-backed
securities related to the securitization and the cost basis of the mortgage
loans, net of any hedge losses or gains associated with the securitization,
deferred origination costs or fees, and costs associated with the
securitization.
In
addition to the impact of the loss
from the securitization structured as a sale during the three months ended
September 30, 2007, net gain on sale of mortgage loans decreased by $1.7 million
related to whole-loan sales primarily due to a 155 basis point decrease in
the
gross premiums received period-over-period, offsetting the impact of the 24.3%
increase in the amount of loans sold. The decrease in the premiums
received during the third quarter of 2007 reflected the market conditions and
weighted-average coupon on the mortgage loans sold during the same period,
coupled with our selling $2.5 million of non-performing loans at a discount
of
$855,000. During the three months ended September 30, 2007, we
recorded a $7.8 million gain on the sale of $244.5 million of mortgage loans
on
a whole-loan basis, as compared to a gain of $9.5 million on the sale of $196.7
million of mortgage loans on a whole-loan basis during the three months ended
September 30, 2006. The net gain on sale of mortgage loans related to
whole-loan sales is comprised of the premium received from selling whole loans
on a servicing-released basis, together with any deferred origination costs
or
fees associated with mortgage loans sold, less any premium recapture and
secondary marketing (indemnification) reserves.
The
following table is a summary of our
net loss or gain on sale of mortgage loans for the
three months ended September
30,
2007
and
2006:
|
|
For
the Three Months Ended
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
(Dollars
in
thousands)
|
|
Securitization
|
|
|
Whole-loan
|
|
|
Total
|
|
|
Whole-loan
|
|
Loans
sold
|
|
$
|
899,999
|
|
|
$
|
244,510
|
|
|
$
|
1,144,509
|
|
|
$
|
196,744
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
gain on
securitization/whole-loan sales
(1)
|
|
$
|
(91,829
|
)
|
|
$
|
5,466
|
|
|
$
|
(86,363
|
)
|
|
$
|
7,449
|
|
Premium
recapture reserve
(2)
|
|
|
--
|
|
|
|
117
|
|
|
|
117
|
|
|
|
(248
|
)
|
Secondary
marketing
(indemnification) reserve
(3)
|
|
|
--
|
|
|
|
(502
|
)
|
|
|
(502
|
)
|
|
|
(158
|
)
|
Net
loan origination
fees
|
|
|
4,399
|
|
|
|
2,765
|
|
|
|
7,164
|
|
|
|
2,458
|
|
Hedging
loss
|
|
|
(1,001
|
)
|
|
|
--
|
|
|
|
(1,001
|
)
|
|
|
--
|
|
Discounts
|
|
|
34,635
|
|
|
|
--
|
|
|
|
34,635
|
|
|
|
--
|
|
Securitization
transaction
costs
|
|
|
(2,393
|
)
|
|
|
--
|
|
|
|
(2,393
|
)
|
|
|
--
|
|
Net
(loss) gain on sale
recorded
|
|
$
|
(56,189
|
)
|
|
$
|
7,846
|
|
|
$
|
(48,343
|
)
|
|
$
|
9,501
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
whole-loan sales
(discount) premium
|
|
|
(10.20
|
)%
|
|
|
2.24
|
%
|
|
|
(7.55
|
)%
|
|
|
3.79
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
whole-loan sales
(discount) premium,
net
of reserves
(4)
|
|
|
(10.20
|
)%
|
|
|
2.08
|
%
|
|
|
(7.58
|
)%
|
|
|
3.58
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
net (loss) gain on sale
ratio
(5)
|
|
|
(6.24
|
)%
|
|
|
3.21
|
%
|
|
|
(4.22
|
)%
|
|
|
4.83
|
%
|
(1) The amount shown is inclusive of the lower of cost or
market adjustment recorded on the date we determined that the mortgage loans
would be sold.
(2)
The
premium recapture reserve amount shown for the three months ended September
30,
2007 was comprised of a provision of $187,000 related to the loans sold during
the three months ended September 30, 2007 and a recovery of $304,000 related
to
reserve adjustments for loan sales from prior year periods.
(3)
The
secondary marketing
(indemnification) reserve amount shown for the three months ended September
30,
2007 was comprised of a provision of $242,000 related to the loans sold during
the three months ended September 30, 2007 and an additional provision of
$260,000 related to reserve adjustments for loan sales from prior
periods.
(4)
The
average whole-loan sales premium,
net of reserves, on whole-loan sales for the three months ended September 30,
2007 and 2006 was 2.08% and 3.58%, respectively. The average
whole-loan sales premium, net of reserves, is calculated by dividing the gain
on
whole-loan sales, net of premium recapture and secondary marketing
(indemnification) reserves, by the total amount of loans
sold.
(5) The
average net gain on sale ratio on whole-loan sales for the three months ended
September 30, 2007 and 2006 was 3.21% and 4.83%, respectively. The
average net gain on sale ratio is calculated by dividing the net gain on sale
by
the total amount of loans sold.
Other Income.
Other income decreased $1.8 million to
$23,000 for the three months ended September 30, 2007, from $1.8 million for
the
three months ended September 30, 2006. The decrease in other income
period over period primarily relates to $1.7 million decline in the amount
of
the fair value change recorded on our excess cashflow
certificates. During the three months ended March 31, 2007, we sold
all of our remaining excess cashflow certificates. Accordingly, we
did not record any fair value adjustments during the three months ended
September 30, 2007, compared to a $1.7 million fair value adjustment gain for
the three months ended September 30, 2006.
Additionally,
during
the three months ended September
30, 2006,
we recorded a gain of $50,000 on the sale of our MSRs to a
third-party. We did not sell any MSRs during the three months ended
September 30, 2007.
Non-interest
Expense
Total non-interest expense increased by $3.4 million, or 11.7%, to $32.6 million
for the three months ended September 30, 2007, from $29.2 million for the three
months ended September 30, 2006. The increase primarily is due to (1)
a $5.0 million increase in REO related expenses and (2) the $1.4 million
restructuring charge related to the August 2007 staff reduction (approximately
20.1% of the workforce) and office closings.
Payroll and Related Costs.
Payroll and related costs include
salaries, benefits and payroll taxes for all employees, but excludes the
deferrable portion of those costs attributable to employees involved in loan
production. Payroll and related costs decreased by $2.0 million, or
12.3%, to $14.5 million for the three months ended September 30, 2007, from
$16.5 million for the three months ended September 30, 2006. The
decrease was primarily the result of lower compensation and related payroll
cost
associated with our staff reduction, which occurred during the second half
of
August 2007, and by the lower commissions due to the decrease in our quarterly
loan production. As of September 30, 2007, we employed 1,056 full-
and part-time employees, a decrease of 23.3% over our 1,376 full- and part-time
employees as of September 30, 2006, which is primarily as a result of the August
2007 staff reduction. Included in payroll and related costs during
the three months ended September 30, 2007 was a severance expense of $775,000
related to the August 2007 staff reduction. Additionally, payroll and
related costs, specifically for loan production related personnel, were lower
due to the 18.7% decrease in loan production during the three months ended
September 30, 2007, compared to the three months ended September 30,
2006.
General and Administrative Expenses.
General and
administrative expenses consist primarily of office rent, insurance expense,
telephone expense, depreciation, legal reserves and fees, license fees,
accounting fees, travel and entertainment expenses, advertising and promotional
expenses, REO-related expenses and the provision for recourse
loans. General and administrative expenses increased $5.5 million, or
44.5%, to $17.9 million for the three months ended September 30, 2007, from
$12.4 million for the three months ended September 30, 2006. The
increase primarily was due to a $5.0 million increase in REO expenses, a
$462,000 increase in professional fees (i.e., legal, accounting and consulting
fees) and $652,000 of restructuring charges related to the closing of wholesale
origination offices in August 2007. The increase in REO-related
expenses in the three months ended September 30, 2007 was due to the expected
increase in REO activity as our mortgage loan portfolio became more seasoned,
coupled with the impact of the declining real estate market during the
period. As the portfolio of REO properties increases, the expenses
arising from the operation (i.e., payment of real estate taxes and insurance)
and disposal of those properties will also generally increase. The
amount of REO properties held totaled $62.9 million and $17.8 million at
September 30, 2007 and 2006, respectively.
Loss (Gain) on Derivative Instruments.
The gain or loss
on derivative instruments recorded during the three months ended June 30, 2007
and 2006 represented (1) the ineffective portion of the change in fair value
of
interest rate swaps used to lock in a pre-determined interest rate on designated
portions of our prospective future securitization financing, (2) the ineffective
portion related to the change in the fair value of our corridors we use to
protect the variable-rate financing and (3) changes in the fair value of the
derivative instruments classified as trading securities.
During the three months ended September 30, 2007, we recorded a net loss on
derivative instruments of $197,000, as compared to a net loss on derivative
instruments of $262,000 during the three months ended September 30,
2006. During the three months ended September 30, 2007, we recorded a
loss of $154,000 on the ineffective portion of corridors and interest rate
swaps, compared to a loss of $99,000 recorded on the ineffective portion of
corridors and interest rate swaps during the three months ended September 30,
2006. Additionally, at September 30, 2007 and 2006, we held $179,000
and $258,000, respectively, of corridors classified as trading securities in
prepaid and other assets, as these corridors were no longer deemed “highly
effective.” During the three months ended September 30, 2007 and
2006, we recorded a loss of $43,000 and $163,000, respectively, for the changes
in the fair value of the hedges (specifically corridors) held as trading
securities.
Provision
for Income Tax (Benefit) Expense
We
recorded an income tax benefit of
$25.0 million on a pre-tax loss of $64.7 million for the three months ended
September 30, 2007 (an effective tax rate of approximately
38.7%). The effective tax rate for the three months ended September
30, 2007
reflects our estimate of a lower overall effective tax rate for
2007 and subsequent years.
As a result of our net loss
before
income tax benefit, we recorded a tax benefit for the three months ended
September 30, 2007, which mitigated the impact of the permanent differences
(which were fairly consistent period-over-period). We recorded an
income tax expense of $4.9 million on pre-tax income of $12.9 million for the
three months ended September 30, 2006 (an effective tax rate of approximately
38.1%).
Nine
Months Ended September 30, 2007
Compared to Nine Months Ended September 30, 2006
General
Our
net loss for the nine months ended
September 30, 2007 was $34.0 million, or $1.46 per share basic and diluted,
compared to net income of $21.8 million, or $0.98 per share basic and $0.95 per
share diluted, for the nine months ended September 30, 2006. As
described in more detail below, the decrease in net income primarily
related to (a) the $56.2 million loss incurred on the sale of mortgage
loans we recorded on the securitization we structured as a sale during the
third
quarter of 2007, (b) the $25.1 million increase in the provision for loan losses
due primarily to the increase in the size and seasoning of the mortgage loan
held for investment – securitized portfolio, (c) the $10.2 million increase in
REO related expenses, (d) the $1.9 million of interest expense related to our
August 2007 financing arrangements, (e) the $1.4 million restructuring charge
incurred due to the elimination of 313 positions and the closing of some
wholesale origination offices and (f) the $7.6 million decrease in the amount
of
fair value change recorded on our excess cashflow certificates due to our sale
of all remaining excess cashflow certificates in the first quarter of
2007.
These
decreases were partially offset by
an increase in net interest income before the provision for loan losses of
$8.5
million, or 7.8%, to $117.2 million during the nine months ended September
30,
2007, from $108.7 million recorded during the nine months ended September 30,
2006. The increase in net interest income before the provision for
loan losses reflects the net effect of recognizing interest income on a 18.2%
larger amount of mortgage loans held for investment, net and recognizing
interest expense on a 17.3% larger amount of mortgage loan related financing
(including warehouse credit financing) from September 30,
2006. Mitigating the increase in interest income was the $14.2
million increase in non-accrual interest for the nine months ended September
30,
2007 as compared to the prior comparable period. The increase in net
interest income was also mitigated by a $1.8 million decrease in interest income
related to a reduction in prepayment penalty income (despite a 18.2% increase
in
the size of our mortgage loans held for investment, net at September 30, 2007
from September 30, 2006) as compared to the nine months ended September 30,
2006, due to the slower prepayments occurring during the nine months ended
September 30, 2007 compared to the same period in 2006. Additionally
impacting both interest income and interest expense during the nine months
ended
September 30, 2007 was a change in the prepayment assumptions in the second
quarter of 2007, used to accrete/amortize deferred income and expenses, which
lowered net interest income during the period
.
We
originated $3.4 billion of mortgage
loans during the nine months ended September 30, 2007, representing a $492.3
million, or 16.9%, increase from $2.9 billion of mortgage loans originated
during the nine months ended September 30, 2006. We securitized
and/or sold $3.3 billion of loans during the nine months ended September 30,
2007, an increase of 9.4% compared to the $3.0 billion of loans securitized
and/or sold during the nine months ended September 30, 2006.
Net
Interest
Income
We recorded net interest income of $117.2 million during the nine months ended
September 30, 2007, an increase of $8.5 million, or 7.8%, from the $108.7
million recorded during the nine months ended September 30, 2006. The
increase in net interest income primarily reflects the net effect of the higher
average balance of mortgage loans held for investment and the related financing,
coupled with the net changes in the interest rates earned or incurred on those
balances, and the impact of the change in prepayment speeds on the
accretion/amortization of deferred income and expenses during the nine months
ended September 30, 2007 compared to the nine months ended September 30,
2006. Additionally offsetting net interest income during the nine
months ended September 30, 2007 were (1) the increase in non-accrual loans,
which reduces the amount of interest income recognized for the period, and
(2)
the interest expense incurred on the August 2007 financings. Net
interest income represents the difference between our interest income and our
interest expense, each of which is described in the following
paragraphs.
Interest Income.
Interest income increased $107.4
million, or 31.8%, to $444.4 million for the nine months ended September 30,
2007, from $337.0 million for the nine months ended September 30,
2006. The increase was primarily due to (1) a $77.3 million increase
in interest income earned (including prepayment penalty income) on our loans
held for investment - securitized, which totaled $6.6 billion at September
30,
2007, compared to $5.9 billion at September 30, 2006, coupled with a 31 basis
point increase in the average interest rate over the same period, (2) a $31.6
million increase in interest income on mortgage loans held for investment –
pre-securitized due to an increase in the average amount of mortgage loans
we
originated and held prior to securitization or sale during the nine months
ended
September 30, 2007 compared to the nine months ended September 30, 2006, coupled
with a 50 basis point increase in the average interest rate over the same
period, and (3) $2.0 million of interest income related to mortgage loans held
for sale (interest earned on the mortgage loans collateralizing the third
quarter 2007 securitization structured as a sale from the reclassification
date
to the date of securitization) during the nine months ended September 30,
2007. These increases were partly offset by (1) an increase in
non-accrual loans for the nine months ended September 30, 2007, representing
$14.2 million less in interest income from the period one-year ago (2) a $3.6
million decrease in securitization pass-through interest received from
securitization trusts on fixed-rate asset-backed securities was primarily due
to
structuring one of the three securitizations as a sale during the nine months
ended September 30, 2007, and (3) a $1.8 million decrease in prepayment penalty
income recognized during the nine months ended September 30, 2007 compared
to
the nine months ended September 30, 2006, due to the slower prepayment
environment that existed during 2007 as compared to 2006.
The
following table is a summary of
interest income for the nine months ended September 30, 2007 and
2006:
|
|
For
the Nine Months
Ended
September
30,
|
|
(Dollars
in
thousands)
|
|
2007
|
|
|
2006
|
|
Interest
income on mortgage loans
held for investment - securitized, net
(1)
|
|
$
|
377,611
|
|
|
$
|
300,357
|
|
Interest
income on mortgage loans
held for investment - pre-securitization, net
|
|
|
58,295
|
|
|
|
26,664
|
|
Interest
income on mortgage loans
held for sale, net
|
|
|
2,014
|
|
|
|
--
|
|
Securitization
pass-through
interest
|
|
|
5,934
|
|
|
|
9,553
|
|
Interest
income on excess cashflow
certificates
|
|
|
17
|
|
|
|
433
|
|
Miscellaneous
interest
income
|
|
|
488
|
|
|
|
15
|
|
Total
interest
income
|
|
$
|
444,359
|
|
|
$
|
337,022
|
|
(1)
The
amounts for the nine months ended
September 30, 2007 and 2006 include $13.4 million and $15.2 million,
respectively, of prepayment penalties.
Interest Expense.
Interest expense increased by $98.9
million, or 43.3%, to $327.2 million for the nine months ended September 30,
2007, from $228.3 million for the nine months ended September 30,
2006. The $79.1 million, or 38.6%, increase in interest expense on
mortgage loans held for investment financing was primarily due to the increase
in the weighted average cost of the financing, which increased by 42 basis
points from 5.26% during the nine months ended September 30, 2006 to 5.68%
during the nine months ended September 30, 2007, coupled with the increase
in
the average balance of the financing over the same period. The $18.0
million, or 78.3%, increase in interest expense on warehouse financing was
due
to the increase in the average balance of the loans held for investment –
pre-securitization and financed during the nine months ended September 30,
2007
on our warehouse facilities, compared to the nine months ended September 30,
2006, coupled with an increase in the average one-month LIBOR rate, which is
the
benchmark index used to determine the cost of our borrowed funds. The
index rate increased 34 basis points to an average of 5.36% for the nine months
ended September 30, 2007, compared to an average of 5.02% for the nine months
ended September 30, 2006. Additionally, the slowing of prepayments on
the mortgage loans as described above has the effect of extending (slowing
the
repayments) the life of the financing on mortgage loans held for investment,
thereby slowing the amortization of the deferred debt issuance costs, trustee
expenses and hedging. Also increasing interest expense during the
nine months ended September 30, 2007 was the $1.9 million increase in interest
expense incurred on the August 2007 financings (residual financing facility
and
convertible notes).
The
following is a summary of the
components of interest expense for the nine months ended September 30, 2007
and
2006:
|
|
For
the Nine Months
Ended
September
30,
|
|
(Dollars
in
thousands)
|
|
2007
|
|
|
2006
|
|
Interest
expense on mortgage loans
held for investment financing
(1)
|
|
$
|
283,840
|
|
|
$
|
204,738
|
|
Interest
expense on warehouse
financing
|
|
|
40,964
|
|
|
|
22,979
|
|
Interest
expense on other
borrowings
(2)
|
|
|
2,252
|
|
|
|
317
|
|
Other
interest
expense
|
|
|
145
|
|
|
|
260
|
|
Total
interest
expense
|
|
$
|
327,201
|
|
|
$
|
228,294
|
|
(1)
The
amounts for the nine months ended
September 30, 2007 and 2006 include $7.0 million and $782,000, respectively,
of
securitization debt issuance cost amortization and trustee expenses recognized
during the period, net of hedge amortization.
(2)
The
amount for the nine months ended
September 30, 2007 includes an expense of $911,000 of debt issuance cost and
discount amortization related to the August 2007 financings (residual financing
facility and convertible notes).
Provision
for Loan
Losses
A provision for loan losses on mortgage loans held for investment is recorded
to
maintain the related allowance for loan losses at an appropriate level for
currently existing probable losses of principal. We recorded a
provision for loan losses of $45.4 million (including a recovery of $333,000
of
a specific provision related to impaired loans) and $20.3 million (including
a
recovery of $675,000 of a specific provision related to impaired loans) for
the
nine months ended September 30, 2007 and 2006, respectively, related to mortgage
loans held for investment. The increase in the amount of the
provision for loan losses, excluding the specific provision related to impaired
loans, corresponds to the performance and seasoning of our mortgage loans held
for investment during the respective period, coupled with the impact of the
declining real estate market during the later part of the nine months ended
September 30, 2007, which increased our loss estimates.
Non-Interest
Income
Total
non-interest income decreased by
$63.4 million to a loss of $30.4 million for the nine months ended September
30,
2007, from $33.0 million for the nine months ended September 30,
2006. The decrease in non-interest income resulted from the $56.2
million of losses recorded on the securitizations structured as a sale during
the nine months ended September 30, 2007 and, to a lesser extent, a $7.6 million
decrease in the amount of fair value gains recorded on our excess cashflow
certificates.
Net (Loss) Gain on Sale of Mortgage Loans.
The net loss
on the sale of mortgage loans recorded during the nine months ended September
30, 2007 was comprised of (1) a loss from the securitization structured as
a
sale and (2) a gain from the sale of loans on a whole-loan
basis. During the three months ended September 30, 2007, we recorded
a $56.2 million net loss on the sale of $900.0 million of mortgage loans related
to the third quarter 2007 securitization. The third quarter 2007
securitization was structured to be accounted for as a sale under SFAS No.
140. The net loss on sale of mortgage loans related to the
securitization was comprised primarily of the basis differential between the
cash purchase price we received in connection with selling the asset-backed
securities related to the securitization and the cost basis of the mortgage
loans, net of any hedge losses or gains associated with the securitization,
deferred origination costs or fees, and costs associated with the
securitization.
In addition to the impact of the loss from the securitization structured as
a
sale during the three months ended September 30, 2007, net gain on sale of
mortgage loans increased by $112,000 related to whole-loan sales primarily
due
to the 21.6% increase in the amount of loans sold during the nine months ended
September 30, 2007 as compared to the same period in 2006, offsetting the impact
of the 72 basis point decrease in the gross premiums received (2.88% during
the
nine months ended September 30, 2007 compared to 3.60% during the same period
in
2006) period-over-period. The decline in the premiums received during
the third quarter of 2007 reflected the declining market conditions in the
whole-loan market during the same period, coupled with our selling $2.5 million
loans at a discount of $855,000. During the nine months ended
September 30, 2007 we recorded a $23.7 million gain on the sale of $627.0
million of mortgage loans on a whole-loan basis, as compared to a gain of $23.6
million on the sale of $515.5 million of mortgage loans on a whole-loan basis
during the nine months ended September 30, 2006.
The
following table is a summary of our
net loss or gain on sale of mortgage loans for the
nine months ended September
30,
2007
and
2006:
|
|
For
the Nine Months Ended
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
(Dollars
in
thousands)
|
|
Securitization
|
|
|
Whole-loan
|
|
|
Total
|
|
|
Whole-loan
|
|
Loans
sold
|
|
$
|
899,999
|
|
|
$
|
626,971
|
|
|
$
|
1,526,970
|
|
|
$
|
515,462
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
gain on
securitization/whole-loan sales
(1)
|
|
$
|
(91,829
|
)
|
|
$
|
18,054
|
|
|
$
|
(73,775
|
)
|
|
$
|
18,543
|
|
Premium
recapture reserve
(2)
|
|
|
--
|
|
|
|
(179
|
)
|
|
|
(179
|
)
|
|
|
(732
|
)
|
Secondary
marketing
(indemnification) reserve
(3)
|
|
|
--
|
|
|
|
(1,164
|
)
|
|
|
(1,164
|
)
|
|
|
(386
|
)
|
Net
loan origination
fees
|
|
|
4,399
|
|
|
|
7,004
|
|
|
|
11,403
|
|
|
|
6,176
|
|
Hedging
loss
|
|
|
(1,001
|
)
|
|
|
--
|
|
|
|
(1,001
|
)
|
|
|
--
|
|
Discounts
|
|
|
34,635
|
|
|
|
--
|
|
|
|
34,635
|
|
|
|
--
|
|
Securitization
transaction
costs
|
|
|
(2,393
|
)
|
|
|
--
|
|
|
|
(2,393
|
)
|
|
|
--
|
|
Net
(loss) gain on sale
recorded
|
|
$
|
(56,189
|
)
|
|
$
|
23,713
|
|
|
$
|
(32,476
|
)
|
|
$
|
23,601
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
whole-loan sales
(discount) premium
|
|
|
(10.20
|
)%
|
|
|
2.88
|
%
|
|
|
(4.83
|
)%
|
|
|
3.60
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
whole-loan sales
(discount) premium,
net
of reserves
(4)
|
|
|
(10.20
|
)%
|
|
|
2.67
|
%
|
|
|
(4.92
|
)%
|
|
|
3.38
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
net (loss) gain on sale
ratio
(5)
|
|
|
(6.24
|
)%
|
|
|
3.78
|
%
|
|
|
(2.12
|
)%
|
|
|
4.58
|
%
|
(1) The amount shown is inclusive of the lower of
cost or market adjustment recorded on the date we determined that the mortgage
loans would be sold.
(2) The
premium recapture reserve amount shown for the nine months ended September
30,
2007 was comprised of a provision of $712,000 related to the loans sold during
the nine months ended September 30, 2007 and a recovery of $533,000 related
to
reserve adjustments for loan sales from prior year periods.
(3)
The
secondary marketing
(indemnification) reserve amount shown for the nine months ended September
30,
2007 was comprised of a provision of $624,000 related to the loans sold during
the nine months ended September 30, 2007 and an additional provision of $540,000
related to reserve adjustments for loan sales from prior
periods.
(4)
The
average whole-loan sales premium,
net of reserves, related to whole-loan sales for the nine months ended September
30, 2007 and 2006 was 2.67% and 3.38%, respectively. The average
whole-loan sales premium, net of reserves, is calculated by dividing the gain
on
whole-loan sales, net of premium recapture and secondary marketing
(indemnification) reserves, by the total amount of loans
sold.
(5)
The average net gain
on sale ratio
related to whole-loan sales for the nine months ended September 30, 2007 and
2006 was 3.78% and 4.58%, respectively. The average net gain on sale
ratio is calculated by dividing the net gain on sale by the total amount of
loans sold.
Other Income.
Other income decreased $7.3 million, or
77.7%, to $2.1 million for the nine months ended September 30, 2007, from $9.4
million for the nine months ended September 30, 2006. The decrease in
other income primarily relates to a $7.6 million decline in the amount of the
fair value change recorded on our excess cashflow
certificates. During the nine months ended September 30, 2007, we
recorded a $1.6 million fair value adjustment gain, compared to a $9.2 million
fair value adjustment gain for the nine months ended September 30,
2006. The decrease in the amount of fair value adjustment gains
recorded during the nine months ended September 30, 2007 was primarily driven
by
the amount of excess cashflow certificates that we held throughout the period,
prior to our sale of the remaining excess cashflow certificates during the
first
quarter of 2007. As the cash flows are received, the value of the
excess cashflow certificates declines.
Also
included in other income are the gains recognized on the sale of
MSRs. During
the nine
months ended September 30, 2007,
we recorded a gain of $491,000 on the
sale of our MSRs to a third-party, an increase of $347,000 over the amount
recognized during
the nine months
ended September 30, 2006
. The increase in the gain on sale of
MSRs is due to the composition of the relative fair values of the MSRs and
the
related mortgage loans used in the gain calculation during
the nine months ended September
30, 2007
as compared to the nine months ended September 30, 2006.
Non-interest
Expense
Total non-interest expense increased by $10.4 million, or 12.1%, to $96.3
million for the nine months ended September 30, 2007, from $85.9 million for
the
nine months ended September 30, 2006. The increase primarily is due
to the $1.4 million restructuring charge related to the August 2007 staff
reduction (approximately 20.1% of the workforce) and office
closings. Additionally, the increase in non-interest expense is due
to an increase in general and administrative expenses reflecting the impact
of
the 16.9% increase in our mortgage loan production and increased REO related
expenses. The increase was somewhat offset by a decrease in payroll
and related costs due to our decrease in staff after giving effect to the August
2007 staff reduction.
Payroll and Related Costs.
Payroll and related costs
decreased by $849,000, or 1.7%, to $49.2 million for the nine months ended
September 30, 2007, from $50.1 million for the nine months ended September
30,
2006. The slight decrease was primarily the result of lower
compensation and related payroll cost associated with the decrease in our
staff. As of September 30, 2007, we employed 1,056 full- and
part-time employees, a decrease of 23.3% over our 1,376 full- and part-time
employees as of September 30, 2006. The majority of the decline in
headcount occurred during the August 2007 reduction (eliminated 313
positions). Included in payroll and related costs during the nine
months ended September 30, 2007 was $775,000 of severance expense related to
the
August 2007 staff reduction. Offsetting the decreases in payroll and
related costs was an increase in costs associated with loan production,
specifically commissions, due to the 16.9% increase in loan production during
the nine months ended September 30, 2007, compared to the nine months ended
September 30, 2006.
General and Administrative Expenses.
General and
administrative expenses increased $10.8 million, or 30.2%, to $46.8 million
for
the nine months ended September 30, 2007, from $36.0 million for the nine months
ended June 30, 2006. The increase primarily was due to (1) a $10.2
million increase in REO related expenses due to the increase in the average
amount of REO properties held period-over-period, and (2) an increase in
expenses associated with our 16.9% increase in loan production during the nine
months ended September 30, 2007, compared to the nine months ended September
30,
2006. Additionally, included in general and administrative expenses
was $652,000 of restructuring charges related to the closing of three wholesale
origination offices in August 2007. This increase was partially
offset by a $913,000 decrease in advertising and marketing expenses, primarily
due to our reduced marketing efforts during the later part of the nine months
ended September 30, 2007 in response to the prevailing market
conditions.
The
increase in REO-related expenses in the nine months ended September 30, 2007
was
due to the expected increase in REO activity as the mortgage loan portfolio
became more seasoned, coupled with a decline in market values of real estate
that have occurred during 2007. As the portfolio of REO properties
increases, the expenses arising from the operation (i.e., payment of real estate
taxes and insurance) and disposal of those properties will also generally
increase. The amount of REO properties held totaled $62.9 million and
$17.8 million at September 30, 2007 and 2006, respectively.
(Gain) Loss on Derivative Instruments.
The gain or loss
on derivative instruments recorded during the nine months ended September,
2007
and 2006 represented (1) the ineffective portion of the change in fair value
of
interest rate swaps used to lock in a pre-determined interest rate on designated
portions of our prospective future securitization financing, (2) the ineffective
portion related to the change in the fair value of our corridors we use to
protect the variable-rate financing, and (3) changes in the fair value of the
derivative instruments classified as trading securities.
During
the nine months ended September
30, 2007, we recorded a loss on derivative instruments of $210,000, as compared
to a net gain on derivatives instruments of $161,000 during the nine months
ended September 30, 2006. During the nine months ended September 30,
2007, we recorded a loss of $252,000 on the ineffective portion of corridors
and
interest rate swaps, compared to a gain of $40,000 recorded on the ineffective
portion of corridors and interest rate swaps during the nine months ended
September 30, 2006. Additionally,
at September 30, 2007 and
2006, we held $179,000 and $258,000, respectively, of corridors classified
as
trading securities in prepaid and other assets, as these corridors were no
longer deemed “highly effective.” During
the nine months ended September
30,
2007
and 2006, we recorded a gain of $42,000 and a gain of $121,000,
respectively, for the changes in the fair value of the hedges (specifically
corridors) held as trading securities.
Provision
for Income Tax (Benefit)
Expense
We
recorded an income tax benefit of
$20.9 million on a pre-tax loss of $54.9 million for the nine months ended
September 30, 2007 (an effective tax rate of approximately
38.1%). The effective tax rate for the nine months ended September
30, 2007,
reflects our estimate of a lower overall effective tax rate for
2007 and subsequent years.
As a result of our net loss
before
income tax benefit, we recorded a tax benefit for the nine months ended
September 30, 2007. We recorded an income tax expense of $13.8
million on pre-tax income of $35.6 million for the nine months ended September
30, 2006 (an effective tax rate of approximately 38.8%).
Financial
Condition
September
30, 2007 Compared to December 31, 2006
Cash and Cash Equivalents.
Cash and cash equivalents
decreased $1.5 million, or 26.7%, to $4.2 million at September 30, 2007,
from
$5.7 million at December 31, 2006. This decrease was primarily
related to the timing of cash received and disbursed from normal
operations.
Mortgage Loans Held for Investment,
Net
.
Mortgage loans held for
investment, net increased $612.0 million, or 9.6%, to $7.0 billion at September
30, 2007, from $6.4 billion at December 31, 2006. This account
represents our basis in the mortgage loans that were either delivered to the
securitization trusts (recorded as mortgage loans held for investment –
securitized) structured as financings or are pending delivery into future
securitizations intended to be financing transactions (recorded as mortgage
loans held for investment – pre-securitization), net of discounts, deferred fees
and allowance for loan losses.
The
following table sets forth a summary
of mortgage loans held for investment, net at September 30, 2007 and December
31, 2006:
(Dollars
in
thousands)
|
|
At
September
30,
2007
|
|
|
At
December 31,
2006
|
|
Mortgage
loans held for investment
– securitized
|
|
$
|
6,629,892
|
|
|
$
|
6,051,996
|
|
Mortgage
loans held for investment
- pre-securitization
(1)
|
|
|
480,514
|
|
|
|
417,818
|
|
Discounts
(MSR
related)
|
|
|
(43,412
|
)
|
|
|
(36,933
|
)
|
Net
deferred origination
fees
|
|
|
(20,722
|
)
|
|
|
(19,194
|
)
|
Allowance
for loan
losses
|
|
|
(75,878
|
)
|
|
|
(55,310
|
)
|
Mortgage
loans held for
investment, net
|
|
$
|
6,970,394
|
|
|
$
|
6,358,377
|
|
(1) Included in our mortgage loans held for investment –
pre-securitization at September 30, 2007 and December 31, 2006 was approximately
$433.9 million and $335.9 million, respectively, of mortgage loans that were
pledged as collateral for our warehouse financings at September 30, 2007 and
December 31, 2006, respectively.
Mortgage loans held for investment – securitized is comprised of the mortgage
loans collateralizing our outstanding financings on mortgage loans held for
investment. During the three months ended September 30, 2007 we did
not close a securitization structured to be accounted for as secured financing
(during the three months ended September 30, 2007, we reclassified $900.0
million of mortgage loans to mortgage loans held for sale, which were included
in the securitization structured as a sale during the third quarter of
2007). During the three months ended September 30, 2006 we closed a
securitization transaction totaling $800.3 million which was structured to
be
accounted for as a secured financing and was collateralized by $825.0 million
of
mortgage loans held for investment - securitized. During the nine
months ended September 30, 2007 and 2006, we closed securitization transactions
totaling $1.7 billion and $2.5 billion, respectively, which were structured
to
be accounted for as secured financings and were collateralized by $1.8 billion
and $2.5 billion, respectively, of mortgage loans held for investment -
securitized. Mortgage loans held for investment – securitized had a
weighted-average interest rate of 8.31% and 8.19% per annum at September 30,
2007 and December 31, 2006, respectively.
Mortgage loans held for investment – pre-securitization is comprised primarily
of mortgage loans waiting to be securitized, and, to a lesser extent, a
relatively small amount of loans that may be sold on a whole loan
basis. Included in our mortgage loans held for investment –
pre-securitization at September 30, 2007 and December 31, 2006, was
approximately $433.9 million and $335.9 million, respectively, of mortgage
loans
that were pledged as collateral for our warehouse financings at those same
respective dates. Mortgage loans held for investment –
pre-securitization had a weighted-average interest rate of 9.81% and 8.73%
per
annum at September 30, 2007 and December 31, 2006, respectively.
We maintain an allowance for loan losses based on our estimate of losses that
we
expect will arise (i.e., for which the confirming event will take place) within
the next 18 to 24 months on our mortgage loans held for investment (both
securitized and pre-securitization). At September 30, 2007 and
December 31, 2006, we established an allowance for loan losses totaling $75.9
million and $55.3 million, respectively, based upon our analysis of the mortgage
loans held for investment portfolio, including a $306,000 and $1.0 million,
respectively, reserve for probable loan losses on impaired mortgage
loans. The increase in the allowance for loan losses is primarily
driven by the growth and seasoning of our mortgage loans held for investment
portfolio. We have not substantively changed any aspect of our
overall approach in the determination of the allowance for loan losses under
SFAS No. 5, and there have been no material changes in our assumptions or
estimates as compared to the prior year that impacted the determination of
the
allowance for loan losses at September 30, 2007.
The
following table sets forth a summary
of the activity in the allowance for loan losses for the nine months ended
September 30, 2007 and the year ended December 31, 2006:
(Dollars
in
thousands)
|
|
For
the
Nine
Months
Ended
September
30,
2007
|
|
|
For
the
Year
Ended
December
31,
2006
|
|
Allowance
for loan losses –
beginning of year
|
|
$
|
55,310
|
|
|
$
|
36,832
|
|
Provision
for loan losses
(1)
|
|
|
45,392
|
|
|
|
29,085
|
|
Charge-offs
(2)
|
|
|
(24,824
|
)
|
|
|
(10,607
|
)
|
Allowance
for loan losses – end of
period/year
(3)
|
|
$
|
75,878
|
|
|
$
|
55,310
|
|
(1)
The
provision for loan losses for the
nine months ended September 30, 2007 and the year ended December 31, 2006
includes a specific provision which consisted of a $333,000 recovery and a
$377,000 recovery, respectively. The specific provisions
relates to probable losses attributable to impaired
loans.
(2)
The
charge-offs for the nine months ended September 30, 2007 includes $333,000
of
charge-offs related to impaired loans. The charge-offs for the year
ended December 31, 2006 includes $342,000 (net of $10,000 of recoveries) in
charge-offs against the specific allowance for loan losses attributable to
impaired loans, primarily related to loans located in Hurricanes Katrina and
Rita disaster areas.
(3)
The
allowance for loan losses at September 30, 2007 and December 31, 2006 includes
a
specific allowance for impaired loans of $306,000 and $1.0 million,
respectively. A portion of the specific allowance, or $212,000 and
$675,000, relates to impaired loans located in Hurricanes Katrina and Rita
disaster areas at September 30, 2007 and December 31, 2006,
respectively.
Our
specific allowance for loan losses at September 30, 2007 and December 31, 2006
is based upon our probable loss exposure attributable to 10 and 17 properties,
respectively, securing a total unpaid principal balance (impaired loans) of
$893,000 and $2.5 million, respectively. The impaired loan totals at
September 30, 2007 and December 31, 2006 include approximately $460,000 (none
of
which are pre-securitization loans) and $1.3 million (of which $226,000 are
pre-securitization loans), respectively, of mortgage loans held for investment
located in the Hurricanes Katrina and Rita disaster areas designated by the
Federal Emergency Management Agency (“FEMA”). As additional
information is obtained, we will continue to assess the need for any adjustments
to our specific reserves related to our impaired loans.
Trustee Receivable.
Trustee receivable decreased $41.2
million, or 56.2%, to $32.2 million at September 30, 2007 from $73.4 million
at
December 31, 2006. Trustee receivable principally represents any
un-remitted principal and interest payments collected by the securitization
trust’s third-party loan servicer subsequent to the monthly remittance cut-off
date on our mortgage loans held for investment – securitized
portfolio. The unscheduled principal payments and prepaid loan
payments received after the remittance cut-off date as of September 30, 2007
and
December 31, 2006 totaled $28.4 million and $67.0 million, respectively,
relating to the securitizations accounted for as secured
financings. The trustee is expected to remit these amounts on the
following month’s scheduled remittance date, at which time they mainly will be
used to pay down principal on the related financing on mortgage loans held
for
investment, net. Additionally comprising the balance in trustee
receivable is the interest portion of mortgage payments collected by our loan
servicing provider during the month which are remitted to us one month after
collection (
i.e.
, interest collected by the third-party servicer after
our September 2007 remittance cut-off date will be remitted to us in October
2007).
The decrease in the trustee receivable balance primarily reflects the reduction
in prepayment activity that occurred during the third quarter of 2007 and,
to a
lesser degree, due the seasoning of the loan portfolio. Additionally,
since the third quarter 2007 securitization was structured as a sale, we do
not
record any trustee receivables related to that securitization.
Accrued Interest Receivable.
Accrued interest
receivable increased $11.1 million, or 26.7%, to $52.8 million at September
30,
2007, from $41.7 million at December 31, 2006. The increase is due to
(1) the 9.5% increase in mortgage loans held for investment – securitized from
December 31, 2006, and, to a lesser extent, (2) the effect of an increase in
the
weighted-average interest rates on the mortgage loans held for investment –
securitized of 12 basis points from December 31, 2006 to September 30,
2007. Additionally contributing to the increase in the accrued
interest receivable balance is the increase in the amount of accrued interest
owed relating to loans that are 30 to 89 days past due in accordance with the
contractual terms of the mortgage at September 30, 2007 compared to December
31,
2006.
Excess
Cashflow
Certificates
.
The
following table presents the
activity related to our excess cashflow certificates for the nine months ended
September 30, 2007 and the year ended December 31, 2006:
(Dollars
in
thousands)
|
|
For
the Nine
Months
Ended
September
30,
2007
|
|
|
For
the
Year
Ended
December
31,
2006
|
|
Balance,
beginning of
year
|
|
$
|
1,209
|
|
|
$
|
7,789
|
|
Excess
cashflow certificates
sold
|
|
|
(1,050
|
)
|
|
|
(1,500
|
)
|
Accretion
|
|
|
17
|
|
|
|
452
|
|
Cash
receipts
|
|
|
(1,736
|
)
|
|
|
(16,198
|
)
|
Net
change in fair
value
|
|
|
1,560
|
|
|
|
10,666
|
|
Balance,
end of
period
|
|
$
|
--
|
|
|
$
|
1,209
|
|
During the nine months ended September 30, 2007 and the year ended December
31,
2006, we sold at fair value $1.1 million and $1.5 million, respectively, of
excess cashflow certificates to a third-party without recourse. After
the sale in the first quarter of 2007, we no longer hold any excess cashflow
certificates.
Equipment, Net
.
Equipment, net,
decreased $1.1 million, or 13.0%, to $7.2 million at September 30, 2007, from
$8.3 million at December 31, 2006. The decrease is primarily due to
the depreciation recognized during the nine months ended September 30, 2007
exceeding the amount of equipment purchases made during the same period. During
the third quarter of 2007, we eliminated 313 employee positions and closed
some
origination offices, which reduced our equipment needs and resulted in the
disposal of certain furniture and fixtures at those closed
locations. In contrast, during the later part of 2006, we purchased
computer equipment and office furnishings, in addition to making leasehold
improvements, which reflected the increase in employees and office expansions
made during that period of time.
Accounts Receivable.
Accounts receivable increased $12.9
million to $17.8 million at September 30, 2007, from $4.9 million at December
31, 2006. The increase primarily is due to a $12.7 million increase
in current taxes receivable to $13.4 million at September 30,
2007. The increase in the current taxes receivable is primarily
attributable to the estimated refund attributable to the carryback of the net
operating loss recorded during the nine months ended September 30, 2007, which
resulted principally from the sale of our remaining excess cashflow certificates
(which also resulted in a decrease in our deferred tax asset, as described
below) during the first quarter of 2007 and the impact of the loss recorded
on
the third quarter 2007 securitization structured as a sale.
Prepaid and Other Assets.
Prepaid and other assets
increased $29.8 million, or 59.7%, to $79.6 million at September 30, 2007,
from
$49.8 million at December 31, 2006. The increase primarily is due to
the $33.3 million, or 112.6%, increase in REO properties due to the expected
seasoning of the loan portfolio, partially offset by a $806,000 decrease in
prepaid securitization fees and a $3.1 million net decrease in the fair value
of
our derivative instruments used to hedge our securitization debt during the
nine
months ended September 30, 2007. The decrease in prepaid
securitization fees resulted from the amortization of those fees from all of
our
outstanding securitizations exceeding the fees paid related to our
securitizations structured as financings during the nine months ended September
30, 2007.
At September 30, 2007 and December 31, 2006, we held $62.9 million and $29.6
million, respectively, of REO properties, which we carry at the lower of cost
or
fair value, less estimated selling costs.
Deferred
Tax
Asset.
The
deferred tax asset
increased by $13.5 million, or 29.7%, to $59.3 million at September 30, 2007,
from $45.8 million at December 31, 2006. The increase primarily
relates to (1) a net operating loss carryforward resulting from the loss on
sale, for both GAAP and tax purposes, related to the third quarter 2007
securitization, (2) the timing of loan losses (allowance for loan losses),
(3)
non-accrual interest, (4) our 2004 securitizations which were accounted for
as
secured financings versus REMIC tax accounting, and (5) a $2.7 million increase
related to the fair value of the hedge instruments within accumulated
OCI. These increases were partially offset by a decrease related to
(1) gain-on-sale accounting versus REMIC tax accounting for securitizations
entered into prior to 2004 (primarily attributable to the sale of our remaining
excess cashflow certificates), and (2) deferred origination fees and related
costs, net.
Bank Payable.
Bank payable increased $240,000, or
15.4%, to $1.8 million at September 30, 2007, from $1.6 million at December
31,
2006. Bank payable represents the amount of checks written against
our operating account which are subsequently covered as they are presented
to
the bank for payment by either drawing down our lines of credit or from
subsequent deposits of operating cash.
Warehouse Financing.
Our warehouse financing increased
$70.8 million, or 21.1%, to $406.7 million at September 30, 2007, from $335.9
million at December 31, 2006. The increase was primarily due to a
$62.7 million, or 15.0%, increase in the amount of mortgage loans held for
investment - pre-securitization from December 31, 2006 to September 30,
2007.
Financing on Mortgage Loans Held for Investment,
Net.
Our financing on mortgage loans held for
investment, net increased $496.2 million, or 8.2%, to $6.5 billion at September
30, 2007, from $6.0 billion at December 31, 2006. This increase in
the issuance of asset-backed securities corresponds to the 9.5% increase in
loans held for investment - securitized during the nine months ended September
30, 2007. The balance of this account will generally increase or
decrease in proportion to the change in the balance of our mortgage loans held
for investment - securitized.
Other
Borrowings.
Other borrowings are comprised of (1) a residual
financing facility, (2) convertible notes, and (3) capital leases and other
arrangements related to our equipment financing. Other borrowings
increased $62.6 million to $68.6 million at September 30, 2007 from $6.0 million
at December 31, 2006. The increase in other borrowings was due to the
$70.0 million of financing arrangements ($60.0 million residual financing
facility and $10.0 million of convertible notes) entered into in August of
2007.
The
following table summarizes certain information regarding other borrowings at
September 30, 2007 and December 31, 2006:
(Dollars
in
thousands)
|
|
Range
of Interest Rates
(1)
|
|
|
Balance
at
September
30,
2007
|
|
|
Balance
at
December
31,
2006
|
|
Range
of Expiration Dates
(1)
|
|
|
|
|
|
|
|
|
|
|
|
Residual
financing facility, net
(2)
|
|
600
basis points over
one-month
LIBOR
|
|
|
$
|
52,494
|
|
|
$
|
--
|
|
August
2008
|
Convertible
notes
(3)
|
|
|
6.00%
|
|
|
|
10,000
|
|
|
|
--
|
|
August
2008
|
Equipment
financing
(4)
|
|
7.05%
to
8.95%
|
|
|
|
6,088
|
|
|
|
5,970
|
|
January
2008 to September
2010
|
Total
|
|
|
|
|
|
$
|
68,582
|
|
|
$
|
5,970
|
|
|
(1)
The
range of interest rates and
expiration dates are as of September 30, 2007.
(2)
The
balance at September 30, 2007 is net
of $4.5 million related to deferred warrant costs associated with the residual
financing facility.
(3)
The
convertible notes were converted
into 2.0 million shares of our common stock on October 4,
2007.
(4)
At
December 31, 2006, the outstanding
equipment financing had a range of interest rates of 6.26% to 8.95% and a range
of expiration of January 2007 to November 2009.
Accrued Interest Payable.
Accrued interest payable
increased $3.6 million, or 14.6%, to $28.7 million at September 30, 2007, from
$25.1 million at December 31, 2006. The increase was primarily
related to (1) the 8.2% increase in financing on mortgage loans held for
investment, net, (2) the 21.1% increase in warehouse financing and (3) the
impact of the 15 basis point increase (5.75% at September 30, 2007 from 5.60%
at
December 31, 2006) in the weighted-average cost on mortgage loans held for
investment financing.
Accounts Payable and Other Liabilities.
Accounts
payable and other liabilities increased $35.1 million, or 66.1%, to $88.3
million at September 30, 2007, from 53.2 million at December 31,
2006. The increase relates primarily to (1) the $33.9 million
increase in accrued servicer payables related primarily to the growth in our
mortgage loans held for investment portfolio, and (2) a $1.8 million increase
in
the fair value of the interest rate swaps hedging our securitization debt and
future securitization debt. These increases were partially offset by
a $1.2 million decrease in dividends payable as we did not declare a dividend
during the third quarter of 2007.
Stockholders’ Equity.
Stockholders’ equity decreased
$34.3 million, or 22.9%, to $115.3 million at September 30, 2007 from $149.6
million at December 31, 2006. This decrease is primarily due to (1)
the recording of a $34.0 million net loss for the nine months ended September
30, 2007, (2) a $4.3 increase in the net unrealized losses from derivatives
and
(3) the payment of $2.3 million of common stock dividends during the first
and
second quarter of 2007. These decreases were partially offset by
increases to stockholders’ equity related to (1) the $5.1 million from the
issuance of warrants and (2) the $998,000 of stock-based compensation recorded
during the nine months ended September 30, 2007. No common stock
dividends were declared during the three months ended September 30,
2007.
Contractual
Obligations
The
following table summarizes our
material contractual obligations as of September 30, 2007:
(Dollars
in
thousands)
|
|
Total
|
|
|
Less
than
One
Year
|
|
|
One
to
Three
Years
|
|
|
Three
to
Five
Years
|
|
|
More
than
Five
Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financing
on mortgage loans held
for investment, net
(1)
|
|
$
|
6,514,154
|
|
|
$
|
2,153,017
|
|
|
$
|
2,380,857
|
|
|
$
|
1,005,556
|
|
|
$
|
974,724
|
|
Operating
leases
|
|
$
|
27,909
|
|
|
$
|
8,050
|
|
|
$
|
14,486
|
|
|
$
|
5,373
|
|
|
$
|
--
|
|
Residual
financing facility, net
(1)
|
|
$
|
52,494
|
|
|
$
|
52,494
|
|
|
$
|
--
|
|
|
$
|
--
|
|
|
$
|
--
|
|
Convertible
notes
(2)
|
|
$
|
10,000
|
|
|
$
|
10,000
|
|
|
$
|
--
|
|
|
$
|
--
|
|
|
$
|
--
|
|
Equipment
financing
|
|
$
|
6,088
|
|
|
$
|
555
|
|
|
$
|
5,533
|
|
|
$
|
--
|
|
|
$
|
--
|
|
(1)
Amounts
shown reflect estimated repayments based on anticipated receipt of principal
and
interest of the underlying mortgage loan collateral using prepayment speed
assumptions based upon historical loan performance.
(2)
The
convertible notes were converted
into 2.0 million shares of our common stock on October 4,
2007.
Loan
Commitments
We
provide commitments to fund mortgage
loans to customers as long as all of the proper conditions are
met. Our commitments have fixed expiration dates. Although
we typically honor these interest rate quotes, the quotes do not constitute
future cash requirements, minimizing the potential interest rate risk
exposure. We do not believe these non-conforming mortgage loan
commitments meet the definition of a derivative under SFAS No.
133. Accordingly, they are not recorded in our consolidated financial
statements.
At
September 30, 2007 and December 31, 2006, we had outstanding origination
commitments to fund approximately $26.8 million and $117.1 million,
respectively, in mortgage loans.
Off-Balance
Sheet
Arrangements
We
structured our third quarter 2007
securitization, as well as all of our pre-2004 securitizations, as off-balance
sheet sale transactions. In our third quarter 2007 securitization, we
did not retain any residual economic interests, while in our pre-2004
securitizations we retained the excess cashflow certificates on-balance sheet
to
reflect our ownership interest in these securitizations. During the
nine months ended September 30, 2007, we sold our remaining excess cashflow
certificates pertaining to our pre-2004 securitizations.
We
have no obligation to provide funding
support to either the third-party investors or the off-balance sheet
trusts. The third-party investors and the trusts have no recourse to
our assets or to us and do not have the ability to require us to repurchase
their loans, other than for non-credit-related recourse that can arise under
standard representations and warranties. See “- Origination of
Mortgage Loans – Securitizations” and “- Securitizations Structured as a Sale”
for additional information regarding these transactions.
Cash
Flows
The
following table summarizes our cash flows for the nine months ended September
30, 2007 and 2006:
|
|
For
the Nine Months Ended
September 30,
|
|
(Dollars
in
thousands)
|
|
2007
|
|
|
2006
|
|
Net
cash provided by (used
in):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
activities
|
|
$
|
62,761
|
|
|
$
|
28,581
|
|
|
|
|
|
|
|
|
|
|
Investing
activities
|
|
$
|
(691,119
|
)
|
|
$
|
(1,286,832
|
)
|
|
|
|
|
|
|
|
|
|
Financing
activities
|
|
$
|
626,824
|
|
|
$
|
1,258,685
|
|
Operating
Activities
– The net
cash provided by operating activities
was $62.8 million for the nine months ended September 30, 2007, compared to
$28.6 million for the nine months ended September 30, 2006. The
decrease for the nine months ended September 30, 2007 primarily reflects the
net
impact of the net loss on the sale of mortgage loans, $33.9 million increase
in
accrued interest payable, accounts payable and other liabilities, the $45.4
million provision for loan losses, the $16.3 million of proceeds received from
the sale of MSRs, the $1.7 million of cash received related to our excess
cashflow certificates (including proceeds from sales) and the $41.2 million
decrease in trustee receivable. Partially offsetting these increases
was the impact of the $34.0 million loss recorded, $60.0 million increase in
accrued interest receivable, accounts receivable and prepaid and other assets,
the $10.9 million of deferred tax benefit recorded, the $16.9 million of
deferred origination income and $1.6 million of gains on the change in fair
value of excess cashflow certificates.
Investing
Activities –
The net cash used in investing activities was $691.1 million
for the nine months ended September 30, 2007, compared to $1.3 billion for
the
nine months ended September 30, 2006. The decrease in net cash used
in investing activities during the nine months ended September 30, 2007
primarily related to the $3.4 billion of mortgage loans held for investment
originated, offset by $1.2 billion in principal repayments received on mortgage
loans held for investment and by $1.5 billion in proceeds received from the
sale
of mortgage loans (securitized and whole-loan combined).
Financing
Activities
–
The net
cash provided by financing activities was $626.8 million for the nine months
ended September 30, 2007, compared to $1.3 billion for the nine months ended
September 30, 2006. The decrease in net cash provided during the nine
months ended September 30, 2007 primarily related to the $3.4 billion in
proceeds received from warehouse financing, the $64.0 million of residual
financing and convertible notes and by $1.8 billion in the proceeds received
from the financing on mortgage loans held for investment. Partially
offsetting the increases was a $3.4 billion decrease from the repayment of
warehouse financing and a $1.3 billion decrease from the repayment of financing
on mortgage loans held for investment.
Liquidity
and Capital
Resources
The term “liquidity” refers to our ability to generate adequate amounts of cash
to fund our operations, including our loan originations, loan purchases,
operating expenses, securitization activities, tax payments and dividend
payments, if any. Historically, we have generated working capital
primarily from the cash proceeds we receive from our securitizations, including
the NIM transactions and the sale of MSRs. Our current cost structure
has many embedded fixed costs, which can be significantly affected by a
relatively substantial decrease in our loan origination volume. There
can be no assurance, however, that we will continue to originate a sufficient
amount of mortgage loans or be able to securitize our loans at favorable terms
or at all.
For
instance, in the third quarter of 2007, as a result of what many describe as
the
"worst global credit crisis to date" the entire credit market, including the
securitization market, became extremely illiquid with virtually no new subprime
securitizations being issued or sold. While we were one of the only
subprime companies to successfully complete a securitization - we were able
to
sell all our securitization bonds - we did receive adverse pricing on the
transaction. The transaction was structured as a sale, and not a
financing, in which we incurred all of the losses associated with the
transaction, totaling $56.2 million, during the third quarter of
2007. Our rationale for completing a securitization during this time
was to significantly reduce our credit risk on our balance sheet
and exposure to additional margin calls from our warehouse
providers.
In addition, because of changes we made to our underwriting guidelines and
increases we made to our mortgage rates in response to the turbulent operating
environment, we originated substantially fewer mortgage loans in the third
quarter of 2007. As a result, we were unable to generate sufficient
sources of cash to offset our uses of cash in the third quarter of 2007
and, in fact, expended substantially more cash than we generated.
To the extent that we may be able in the future to securitize our loans at
favorable terms, and originate a sufficient amount of loans in order to generate
adequate amounts of cash to fund our operations, there are still other factors
that could affect our liquidity.
For
example, each of the following may negatively impact our cash flow in any period
in which any of these events occur: higher than expected margin calls on
our warehouse financing facilities; choosing to not sell MSRs; reduce the
amount of securitization debt we issue; higher funding costs, or higher reserve
requirements on our securitization transactions as driven by the agencies rating
our securitizations.
Additionally,
although we believe our strategy to hedge our exposure to rising interest rates
in an effort to “lock in” our spread (as discussed in more detail in “- Summary
of Critical Accounting Policies - Accounting for Hedging Activities” above and
“- Item 3. Quantitative and Qualitative Disclosures About Market Risk - Hedging”
below) to be appropriate, changes in prevailing interest rates could adversely
impact our cash flow in future periods.
The subprime mortgage industry has experienced a period of turmoil during the
first nine months of 2007, which has worsened since mid- to late- July
2007. Our liquidity has been adversely impacted by these
unprecedented market conditions and the resultant margin calls we have received
from our warehouse line providers (described below). (See "-Part II -
Item 1A - Risk Factors"). During the third quarter of 2007, we
received margin calls from our warehouse credit facility providers which, when
we evaluated our business and prevailing market conditions, caused us to seek
additional sources of working capital and to alter our operations to address
the
volatility of the current operating environment. In response to that
evaluation, we entered into two financing transactions, as described
below.
August
2007 Financing
On
August
14, 2007, we closed a financing facility with an affiliate of Angelo Gordon
in
the principal mount of $60.0 million and bearing interest at 600 basis points
over one-month LIBOR. The facility is collateralized by our
securitization BIO and owner trust certificates (the “securitization-related
certificates”) – which entitle the holder to receive the difference between the
interest payments received from the loans held in the related securitization
trust and the payments to the related asset-backed investors (less the
contractual servicing fee and other fees, costs and expenses of administering
the securitization trust). The cash flows from these securitization
related certificates are utilized to pay the principal under the
facility. Additionally, we make monthly interest payments on the
then-existing principal balance of the facility from other operating
sources. The facility matures in 12 months (August 2008), if not
repaid earlier.
In
connection with this transaction, we issued to an affiliate of Angelo Gordon
warrants to purchase up to 10.0 million shares of our common stock, with an
initial exercise price of $5.00 per share and expiring in February
2009. The issuance of 5.4 million of the warrants was subject to the
approval of our shareholders, which we received on October 4, 2007.
On
August
14, 2007, we also issued $10.0 million of convertible notes to several funds
controlled by one of our existing equity investors, Mr. Mohnish
Pabrai. The convertible notes were scheduled to mature in 12 months,
if not converted or redeemed earlier, from the date of issuance. Upon
receipt of approval by our stockholders, these notes automatically convert
into
2.0 million shares of our common stock. On October 4, 2007, we
obtained shareholder approval and the notes were converted into 2.0 million
shares of our common stock, at the conversion price of $5.00 per
share. The convertible notes bore interest at a rate of 6% per annum
for the period commencing with the date of issuance until the October 4, 2007
conversion date.
As of the date of this report, adverse conditions in the securitization
market
for subprime and other mortgage-backed securities still persist and may
limit
our ability to complete securitization transactions on favorable terms,
or at
all. Until such time that these conditions improve, we will seek to
sell our originations to whole loan investors and/or government
agencies. We may be unable to do so on terms that are favorable to
us. Accordingly, unless market conditions improve substantially, we
believe that it is likely that we will need to complete one or more financing
transactions during the next twelve months in order to continue our operations
and to satisfy our liquidity obligations. We have been pursuing
financing alternatives, and have been in discussions with potential investors
which may lead to a significant issuance of debt or equity securities,
and may
result in significant dilution for existing stockholders. Under these
circumstances, any failure to obtain additional financing, or to satisfy
these
obligations, could require us to reduce the scope of our operations, and
could
adversely affect our ability to operate as a going concern.
We
believe we must generate sufficient
cash from the following in order to maintain sufficient working
capital:
|
·
|
the
proceeds we receive from selling or financing asset-backed securities
(including NIM notes or Class N Notes) in connection with our
securitizations;
|
|
·
|
the
proceeds from the sale of MSRs to a third-party mortgage
servicer;
|
|
·
|
the
premiums we receive from selling whole loans on a servicing-released
basis;
|
|
·
|
origination
fees collected on newly closed
loans;
|
|
·
|
the
cash flow from corridors and interest rate swaps;
and
|
|
·
|
principal
and interest payments we receive on our loans held for investment
or
sale.
|
Currently, our primary uses of cash include the funding of:
|
·
|
mortgage
loans held for investment – pre-securitization and mortgage loans held for
sale which are not financed;
|
|
·
|
the
difference between (a) the
amount advanced by our credit providers on, and (b) the principal
balance
of,
mortgage loans held for investment – pre-securitization and
mortgage loans held for sale which are
financed;
|
|
·
|
posting
additional variation
margin with our derivative counterparties on interest rate swaps
used to
finance future
securitizations;
|
|
·
|
the
required overcollateralization
on new securitization
transactions;
|
|
·
|
securitization
bond
discounts;
|
|
·
|
interest
expense on warehouse credit financings (including any related margin
calls), financing of mortgage loans held for investment, residual
financing facilities, interest rate swap payments and other
financings;
|
|
·
|
scheduled
principal pay-downs on financing of mortgage loans held for investment,
warehouse credit financings, residual financing facilities, and other
financings;
|
|
·
|
transaction
costs, derivative costs and related margin requirements and credit
enhancement (O/C requirements) in connection with our
securitizations;
|
|
·
|
repurchase
of mortgage loans due
to breaches of representations and/or
warranties;
|
|
·
|
general
ongoing administrative and operating expenses, including the cost
to
originate loans;
|
|
·
|
tax
payments, including those related to excess inclusion income on our
REMIC
securitizations issued through 2004 and in the third quarter of 2007,
and
all, or a portion, of the dividends received from our REIT subsidiary;
and
|
|
·
|
common
stock dividends, if and when approved by the board of
directors.
|
Historically, we have financed our operations utilizing securitization
financings, various secured credit financing facilities, issuances of corporate
debt, issuances of equity, and MSRs sold in conjunction with each of our
securitizations.
We have repurchase agreements with institutions that purchased mortgage loans
from us several years ago. Some of the agreements provide for our
repurchase of any of the mortgage loans that go to foreclosure
sale. At the foreclosure sale, we will repurchase the mortgage, if
necessary, and make the institution whole. The dollar amount of loans
that were sold with recourse and are still outstanding totaled $271,000 and
$387,000 at September 30, 2007 and December 31, 2006,
respectively. Included in “accounts payable and other liabilities” is
an allowance for recourse loans related to those loans sold with recourse of
$142,000 and $81,000 at September 30, 2007 and December 31, 2006,
respectively. During the nine months ended September 30, 2007, we
reimbursed investors $70,000 through the recourse reserve to net settle several
loans. We did not repurchase any loans that were sold with recourse
under our existing repurchase agreements during the nine months ended September
30, 2007 or during the year ended December 31, 2006.
Warehouse
Financing Facilities
We need to borrow substantial sums of money each quarter to originate mortgage
loans. We have relied upon a limited number of counterparties to
provide us with the financing facilities to fund our loan
originations. Our ability to fund current operations and accumulate
loans for securitization depends to a large extent upon our ability to secure
short-term financing on acceptable terms. There can be no assurance
that we will be able to either renew or replace our warehouse facilities at
their maturities at terms satisfactory to us or at all. There also
can be no assurance that we will be able to utilize all or any portion of our
warehouse facilities that are uncommitted. If we are not able to
obtain financing, we will not be able to originate new loans and our business
and results of operations will be negatively impacted.
To originate and accumulate loans for securitization, we borrow money on a
short-term basis primarily through secured warehouse credit
facilities. Throughout each quarter, as we amass loans for inclusion
in the next securitization, a significant portion of our total warehouse
financing lines may be utilized to fund these loans. As
securitization transactions or whole-loan sales are completed, a substantial
portion of the proceeds from the securitization or whole-loan sale are used
to
pay down our warehouse credit facilities. Therefore, the outstanding
amount of warehouse financing will fluctuate from quarter to quarter, and could
be significantly higher or lower as our mortgage production and securitization
programs continue.
The
amounts we are able to borrow under our warehouse credit facilities may be
dependent upon the valuations placed on the collateral (mortgage loans) by
the
warehouse providers. The collateral is subject to valuation changes
at any time and at the warehouse providers’ sole discretion. Any
subsequent reduction in the valuations of the collateral may result in a margin
call, which will subject us to either posting a cash payment or delivering
additional collateral to the warehouse provider and result in the reduction
in
our available liquidity and substantially harm our financial condition and
results of operations. There can be no assurance that we will be able
to satisfy
margin
calls. We have received substantial margin calls from our warehouse
providers during the third quarter of 2007. To date, we have been
able to satisfy these margin calls from our existing liquidity. There
can be no assurance, however, that we will not be subject to increased margin
calls after the date of this Report and, if so, whether we will be able to
satisfy our obligations thereunder.
The
terms of our warehouse agreements
require us to comply with various operating and financial covenants, which
are
customary for agreements of this type. The continued availability of
funds provided to us under these agreements is subject to, among other
conditions, our continued compliance with these covenants.
If
we fail to comply with any of these covenants or otherwise default under a
warehouse credit facility, the lender has the right to terminate the warehouse
credit facility and require immediate payment, which may require sale of the
collateral at less than optimal terms. In addition, if we default
under any one warehouse credit facility, it would generally trigger a
cross-default under the other warehouse credit facilities.
We believe that we are in compliance
with these covenants as of September 30, 2007.
All
of our warehouse
facilities provides us with
the ability
to borrow at the lower of 95% to 98% of fair market value or 100% of the par
amount of the mortgage loans between 0 to 59 days delinquent (0 to 29 days
delinquent for Deutsche Bank) and a limited amount of mortgage loans between
60
to 89 days delinquent (30 to 89 days delinquent for Deutsche
Bank).
The majority of the loans collateralizing warehouse
borrowings are held for a period of up to 120 days, at which point they are
typically securitized or sold.
Each facility provides the ability
to
borrow against first and second lien loans and “wet” collateral, which are loans
that have closed and have been funded, but for which we have not yet received
the loan documents from the closing agent. The material terms and
features of our warehouse credit facilities in place at September 30, 2007
(including any subsequent changes thereto) are as follows:
Deutsche Bank Warehouse Credit Facility.
We have a $500.0
million facility ($250.0 million of which is committed) with Deutsche Bank
which
bears interest based upon a fixed margin over one-month LIBOR. This
facility was scheduled to expire in October 2007, but has been extended to
December 2007. As of September 30, 2007, the outstanding balance
under the facility was $158.6 million.
RBS Greenwich Capital Warehouse Credit Facility.
We have a
$500.0 million facility ($250.0 million of which is committed) with RBS
Greenwich Capital Financial Products, Inc., which bears interest based upon
a
fixed margin over one-month LIBOR. This facility was scheduled to
expire in November 2007, but has been extended to December 2007. As
of September 30, 2007, the outstanding balance under the facility was $133.4
million.
JPMorgan
Chase Warehouse Credit
Facility.
We have a $500.0
million
facility ($250.0 million of which is committed) with JPMorgan Chase which bears
interest based upon a fixed margin over one-month LIBOR. As of
September 30, 2007, the outstanding balance under the facility was $114.7
million.
Citigroup Warehouse Credit Facility.
We have a $500.0
million committed facility with Citigroup Global Markets Realty Corp., which
bears interest based upon a fixed margin over one-month LIBOR. This facility
expires in May 2008. As of September 30, 2007, we had no outstanding
balance under the facility.
During
the three months ended September 30, 2007, we did
not renew our $500.0 million warehouse credit facility ($250.0 million of which
was committed) with Bank of America. We did not replace this credit
facility as of September 30, 2007, as we believed our borrowing capacity under
the remaining warehouse credit facilities were deemed to be sufficient to meet
our needs.
Interest
Rate Risk
Our primary market risk exposure is interest rate risk. Our results
of operations may be significantly affected by the level of and fluctuation
in
interest rates. (See “Item 3. Quantitative and Qualitative
Disclosures About Market Risk – Interest Rate Risk”).
Current Interest Rate Environment.
Net interest income after
provision for loan loss represented 173.4% and 72.8% of our net revenues (net
interest income and non-interest income, less provision for loan loss) during
the nine months ended September 30, 2007 and 2006,
respectively. Accordingly, the interest rate environment has a
substantial impact on our earnings, affecting such matters as credit market,
credit quality and changes to rating agencies assumptions (i.e., bad debt,
losses, etc.). Our balance sheet is currently liability
sensitive. A company with a liability sensitive balance sheet
generally experiences reduced net interest income in a rising interest rate
environment, while earnings are enhanced in a decreasing interest rate
cycle. The impact of rising short-term interest rates and a
flattening of the yield curve have negatively impacted our margin since the
spread between our longer-term assets and our shorter-term liabilities has
contracted.
Credit
Risk
A
significant portion of our loans held
for investment have been made to non-prime credit borrowers and are secured
by
residential property. There is no guarantee that, in the event of
borrower default, we will be able to recoup the full principal amount and
interest due on a loan. We have adopted underwriting and loan quality
monitoring systems, procedures and credit policies, including the establishment
and review of the allowance for loan losses, that management believe are prudent
and appropriate to minimize this risk by tracking loan performance, assessing
the likelihood of nonperformance and diversifying our loan
portfolio. These policies and procedures, however, may not prevent
unexpected losses that could adversely affect our results.
We
also sell loans on a whole-loan
basis, from time-to-time, to banks and other financial
institutions.
When we sell mortgage loans on a whole-loan
basis, we normally make standard mortgage industry representations and
warranties, which may require us to repurchase one or more of the mortgage
loans
if they are breached. Additionally, certain whole-loan sale contracts
include provisions that require us to repurchase a loan if a borrower fails
to
make one or more of the first loan payments due on the loan.
In these instances, we are subject
to
repurchase risk in the event of a breach of the representations or warranties
we
make in connection with these whole-loan sales. During the nine
months ended September 30, 2007 and the year ended December 31, 2006, we
repurchased or net settled $4.5 million ($1.2 million related to the three
months ended September 30, 2007) and $2.3 million, respectively, of loans under
certain re-purchase provisions related to whole-loan sales.
Geographical
Concentration
Properties
securing our mortgage loans held for investment are geographically dispersed
throughout the United States. For the three months ended September
30, 2007, approximately 21.1%, 12.0%, 7.5%, 6.9% and 5.9%, based upon principal
balance, of the mortgage loans we originated were on properties located in
New
York, Florida, New Jersey, Illinois and Pennsylvania, respectively, with no
other state representing more than 5% of the originations.
The
concentration of mortgage loans in specific geographic areas may increase the
risk of loss. Economic conditions in the states where borrowers
reside may affect the delinquency, loss and foreclosure experience of the
mortgage loans. These states may suffer economic problems, natural
disasters or reductions in market values for residential properties that are
not
experienced in other states.
The
value
of mortgaged properties could decline as a result of an overall decline in
the
economy or residential real estate market, or from the occurrence of a natural
disaster that is not covered by standard homeowners’ insurance policies
(
i.e.,
hurricane-related damages). This decline, in turn,
would increase the risk of delinquency, default or foreclosures on mortgage
loans in our mortgage loans held for investment portfolio and restrict our
ability to originate, sell or securitize mortgage loans.
E
nvironmental
Matters
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. There can be no assurance, however, 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 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.
Inflation
Inflation affects us most significantly in the areas of mortgage loan
originations and profit margins. Interest rates normally increase
during periods of rising inflation (or in periods when the Federal Reserve
Bank
attempts to prevent inflation). Historically, as interest rates
increase, mortgage loan production decreases, particularly from loan
refinancing. Generally, in those periods of reduced mortgage loan
production, the associated profit margins also decline due to increased
competition among loan originators and higher unit costs, further reducing
our
earnings. (See “- Item 3. Quantitative and Qualitative Disclosures
About Market Risk - Interest Rate/Market Risk”).
Impact
of New Accounting Standards
Fair Value Measurement of Loan Commitments.
On November 5, 2007,
the SEC issued SAB No. 109, which provides guidance regarding written loan
commitments that are accounted for at fair value through earnings under
GAAP. The SEC had previously issued SAB No. 105, which stated that in
measuring the fair value of a derivative loan commitment, it would be
inappropriate to incorporate the expected net future cash flows related to
the
associated servicing of the loan. SAB No. 109 supersedes SAB No. 105
and expresses the current view of the SEC that, consistent with the guidance
in
SFAS No. 156 and SFAS No. 159, the expected net future cash flows related
to the
associated servicing of the loan should be included in the measurement of
all
written loan commitments that are accounted for at fair value through
earnings. We will apply SAB No. 109 on a prospective basis to
derivative loan commitments issued or modified in fiscal quarters beginning
after December 15, 2007. We are currently evaluating SAB No. 109, and
have not yet determined the effect it will have on our consolidated financial
statements.
Offsetting
of Amounts Related to
Certain Contracts.
In April 2007, the FASB issued FSP No.
FIN 39-1,
which amends FIN
No. 39
to permit a
reporting entity to offset fair value amounts recognized for the right to
reclaim cash collateral (a receivable) or the obligation to return cash
collateral (a payable) against fair value amounts recognized for derivative
instruments executed with the same counterparty under the same master netting
arrangement that have been offset in accordance with FIN No. 39. FSP
No. FIN 39-1 also amends FIN No. 39 for certain terminology
modifications. FSP No. FIN 39-1 is effective for fiscal years
beginning after November 15, 2007, with early application permitted, and is
applied retrospectively as a change in accounting principle for all financial
statements presented. Upon adoption of FSP No. FIN 39-1, we are
permitted to change our accounting policy to offset or not offset fair value
amounts recognized for derivative instruments under master netting
arrangements. We are currently evaluating FSP No. FIN 39-1, and have
not yet determined the effect the adoption of FSP No. FIN 39-1 will have on
our
consolidated financial statements.
Fair
Value Option for Financial Assets and Financial Liabilities
. In
February 2007,
FASB issued SFAS No. 159, which permits entities to
elect to measure many financial instruments and certain other items at fair
value that are not currently required to be so measured. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently, without having to apply complex
hedge accounting provisions. SFAS No. 159 also establishes
presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types
of assets and liabilities. SFAS No. 159 does not affect any existing
accounting literature that requires certain assets and liabilities to be carried
at fair value, and does not eliminate disclosure requirements included in other
accounting standards, including requirements for disclosures about fair value
measurements included in SFAS No. 157 and SFAS No. 107.
SFAS No.
159 is effective for our fiscal year beginning after November 15,
2007.
We are currently
assessing the impact that the adoption of SFAS No. 159 will have on our
consolidated financial statements
, but we do not expect that the adoption
during the first quarter of 2008 will have a material impact on our financial
condition or results of operations.
Fair
Value Measurements.
In September 2006, FASB issued SFAS No. 157,
which defines fair value, establishes a framework for measuring fair value
in
GAAP, and expands disclosures about fair value measurements. SFAS No.
157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal
years.
We are currently
assessing the impact that the adoption of SFAS No. 157 will have on our
consolidated financial statements, but
we do not expect that the adoption
during the first quarter of 2008 will have a material impact on our financial
condition or results of operations.
Accounting
for Uncertainty in Income Taxes.
In June
2006,
FASB issued FIN No. 48, which clarifies the accounting for
uncertainty in income taxes recognized in
accordance with SFAS
No.
109. Only tax positions meeting a “more-likely-than-not” threshold of
being sustained are recognized under FIN No. 48. FIN No. 48 also
provides guidance on derecognition, classification of interest and penalties
and
accounting and disclosures for annual and interim financial
statements. FIN No. 48 is effective for fiscal years beginning after
December 15, 2006. The cumulative effect of the changes arising from
the initial application of FIN No. 48 is required to be reported as an
adjustment to the opening balance of retained earnings in the period of
adoption. The adoption of FIN No. 48 on January 1, 2007 did not have
a material effect on our consolidated financial statements.