Item 1. Business ..................................................... 3
Item 2.
Item 2. Properties.
The Company's principal executive offices are located at 277 Park Avenue, New York, New York, 10172 and are occupied under a sublease with Continental Grain. The lease on this premises extends through February 28, 2000.
ContiMortgage's current headquarters in Horsham, Pennsylvania, and regional offices located in Phoenix, Arizona; Orange and Pleasanton, California; Atlanta, Georgia; Oak Brook, Illinois and Horsham, Pennsylvania are operated under leases with third parties that expire through April 2001.
ContiMortgage is currently redeveloping a manufacturing facility in Hatboro, Pennsylvania as its new headquarters. The facility will operate under a lease with a third party that extends twelve years from the facility's anticipated completion at the end of calendar 1997.
ContiFinancial Services and ContiTrade occupy office space in Santa Monica, California under a lease with a third party that expires in September 1999. ContiWest occupies office space in Las Vegas, Nevada under a lease with a third party that expires in January 2000. ULG, Resource One, Royal and Triad have various offices throughout the United States and operate under various leases with third parties that expire through July 2003.
The Company believes that its present facilities are adequate for its current needs.
Item 3.
Item 3. Legal Proceedings.
In May 1997, a class action suit was filed in the Court of Common Pleas of the State of South Carolina naming ContiMortgage as a defendant. On June 6, 1997, the case was removed to the United States District Court in the District of South Carolina Florence Division. The complaint alleges violations of a state notification law by the originator of certain home equity loans purchased by ContiMortgage. Such law requires the originator to notify, ascertain and comply with the preferences of borrowers as to the legal counsel employed to represent such borrowers and as to the insurance agent to furnish the required insurance in connection with the mortgage. The Company is currently investigating the allegations. The suit has not yet been certified as a class action. The Company does not believe the lawsuit will have a material adverse effect on the consolidated financial position or results of operations of the Company.
In addition, the Company has been named as a defendant in various legal actions arising from the conduct of its normal business activities. Although the amount of any liability that could arise with respect to these actions cannot be accurately predicted, in the opinion of the Company, any such liability will not have a material adverse effect on the consolidated financial position or results of operations of the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Part II.
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
On February 9, 1996, the Company's common stock began trading under the symbol "CFN" on the New York Stock Exchange. The following table sets forth, for the period indicated, the high and low closing sale price per share of the Company's common stock:
Sales Price ----------- High Low ---- --- Fiscal Year Ended March 31, 1996: Fourth Quarter $31.25 $25.50
Fiscal Year Ended March 31, 1997:
First Quarter $33.00 $28.50 Second Quarter $30.25 $23.25 Third Quarter $39.25 $28.875 Fourth Quarter $39.375 $31.00
As of June 9, 1997, the Company had 83 stockholders of record, and approximately 4,550 beneficial owners of its common stock.
During fiscal 1995 and during fiscal 1996, prior to the close of its IPO on February 14, 1996, the Company paid cash dividends to Continental Grain of $30 million and $0.3 million, respectively. The Company has no current intention to pay cash dividends on its Common Stock. As a holding company, the ability of the Company to pay dividends is dependent upon the receipt of dividends or other payments from its subsidiaries. Any future determination as to the payment of dividends will be at the discretion of the Company's Board of Directors and will depend upon the Company's operating results, financial condition and capital requirements, contractual restrictions, general business conditions and such other factors as the Company's Board of Directors deems relevant. Furthermore, covenants in the Company's and Continental Grain Company's loan agreements restrict the payment of dividends by the Company. There can be no assurance that the Company will have earnings sufficient to pay a dividend on its Common Stock or that, even if there are sufficient earnings, dividends will be permitted under applicable law.
Item 6.
Item 6. Selected Financial Data.
SELECTED FINANCIAL DATA (dollars in thousands, except share data)
SELECTED FINANCIAL DATA--(continued) (dollars in thousands, except share data)
Triad Delinquency and Loan Loss Data : Year Ended ------------------------------ - ---------- March 31, 1997 --------------
Portfolio ........................... $ 71,648 Delinquency rate (at end of year) ... 1.17% Net losses as a percentage of average amount outstanding (November 1, 1996 through March 31, 1997) ............ 0.60%
(1) Includes home equity loans originated by Royal MortgageBanc, Resource One and United Lending Group, and serviced by ContiMortgage.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
This discussion should be read in conjunction with "Selected Financial Data" and the Company's Consolidated Financial Statements and the Notes thereto. Certain statements under this caption constitute "forward-looking statements" under federal securities laws. See "Forward-looking Statements."
General
The Company is engaged in the consumer and commercial finance business by originating and servicing home equity loans and providing financing and asset securitization expertise to originators of a broad range of loans, leases and receivables. Through ContiMortgage Corporation ("ContiMortgage"), the Company is a leading originator, purchaser, seller and servicer of home equity loans made to borrowers whose borrowing needs may not be met by traditional financial institutions due to credit exceptions or other factors. The Company has strategic alliances with various originators of a broad range of consumer and commercial loans and other assets ("Strategic Alliances"). Through ContiTrade Services L.L.C. ("ContiTrade") the Company provides financing and asset securitization structuring expertise, and through ContiFinancial Services Corporation ("ContiFinancial Services"), an NASD registered broker/dealer, the Company provides placement services. In September 1996, the Company established ContiWest Corporation, a Nevada corporation, to administer and underwrite a portion of the Company's origination portfolio.
The Company's Strategic Alliance clients are originators of consumer and commercial loans, leases and receivables. The Company provides financing and asset securitization execution and expertise to the Strategic Alliance client while the client provides a consistent flow of securitizable assets to the Company. In certain Strategic Alliances, the Company receives interests ("Strategic Alliance Equity Interests") in the Strategic Alliance client. The realization of value on such Strategic Alliance Equity Interests is subject to many factors, including the future growth and profitability of the Strategic Alliance clients and the completion of initial public offerings or sale of such Strategic Alliance clients.
In the third quarter of fiscal 1997, the Company acquired three home equity companies and one auto finance company to implement growth strategies of expanding into the western United States, diversifying into retail origination and owning other asset origination platforms with which the Company has significant securitization experience. The four new loan origination subsidiaries, California Lending Group, Inc. d/b/a United Lending Group, Inc. ("ULG"), Royal Mortgage Partners, L.P., d/b/a Royal MortgageBanc ("Royal"), Triad Financial Corporation ("Triad"), and Resource One Consumer Discount Company, Inc. ("Resource One"), collectively called the "Acquisitions", are discussed below:
On November 8, 1996, the Company purchased 100% of the outstanding stock of ULG, a west coast-based home equity lender specializing in retail originations via direct mail and telemarketing throughout the United States.
On November 15, 1996, the Company, through its subsidiary ContiMortgage, purchased 100% of Royal. Royal is a California-headquartered wholesale and retail originator of fixed and adjustable rate home equity loans.
On November 21, 1996, the Company acquired a 53.5% equity interest in Triad and an additional 2.5% in January 1997, a California-based non-prime auto finance company. The Company has the right and obligation to acquire the remaining common stock of Triad from existing shareholders.
On December 16, 1996, the Company, through its subsidiary ContiMortgage, purchased 100% of the outstanding stock of Resource One. Resource One, headquartered in Langhorne, Pennsylvania, is a retail branch home equity
loan originator that utilizes direct mail, television, telemarketing, referrals and other sources to generate loan inquiries directly from borrowers.
In each case, the companies acquired were former Strategic Alliances or ContiMortgate loan origination sources.
The Acquisitions have been accounted for as purchases, and the results of operations have been included with the Company's results of operations since the effective acquisition dates. The cumulative purchase price was approximately $38.0 million, which includes deferred payments of approximately $5.0 million, resulting in approximately $35.0 million of cost in excess of equity which will be amortized on a straight-line basis over a 25 year useful life. Certain acquisition's terms contain payments which are contingent upon future earnings or employment of key management. Such contingent payments will be recorded as purchase price or compensation as is appropriate for the nature of the payments. The Company has a right and obligation to purchase the remaining 44% of the common stock of Triad over the next 4.5 years. The purchase price will be based upon the future earnings of Triad and will be recorded when determinable. The excess of the purchase price over the fair value of the net assets acquired will be recorded as an increase in cost in excess of equity. The Acquisitions are not material to the financial position or results of operations of the Company.
Certain Accounting Considerations
As a fundamental part of its business and financing strategy, the Company sells substantially all of its loans or other assets through securitization in the form of REMICs, owner trusts or grantor trusts. In a securitization, the Company sells loans or other assets that it has originated or purchased to a trust for a cash purchase price and an interest in the loans or other assets securitized (in the form of the "excess spread"). The cash purchase price is raised through an offering of pass-through certificates by the trust. Following the securitization, the purchasers of the pass-through certificates receive the principal collected and the investor pass-through interest rate on the certificate balance, while the Company receives the excess spread . The excess spread represents, over the life of the loans or other assets, the excess of the weighted average coupon on each pool of loans or other assets sold over the sum of the pass-through interest rate plus a normal servicing fee, a trustee fee, an insurance fee and an estimate of annual future credit losses related to the loans or other assets securitized (the "Excess Spread"). These cash flows are projected over the life of the loans or other assets using prepayment, default, and interest rate assumptions that market participants would use for similar financial instruments subject to prepayment, credit and interest rate risk and are discounted using an interest rate that a purchaser unrelated to the seller of such a financial instrument would demand. The majority of the Company's gross income is recognized as gain on sale of loans or other assets, which represents the value of the Excess Spread less origination and underwriting costs. The present value of the Excess Spread is the Excess Spread receivable (the "Excess Spread Receivable"). The Excess Spread Receivable is either a contractual right or a certificated security generally in the form of an interest-only or residual certificate. The majority of the Company's Excess Spread Receivable at March 31, 1997 and 1996 is interest-only and residual certificates. Consequently, the Company's consolidated balance sheets designate Excess Spread Receivable as "interest-only and residual certificates."
The Company recognizes the gain on sale of loans or other assets in the fiscal year in which such loans or other assets are sold, although cash (representing the Excess Spread and servicing fees) is received by the Company over the life of the loans or other assets. Concurrent with recognizing such gain on sale, the Company records the Excess Spread Receivable as an asset on its consolidated balance sheets. The Excess Spread Receivable is reduced as cash distributions are received from the securitization.
Due to the fact that the gain recognized in the year of sale is equal to the present value of the estimated future cash flows from the Excess Spread, the amount of cash actually received over the lives of the loans or other assets normally exceeds the gain previously recognized at the time the loans or other assets were sold and therefore interest income is recognized over the life of the loans or other assets securitized. In periods subsequent to the sale, the Company may recognize an increase in fair value of Excess Spread Receivable as gain on sale of receivables to the extent that estimates of the loan pools' future remaining lives exceed those originally projected. This estimate of extended life is performed by reviewing past prepayment experience and estimating future prepayment experience by considering numerous factors which include current market assumptions, the interest rate environment and economic factors. If actual prepayments with respect to sold loans occur faster or credit experience is worse than projected at the time such loans were sold, the carrying value of the Excess Spread Receivable may have to be written down through a charge to earnings in the period of adjustment.
Additionally, upon sale or securitization of servicing retained mortgages, the Company capitalizes the cost associated with the right to service mortgage loans based on its relative fair value. The Company determines fair value based on the present value of estimated net future cash flows related to servicing income. The cost allocated to the servicing rights is amortized in proportion to and over the period of estimated net future servicing fee income. The Company periodically reviews capitalized servicing fees receivable for valuation impairment. This review is performed on a disaggregated basis for the predominant risk characteristics of the underlying loans which are loan type, loan-to-value ratio and credit quality. The Company generally makes loans to credit impaired borrowers whose borrowing needs may not be met by traditional financial institutions due to credit exceptions. The Company has found that credit impaired borrowers are payment sensitive rather than interest rate sensitive. As such the Company does not consider interest rates a predominant risk characteristic for purposes of valuation impairment. Impairment is recognized in a valuation allowance for each disaggregated stratum in the period of impairment.
On January 1, 1997, the Company adopted the Financial Accounting Standards Board's ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125") which addresses the accounting for transfers of financial assets in which the transferor has some continuing involvement either with the assets transferred or with the transferee. A transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interest in the transferred assets is received in exchange. SFAS 125 requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value, if practicable. In addition, SFAS 125 requires that servicing assets and liabilities be subsequently measured by the amortization over their estimated life and assessment of asset impairment be based on such assets' fair value. SFAS 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. The adoption of this standard did not have a material impact on the Company's results of operations. However, certain of the assets that the Company had sold under the Purchase and Sale Facilities subsequent to January 1, 1997 did not qualify for sale treatment under SFAS 125 and as a result $251.5 million of such assets were included as trade receivables sold under agreements to repurchase on the Company's consolidated balance sheets. SFAS 125 does not in any way effect the ability of the Company to finance these assets. The Company expects to replace the Purchase and Sale Facilities with repurchase agreements for those asset types which do not qualify for sale treatment.
Financial Condition
March 31, 1997
Securities purchased under agreements to resell increased $44.1 million from $179.9 million at March 31, 1996 to $224.0 million at March 31, 1997. The Company hedges, in part, its interest rate exposure on its receivables held for sale and loans and other assets sold, with recourse, under its Purchase and Sale Facilities, through the use of United States Treasury securities and futures contracts. Securities purchased under agreements to resell are part of this hedging strategy. This increase was due primarily to the increase in the Company's securitization volume in fiscal 1997 as compared to fiscal 1996.
Interest-only and residual certificates increased $151.8 million from $293.2 million at March 31, 1996 to $445.0 million at March 31, 1997. Excluding $15.2 million of interest-only and residual certificates relating to the Acquisitions, the March 31, 1997 balance increased by $136.6 million from March 31, 1996. This increase represents $251.1 million recorded during fiscal 1997 relating to new securitizations and recorded interest income of $33.7 million partially offset by $96.5 million of sales and $51.7 million of collections.
Capitalized servicing fees receivable increased $17.7 million from $11.7 million at March 31, 1996 to $29.4 million at March 31, 1997. This balance reflects the capitalization of $24.0 million of servicing rights and $1.4 million of prepayment premiums paid partially offset by amortization of $7.7 million.
Trade receivables, net increased $356.9 million from $352.3 million at March 31, 1996 to $709.2 million at March 31, 1997. Excluding $51.3 million of trade receivables, net relating to the Acquisitions, the March 31, 1997 balance increased by $305.6 million from March 31, 1996. This increase was primarily due to an increase in receivables held for sale from $303.7 million as of March 31, 1996 to $574.3 million at March 31, 1997, and partially due to the increase in other receivables from $50.5 million at March 31,1996 to $85.7 million at March 31, 1997. The increase in receivables held for sale was primarily due to the adoption of SFAS 125 on January 1, 1997. As of March 31, 1997, $251.5 million of receivables held for sale under the Purchase and Sale Facilities were categorized as financing under SFAS 125 and classified as "Trade receivables sold under agreements to repurchase". In addition to the SFAS 125 classification, there was an additional increase of $19.1 million of receivables held for sale due to an overall increase in securitization volume from fiscal 1996 to fiscal 1997.
The increase in other receivables of $35.2 million from fiscal 1996 to fiscal 1997 was primarily due to an increase in servicing advances of $16.8 million and an increase in short-term receivables of $17.2 million. The increase in servicing advances was due to advances made by ContiMortgage on loans in the servicing system. ContiMortgage, as servicer, is contractually liable to pay the REMIC for certain delinquencies and then collects the past due amounts from the borrower. This increase is because of an overall dollar increase in delinquencies from fiscal 1996 to fiscal 1997. The increase in short-term receivables is due to timing differences in receiving loan payments from third party intermediaries.
Premises and equipment, net increased $3.8 million from $3.9 million at March 31, 1996 to $7.7 million at March 31, 1997. Excluding $3.4 million of premises and equipment relating to the Acquisitions, the March 31, 1997 balance decreased by $0.4 million from March 31, 1996. This decrease was primarily as a result of office equipment acquisitions which were more than offset by the normal periodic depreciation of owned equipment.
Cost in excess of equity increased $33.6 million from $14.6 million at March 31, 1996 to $48.2 million at March 31, 1997. The increase was primarily due to the costs in excess of equity recorded upon the purchase of the Acquisitions made by the Company during the third quarter of fiscal 1997.
Other assets increased $26.8 million from $3.9 million at March 31, 1996 to $30.7 million at March 31, 1997. Excluding the effects of the Acquisitions, March 31, 1997 other assets increased by $24.4 million from March 31, 1996. Other assets represents prepaid expenses, margin and other deposits, deferred bond issuance costs and other investments. This increase is primarily due to an increase of approximately $12.0 million of deferred issuance costs on the 8 3/8% and 7 1/2% Senior Notes (defined below), $3.7 million of prepaid shelf registration and servicing fees and an increase of $4.3 million in escrow deposits.
Accounts payable and accrued expenses increased $14.3 million from $73.5 million at March 31, 1996 to $87.8 million at March 31, 1997. Excluding $6.6 million of accounts payable and accrued expenses relating to the Acquisitions, the March 31, 1997 balance increased by $7.7 million from March 31, 1996. The balance increased primarily due to an increase in accrued taxes payable of $14.6 million, incentive accruals of approximately $5.5 million, accruals for securitization obligations of $4.1 million, accrued interest payable of $3.1 million, accrued pension and health care costs of approximately $1.5 million offset by a decrease in accrued amounts payable under the Company's Purchase and Sale Facilities of approximately $20.8 million. The increases in accrued taxes payable, and accruals for securitization obligations were due to increased securitization volume, producing higher net income in fiscal 1997. The increase in incentive accruals in fiscal 1997 as compared to fiscal 1996 was due to the deferral of payments. The increase in accrued pension and healthcare costs was due to an increase in the number of employees (excluding the Acquisitions) to 703 in fiscal 1997 as compared to 455 employees in fiscal 1996. The decrease in accrued amounts payable under the Company's Purchase and Sale Facilities was due to a timing difference in the amounts payable under these obligations.
Securities sold but not yet purchased increased $44.4 million from $180.7 million at March 31, 1996 to $225.1 million at March 31, 1997. The Company hedges, in part, its interest rate exposure on its receivables held for sale and loans and other assets sold with recourse under its Purchase and Sale Facilities through the use of United States Treasury securities and futures contracts. Securities sold but not yet purchased are part of this hedging strategy. This increase was due primarily to the increase in the Company's securitization volume in fiscal 1997 from fiscal 1996.
Payables to affiliates decreased $301.3 million from $337.7 million at March 31, 1996 to $36.4 million at March 31, 1997. In connection with the Company's IPO on February 14, 1996, Continental Grain Company ("Continental Grain") provided financing with three notes totaling $324.0 million. These notes were refinanced principally with the net proceeds of the Senior Notes, as defined below. The remaining balance of Payables to affiliates at March 31, 1997 represents amounts due under a services agreement and a tax sharing agreement with Continental Grain.
Short-term borrowed funds represents borrowings from a $200.0 million unsecured revolving credit facility the Company entered into on January 8, 1997. At March 31, 1997, $25.0 million of drawings under this line were outstanding.
On August 14, 1996, the Company issued the $300.0 million 8 3/8% unsecured senior notes due 2003 (the "8 3/8% Senior Notes") and on March 12, 1997, the Company issued the $200.0 million unsecured 7 1/2% senior notes due 2002 (the "7 1/2% Senior Notes") (collectively the "Senior Notes"), resulting in $498.5 million of the balance sheet increase in Long-term debt from March 31, 1996. The Senior Notes were issued at a discount which is being amortized over the life of the Senior Notes. The remaining $0.3 million of long-term debt represents amounts payable under a long term capitalized lease.
Other liabilities increased $6.3 million from $5.8 million at March 31, 1996 to $12.1 million at March 31, 1997. Excluding the effects of the Acquisitions, March 31, 1997 other liabilities increased by $5.9 million from March 31, 1996. The increase is primarily due to the accrual of contingent payments relating to the Acquisitions.
Stockholders' equity increased $113.0 million from $294.8 million at March 31, 1996 to $407.8 million at March 31, 1997 due to net income of $106.0 million, the amortization of deferred compensation of $6.7 million and the exercise of stock options of $0.3 million. Excluding the effect of the Acquisitions, March 31, 1997, stockholders' equity increased by $109.4 million from March 31, 1996.
Results of Operations
Year Ended March 31, 1997 Compared to Year Ended March 31, 1996 and Year Ended March 31, 1995
The Company's total gross income increased $156.0 million or 57% to $427.8 million in fiscal 1997 as compared to $271.8 million of total gross income in fiscal 1996 which in turn increased $149.8 million or 123% from total gross income of $122.0 million for fiscal 1995. Excluding the effects of the Acquisitions, fiscal 1997 gross income increased by $123.9 million from fiscal 1996. The Company's total expenses as a percentage of total gross income increased to 59% in fiscal 1997 from 53% in fiscal 1996 and fiscal 1995. As a result, net income for fiscal 1997 increased $79.9 million or 306% to $106.0 million compared to net income of $26.1 million in fiscal 1995. Excluding the Acquisitions during the third quarter of fiscal 1997, net income increased by $76.3 million from fiscal 1995.
On a percentage basis, the following table sets forth the composition of the Company's results as a percentage of total gross income for the periods indicated:
Income. The increase in total gross income was due to a greater volume of loans originated as a result of the expansion of the Company's wholesale and broker origination sources. The following table sets forth information regarding the components of the Company's total gross income in each of the last three fiscal years ending on March 31:
Gain on sale of receivables was the primary component of total gross income, comprising 49%, 54% and 55% of total gross income in fiscal 1997, 1996 and 1995, respectively. Gain on sale of receivables increased $64.3 million or 44% in fiscal 1997 as compared to fiscal 1996 which in turn increased by $79.0 million or 117% from fiscal 1995. Excluding $26.5 million of gain on sale of receivables relating to the Acquisitions, the fiscal 1997 balance increased by $37.8 million or 26% from fiscal 1996. Gain on sale of receivables as a percentage of total gross income was lower in fiscal 1997 due to an increased outstanding balance of interest earning assets resulting in increased interest income.
Gain on sale of receivables represents income primarily from the structuring and sale of pools of home equity loans originated by ContiMortgage and Strategic Alliance clients of the Company in REMICs, OWNER TRUSTS AND GRANTOR TRUSTS. In addition, gains on sale of receivables are earned upon whole loan sales and upon securitization of commercial and multi-family loans, self-storage facilities, Title I home improvement loans, franchisee loans, auto loans and equipment leases which are sold into REMICs and whole loan and other trust structures.
The increase in income earned from gain on sale of receivables was due to an increased volume of loans, leases and other assets structured and an increased gain on sale percentage. Excluding contributions from the Acquisitions, the Company structured and sold $4.9 billion of mortgages, loans and leases in fiscal 1997, an increase of $0.9 billion from fiscal 1996, which contributed $32.7 million of the increase in gain on sale of receivables, and structured and sold $4.0 billion of mortgages, loans and leases in fiscal 1996, an increase of $1.7 million from fiscal 1995, which contributed $62.6 million of the increase in gain on sale of receivables.
The gain on sale percentage represents the differential between the interest rate earned on underlying securitized loans, leases or other assets and the pass-through rate paid to the securitization investors during the estimated life of the loans, leases or other assets. The increase in the gain on sale percentage was primarily due to the type of assets securitized and changes in the yield curve. The larger gain on sale percentage in fiscal 1997 as compared to fiscal 1996 was partially due to an increased proportion of ContiMortgage securitizations which yield higher gain on sale percentages than securitizations and placements for Strategic Alliance clients. In fiscal 1997, ContiMortgage securitizations represented 75% of total volume as compared to 51% for fiscal 1996 and 57% for fiscal 1995. This contributed to a gain of 13 basis points in Excess Spread or a $5.1 million increase in gain on sale of receivables in fiscal 1997 as compared to fiscal 1996. The combination of the $32.7 million increase due to increased volume and the $5.1 million increase due to an increase in the percentage of ContiMortgage assets securitized resulted in a total increase in gain on sale of receivables from fiscal 1996 to fiscal 1997 of $37.8 million.
In fiscal 1996 as compared to fiscal 1995, the relationship between interest rates and maturity caused an increase in the gain on sale percentage. As the Company originates and sells loans and leases based on the interpolated United States Treasury interest rate plus a negotiated additional interest spread, the gain on sale of receivables is affected by unequal movements in interest rates at various maturities. The interpolated Treasury interest rate is based on the Company's estimate of the average life of the pool of loans or leases. In fiscal 1996 as compared to fiscal 1995, the yield curve steepened which contributed an additional 72 basis points to Excess Spread or $16.4 million of the increase in gain on sale of receivables. The combination of the $16.4 million increase due to the yield curve and the $62.6 million increase due to increased volume resulted in a total increase in gain on sale of receivables from fiscal 1995 to fiscal 1996 of $79.0 million. The gain on sale as a percentage of loans securitized and sold for fiscal 1997, 1996 and 1995 was 4.2%, 3.7% and 3.0%, respectively.
Interest income increased $69.7 million or 76% in fiscal 1997 from fiscal 1996 and $48.8 million or 114% in fiscal 1996 from fiscal 1995. Excluding the effects of the Acquisitions, fiscal 1997 interest income increased by $65.9 million, or 72% from fiscal 1996. Interest income represents interest earned on loans originated or purchased by the Company during the period from origination or purchase until the actual sale of the loans, as well as the recognition of the increased value of the discounted Excess Spread Receivables over time. The interest earned on loans originated and purchased contributed $50.1 million to the increase between fiscal 1996 and fiscal 1997 and $35.5 million to the increase between fiscal 1995 and fiscal 1996. The increase in interest earned on loans originated and purchased was due primarily to the increase in the average balance of loans originated and purchased but not yet securitized during the periods, an increase of $715.6 million in fiscal 1997 as compared to fiscal 1996 and an increase of $591.5 million in fiscal 1996 as compared to fiscal 1995. The recognition of the increased value of the discounted Excess Spread Receivables over time, due to an increase in interest-only and residual certificates, as previously discussed, accounted for $12.8 million of the increase in interest income between fiscal 1996 and fiscal 1997 and $13.3 million of the increase between fiscal 1995 and fiscal 1996.
Net servicing income increased $17.0 million or 58% in fiscal 1997 compared to fiscal 1996 and $20.0 million or 215% in fiscal 1996 compared to fiscal 1995 due to the increase in the size of the servicing portfolio, the volume of loan sales and securitizations and, in fiscal 1996, a change in accounting principles. Excluding the effects of the Acquisitions, fiscal 1997 net servicing income increased by $16.5 million, or 56% from fiscal 1996. The Company's home equity loan servicing portfolio increased $2.5 billion or 66% to $6.4 billion at March 31, 1997 from March 31, 1996 and $1.7 billion or 76% to $3.9 billion at March 31, 1996 from March 31, 1995 . The growth of the servicing portfolio contributed $11.9 million of the increase between fiscal 1996 and fiscal 1997, and $8.3 million of the increase between fiscal 1995 and fiscal 1996. Additionally, net servicing income increased by $4.6 million in fiscal 1997 as compared to fiscal 1996 due to capitalized servicing income associated with the 79% increase in the ContiMortgage home equity loan sales and securitizations during the same period. In fiscal 1996 as compared to fiscal 1995 the capitalization of servicing fees increased servicing income by $11.7 million as servicing fees were not capitalized in fiscal 1995.
Other income increased $4.9 million or 114% to $9.2 million in fiscal 1997 as compared to fiscal 1996 and increased $2.0 million or 87% to $4.3 million in fiscal 1996 as compared to fiscal 1995. Excluding the effects of the Acquisitions, fiscal 1997 other income increased by $3.7 million or 86% from fiscal 1996. Other income consists primarily of "purchase premium refunds" and for fiscal 1997, warrant income. "Purchase premium refunds" are received from certain origination sources related to loans that prepay within a contractually set time period. Upon origination of a loan, the Company will pay a wholesale originator a purchase premium for the loan or pools of loans. The Company negotiates agreements with wholesale originators that provide that a portion of such purchase premium will be repaid if individual loans are repaid within a contractually set time period. The income from "purchase premium refunds"
increased due to the increase in ContiMortgage origination volume. The fiscal 1997 warrant income received consists of $2.7 million of income from the sale of stock warrants in a Strategic Alliance company.
Expenses. Total expenses for fiscal 1997 increased $105.5 million or 73% from fiscal 1996 which in turn increased $80.3 million or 123% from fiscal 1995. Excluding the effects of the Acquisitions, fiscal 1997 total expenses increased by $77.0 million or 53% from fiscal 1996. These increases in total expenses were due to the increase in number of employees and costs associated with increased mortgage volume and increased interest costs from financing larger balances of securitizable loans.
The following table sets forth the components of the Company's expenses for each of the last three fiscal years.
Compensation and benefits increased $30.0 million or 57% in fiscal 1997 compared to fiscal 1996 and increased $28.4 million or 119% in fiscal 1996 as compared to fiscal 1995. Excluding $16.1 million of compensation and benefits relating to the Acquisitions, fiscal 1997 compensation and benefits expense increased by $13.9 million or 27% from fiscal 1996. The increase was primarily due to the addition of new personnel, changes in and accruals under incentive compensation plans, vesting of restricted common stock and commissions paid to certain employees based upon volume of loan originations. On March 31, 1997, the Company had 1,562 employees, 859 from the Acquisitions, as compared to 455 employees on March 31, 1996 and 234 employees on March 31, 1995. This increase primarily contributed to a $14.0 million increase in compensation costs in fiscal 1997 compared to fiscal 1996, excluding the Acquisitions, and a $6.4 million increase in compensation costs in fiscal 1996 as compared to fiscal 1995. The fiscal 1997 accrual for incentive compensation was $23.2 million as compared to $28.0 million in fiscal 1996 and $12.4 million in fiscal 1995, which contributed to a $4.8 million decrease in compensation costs in fiscal 1997 compared to fiscal 1996 and a $15.6 million increase in fiscal 1996 compared to fiscal 1995. In connection with the IPO, shares of "restricted" common stock were granted to certain key employees. The "restricted" common stock granted, subject to the employee's continued employment with the Company, generally vests between February 14, 1996 and March 31, 2000. The expense related to the vesting of "restricted" common stock increased by $1.7 million to $6.7 million during fiscal 1997 from fiscal 1996 restricted stock expense of $5.0 million. The commissions paid to certain ContiMortgage employees increased $3.0 million and $1.4 million from fiscal 1996 to fiscal 1997 and fiscal 1995 to fiscal 1996, respectively, associated with increased ContiMortgage origination volume. Compensation and related expenses represents 19% of total gross income for fiscal 1997 and 1996 and 20% of total gross income for fiscal 1995.
Interest expense increased $45.9 million or 61% in fiscal 1997 as compared to fiscal 1996 and increased $45.1 million or 152% in fiscal 1996 as compared to fiscal 1995. Excluding the effects of the Acquisitions, fiscal 1997 interest expense increased by $45.3 million or 61% from fiscal 1996. This increase was primarily a result of interest expense associated with the issuance of the Senior Notes, the costs of the sale, with limited recourse, of certain Excess Spread Receivables, increased expenses from the Purchase and Sale Facilities and an overall increase in the cost of borrowing offset by decreased borrowing from Continental Grain. The average borrowings from Continental Grain, Purchase and Sale Facilities, the Senior Notes and Excess Spread Receivables sold with limited recourse, increased by $621.3 million in fiscal 1997 as compared to
fiscal 1996, resulting in a $43.5 million increase in interest expense, while such average increased $627.4 million in fiscal 1996, as compared to fiscal 1995 resulting in a $43.0 million increase in interest expense. The increase in interest rates contributed $1.8 million to the increase in interest expense between fiscal 1997 as compared to fiscal 1996 and the increase in interest rates contributed $2.1 million in fiscal 1996 as compared to fiscal 1995.
Provision for loan losses increased to $3.0 million in fiscal 1997 as compared to $0.3 million in fiscal 1996 and $1.9 million in fiscal 1995. Excluding $2.4 million of provision for loan losses relating to the Acquisitions, the fiscal 1997 balance increased by $0.3 million from fiscal 1996. Provision for loan losses is recorded in sufficient amounts to maintain an allowance at a level considered adequate to cover anticipated losses resulting from liquidation of receivables held for sale and receivables sold with limited recourse under Purchase and Sale Facilities, prior to sale or securitization. The increase in fiscal 1997 as compared to fiscal 1996 and the decrease in fiscal 1996 as compared to fiscal 1995 resulted from a determination of adequate reserves in light of actual loss experience during the period.
General and administrative expenses increased $26.9 million or 149% in fiscal 1997 compared to fiscal 1996 and $8.4 million or 87% in fiscal 1996 compared to fiscal 1995. Excluding $9.4 million of general and administrative expenses relating to the Acquisitions, the fiscal 1997 balance increased by $17.5 million, or 97% from fiscal 1996. The increases were partially a result of a $7.1 million and a $3.7 million increase in costs associated with underwriting, originating and servicing higher loan volumes in fiscal 1997 as compared to fiscal 1996 and fiscal 1996 as compared to fiscal 1995, respectively. In fiscal 1997, the origination volume increased 69% as compared to fiscal 1996 and 74% in fiscal 1996 as compared to fiscal 1995. Expenses related to the implementation of collection technology accounted for approximately $1.3 million of the increase in fiscal 1997 as compared to fiscal 1996. The remaining increases were primarily due to an increase in general and administrative expenses related to the increase in the number of employees by 248, excluding employees of the Acquisitions, from fiscal 1996 to fiscal 1997 and the increase of 221 employees from fiscal 1995 to fiscal 1996.
Income Taxes. The Company's provision for income taxes was $71.3 million, $49.1 million and $22.2 million for fiscal 1997, fiscal 1996 and fiscal 1995, respectively. The Company is included in the consolidated Federal income tax return of Continental Grain. The increase in taxes over the three fiscal years is directly related to the increase in income before taxes and minority interest over the same period. The effective tax rate for each year remained relatively consistent at 39% to 40%. Increases in the effective tax rate were due to changes in the provision for state income taxes.
Minority Interest. In fiscal 1996 and fiscal 1995, minority interest represents the portion of income before taxes and minority interest due to the 20% minority shareholders of ContiMortgage. Minority interest decreased $5.4 million or 62% in fiscal 1996 compared to fiscal 1995. This decrease in minority interest was directly related to the change in the Company's ownership percentage of ContiMortgage. On June 19, 1995, ContiTrade Services Corporation ("ContiTrade Services") effectively acquired control of the remaining 20% minority interest in ContiMortgage, which became a wholly-owned subsidiary of ContiFinancial Corporation. Accordingly, the fiscal 1996 results of operations include approximately three months of minority interest of $3.3 million, while the comparable period of fiscal 1995 reflected 12 months of minority interest of $8.7 million.
In fiscal 1997, minority interest represents the portion of loss before taxes and minority interest due to the 44% minority shareholders of Triad. In the third and fourth quarters of fiscal 1997, the Company acquired 56% of the common stock of Triad. Minority interest was ($0.3) million for the period ended March 31, 1997.
Liquidity and Capital Resources
In a securitization, the Company recognizes a gain on the sale of loans or assets securitized upon the closing of the securitization, but does not receive the cash representing such gain until it receives the Excess Spread, which is payable over the actual life of the loan or other assets securitized. The Company incurs significant expenses in connection with a securitization and incurs both current and deferred tax liabilities as a result of the gain on sale. Therefore, the Company requires continued access to short and long term external sources of cash to fund its operations. The Company's primary cash requirements are expected to include the funding of: (i) mortgage, loan and lease originations and purchases pending their pooling and sale; (ii) the points and expenses paid in connection with the acquisition of wholesale loans; (iii) fees and expenses incurred in connection with its securitization program; (iv) over collateralization or reserve account requirements in connection with loans and leases pooled and sold; (v) ongoing administrative and other operating expenses; (vi) payments related to its tax obligations under a Tax Sharing Agreement with Continental Grain or to tax authorities; (vii) interest and principal payments under the Senior Notes; (viii) the costs of the Purchase and Sale Facilities; (ix) interest payments under the unsecured revolving credit facility; and (x) the cost of any new acquisitions that the Company may pursue.
As a result of its growing securitization program, the Company has operated, and expects to continue to operate, on a negative cash flow basis, which is expected to increase as the volume of its loan and asset purchases and originations increases and its securitization program grows. During fiscal 1995, 1996 and 1997, the Company securitized and sold in the secondary market $2.3 billion, $4.0 billion and $5.0 billion of loans, respectively. The Company used $153.2 million, $300.5 million and $35.3 million of cash in operations during fiscal 1997, 1996 and 1995, respectively.
During the life of the REMICs, owner trusts or grantor trusts, the Company subordinates to the rights of holders of senior interests a portion of the Excess Spread otherwise due to the Company as a credit enhancement to support the sale of senior interests. The terms of the REMICs, owner trusts and grantor trusts generally require that the Excess Spread otherwise payable to the Company during the early months of the trusts be used to increase the cash reserve account, or to repay the senior interests in order to increase over collateralization to specified maximums. The value of such "deposit" accounts is included in the value of Excess Spread Receivables and the related gain on sale of receivables, net of necessary reserves for credit losses, if applicable.
In addition, increased use of securitization transactions as a funding source by the Company has resulted in a significant increase in the amount of gain on sale of receivables recognized by the Company. During fiscal 1995, 1996 and 1997, the Company recognized gain on sale of receivables in the amounts of $67.5 million, $146.5 million, and $210.9 million, respectively. The recognition of gain on sale of receivables will have a negative impact on the cash flows of the Company to the extent the Company is required to pay state and Federal income taxes on these amounts in the period recognized, notwithstanding that the Company does not receive the cash representing the gain until later periods as the related loans are repaid or otherwise collected.
The Company's primary sources of liquidity are sales of loans, leases and other assets through securitization, the sale of loans, leases and other assets under the Purchase and Sale Facilities and trade receivables sold under agreements to repurchase, the sale of Excess Spread Receivables, the sale of the Senior Notes and the unsecured revolving credit facility. While the Company sells Excess Spread Receivables from time to time, there is no liquid market for such Excess Spread Receivables.
The Company had $2.3 billion of committed sale capacity under its Purchase and Sale Facilities with various financial institutions as of March 31, 1997. The Purchase and Sale Facilities allow the Company to sell, with limited recourse, interests in designated pools of loans and other assets. These agreements
generally have one year renewable terms (one Purchase and Sale Facility has a two-year term), all of which will expire between May 1997 and June 1998. On March 31, 1997, the Company utilized $590.7 million of the capacity under these facilities. The Company currently anticipates that it will be able to renew these facilities when they expire and to obtain additional facilities.
On March 31, 1997, the Company entered into a funding agreement under an agreement to repurchase ("Repurchase Agreement"). The Repurchase Agreement allows the Company to sell receivables held for sale to a financial institution under an agreement that the Company will repurchase the asset. This agreement has a one year renewable term which expires January 1998. The Company currently anticipates that it will be able to renew this facility when it expires and to obtain additional facilities.
The Company sells Excess Spread Receivables, with limited recourse, to provide cash to fund the Company's securitization program. These sales aggregated $50.0 million in fiscal 1995, $54.5 million in fiscal 1996 and $96.5 million in fiscal 1997. At March 31, 1997, $144.9 million of these sales were outstanding. Under the recourse provisions of the agreements, the Company is responsible for losses incurred by the purchaser within an agreed-upon range. The Company's performance obligations in these transactions are guaranteed by Continental Grain for an agreed-upon fee. Although the Company intends to continue to pursue opportunities to sell Excess Spread Receivables, no assurance can be given that such opportunities will be available in the future.
In order to fund the Company's growth prior to the IPO, Continental Grain provided the Company with intercompany financing ("Intercompany Debt"). To refinance the Intercompany Debt, simultaneously with the completion of the IPO, Continental Grain purchased from the Company a $125 million five-year note issued under an indenture (the "Indenture Note"), a $74 million four-year note (the "Four Year Note") and a $125 million term note (the "Term Note") for $324 million in aggregate (collectively, the "Notes").
On August 14, 1996, the Company issued the 8 3/8% Senior Notes maturing August 15, 2003. Interest on these notes is payable semiannually on February 15 and August 15 commencing February 15, 1997. The 8 3/8% Senior Notes are redeemable as a whole or in part, at the option of the Company, at any time or from time to time, at a redemption price equal to the greater of (i) 100% of their principal amount and (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted to the date of redemption on a semiannual basis at the treasury yield plus 50 basis points, plus in each case, accrued interest to the date of redemption. Proceeds to the Company, net of underwriting fees, market discount and other costs were $287.7 million. Of this amount, $125.0 million was used by the Company to repay in full the Term Note payable to Continental Grain and the remaining funds have been used for general corporate purposes, including funding loan originations and purchases, supporting securitization transactions and other working capital needs.
On January 8, 1997, the Company closed a $200 million unsecured revolving credit facility. The three-year facility has several interest rate pricing alternatives, including those based on LIBOR and federal funds rates. The facility will be used for general corporate and liquidity purposes.
On March 12, 1997, the Company issued the 7 1/2% Senior Notes maturing March 15, 2002. Proceeds to the Company, net of underwriting fees, market discount and other costs were $197.7 million. Interest on these notes is payable semi-annually on March 15 and September 15 commencing September 15 ,1997. This amount, together with other funds of the Company, were used to repay in full the Indenture Note and the Four Year Note payable to Continental Grain which constituted all of the remaining financing indebtedness due to Continental Grain.
On June 4, 1997, the Company completed a primary offering of 2,800,000 shares of common stock and an additional 420,000 shares were purchased by the underwriters for over allotments. The net proceeds of the offering to the Company were $100.8 million.
The net proceeds from the IPO, the issuance of the 8 3/8% and the 7 1/2% Senior Notes and the June 4, 1997 primary offering, were used by the Company for general corporate purposes, including funding loan originations and purchases, supporting securitization transactions (including the retention of Excess Spread Receivables), other working capital needs and to make certain strategic acquisitions. Sales of the loans, leases and other assets through securitizations, the sale of loans under the Purchase and Sale Facilities, the sale of Excess Spread Receivables and the June 4, 1997 primary offering of 2,800,000 shares of common stock, together with cash on hand, are expected to be sufficient to fund the Company's liquidity requirements for at least the next 12 months if the Company's future operations are consistent with management's current growth expectations. The Company has no commitments for additional financing and there can be no assurance that the Company will be successful in consummating any such financing transactions in the future on terms that the Company would consider to be favorable. Furthermore, no assurance can be given that Continental Grain will provide such financing if the Company is unable to obtain third party financing or that the terms of the Continental Grain debt agreements will permit the Company to obtain such financing.
During fiscal 1995 and during fiscal 1996, prior to the close of its IPO on February 14, 1996, the Company paid cash dividends to Continental Grain of $30 million and $0.3 million, respectively. The Company has no current intention to pay cash dividends on its Common Stock. As a holding company, the ability of the Company to pay dividends is dependent upon the receipt of dividends or other payments from its subsidiaries. Any future determination as to the payment of dividends will be at the discretion of the Company's Board of Directors and will depend upon the Company's operating results, financial condition and capital requirements, contractual restrictions, general business conditions and such other factors as the Company's Board of Directors deems relevant. Furthermore, covenants in the Company's and Continental Grain's loan agreements restrict the payment of dividends by the Company. There can be no assurance that the Company will have earnings sufficient to pay a dividend on its Common Stock or that, even if there are sufficient earnings, dividends will be permitted under applicable law.
Effects of Accounting Pronouncements
On January 1, 1997, the Company adopted the SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities". See "Certain Accounting Considerations" for discussion of the statement and its impact on the Company's financial condition and results of operations.
In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share ("EPS")" ("SFAS 128") which is effective in fiscal 1998, early application is not permitted. SFAS 128 simplifies the standards for computing earnings per share. It replaces the presentation of primary EPS with a presentation of basic EPS. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. If SFAS 128 had been applied to fiscal 1997 results of operations, the Company's basic EPS would have been $2.44 (pro forma) of earnings per common share based on net income of $106,004 and weighted-average number of common shares of 43,361,253 (pro forma). Fully dilutive EPS remains the same under SFAS 128 but will be referred to as diluted EPS.
Forward-looking Statements
Certain statements contained in this Annual Report Form 10-K which are not historical fact, may be deemed to be forward-looking statements under the federal securities laws. There are many important factors that could cause the Company's actual results to differ materially from those indicated in the forward-looking statements. Such factors include, but are not limited to, general economic conditions, interest rate risk, prepayment speeds, delinquency and default rates, changes (legislative and otherwise) in the asset securitization industry, demand for the Company's services, the impact of certain covenants in loan agreements of the Company and Continental Grain, the degree to which the Company is leveraged, its needs for financing, and other
risks identified in the Company's Securities and Exchange Commission filings. In addition, it should be noted that past financial and operational performance of the Company is not necessarily indicative of future financial and operational performance.
Item 8.
Item 8. Financial Statements and Supplementary Data.
CONTIFINANCIAL CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of ContiFinancial Corporation:
We have audited the accompanying consolidated balance sheets of ContiFinancial Corporation (a Delaware corporation) and subsidiaries as of March 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended March 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ContiFinancial Corporation as of March 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 1997, in conformity with generally accepted accounting principles.
New York, New York May 8, 1997 (except with respect to the matter discussed in Note 14, as to which the date is June 4, 1997)
CONTIFINANCIAL CORPORATION Consolidated Statements of Income for the years ended March 31, 1997, 1996 and 1995 (dollars in thousands, except share data)
CONTIFINANCIAL CORPORATION Consolidated Statements of Changes in Stockholders' Equity for the years ended March 31, 1997, 1996 and 1995 (dollars in thousands, except share data)
The accompanying notes to consolidated financial statements are an integral part of these statements.
CONTIFINANCIAL CORPORATION Consolidated Statements of Cash Flows for the years ended March 31, 1997, 1996 and 1995 (dollars in thousands)
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements March 31, 1997, 1996 and 1995 (dollars in thousands)
1. BACKGROUND AND BASIS OF PRESENTATION
ContiFinancial Corporation ("ContiFinancial" or the "Company") was incorporated as a Delaware corporation on September 29, 1995. The accompanying consolidated financial statements include the accounts of the Company and its direct wholly or majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Reorganization
Prior to February 14, 1996, the consolidated financial statements present the financial condition and results of operations of the Company which includes its directly wholly-owned subsidiaries: ContiSecurities Asset Funding Corp. ("CSAF"), ContiSecurities Asset Funding II, L.L.C. ("CSAF II"), ContiFunding Corporation ("CFC"), ContiTrade Services L.L.C. ("CTS"), ContiMortgage Corporation ("CMC") (all Delaware corporations or limited liability companies) and ContiFinancial Services Corporation ("CSC"), a New York corporation.
On February 14, 1996, ContiFinancial closed an initial public offering in the United States and internationally (the "IPO") of approximately 16% of its common stock. In the reorganization that occurred in December 1995 (the "Reorganization"), (i) ContiTrade Services Corporation ("CTSC") transferred certain of its businesses (excluding its trade finance business) to CTS and the common stock of its subsidiaries, CMC and CSC, and its interest-only and residual certificates to Continental Grain Company ("Continental Grain") and (ii) Continental Grain transferred all of the common stock of CMC, CSC, CSAF and CFC, all of the members' interest held by it in CTS and CSAF II and the transferred interest-only and residual certificates (See Note 7) to ContiFinancial. As a result, ContiFinancial owns all of the common stock or members' interests in CTS, CMC, CSC, CFC, CSAF and CSAF II (collectively, the "Previous Companies"). Prior to the IPO, both ContiFinancial and the Previous Companies (exclusive of CMC) were direct or indirect wholly-owned subsidiaries of Continental Grain. As described in Note 6, on June 19, 1995, CTSC effectively acquired control of the remaining 20% minority interest in CMC, which became a wholly-owned subsidiary of CTSC.
As a result of the Reorganization, the Company issued 35,918,421 shares of common stock to Continental Grain. Additionally, the Company converted $84,732 of the Previous Companies retained earnings to paid-in capital.
The consolidated financial statements for the periods prior to the IPO have been combined to reflect the Reorganization accounted for similar to a pooling of interests method. All material intercompany transactions have been eliminated in the combination. The Consolidated Financial Statements include additional charges and liabilities related to expenses incurred by Continental Grain for the Previous Companies, which historically had not been allocated to the Previous Companies. These charges include corporate service charges from Continental Grain and income taxes (See Note 7.).
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
Acquisitions
In fiscal 1997, the Company acquired 100% of three home equity companies, California Lending Group, Inc., d/b/a United Lending Group, Inc. ("ULG"), Resource One Consumer Discount Company, Inc. ("Resource One"), and Royal Mortgage Partners, L.P., d/b/a Royal MortgageBanc ("Royal") and 56% of an auto finance company, Triad Financial Corporation ("Triad"), collectively, the "Acquisitions". In each case, the companies acquired were former Strategic Alliances or CMC loan origination sources. The Acquisitions have been accounted for as purchases, and the results of operations have been included with the Company's results of operations since the effective acquisition date. ( See Note 6.).
Other
The Company organized ContiWest Corporation ("CWC"), a Nevada corporation, in fiscal 1997 to administer and underwrite a portion of the Company's origination portfolio. Other direct or indirect wholly-owned subsidiaries were also organized in fiscal 1997.
2. NATURE OF BUSINESS
The Company engages in the consumer and commercial finance business by originating and servicing home equity loans and providing financing and asset securitization expertise to originators of a broad range of loans, leases and receivables. Securitization provides significant benefits, including greater operating leverage and reduced costs of funds, in the financing of assets, such as non-conforming home equity loans, equipment leases, home improvement loans, franchisee loans, commercial/multi-family loans, non-prime and sub-prime auto loans and leases and timeshare loans. The Company considers this business to be one operating segment.
Through CMC and CWC, the Company is an originator, purchaser and servicer of home equity loans made to borrowers who may not otherwise qualify for conventional loans. The loans are then sold to whole-loan investors or securitized in the form of Real Estate Mortgage Investment Conduits ("REMICs"), owner trusts or grantor trusts. All of the mortgages are sold on a servicing retained basis. The outstanding principal balance in CMC's mortgage servicing portfolio at March 31, 1997 and March 31, 1996 was $6,423,376 and $3,863,575, respectively. Through CTS and CSC, the Company provides complete balance sheet liability management, including warehouse financing, interest rate hedging services and the structuring and placement of asset portfolios in the form of asset-backed securities to CMC, the Acquisitions and other originators ("Strategic Alliances") of consumer and commercial loans, leases, receivables and other assets (collectively, the "Receivables"). The Strategic Alliances provide ContiFinancial with a consistent flow of securitizable Receivables. In certain of the Strategic Alliances, CTSC receives warrants or warrant-like equity participations ("Strategic Alliance Equity Interests") in the Strategic Alliance client. The Strategic Alliance Equity Interests in existence prior to the IPO are held by Continental Grain and as such are not reflected in ContiFinancial's consolidated financial statements. Strategic Alliance Equity Interests received from Strategic Alliance clients subsequent to the IPO have been granted to ContiFinancial. If such Strategic Alliance Equity Interests develop a readily determinable fair value, the Strategic Alliance Equity Interests will be recorded at fair value. If such value is not determinable, the Strategic Alliance Equity Interests will be recorded at cost adjusted for write downs for impairments as appropriate.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
The Company's business may be affected by many factors including real estate and other asset values, the level of and fluctuations in interest rates, changes in the securitization market and competition. In addition, the Company's operations require continued access to short and long term sources of cash.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of reserves and expenses during the reporting period. Actual results could differ from these estimates.
Income Recognition
Gain on sale of receivables is recognized upon delivery and acceptance of loans, leases or receivables by whole-loan investors or upon the securitization of the Receivables in the form of REMICs, owner trusts or grantor trusts, as applicable. Gains from sales of whole-loans are calculated based upon the difference between the net sales proceeds and the net carrying amount of the loans sold. Gains on sales of Receivables from securitizations represent the present value of the differential between the interest rate earned on the Receivables sold and the pass-through rate paid to the securitization investors, after considering the effects of estimated prepayments, defaults and other costs, including normal servicing fees, less the costs of originating such Receivables, and the gain or loss on certain transactions structured as an economic hedge that are designed to minimize the risk of interest rate fluctuations.
Interest income is recorded as earned. Interest income represents the interest earned on the loans and leases during the warehousing period (the period prior to their securitization) and the recognition of interest income on the interest-only and Residual Certificates, which is the recognition of the increased time value of the discounted interest-only and Residual Certificates over time. Receivables are placed on non-accrual status when the loans become sixty days past due. When a loan is classified as non-accrual, the accrual of interest income ceases, and all interest income previously accrued and unpaid on such loans is reversed.
Income Taxes
The Company is included in the consolidated Federal income tax return of Continental Grain. The Company has a tax sharing arrangement with Continental Grain whereby Federal income taxes are computed on a separate company basis. Federal income taxes are settled through the due to affiliates accounts.
The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 utilizes the balance sheet method and deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provision of the enacted tax laws.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an original maturity of no more than three months to be cash equivalents.
Restricted Cash
As of March 31, 1997 and 1996, the Company had restricted cash of $464 and $620, respectively, related to the sale of mortgage loans with limited recourse to a counterparty. The amount of cash required to be restricted is based on a percentage of the outstanding balance of the loans sold.
Securities Purchased Under Agreements to Resell and Securities Sold But Not Yet Purchased
In order to hedge the interest rate risk on loan purchases and commitments, the Company sells short United States Treasury securities which match the duration of the Receivables and purchases the securities under agreements to resell.
Securities sold but not yet purchased are recorded on a trade date basis and are carried at their sale amount. The unrealized gain or loss on these instruments is deferred and recognized upon securitization as an adjustment to the carrying value of the hedged asset.
Securities purchased under agreements to resell are recorded on a trade date basis and are carried at the amounts at which the securities will be subsequently resold, plus accrued interest. The agreements mature through May 1997 and have interest rates ranging from 4.9% to 5.4%.
Interest-only and Residual Certificates
The Company purchases Receivables for the purpose of securitization and sale. The Company securitizes the Receivables primarily into the form of a REMIC. A REMIC is a multi-class security structure with certain tax advantages which derives its monthly principal paydowns from a pool of underlying mortgages. The senior classes of the REMICs are sold, with the subordinated classes retained by the Company. The subordinated classes are in the form of interest-only and residual certificates. These subordinated classes of REMICs represent an interest in the REMIC, or in other minor cases an owner trust or a grantor trust, as compared to the right to receive funds under the form of retained or capitalized excess servicing assets.
In accordance with the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities", the Company classifies subordinated classes of REMICs, owner trusts and grantor trusts as "trading securities" and, as such, they are recorded at fair value with the resultant unrealized gain or loss recorded in the results of operations in the period of the change in fair value. The Company determines fair value based on a discounted cash flow analysis. The cash flows are estimated as the excess of the weighted average coupon on each pool of Receivables sold over the sum of the pass-through interest rate plus a normal servicing fee, a trustee fee, an insurance fee and an estimate of annual future credit losses related to the Receivables securitized, over the life of the Receivables. These cash flows are projected over the life of the Receivables using prepayment, default, and interest rate assumptions that market participants would use for similar financial instruments subject to prepayment, credit and interest rate risk and are discounted using an interest rate that a purchaser unrelated to the seller of such a financial instrument would demand. The fair valuation includes consideration of the
following characteristics: loan type, size, interest rate, date of origination, term and geographic location. The Company also uses other available information such as externally prepared reports on prepayment rates, interest rates, collateral value, economic forecasts and historical default and prepayment rates of the portfolio under review.
Receivables Held for Sale/Trade Receivables Sold Under Agreements to Repurchase
Receivables held for sale are mortgages, loans, leases and other assets the Company plans to sell or securitize and other related assets including deposits made with financial institutions. Receivables held for sale are stated at the lower of cost, the origination costs plus accrued interest, or market. Market value is determined by outstanding commitments from investors or current investor yield requirements plus any deferred hedging gain less any deferred hedging loss calculated on the aggregate loan basis. The carrying amount of receivables held for sale is a reasonable estimate of fair value based on current pricing of whole-loan transactions.
On January 1, 1997, the Company adopted SFAS No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS 125") which addresses the accounting for transfers of financial assets in which the transferor has some continuing involvement either with the assets transferred or with the transferee. A transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interest in the transferred assets is received in exchange. SFAS 125 requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value, if practicable. In addition, SFAS 125 requires that servicing assets and liabilities be subsequently measured by the amortization over their estimated life and assessment of asset impairment be based on such assets' fair value. SFAS 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. The adoption of this standard did not have a material impact on the Company's results of operations. However, certain of the assets that the Company has sold under the Purchase and Sale Facilities subsequent to January 1, 1997 did not qualify for sale treatment under SFAS 125 and as a result are accounted for on the balance sheet of the Company on a trade date basis and are carried at their sale amount of $251,539 as of March 31, 1997. In the opinion of management, SFAS 125 does not in any way effect the ability of the Company to finance these assets.
Capitalized Servicing Fees Receivable
Effective April 1, 1995, the Company adopted SFAS No. 122 "Accounting for Mortgage Servicing Rights" ("SFAS 122") which requires that upon sale or securitization of servicing retained mortgages, companies capitalize the cost associated with the right to service mortgage loans based on their relative fair values. Effective January 1, 1997, SFAS 122 was superseded by SFAS 125, as discussed above, with minor amendments. The Company determines fair value based on the present value of estimated net future cash flows related to servicing income. The cost allocated to the servicing rights is amortized in proportion to and over the period of estimated net future servicing fee income.
Prior to the adoption of SFAS 122, income related to servicing rights acquired through loan origination activities was recorded in the period the loans were serviced. Under SFAS 122 and SFAS 125, the Company capitalized, at fair value, $24,004 and $13,828 of such costs during the years ended March 31, 1997 and 1996, respectively. During the same periods, amortization of capitalized servicing rights were $7,676 and $2,139, respectively. Also increasing the capitalized servicing fees receivable were prepayment premiums paid during the
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
year ended March 31, 1997 of $1,336. At March 31, 1997 and 1996 the capitalized servicing rights approximated fair value. The Company periodically reviews capitalized servicing fees receivable for valuation impairment. This review is performed on a disaggregated basis for the predominant risk characteristics of the underlying loans which are loan type, loan-to-value ratio and credit quality. The Company generally makes loans to credit impaired borrowers whose borrowing needs may not be met by traditional financial institutions due to credit exceptions. The Company has found that credit impaired borrowers are payment sensitive rather than interest rate sensitive. As such the Company does not consider interest rates a predominant risk characteristic for purposes of valuation impairment. Impairment is recognized in a valuation allowance for each disaggregated stratum in the period of impairment.
Other Receivables
Other receivables consist primarily of amounts relating to the origination and execution of securitization transactions which include advances made to Strategic Alliances to finance their purchase of interest-only and residual certificates, servicing advances, short-term receivables, mortgage loan advances, and accrued interest on loans and other receivables.
Allowance for Loan Losses
The allowance for loan losses represents an amount considered by management to be adequate to cover estimated losses and valuation adjustments related to the balance of mortgage and non-prime auto receivables held for sale and mortgage receivables sold with limited recourse. The allowance for loan losses is based upon periodic analysis of the portfolio, economic conditions and trends, historical credit loss experience, borrowers' ability to repay and collateral values. The Company's charge-off policy is based on a review of each individual receivable.
Premises and Equipment, Net of Accumulated Depreciation
Property and equipment are carried at cost and depreciated on a straight-line basis over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the useful lives of the improvements or term of the leases. The estimated useful lives of property and equipment and leasehold improvements are between two to twelve years.
Other Assets
Other assets is comprised of prepaid expenses, margin and other deposits, deferred bond issuance costs and other investments. Certain of these assets are periodically reviewed for impairment.
Stock Based Compensation
In October 1995, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") which is effective beginning in fiscal 1997. SFAS 123 allows companies either to continue to account for stock-based employee compensation plans under existing accounting standards or adopt a fair value based method of accounting for stock options as compensation expense over the service period (generally the vesting period) as defined in the new standard. SFAS 123 requires that if a company continues to account for stock options under Accounting Principles Board ("APB") Opinion No.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
25, it must provide pro forma net income and earnings per share information "as if " the new fair value approach had been adopted. The Company will continue to account for stock based compensation under APB Opinion No. 25 and made the required disclosures in fiscal 1997 (See Note 9.).
Recent Accounting Pronouncements
In February 1997, the FASB issued SFAS No. 128 "Earnings Per Share ("EPS")" ("SFAS 128") which is effective in fiscal 1998, early application is not permitted. SFAS 128 simplifies the standards for computing earnings per share. It replaces the presentation of primary EPS with a presentation of basic EPS. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. If SFAS 128 had been applied to fiscal 1997 results of operations, the Company's basic EPS would have been $2.44 (pro forma) of earnings per common share based on net income of $106,004 and weighted-average number of common shares of 43,361,253 (pro forma). Fully dilutive EPS remains the same under SFAS 128 but will be referred to as diluted EPS.
Consolidated Statements of Cash Flows--Supplemental Disclosures
Total interest paid was $119,223, $71,539, and $29,635 for the years ended March 31, 1997, 1996, and 1995, respectively. Total income taxes paid were $45,624, $896, and $441 for the years ended March 31, 1997, 1996 and 1995, respectively. For the year ended March 31, 1997, federal income taxes were paid, on a current basis, to Continental Grain in accordance with the provisions of the tax sharing agreement (See Note 7.). As such, these amounts were included in total income taxes paid for the year ended March 31, 1997. Prior to the IPO, federal income taxes were included in due to affiliates, which was not repaid to Continental Grain on a current basis, and as such were not included in total income taxes paid for the years ended March 31, 1996 and 1995.
Pro Forma Earnings Per Common Share and Earnings Per Common Share
Due to the Reorganization and the issuance of common stock in the IPO, net earnings per common share for the year ended March 31, 1996 have been computed on a pro forma basis, assuming the Reorganization occurred at the beginning of fiscal 1996, and includes the number of common shares issued by the Company in the IPO from the date of issuance plus the effect of common stock equivalent shares under the restricted stock awards and stock options plans (See Note 9.) from that same date. Because of the Company's Reorganization and changes in capital structure, per share data for the year ended March 31, 1995 is not meaningful.
Net earnings per common share for the year ended March 31, 1997 have been computed using the weighted average number of common shares outstanding during the year, after giving effect of common stock equivalents issued under the "1995 Long-Term Stock Incentive Plan" (See Note 9.).
Reclassifications
Certain reclassifications of prior years' amounts have been made to conform to the current year presentation.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands) 4. STOCKHOLDERS' EQUITY
The stockholders' equity as of March 31, 1995 reflects the combined common stock, paid-in capital and retained earnings of the Previous Companies.
CMC is subject to minimum capital requirements imposed by the states in which it operates, with the highest being $250. In addition, CMC is required by the U.S. Department of Housing and Urban Development to maintain minimum capital of $250 plus an amount based on the volume of Federal Housing Authority business. Furthermore, CMC is required by the Federal National Mortgage Association ("FNMA") to maintain minimum capital of $250 plus .20% of the principal balance of the portfolio being serviced for FNMA.
CSC is registered as a broker/dealer with the Securities and Exchange Commission and is subject to the SEC's Uniform Net Capital Rule 15c3-1, under which the ratio of aggregate indebtedness to net capital, as those are defined, may not exceed 15 to 1.
5. ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses and related additions and deductions to the allowance for the years ended March 31, 1997,1996, and 1995, were as follows:
The deductions in the allowance for loan losses for the years ended March 31, 1997, 1996, and 1995 relate to the reversal of reserves and net loan charge-offs.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
6. ACQUISITIONS
On June 19, 1995, CTSC effectively acquired control of the remaining 20% minority interest of CMC for $34,600. The acquisition has been accounted for by the purchase method of accounting. Associated cost in excess of equity is being amortized over 25 years on a straight-line basis. The Company assesses the future useful life of this asset whenever events or changes in circumstances indicate that the current useful life has diminished. The Company considers the future undiscounted cash flows of the acquired business in assessing the recoverability of this asset. If the fair value of the estimated future undiscounted cash flows from this business is lower than the carrying value of this asset, and the decline is deemed to be other than temporary, the Company will write down the asset to fair value.
The March 31, 1996 consolidated statement of income of the Company reflects the entire results of the operations of CMC for the period from June 19, 1995 to March 31, 1996.
The pro forma results of operations of the Company for the year ended March 31, 1996 would be as follows to reflect the acquisition of the minority interest as if the acquisition occurred as of April 1, 1995: Gross income of $271,816, Net income of $77,319 and pro forma primary and fully diluted earnings per common share of $2.09.
On November 8, 1996, the Company purchased 100% of the outstanding stock of ULG, a west coast-based home equity lender specializing in retail originations via direct mail and telemarketing throughout the United States. On November 15, 1996, the Company, through its subsidiary CMC, purchased 100% of Royal, a California-based wholesale and retail originator of fixed and adjustable rate home equity loans. On November 21, 1996, the Company purchased 53.5% of the common stock of Triad and an additional 2.5% of the common stock in January 1997. Triad is a California-based auto finance company specializing in origination of non-prime auto finance contracts for used and new vehicles. On December 16, 1996, the Company, through its subsidiary CMC, purchased 100% of the outstanding stock of Resource One, a Pennsylvania-based home equity lender specializing in retail origination via direct mail, television, and telemarketing throughout the eastern and mid-western states. In each case the companies acquired were former Strategic Alliances or CMC loan origination sources. These transactions have been accounted for as purchases, and the results of operations have been included with the Company's results of operations since the effective acquisition dates. The cumulative purchase price was approximately $38,000, which includes deferred payments of approximately $5,000. As a result of the acquisitions, approximately $35,000 of cost in excess of equity was recorded which will be amortized on a straight-line basis over a 25 year useful life. Certain acquisition's terms contain payments which are contingent upon future earnings or employment of key management. Such contingent payments will be recorded as purchase price or compensation as is appropriate for the nature of the payments. The Company has a right and obligation to purchase the remaining 44% of the common stock of Triad over the next 4.5 years. The purchase price will be based upon the future earnings of Triad and will be recorded, when determinable. The excess of the purchase price over the fair value of the net assets acquired will be recorded as an increase in cost in excess of equity. The Acquisitions are not material to the financial position or results of operations of the Company.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
7. RELATED PARTY TRANSACTIONS
Notes Payable
In connection with the IPO (See Note 1.), the Company entered into a note purchase agreement with Continental Grain, pursuant to which Continental Grain purchased from the Company a $125,000 five-year note issued under an indenture (the "Indenture Note"), a $74,000 four-year note (the "Four Year Note") and a $125,000 term note (the "Term Note") for $324,000 in the aggregate (collectively, the "Notes"). As of March 12, 1997 the intercompany debt was paid in full and the Company is no longer subject to the covenants of the intercompany debt.
The Company is indirectly subject to the financial covenants of Continental Grain's debt agreements which restrict dividends by less than wholly-owned subsidiaries. If these covenants are still in place at the time the Company decides to declare a dividend, a waiver from the related lenders would have to be obtained.
Due to Affiliates
Prior to the IPO, Continental Grain provided interest bearing and non-interest bearing funds to support operations of the Company. On February 14, 1996, this support of operations was replaced by the Notes. The interest bearing funds ("Interest Bearing Funds") provided by Continental Grain were subject to interest charges which represent Continental Grain's all inclusive weighted average cost of short term funds (the "FMA Rate"). Interest expense incurred at the FMA Rate was $19,584 and $10,234 for the years ended March 31, 1996 and 1995, respectively.
The average Interest Bearing Funds for the years ended March 31, 1996 and 1995, were $325,355 and $160,659, respectively. The weighted average interest rates charged on the Interest Bearing Funds for the years ended March 31, 1996 and 1995 were 6.88% and 6.37%, respectively.
The March 31, 1997 and 1996 due to affiliates balance represents payments due on the Services Agreement, the Tax Sharing Agreement, the Employee Benefits Allocation Agreement and the Sublease Agreement, as defined below. The March 31, 1996 due to affiliates balance also included accrued interest due to Continental Grain under the terms of the Notes.
Affiliate Charges
Continental Grain incurs certain general and administrative expenses that support the Company's operations. Expenses directly attributable to the Company, such as occupancy and communication charges, are directly charged to the Company. Other general and administrative expenses indirectly charged relate to support services such as treasury functions, tax services, human resource management, information technology, internal audit functions, insurance management, legal services, and others. The amount of such expenses was $1,749, $1,907 and $2,848 for the years ended March 31, 1997, 1996 and 1995, respectively.
The determination of expenses incurred by Continental Grain applicable to the Company is based first, on identifying specific expenses that are directly attributable to its operations and second, on estimating that portion of general and administrative expenses of Continental Grain used to support the operations
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
of the Company based on the service hours attributable to the Company and the asset base of the Company. Management believes that the method of allocation of general and administrative expenses is reasonable.
On February 14, 1996, the Company entered into an agreement with Continental Grain (the "Services Agreement") under which Continental Grain agrees to continue to provide the Company certain corporate services, including treasury administration, risk management, internal audit, Federal and state tax (including payroll) administration, management information and communication support services, public affairs, and facilities management through March 31, 1999 and from year-to-year thereafter.
Interest-only and Residual Certificates Transfer
On February 14, 1996, the Company entered into an agreement with Continental Grain to transfer $60,701 of its interest-only and residual certificates at book value to Continental Grain in order to reduce the amount of due to affiliates to $324,000 on such date. Based upon management's valuation of these interest-only and residual certificates and other sales transactions with unrelated third parties, the Company believes that the book value of such interest-only and residual certificates represented the fair value of such interest-only and residual certificates.
Tax Sharing Agreement
On February 14, 1996, Continental Grain and the Company entered into a tax sharing agreement (the "Tax Sharing Agreement") which (i) defines their respective rights and obligations with respect to Federal, state, local and all other taxes for all taxable periods both prior to and after the IPO and (ii) governs the conduct of all audits and other tax controversies relating to the Company. Pursuant to the Tax Sharing Agreement, the Company will be charged or credited, as the case may be, for its Federal income tax liability or refund that would have been payable or received by the Company for such year, or portion thereof, determined as if the Company had filed a separate Federal income tax return computed in accordance with prevailing Federal income tax laws and regulations as applied to the Company as if it were a separate taxpayer.
Employee Benefits Allocation Agreement
On February 14, 1996, Continental Grain and the Company entered into an employee benefits allocation agreement (the "Employee Benefits Allocation Agreement") which permits the Company's employees to continue to participate in the Continental Grain employee benefit plans. The cost of the Company's employees' participation in these programs will be allocated to the Company based on the actual cost of benefit accruals and an allocated cost of administration of the plans and overhead (See Note 9.).
Sublease Agreement
On February 14, 1996, Continental Grain and the Company entered into a sublease agreement with subsequent amendments (the "Sublease Agreement") for the utilization of the facilities leased from Continental Grain. The Sublease Agreement will require an annual payment of approximately $787 through the year 2000.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands) 8. DEBT
In fiscal 1996, debt financing was provided by Continental Grain (See Note 7.). During fiscal 1997, this debt was retired and replaced with publicly issued debt. Long-term debt at March 31, 1997 consists of the following: March 31, ---- 8 3/8% Senior Notes, $300 million face amount, due 2003 $299,194 7 1/2% Senior Notes, $200 million face amount, due 2002 199,288 Capitalized lease 335 -------- Total long-term debt $498,817 ========
On August 14, 1996, the Company issued $300 million of unsecured senior notes (the "8 3/8% Senior Notes") due August 15, 2003. Proceeds to the Company, net of underwriting fees, market discount and other costs were $287,742. Interest on these notes is payable semi-annually on February 15 and August 15 commencing February 15, 1997. The 8 3/8% Senior Notes are redeemable as a whole or in part, at the option of the Company, at any time or from time to time, at a redemption price equal to the greater of (i) 100% of their principal amount or (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon discounted to the date of redemption on a semiannual basis at the treasury yield plus 50 basis points, plus, in each case, accrued interest to the date of redemption. Interest expense on the unsecured 8 3/8% Senior Notes was $15,484 for fiscal 1997.
On March 12, 1997, the Company issued $200 million of unsecured senior notes (the "7 1/2% Senior Notes") due March 15, 2002 (together with the 8 3/8% Senior Notes, the "Senior Notes"). Proceeds to the Company, net of underwriting fees, market discount and other costs were $197,700. Interest on these notes is payable semi-annually on March 15 and September 15 commencing September 15, 1997. Interest expense on the 7 1/2% Senior Notes was $756 for fiscal 1997.
The Company is required to comply with various operating and financial covenants as set forth in the agreements governing the issuance of the Senior Notes. Among other restrictions, the Company must comply with limitations on indebtedness and restricted payments.
The Senior Notes are equal in right of payment with all existing and future senior indebtedness of the Company and will be senior in right of payment to all future subordinated indebtedness of the Company.
On January 8, 1997, the Company closed a $200 million unsecured revolving credit facility (the "Short-Term Borrowing"). The three-year Short-Term Borrowing has several interest rate pricing alternatives, including those based on the London Interbank Offering Rate ("LIBOR") and federal funds rate. The amount available under the Short-Term Borrowing is based on a formula based on certain of the Company's consolidated assets. Interest expense on the Short-Term Borrowing was $164 for fiscal 1997.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
9. EMPLOYEE BENEFITS
The Company's employees are included in Continental Grain's employee benefits programs, and the Company reimburses Continental Grain for the actual cost of benefit accruals and an allocable cost of administration and overhead.
Continental Grain has a number of noncontributory pension plans covering substantially all United States employees. The pension plan covering salaried employees provides benefits that are generally based on a percentage of the employee's salary during the five years before retirement. Continental Grain's funding policy for these plans is generally to make the minimum annual contribution required by applicable regulations. Pension costs charged to the Company by Continental Grain were $374, $118, and $91 for the years ended March 31, 1997, 1996 and 1995, respectively.
Post-retirement health care coverage under Continental Grain's Salaried Health Care Plan is available on a cost sharing basis to retired employees. Life insurance coverage is provided on a noncontributory basis to substantially all retirees. Post-retirement health care costs charged to the Company by Continental Grain were $419, $680 and $394 for the years ended March 31, 1997, 1996, and 1995, respectively. Effective April 1, 1996, Continental Grain transferred the Company's portion of the accrual, as of such date, for post-retirement health care costs. This accrual was determined on a stand alone basis for the Company.
The Company has in effect an incentive compensation program which is a formula plan based on pre-tax income targets. Incentive compensation for the years ended March 31, 1997, 1996 and 1995 was $24,580, $27,986 and $12,400, respectively.
Upon acquisition of ULG, the Company established a long term incentive plan for certain key employees of ULG. The program is a formula plan based on after-tax income. The Company recognized $200 in expense for this plan for the year ended March 31, 1997.
1995 Long-Term Stock Incentive Plan
On February 9, 1996, the Company adopted the 1995 Long-Term Stock Incentive Plan (the "Stock Plan") pursuant to which the Company was authorized to grant certain key employees 4,437,895 of options and restricted stock, in the common stock of the Company. The aggregate equity interests in the Company available under the Stock Plan is not to exceed 9% of all equity interests in the Company as of the date the plan was adopted. In fiscal 1997 and fiscal 1996, the Company granted stock options and restricted stock under the Stock Plan.
The Company applies APB Opinion No. 25 and the related interpretations in accounting for the Stock Plan. In October 1995, the FASB issued SFAS 123. If fully adopted, SFAS 123 changes the method for measurement and recognition of stock-based compensation on plans similar to those of the Company. The Company has adopted the disclosure requirements established by SFAS 123. Pro forma disclosures as if the Company had adopted the cost recognition requirements under SFAS 123 are presented below.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands, except share data)
Stock options granted under the Stock Plan are nonqualified stock options that: (1) are granted at prices which are equal to the market value of the stock on the date of grant; (2) subject to a grantee's continued employment with the Company, vest at various periods over a four year period; and (3) expire ten years subsequent to the award.
A summary of the status of the Company's stock options as of March 31, 1997 and 1996 and the changes during the year is presented below:
The fair value of each option granted during fiscal 1997 and fiscal 1996 is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: (1) dividend yield of zero; (2) expected volatility 49.75%; (3) risk-free interest rate of 5.05% for 1996 and 6.32% for 1997 and; (4) expected life of 3.5 years. The weighted average fair value of options granted during 1997 and 1996 was $15.33 and $8.78, respectively.
Had compensation cost for the Company's fiscal 1997 and fiscal 1996 grants for stock options been determined consistent with SFAS 123, the Company's pro forma net income and pro forma net income per common share for fiscal 1997 and fiscal 1996 would approximate the pro forma amounts below:
The restricted stock granted under the Stock Plan is recorded as deferred compensation in stockholders' equity. The deferred compensation is amortized over the vesting period of the restricted stock. The restricted stock vests over a 3 to 4 year period and is subject to the employee's continued employment with the Company.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands, except share data)
In connection with the restricted stock issuance, the Company recorded compensation expense of $6,721 and $4,967 in fiscal 1997 and fiscal 1996, respectively.
A summary of the status of the Company's restricted stock as of March 31, 1997 and 1996 and the changes during the year is presented below:
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
10. INCOME TAXES
Income taxes included in the consolidated statements of income represent the following:
The difference between the "expected" Federal tax rate and expense computed by applying the statutory tax rate to income before provision for income taxes and the effective tax rate and expense is as follows:
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
11. COMMITMENTS AND CONTINGENCIES
In addition to utilizing facilities leased by Continental Grain, the Company's operations are conducted from leased facilities located in various areas of the United States. These leases have clauses which provide for increases in rent in the event of increases in real estate taxes and maintenance costs. Rental expense for the years ended March 31, 1997, 1996 and 1995 was $3,470, $1,884, and $564, respectively. The Company also has a capital lease on certain machinery and equipment included as part of "Premises and equipment". The future minimum lease payments under the operating and capital leases for the Company, are as follows:
Operating Capital Fiscal Year Leases Leases ----------- ------ ------ 1998 ................................. $ 6,653 $ 362 1999 ................................. 7,580 174 2000 ................................. 7,222 121 2001 ................................. 5,960 64 2002 ................................. 5,159 18 Thereafter ........................... 29,614 0 ------ ------ $ 62,188 $ 739 ======== -------- Less: amounts representing interest ................ (104) --------- Present value of net minimum lease payments .............. 635 Less: current maturties .............. (300) --------- Long-term obligation ................. $ 335 =========
Litigation
The Company is involved in certain litigation arising in the normal course of business. The Company believes that any liability with respect to such legal actions, individually or in the aggregate, is not likely to be material to the Company's consolidated financial position or results of operations.
12. FINANCIAL INSTRUMENTS AND OFF-BALANCE SHEET ACTIVITIES
Sales of Assets with Recourse
During 1997, 1996 and 1995, the Company utilized agreements with financial institutions (the "Purchasers") to sell, with limited recourse, interests in designated pools of securitized and whole loans receivables. Under the agreements, the Purchasers have given the Company a right of first refusal to repurchase such receivables prior to third-party sales. Pursuant to the recourse provisions of these agreements, the Company is responsible for losses incurred by the Purchasers on third-party sales of the receivables up to either 5% or 10% of the sale amounts. The agreements are guaranteed by the Company. The Company monitors its exposure associated with these agreements and records recourse provisions, as necessary, to address this potential exposure. During 1997, 1996 and 1995, the Company utilized these facilities to sell receivables totaling
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
approximately $7,350,000, $5,671,000 and $2,510,000, respectively. At March 31, 1997 and 1996, approximately $591,000 and $565,000, respectively, were outstanding and offset against receivables held for sale.
During 1997, 1996, and 1995, the Company sold, with limited recourse, an interest in certain interest-only and residual certificates for $96,545, $54,500 and $50,000, respectively. At March 31, 1997, 1996 and 1995, $144,926, $90,985 and $50,000, respectively, of these aforementioned sales were outstanding. Under the recourse provisions of the agreements, the Company is responsible for losses incurred by the purchaser within an agreed upon range. The agreements are guaranteed by Continental Grain for an agreed upon fee.
Financial Instruments
SFAS No. 105, "Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk" and SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments" require the disclosure of the notional amount or contractual amounts of financial instruments.
The Company regularly securitizes and sells fixed and variable rate mortgage loan receivables. As part of its interest rate risk management strategy, the Company may choose to hedge its interest rate risk related to its mortgage portfolio and purchase commitments by utilizing financial futures. The Company classifies these futures as hedges of specific loan receivables and purchase commitments. The gains and losses derived from these financial futures are deferred and included in the carrying amounts of the related hedged items and ultimately recognized in income. Deferred gains on the futures used to hedge the anticipated transactions amounted to $2,821, $1,968 and $359 at March 31, 1997, 1996, and 1995, respectively.
The following table identifies the contract and market values of financial instruments as of March 31, 1997, 1996 and 1995.
Market Risk
In the normal course of business the Company enters into various contractual commitments involving forward settlement. These include financial futures contracts and short sales. Commitments involving forward settlement give rise to market risk, which represents the potential loss that can be caused by a change in the market value of a particular financial instrument.
The Company is also exposed to market interest rate risk. A decline in interest rates will typically increase the amount of loan prepayments and decrease the value of the interest-only and residual certificates and capitalized servicing fees receivable. An increase in interest rates may decrease the demand for consumer and commercial credit.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
Periods of economic slowdown or recession may be accompanied by decreased demand for the market for Receivables or declines in real estate values. These factors will influence the Company's ability to obtain and securitize Receivables. During these periods the Company's cost of servicing loans may increase as rates of delinquency and foreclosure increase.
Fair Value of Financial Instruments
The Company's financial instruments recorded at contractual amounts that approximate market or fair value primarily consist of securities purchased under agreements to resell, trade receivables, accounts payable and accrued expenses, securities sold but not yet purchased and trade receivables sold under agreements to repurchase. As these amounts are short term in nature and/or generally bear market rates of interest, the carrying amounts of these instruments are reasonable estimates of their fair values. The carrying amounts of the Company's long-term debt approximate fair value when valued using available quoted market prices.
Credit Risk
The Company is exposed to on-balance sheet credit risk related to its Receivables and interest-only and residual certificates. The Company is exposed to off-balance sheet credit risk related to loans which the Company has committed to originate or buy and loans sold with limited recourse.
The Company utilizes securities purchased under agreements to resell as part of its interest rate management strategy. These instruments expose the Company to credit risk which is measured as the loss the Company would record if counterparties failed to perform pursuant to terms of their contractual obligations and the value of the collateral held, if any, was not adequate to cover such losses. The Company's policy is to take possession of securities purchased under agreements to resell. The Company monitors the market value of the assets acquired to ensure their adequacy as compared to the amount at which the securities will be resold. The Company may require the counterparty to deposit additional collateral or reduce the loan balance when necessary. The interest rate on these instruments depends upon, among other things, the underlying collateral, the term of the agreement and the credit quality of the counterparty. At March 31, 1997 and 1996, these instruments had a weighted average interest rate of 5.1%, and 4.7%, respectively. The Company transacts these resale agreements primarily with three institutional broker/dealers.
The Company is a party to financial instruments with off-balance sheet credit risk in the normal course of business. These financial instruments include commitments to extend credit to borrowers, commitments to purchase loans from correspondents, and recourse provided on loans sold to investors in prior years. The Company has a first or second lien position on all of its loans, and the combined loan-to-value ratio ("CLTV") permitted by the Company's mortgage underwriting guidelines generally may not exceed 85%. The CLTV represents the combined first and second mortgage balances as a percentage of the appraised value or the mortgaged property, with the appraised value determined by an appraiser with appropriate professional designations. A title insurance policy is required for all loans.
As of March 31, 1997 and 1996, the Company had outstanding commitments to extend credit or purchase loans in the amount of $428,234 and $206,314, respectively. As these amounts are short term in nature and/or generally bear market rates of interest, the contractual amounts of these instruments are reasonable estimates of their fair values.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
Commitments to extend credit or to purchase a loan are granted for a period of thirty days and are contingent upon the borrower and the borrower's collateral satisfying the Company's underwriting guidelines. Since many of the commitments are expected to expire without being exercised, the total commitment amount does not necessarily represent future cash requirements or future credit risk.
The Company monitors concentrations of credit risk associated with business conducted with financial institutions and minimizes credit risk by avoiding a concentration with any single financial institution. As of March 31, 1997, and 1996 the majority of loans with on-balance sheet and off-balance sheet risks were collateralized by properties located in the Eastern United States.
Warehousing Exposure
The Company makes warehouse financing available to its securitization clients to facilitate the accumulation of securitizable products prior to securitization. As of March 31, 1997 and 1996, the Company had $1,567,600 and $981,600 of committed warehousing available to its third party clients, of which $566,029 and $425,378, respectively, was drawn down. Warehouse commitments are typically for a term of one year or less and are designated to fund only securitizable assets. Assets from a particular client remain in the warehouse for a period of 90-120 days at which point they are securitized and sold to institutional investors. As these amounts are short term in nature and/or generally bear market rates of interest, the contractual amounts of these instruments are reasonable estimates of their fair values.
13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table presents the quarterly results of operations for the year ended March 31, 1997:
14. SUBSEQUENT EVENT
On June 4, 1997 the Company completed a primary offering of 2,800,000 shares of common stock and an additional 420,000 shares were purchased by the underwriters for over allotments. The proceeds of the offering to the Company, net of estimated expenses and underwriting discount, were $100,778. The proceeds will be used for general corporate purposes, including strategic acquisitions, funding loan originations and purchases, supporting securitization transactions, and other working capital needs. The completion of the offering reduces Continental Grain's ownership of the Company from approximately 81% to approximately 75%.
CONTIFINANCIAL CORPORATION Notes to Consolidated Financial Statements (continued) March 31, 1997, 1996 and 1995 (dollars in thousands)
The consummation of the public offering causes the vesting of certain options granted. The additional vesting would cause options exercisable as of March 31, 1997 to increase to 1,734,311.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Part III.
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The Company incorporates by reference herein information in its proxy statement which complies with the information called for by Item 10 of the Form 10-K. The proxy will be filed at a later date, that is not more than 120 days after the end of the Company's 1997 fiscal year, with the Commission.
Item 11.
Item 11. Executive Compensation
The Company incorporates by reference herein information in its proxy statement which complies with the information called for by Item 11 of the Form 10-K. The proxy will be filed at a later date, that is not more than 120 days after the end of the Company's 1997 fiscal year, with the Commission.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The Company incorporates by reference herein information in its proxy statement which complies with the information called for by Item 12 of the Form 10-K. The proxy will be filed at a later date, that is not more than 120 days after the end of the Company's 1997 fiscal year, with the Commission.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The Company incorporates by reference herein information in its proxy statement which complies with the information called for by Item 13 of the Form 10-K. The proxy will be filed at a later date, that is not more than 120 days after the end of the Company's 1997 fiscal year, with the Commission. Part IV.
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Financial Statements, Financial Statement Schedules and Exhibits.
(1) Financial Statements
See Item 8. "Financial Statements and Supplementary Data."
(2) Financial Statement Schedules
No Financial statement schedules are included because of the absence of the conditions under which they are required or because the information is included in the financial statements or the notes thereto.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, ContiFinancial Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CONTIFINANCIAL CORPORATION
By: /s/ James E. Moore James E. Moore President, Chief Executive Officer and Director Date: June 27, 1997
Pursuant to the requirements of the Securities Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ James E. Moore President, Chief Executive June 27, 1997 James E. Moore Officer and Director (Principal Executive Officer)
/s/ Daniel J. Willett Senior Vice President and Chief June 27, 1997 Daniel J. Willett Financial Officer (Principal Financial Officer)
/s/ Susan E. O'Donovan Vice President and Controller June 27, 1997 Susan E. O'Donovan (Principal Accounting Officer)
* Director and Chairman of the June 27, 1997 James J. Bigham Board
* Director June 27, 1997 Paul J. Fribourg
* Director June 27, 1997 John W. Spiegel
* Director June 27, 1997 Donald L. Staheli
* Director June 27, 1997 John P. Tierney
* Director June 27, 1997 Lawrence G. Weppler
* Director June 27, 1997 Michael J. Zimmerman
* By: /s/ James E. Moore James E. Moore Attorney-In-Fact
Exhibit Index
Exhibit No. Description
11.1 Computation of the Company's pro forma earnings per common share 21.1 List of Subsidiaries of the Company 24.8 Attorneys-In-Fact and Agents for Michael J. Zimmerman 27.1 Financial Data Schedule