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Exhibit a-6
HERITABLE FINANCE LIMITED
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1993, 1994 AND 1995
AND JUNE 30, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
1. ORGANIZATION
Heritable Finance Limited ("the Company") is a consumer finance company
that engages in the business of providing mortgage loans secured primarily by
family residences in the UK. The majority of the Company's loans are second
mortgages made to owners of single family residences who use the loan proceeds
for such purposes as debt consolidation and financing of home improvements,
amongst others.
For the purposes of these financial statements the Group is defined as
Heritable Finance Limited and its subsidiary companies. The principal
subsidiaries at December 31, 1995, which are all registered in England and
Wales, are wholly owned, and are listed below:
Undertaking
Assured Funding Corporation Limited
Greyfriars Financial Services Limited
Heritable Capital Plan Limited
Home and Family Finance Limited
Home Mortgage Corporation Limited
Home Mortgages Limited
Homestead Finance Limited
Secured Funding Limited
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of preparation
The financial statements have been prepared in conformity with generally
accepted accounting principles. The preparation of the financial statements
requires the management of the Company to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as at the date of the financial statements and
the reported revenues and expenses for the reported periods. Actual results
could differ from those estimates.
Combination
The Group financial statements consolidate those of the Company and its
subsidiary companies as at December 31, 1995.
The consideration paid for companies acquired is allocated to each class of
tangible net asset on the basis of the fair value to the Group of those assets
at the date of acquisition. The excess of the purchase consideration over the
fair value of the tangible net assets at the date of acquisition is capitalized
as goodwill and is amortized over a period not exceeding ten years.
Where the purchase consideration is less than the fair value of the
tangible net assets acquired, negative goodwill is recognized which is allocated
against the fair value of any non-current assets acquired. Where non-current
assets are subsequently reduced to zero or, where there are no non-current
assets to allocate negative goodwill against, the balance is carried forward and
amortized over a period not exceeding ten years.
All significant intercompany transactions and balances among the
consolidated entities have been eliminated.
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HERITABLE FINANCE LIMITED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1993, 1994 AND 1995
AND JUNE 30, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
Fees and commission income
Fees are recognized when they have been earned, and have either been paid
or are considered to be recoverable with reasonable certainty.
Acquisition costs
Costs incurred in granting each advance are individually identified, and
are amortized in proportion to income earned on the advance over its term. In
the event of early repayment, any unamortized costs relating to that loan are
written off immediately. The total of unamortized cost at the balance sheet date
is included in advances to customers.
Bad and doubtful debts
Specific provisions are raised on loans which fall more than four
installments in arrears, unless it is evident that the degree of risk on the
loan is significantly increased. In such circumstances, the creation of a
provision is brought forward. Specific provisions are also raised on the
unsecured value of loans (which may be fully performing) to the extent that
there is a shortfall in security, and also where the outstanding loan balance
taken as a whole represents in excess of 150% of the loan balance at inception.
When there is no prospect of recovery, outstanding debt is written off.
In addition, general provisions are made having regard to the overall size
and characteristics of the Group's loan portfolio.
Furniture, equipment and vehicles, net
Furniture, equipment and vehicles, net are stated at original cost less
accumulated depreciation and amortization. Depreciation is computed principally
by using the straight line method based on the estimated lives of the
depreciable assets which are between three and five years.
Expenditures for maintenance and repairs are charged directly to the
appropriate operating account at the time the expense is incurred. Expenditures
determined to represent additions and betterments are capitalized. The cost of
assets sold or retired and the related amounts of accumulated depreciation are
eliminated from the accounts in the year of sale or retirement. Any resulting
profit or loss is reflected in the statement of operations.
Mortgage loans held for investment, net
Interest income includes income from mortgage loans held for investment,
and is recognized on an accrual basis.
SFAS No. 114 "Accounting by Creditors for Impairment of a Loan" (SFAS 114)
as amended by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan --
Income Recognition and Disclosures" (SFAS 118) is effective for accounting
periods beginning after December 15, 1994. SFAS 114 addresses accounting by
creditors for impairment of a loan by specifying how allowances for credit
losses for certain loans should be determined. A loan is impaired when it is
probable that the creditor will be unable to collect all amounts in accordance
with the contractual terms of the loan agreement. As an expedient, impairment is
measured based on the fair value of the loan's collateral.
At December 31, 1995, the Group's net investment in non-accrual loans was
$36,097,950 after specific provisions of $13,004,578. The average net investment
during 1995 in such loans was $41,381,164. These
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HERITABLE FINANCE LIMITED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1993, 1994 AND 1995
AND JUNE 30, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
disclosures are based on the Group's provisioning policy as described above and
accordingly include loans where impairment is possible rather than probable.
Income Taxes
United Kingdom corporation tax and overseas taxes are provided, at
appropriate rates, on the taxable profits for the year.
Fair value of financial instruments
SFAS No. 107 "Disclosures about Fair Value of Financial Instruments" (SFAS
107) requires disclosure of fair value information about financial instruments,
whether or not recognized in the statement of financial condition for which it
is practicable to estimate that value. In cases where quoted market prices are
not available, fair value is based upon estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and the estimated future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. SFAS 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amount does not represent the underlying
value of the Company.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value.
Cash
The carrying amount of cash on hand is considered to be a reasonable
estimate of fair market value.
Mortgage loans held for investment
The carrying value of loans held for investment is considered to be a
reasonable estimate of the fair market value.
Foreign currency translation
The functional currency of the Group is pounds' sterling. Assets and
liabilities are translated to USD rates current on December 31. Profit and loss
items are translated at average rates of exchange for the period. Exchange
differences arising from translation are taken to reserves.
3. INCOME TAXES
The provision for income taxes is summarized as follows:
DECEMBER 31, DECEMBER 31,
1994 1995
DOLLARS IN DOLLARS IN
THOUSANDS THOUSANDS
------------ ------------
Current:
UK corporation tax......................................... $1,003 $1,697
Deferred................................................... 92 430
------------ ------------
$1,095 $2,127
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HERITABLE FINANCE LIMITED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1993, 1994 AND 1995
AND JUNE 30, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
The reconciliation of income tax computed at the UK corporation tax rate to
the effective income tax rate is as follows:
DECEMBER 31, DECEMBER 31,
1994 1995
------------ ------------
UK corporation tax rate...................................... 33.0% 33.0%
Release of deferred tax valuation allowance.................. (6.3) --
Other........................................................ 0.7 (0.1)
------------ ------------
27.4% 32.9%
========== ==========
Deferred taxes are summarized as follows:
DECEMBER 31, DECEMBER 31,
1994 1995
DOLLARS IN DOLLARS IN
THOUSANDS THOUSANDS
------------ ------------
Deferred tax liabilities
Arising from tax treatment of acquisition costs.......... $ 681 $ 1,110
------------ ------------
Gross deferred tax assets
Capital allowances and depreciation...................... 47 55
General provision..................................... 542 594
Other................................................. -- 31
------------ ------------
589 680
------------ ------------
Net deferred tax liabilities............................... $ 92 $ 430
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4. RESERVE FOR LOSSES
The activity in the reserve for losses on mortgage loans held for
investment is summarized as follows:
Specific reserve
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------------------------
1993 1994 1995
DOLLARS IN DOLLARS IN DOLLARS IN
THOUSANDS THOUSANDS THOUSANDS
------------ ------------ ------------
Balance at beginning of year.................. $ 5,726 $ 4,844 $ 12,267
Acquisition of former associate company....... -- 5,029 --
Provision for losses.......................... 2,883 4,890 4,380
Charge-offs................................... (3,430) (2,646) (3,002)
Recoveries.................................... (215) (271) (533)
Foreign currency translation adjustment....... (120) 421 (107)
------------ ------------ ------------
Balance at end of year........................ $ 4,844 $ 12,267 $ 13,005
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HERITABLE FINANCE LIMITED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1993, 1994 AND 1995
AND JUNE 30, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
General Reserve
FOR THE YEAR ENDED
DECEMBER 31,
----------------------------------------------
1993 1994 1995
DOLLARS IN DOLLARS IN DOLLARS IN
THOUSANDS THOUSANDS THOUSANDS
------------ ------------ ------------
Balance at beginning of year.................. $ 1,108 $ 851 $ 1,729
Acquisition of former associate company....... -- 685 --
Provision for losses.......................... (234) 126 87
Foreign currency translation adjustment....... (23) 67 (15)
------------ ------------ ------------
Balance at end of year........................ $ 851 $ 1,729 $ 1,801
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The amounts in the reserve for losses are expressed gross. The Company
continues to record interest on impaired assets as an addition to the related
mortgage loan balance. The amount of interest credited on these loans amounted
to $3,649,561, $2,562,669 and $1,620,863 for the years ended December 31, 1995,
1994 and 1993, respectively. However, these amounts are offset by a
corresponding charge to the reserve for losses, such that the net balance of
mortgage loans held for investment after deducting the reserve for losses
remains unchanged.
5. FURNITURE, EQUIPMENT AND VEHICLES, NET
Furniture, equipment and vehicles, net at cost are summarized as follows:
DECEMBER 31, DECEMBER 31,
1994 1995
DOLLARS IN DOLLARS IN
THOUSANDS THOUSANDS
------------ ------------
Furniture.................................................. $ 305 $ 65
Equipment.................................................. 1,628 710
Vehicles................................................... 302 335
------------ ------------
2,235 1,110
Less: accumulated depreciation............................. (1,711) (522)
------------ ------------
Furniture, equipment and vehicles, net..................... $ 524 $ 588
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6. AMOUNTS OWED TO THE HERITABLE AND GENERAL INVESTMENT BANK
DECEMBER 31, DECEMBER 31,
1994 1995
DOLLARS IN DOLLARS IN
THOUSANDS THOUSANDS
------------ ------------
Advances from The Heritable and General Investment Bank
Limited........................................................ $158,684 $170,766
Group relief payable............................................. 442 262
Dividend payable................................................. 3,911 --
-------- --------
$163,037 $171,028
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At December 31, 1995, advances of $152,494,819 bear interest at market
rates based on the three-month LIBOR rate plus a margin of 0.9%. The remaining
$18,270,997 bears no interest.
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HERITABLE FINANCE LIMITED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1993, 1994 AND 1995
AND JUNE 30, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
7. ACQUISITION OF HOME MORTGAGES LIMITED
On July 29, 1994, Heritable Finance Limited acquired the entire share
capital of Home Mortgages Limited.
The acquisition was accounted for under the purchase method of accounting.
The excess of the fair value of tangible net assets acquired over the
consideration paid gave rise to negative goodwill of $2,159,838 which has been
carried forward as a deferred credit and is being amortized over a period of ten
years.
8. EMPLOYEE BENEFIT PLAN
Heritable Finance Limited is a member of a non-contributory defined
benefits pension plan, The Heritable Group Retirement and Death Benefits Scheme.
Employees become eligible to join the plan following a probationary employment
period of six months and a minimum age of twenty-five years.
During the year ended December 31, 1995, $507,578 (1994: $436,578; 1993:
$394,242) was recognized as pension costs in the profit and loss account.
9. CONCENTRATION OF RISK
The Company operates as a mortgage provider in the UK domestic market with
various regional concentrations and is therefore vulnerable to fluctuations in
the UK housing market. For the year ended December 31, 1995 and 1994, there were
no customers who individually accounted for 10% or more of total revenues.
10. SUBSEQUENT EVENTS
At December 31, 1995, the Company was owned by The Heritable and General
Investment Bank Limited whose ultimate parent company was CoreStates Financial
Corp., a company incorporated in the US.
On June 14, 1996, Heritable Finance Limited was acquired by City Mortgage
Corporation Limited, an indirect wholly-owned subsidiary of Cityscape Financial
Corp., in exchange for cash and shares of that company's common stock.
Cityscape Financial Corp. is a US incorporated consumer finance company,
engaged in the business of originating, purchasing, selling and servicing
mortgage loans secured primarily by one- to four-family residences.
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HERITABLE FINANCE LIMITED
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1993, 1994 AND 1995
AND JUNE 30, 1995 (UNAUDITED) AND 1996 (UNAUDITED)
11. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases premises and equipment under operating leases with
various expiration dates. Both leases are subject to renegotiation every five
years. Minimum annual rental payments at December 31, 1995 are as follows:
DOLLARS IN
YEAR ENDED THOUSANDS
--------------------------------------------------------------------------- ----------
1996....................................................................... $ 331
1997....................................................................... 331
1998....................................................................... 331
1999....................................................................... 331
2000....................................................................... 331
Thereafter................................................................. 3,338
------
Total...................................................................... $4,993
======
Rent expense for office space amounted to $333,070, $265,188 and $316,962
for the years ended December 31, 1995, 1994 and 1993, respectively.
Litigation
In the normal course of business, the Company is subject to various legal
proceedings and claims, the resolution of which, in management's opinion, will
not have a material adverse effect on the consolidated statements of financial
condition or on the related consolidated statements of operations, stockholders'
equity and cash flows of the Company.
12. LOAN COMMITMENTS
At December 31, 1995 and 1994 there were no material undrawn loan
commitments.
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