1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER: 0-27314
CITYSCAPE FINANCIAL CORP.
DELAWARE 11-2994671
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (IRS EMPLOYER IDENTIFICATION NO.)
565 TAXTER ROAD, ELMSFORD, NEW YORK 10523-2300
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(914) 592-6677
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
____________________________________________________
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR IF CHANGED SINCE LAST
REPORT)
INDICATE BY CHECK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO
BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
___ ___
APPLICABLE ONLY TO CORPORATE ISSUERS:
52,810,782 SHARES $.01 PAR VALUE,
OF COMMON STOCK, WERE OUTSTANDING AS OF MAY 11, 1998
2
CITYSCAPE FINANCIAL CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 1998
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Statements of Financial Condition at March 31, 1998 and
December 31, 1997 2
Consolidated Statements of Operations for the three months ended
March 31, 1998 and 1997 3
Consolidated Statements of Cash Flows for the three months ended March
31, 1998 and 1997 4
Notes to Consolidated Financial Statements 5-9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 10-22
PART II - OTHER INFORMATION 23-27
3
CITYSCAPE FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(UNAUDITED)
MARCH 31, DECEMBER 31,
1998 1997
------------- -------------
ASSETS
Cash and cash equivalents $ 3,104,365 $ 2,594,163
Cash held in escrow 14,793,197 24,207,517
Mortgage servicing receivables 7,338,248 9,524,535
Trading securities 96,363,044 126,475,656
Mortgage loans held for sale, net 19,678,097 93,290,024
Mortgages held for investment, net 8,199,764 6,530,737
Equipment and leasehold improvements, net 5,709,335 6,058,206
Investment in discontinued operations, net 95,155,892 84,232,000
Income taxes receivable 18,376,570 18,376,574
Other assets 27,878,084 27,267,770
------------- -------------
Total assets $ 296,596,596 $ 398,557,182
============= =============
LIABILITIES
Warehouse financing facilities $ 12,257,521 $ 77,479,007
Accounts payable and other liabilities 72,960,124 63,427,810
Allowance for losses 7,338,647 4,555,373
Income taxes payable 2,427,711 300,000
Notes and loans payable 300,000,000 300,000,000
Convertible subordinated debentures 129,620,000 129,620,000
------------- -------------
Total liabilities 524,604,003 575,382,190
------------- -------------
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock, $.01 par value, 10,000,000 shares authorized;
5,295 shares issued and outstanding; Liquidation
Preference - Series A Preferred Stock, $6,988,019; Series B
Preferred Stock, $51,466,657 at March 31, 1998; 5,295 shares issued
and outstanding; Liquidation Preference - Series A Preferred Stock,
$6,820,800; Series B Preferred Stock, $47,046,745 at December 31, 1997 53 53
Common stock, $.01 par value, 100,000,000 shares authorized;
47,648,738 issued and outstanding at March 31, 1998 and
December 31, 1997 476,487 476,487
Treasury stock, 70,000 shares at March 31, 1998 and December 31, 1997,
at cost (175,000) (175,000)
Additional paid-in capital 175,477,104 175,477,104
Retained earnings (accumulated deficit) (403,786,051) (352,603,652)
------------- -------------
Total stockholders' equity (deficit) (228,007,407) (176,825,008)
------------- -------------
COMMITMENTS AND CONTINGENCIES
------------- -------------
Total liabilities and stockholders' equity (deficit) $ 296,596,596 $ 398,557,182
============= =============
See accompanying notes to consolidated financial statements.
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4
CITYSCAPE FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1998 1997
------------ ------------
REVENUES
(Loss) gain on sale of loans $ (4,425,047) $ 26,775,590
Net unrealized loss on valuation of residuals (7,100,000) --
Interest 3,201,928 17,695,223
Mortgage origination income 899,308 784,130
Other 233,012 294,440
------------ ------------
Total revenues (7,190,799) 45,549,383
------------ ------------
EXPENSES
Salaries and employee benefits 9,771,879 10,756,244
Interest expense 14,181,530 15,625,268
Selling expenses 969,903 646,898
Other operating expenses 15,684,469 6,373,345
Restructuring charge 3,233,760 --
------------ ------------
Total expenses 43,841,541 33,401,755
------------ ------------
(Loss) earnings from continuing operations
before income taxes (51,032,340) 12,147,628
Income tax provision 150,059 4,661,533
------------ ------------
(Loss) earnings from continuing operations (51,182,399) 7,486,095
Discontinued operations:
Earnings from discontinued operations,
net of income tax provision of $6,534,994 in 1997 -- 9,308,696
------------ ------------
Net (loss) earnings (51,182,399) 16,794,791
Preferred stock dividends - increase in liquidation preference 1,570,356 --
Preferred stock - default payments 3,016,774 --
------------ ------------
NET (LOSS) EARNINGS APPLICABLE TO COMMON STOCK $(55,769,529) $16,794,791
============ ============
Earnings (loss) per common share:
Basic
(Loss) earnings from continuing operations $ (1.17) $ 0.25
Earnings from discontinued operations -- 0.32
------------ ------------
Net (loss) earnings $ (1.17) $ 0.57
============ ============
Diluted
(Loss) earnings from continuing operations $ (1.17) $ 0.24
Earnings from discontinued operations -- 0.30
============ ============
Net (loss) earnings $ (1.17)(1) $ 0.54
============ ============
Weighted average number of common shares outstanding:
Basic 47,578,738 29,724,252
============ ============
Diluted 47,578,738(1) 30,880,485
============ ============
(1) For the three months ended March 31, 1998, the incremental shares from
assumed conversions are not included in computing the diluted per share
amounts because their effect would be antidilutive since an increase in the
number of shares would reduce the amount of loss per share. Therefore,
basic and diluted EPS figures are the same amount.
See accompanying notes to consolidated financial statements.
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5
CITYSCAPE FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1998 1997
------------- -------------
Cash flows from operating activities:
(Loss) earnings from continuing operations $ (51,182,399) $ 7,486,095
Adjustments to reconcile net (loss) earnings from continuing
operations to net cash used in continuing operating activities:
Depreciation and amortization 635,747 239,560
Income taxes payable 2,127,711 676,526
Unrealized gain on securities -- (656,250)
Decrease in mortgage servicing receivables 2,186,288 16,182,288
Decrease (increase) in trading securities 30,112,612 (51,848,955)
Net purchases of securities under agreements to resell -- 104,408,656
Proceeds from securities sold but not yet purchased -- (103,335,506)
Proceeds from sale of mortgages 251,232,531 364,218,058
Mortgage origination funds disbursed (185,812,768) (389,765,219)
Other, net 26,145,939 12,222,056
------------- -------------
Net cash provided by (used in) continuing operating activities 75,445,661 (40,172,691)
------------- -------------
Net cash used in discontinued operating activities (10,923,892) (10,755,611)
------------- -------------
Net cash provided by (used in) operating activities 64,521,769 (50,928,302)
------------- -------------
Cash flows from investing activities:
Purchases of equipment (286,877) (2,306,342)
Proceeds from sale of mortgages held for investment 1,496,796 --
------------- -------------
Net cash provided by (used in) investing activities 1,209,919 (2,306,342)
------------- -------------
Cash flows from financing activities:
(Decrease) increase in warehouse financings (65,221,486) 10,228,465
Proceeds from notes and loans payable -- 49,000,000
Repayment of notes and loans payable -- (6,417,228)
Net proceeds from issuance of common stock -- 309,625
------------- -------------
Net cash (used in) provided by financing activities (65,221,486) 53,120,862
------------- -------------
Net increase (decrease) in cash and cash equivalents 510,202 (113,782)
Cash and cash equivalents at beginning of period 2,594,163 446,285
------------- -------------
Cash and cash equivalents at end of period $ 3,104,365 $ 332,503
============= =============
Supplemental disclosure of cash flow information:
Income taxes paid during the period:
Continuing operations $ 1,200 $ 4,628,346
============= =============
Discontinued operations $ -- $ --
============= =============
Interest paid during the period:
Continuing operations $ 2,145,176 $ 7,253,674
============= =============
Discontinued operations $ -- $ 441,000
============= =============
See accompanying notes to consolidated financial statements.
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CITYSCAPE FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
1. Organization
Cityscape Financial Corp. ("Cityscape" or the "Company") is a consumer
finance company that, through its wholly-owned subsidiary, Cityscape Corp.
("CSC"), engages in the business of originating, purchasing, selling and
servicing mortgage loans secured primarily by one- to four-family residences.
The majority of the Company's loans are made to owners of single family
residences who use the loan proceeds for such purposes as debt consolidation,
financing of home improvements and educational expenditures, among others. CSC
is licensed or registered to do business in 46 states and the District of
Columbia. The Company commenced operations in the United Kingdom in May 1995
with the formation of City Mortgage Corporation Limited ("CSC-UK"), an English
corporation that originates, sells and services loans in England, Scotland and
Wales in which the Company initially held a 50% interest and subsequently
purchased the remaining 50%. CSC-UK had no operations and no predecessor
operations prior to May 1995. In April 1998, the Company sold all of the assets,
and certain liabilities, of CSC-UK (see Note 3).
2. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and the instructions to Form 10-Q and do not include all
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments consisting of normal recurring accruals, considered necessary for a
fair presentation of the results for the interim period have been included.
Operating results for the three months ended March 31, 1998 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1998. The accompanying consolidated financial statements and the information
included under the heading "Management's Discussion and Analysis of Financial
Condition and Results of Operations" should be read in conjunction with the
consolidated financial statements and related notes of the Company for the year
ended December 31, 1997.
The Company's consolidated financial statements have been prepared on a
going concern basis, which contemplates continuity of operations, realization of
assets and the liquidation of liabilities and commitments in the normal course
of business. The Company's operations for 1997 and the first quarter of 1998
have consumed substantial amounts of cash and have generated significant net
losses which have reduced stockholders' equity to a deficit of $228.0 million at
March 31, 1998. The Company is unable to access the capital markets, which
negatively affects profitability, as well as liquidity. The profitability of the
Company has been and will be adversely affected due to an inability to sell its
loan production through securitizations. Furthermore, many of the loan products
previously offered by the Company have been discontinued, and the Company
anticipates that its revenues will be substantially lower in 1998 than in 1997.
These matters raise substantial doubt about the Company's ability to continue as
a going concern. Management believes that the Company's future success is
dependent upon its ability to (i) streamline its operations, (ii) successfully
sell loans in the whole loan sales market, (iii) restructure its balance sheet,
(iv) access warehouse lines of credit and (v) retain an adequate number and mix
of its employees. The Company has begun reducing costs and has expanded its
secondary marketing and sales efforts to pursue whole loan sales opportunities.
The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
The consolidated financial statements of the Company include the
accounts of CSC and its wholly-owned subsidiaries. The Company has restated its
prior financial statements to present the operating results of CSC-UK as a
discontinued operation as discussed in Note 3. All significant intercompany
balances and transactions have been eliminated in consolidation.
Certain amounts in the statements have been reclassified to conform
with the 1998 classifications.
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3. The CSC-UK Sale; Discontinued Operations
As a result of liquidity constraints, the Company adopted a plan in
March 1998 to sell the assets of CSC-UK (the "CSC-UK Sale"). CSC-UK focused on
lending to individuals who are generally unable to obtain mortgage financing
from conventional UK sources such as banks and building societies because of
impaired or unsubstantiated credit histories and/or unverifiable income, or who
otherwise choose not to seek financing from conventional lenders. CSC-UK
originated loans in the UK through a network of independent mortgage brokers
and, to a lesser extent, through direct marketing to occupants of
government-owned residential properties in the UK.
In April 1998, pursuant to an Agreement for the Sale and Purchase of
the Business of CSC-UK and its Subsidiaries and the Entire Issued Share Capital
of City Mortgage Receivables 7 Plc, dated March 31, 1998 (the "UK Sale
Agreement"), the Company completed the sale to Ocwen Financial Corporation
("Ocwen") and Ocwen Asset Investment Corp. ("Ocwen Asset") of substantially all
of the assets, and certain liabilities, of the UK operations of CSC-UK (the "UK
Sale"). The sale did not include the assumption by Ocwen of all of CSC-UK's
liabilities, and therefore, no assurances can be given that claims will not be
made against the Company in the future arising out of its former UK operations.
Such claims could have a material adverse effect on the Company's financial
condition and results of operations. The UK Sale included the acquisition by
Ocwen of CSC-UK's whole loan portfolio and loan origination and servicing
businesses for a price of pound sterling 249.6 million, the acquisition by Ocwen
Asset of CSC-UK's securitized loan residuals for a price of pound sterling 33.7
million and the assumption by Ocwen of pound sterling 7.2 million of CSC-UK's
liabilities. The price paid by Ocwen is subject to adjustment to account for the
actual balances on the closing date of the loan portfolio and the assumed
liabilities. As a result of the sale, the Company received net proceeds of
approximately $102 million, less the costs of approximately $16 million related
to the disposal of UK discontinued operations.
Accordingly, the operating results of CSC-UK and its subsidiaries have
been segregated from continuing operations and reported as a separate line item
on the Company's financial statements. In addition, net assets of CSC-UK have
been reclassified on the Company's financial statements as investment in
discontinued operations. The Company has restated its prior financial statements
to present the operating results of CSC-UK as a discontinued operation.
4. New Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 defines
internal-use software and establishes accounting standards for the costs of such
software. The Company has not completed its analysis of SOP 98-1.
5. Earnings Per Share
Effective December 15, 1997, the Company adopted SFAS No. 128,
"Earnings per Share". SFAS No. 128 simplifies the standards for computing
earnings per share ("EPS") previously found in Accounting Principles Board
Opinion No. 15 and makes them comparable to international earnings per share
standards. It replaces the presentation of primary EPS with a presentation of
basic EPS. It also requires dual presentation of basic and diluted EPS on the
face of the income statement for all entities with complex capital structures
and requires a reconciliation of the numerator and denominator for the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
Basic EPS is computed by dividing net earnings applicable to Common
Stock by the weighted average number of Common Stock outstanding during the
period. Diluted EPS is based on the net earnings applicable to Common Stock
adjusted to add back the effect of assumed conversions (e.g., after-tax interest
expense of convertible debt) divided by the weighted average number of Common
Stock outstanding during the period plus the dilutive potential Common Stock
that were outstanding during the period.
The reconciliation of the numerators and denominators of the basic and
diluted EPS computations for the three months ended March 31, 1998 and 1997 is
as follows:
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INCOME SHARES PER SHARE
1998 (NUMERATOR) (DENOMINATOR) AMOUNT
- -------------------------------------------- ----------- ------------- ---------
Loss from continuing operations ($51,182,399)
Less: Preferred stock dividends 1,570,356
Less: Preferred stock default payments 3,016,774
------------
BASIC EPS
Earnings (loss) applicable to Common Stock (55,769,529) 47,578,738 ($1.17)
========
EFFECT OF DILUTIVE SECURITIES
Warrants --
Stock options --
Convertible preferred stock --
Convertible Debentures --
------------ ----------
DILUTED EPS
Loss applicable to Common Stock+
assumed conversions ($55,769,529) 47,578,738 ($1.17)
============ ========== ========
1997
- --------------------------------------------
Earnings from continuing operations $7,486,095
Less: Preferred stock dividends --
------------
BASIC EPS
Earnings applicable to Common Stock 7,486,095 29,724,252 $0.25
========
Effect of Dilutive Securities
Warrants --
Stock options 1,156,233
Convertible Debentures --
------------ ----------
DILUTED EPS
Earnings applicable to Common Stock+
assumed conversions $7,486,095 30,880,485 $0.24
============ ========== ========
For the three months ended March 31, 1998, the incremental shares from
assumed conversions are not included in computing the diluted per share amounts
because their effect would be antidilutive since an increase in the number of
shares would reduce the amount of loss per share. Securities outstanding at
March 31, 1998 that could potentially dilute basic EPS in the future are as
follows: Convertible Debentures; Series A Preferred Stock; Series B Preferred
Stock; Series A Warrants; Series B Warrants (as such terms are defined below);
and options to purchase the Company's Common Stock, par value $0.01 per share
(the "Common Stock"). For the three months ended March 31, 1997, the effect of
the Convertible Debentures is antidilutive and is not included in the
computation of diluted EPS.
6. Restructuring
In February 1998, the Company announced that it has begun implementing
a restructuring plan that includes streamlining and downsizing its operations.
The Company has closed its branch operation in Virginia and significantly
reduced its correspondent originations for the foreseeable future and has exited
its conventional lending business. Accordingly, the Company has recorded a
restructuring charge of $3.2 million. Of this amount, $1.1 million represents
severance payments made to 142 former employees and $2.1 million represents
costs incurred in connection with lease obligations and write-offs of assets no
longer in service.
7. Valuation of Residuals
The interests that the Company receives upon loan sales through its
securitizations are in the form of interest-only and residual mortgage
securities which are classified as trading securities.
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The table below summarizes the value of the Company's trading
securities by product type.
March 31, December 31,
1998 1997
------------ ------------
Home Equity $ 43,303,778 $ 75,216,390
Sav*-A-Loan (R) 53,059,266 51,259,266
------------ ------------
$ 96,363,044 $126,475,656
============ ============
In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 115, the Company classifies the interest-only and residual certificates as
"trading securities" and, as such, they are recorded at their fair value. Fair
value of these certificates is determined based on various economic factors,
including loan types, sizes, interest rates, dates of origination, terms and
geographic locations. The Company also uses other available information such as
reports on prepayment rates, interest rates, collateral value, economic
forecasts and historical default and prepayment rates of the portfolio under
review. If the fair value of the interest-only and residual certificates is
different from the recorded value, the unrealized gain or loss will be reflected
on the Consolidated Statements of Operations.
The unrealized loss on valuation of residuals of $7.1 million recorded
in the three months ended March 31, 1998 reflects an increase in the expected
default rate on the Company's home equity securitizations. As a result of the
recent increase in the volume of home equity loan liquidations resulting from
the Company's increased liquidation efforts, and corresponding higher losses
experienced than previously expected on such liquidations, the Company increased
its default rate assumption to 3.3% per annum at March 31, 1998 from 1.7% per
annum at December 31, 1997. At March 31, 1998 and December 31, 1997, the Company
used a weighted average discount rate of 15% and a weighted average prepayment
speed of 31.8% after the twelfth month.
For the periods ended March 31, 1998 and December 31, 1997, the
assumptions used to value the Sav*-A-Loan(R) trading securities included a
weighted average discount rate of 15%, a weighted average default rate of 3.0%
and a weighted average constant prepayment speed of 16.8%.
In order to enhance the Company's liquidity position, in January 1998,
the Company sold residual certificates and associated mortgage servicing
receivables relating to certain of the Company's home equity loan products for
net proceeds of $26.5 million (which equated to the book value at December 31,
1997).
8. Comprehensive Income
During the first quarter of 1998, the Company adopted SFAS No. 130,
"Reporting Comprehensive Income". SFAS No. 130 requires the reporting of
comprehensive income in addition to net income from operations. Comprehensive
income is a more inclusive financial reporting methodology that includes
disclosure of certain financial information that historically has not been
recognized in the calculation of net income. The financial statements reflect
the adoption of SFAS No. 130.
Total comprehensive income (loss) for the three months ended March 31,
1998 and 1997 was ($55.8) million and $10.6 million, respectively. For the
three months ended March 31, 1997, comprehensive income represented net income
of $16.8 million and other comprehensive income (loss) of ($6.2) million, as
detailed below.
Before Tax Tax Benefit After Tax
------------ ------------ ------------
Unrealized holding losses $ (1,699,278) $ 652,013 $(1,047,265)
Foreign currency translation (8,419,719) 3,320,646 (5,189,073)
------------ ---------- -----------
$(10,118,997) $3,882,659 $(6,236,338)
============ ========== ===========
9. Subsequent Events
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The Company deferred the May 1, 1998 interest payment on its 6%
Convertible Subordinated Debentures due 2006 (the "Convertible Debentures") as
part of its plan to reorganize its business. During the contractual 30-day cure
period following such a deferral, the Company is continuing its dialogue with
major bondholders to restructure its balance sheet.
In May 1998, Moody's Investors Service ("Moody's") lowered its rating
of the Company's 12-3/4% Senior Notes due 2004 to Ca from Caa3, as well as its
ratings on the Company's Convertible Debentures to C from Ca. Also, in May 1998,
Standard and Poor's Ratings Services ("S&P") withdrew its CCC counterparty
credit rating on the Company and placed its CCC rating on the Company's Notes
(as defined below) on "CreditWatch". These reductions in the ratings of the
Company's debt will likely increase the Company's future borrowing costs.
On May 1, 1998, the Company was informed by the Nasdaq Stock Market,
Inc. ("Nasdaq") that the Company's Common Stock would be delisted from the
Nasdaq SmallCap Market effective with the close of business on May 1, 1998, and
that the Company does not meet the criteria necessary for immediate eligibility
for quotation on the OTC Bulletin Board. As a result of this delisting, it is
likely that the liquidity of the Company's Common Stock will be materially
impaired which is likely to materially and adversely affect the price of the
Common Stock.
In November 1997, Resource Mortgage Banking, Ltd., Covino and Company,
Inc. and LuxMac LLC filed against the Company, CSC and two of the Company's
officers and directors in state court in Connecticut an application for a
prejudgment remedy. The object of the application for the prejudgment remedy was
to obtain a court order granting these plaintiffs prejudgment attachment against
assets of the Company and CSC in Connecticut pending resolution of plaintiffs'
underlying claims. Plaintiffs proposed to file an 18 count complaint against the
defendants seeking $60 million in purported damages, injunctive relief, treble
damages and punitive damages in an unspecified sum. In February 1998, Judge
William B. Lewis orally granted defendants' motion to dismiss on the ground of
forum non conveniens and entered a judgment of dismissal, and shortly
thereafter, set in a memorandum of decision his reasons for granting the motion
to dismiss. Plaintiffs did not file an appeal of the order of dismissal.
In February 1998, Resource Mortgage Banking, Ltd., Covino and Company,
Inc. and LuxMac LLC filed an action against the Company, CSC and two of the
Company's officers and directors in state court in New York seeking $60 million
in purported damages, injunctive relief, treble damages and punitive damages in
an unspecified sum.
In March 1998, plaintiffs sought a preliminary injunction to prevent
the Company and CSC from selling certain assets known as strip, residuals,
excess servicing and/or servicing rights and their substantial equivalent having
as constituent any mortgage loan exceeding $350,000 generated by the Company or
CSC between September 2, 1994, and April 1, 1997, and any mortgage loan
exceeding $500,000 generated by the Company or CSC from April 1, 1997 to the
present. The New York Court signed a temporary restraining order that required
the Company and CSC to refrain from the specified sales.
Settlement discussions commenced after plaintiffs' motion for
preliminary injunction was fully submitted. Settlement negotiations were
concluded and the litigation was settled shortly after the New York Court issued
a decision in plaintiffs' favor. The Company paid and expensed $2.0 million to
plaintiffs, and the Company, CSC and the defendant officers and directors gave
releases in favor of the plaintiffs. Plaintiffs agreed to discontinue their
claims with prejudice, withdraw as moot their motion for injunctive relief,
consent to vacatur of injunctive relief in the litigation and gave releases in
favor of the Company, CSC, and the defendant officers and directors.
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PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements which
involve risks and uncertainties. The Company's actual results could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors including, but not limited to, the ability to access
loan warehouse or purchase facilities in amounts, if at all, necessary to fund
the Company's loan production, the successful implementation of loan sales in
the whole loan sales market, the ability of the Company to successfully
restructure its balance sheet, the initiative to streamline the Company's
operations, the ability of the Company to retain an adequate number and mix of
its employees, legal proceedings and other matters, adverse economic conditions
and other risks detailed from time to time in the Company's Securities and
Exchange Commission (the "Commission") Reports. The Company undertakes no
obligation to release publicly any revisions to these forward-looking statements
to reflect events or circumstances after the date hereof or to reflect the
occurrence of anticipated or unanticipated events.
GENERAL
The Company is a consumer finance company engaged in the business of
originating, purchasing, selling and servicing mortgage loans secured primarily
by one- to four-family residences. The majority of the Company's loans are made
to owners of single family residences who use the loan proceeds for such
purposes as debt consolidation and financing of home improvements and
educational expenditures, among others. The Company is licensed or registered to
do business in 46 states and the District of Columbia.
For the last several months, the Company has been operating in an
increasingly difficult environment and the Company expects to continue to
operate in this environment for the foreseeable future. The market price of the
Common Stock has fallen from a high during the first quarter of 1997 of $32.00
to a low during the fourth quarter of 1997 of $0.25. The Company's operations
for 1997 and the first quarter of 1998 have consumed substantial amounts of cash
and have generated significant net losses, which have reduced stockholders'
equity to a deficit of $228.0 million at March 31, 1998. Because the Company has
been operating on a negative cash flow basis over the last few years, the
Company's ability to operate is dependent upon continued access to loan
warehouse facilities and loan purchase facilities. The Company is unable to
access the capital markets and is experiencing great difficulties in maintaining
or securing loan warehouse or purchase facilities. The terms of the Company's
current loan warehouse and purchasing facilities are less advantageous to
the Company than the terms of the Company's prior facilities. The Company
expects that its difficulties in accessing capital, which has had a negative
impact on liquidity as well as profitability, will continue for the foreseeable
future. The profitability of the Company has been and will continue to be
adversely affected due to an inability to sell its loan production through
securitizations. Furthermore, primarily due to a reduction in the Company's
Correspondent Loan Acquisition Program, through which the Company originated a
significant portion of its loan production from selected financial institutions
and mortgage bankers known as loan correspondents, and the discontinuation of
many of the loan products previously offered by the Company, the Company
anticipates that its revenues will be substantially lower in 1998 than in 1997.
There is substantial doubt about the Company's ability to continue as a going
concern. The Company believes that its future success is dependent upon its
ability to (i) access loan warehouse or purchase facilities, (ii) successfully
sell loans in the whole loan sales market, (iii) restructure its balance sheet,
(iv) streamline its operations and (v) retain an adequate number and mix of its
employees. No assurance can be given that the Company will be able to achieve
these results.
The Company's stockholders' deficit, recent losses and need to
restructure its balance sheet create serious risks of loss for the holders of
the Company's debt and equity securities. No assurances can be given that the
Company will be successful in its restructuring efforts, or, that as a result of
such efforts, the value of the Company's debt and equity securities will not be
materially impaired. In particular, the Company can give no assurances that a
successful restructuring will not result in a material impairment of the value
of the Convertible Debentures or a severe or complete impairment of the value of
the Company's preferred and common equity. The extent of any such impairment
will depend on many factors including the outcome of
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the Company's discussions with its senior noteholders as well as other factors
set forth in the paragraph discussing forward-looking statements above.
THE CSC-UK SALE; DISCONTINUED OPERATIONS
As a result of liquidity constraints, the Company adopted a plan in
March 1998 to sell the assets of CSC-UK. CSC-UK focused on lending to
individuals who are generally unable to obtain mortgage financing from
conventional UK sources such as banks and building societies because of impaired
or unsubstantiated credit histories and/or unverifiable income, or who otherwise
choose not to seek financing from conventional lenders. CSC-UK originated loans
in the UK through a network of independent mortgage brokers and, to a lesser
extent, through direct marketing to occupants of government-owned residential
properties in the UK.
In April 1998, pursuant to the UK Sale Agreement, the Company completed
the sale to Ocwen and Ocwen Asset of substantially all of the assets, and
certain liabilities, of the UK operations of CSC-UK. The sale did not include
the assumption by Ocwen of all of CSC-UK's liabilities, and therefore, no
assurances can be given that claims will not be made against the Company in the
future arising out of its former UK operations. Such claims could have a
material adverse effect on the Company's financial condition and results of
operations. The UK Sale included the acquisition by Ocwen of CSC-UK's whole loan
portfolio and loan origination and servicing businesses for a price of pound
sterling 249.6 million, the acquisition by Ocwen Asset of CSC-UK's securitized
loan residuals for a price of pound sterling 33.7 million and the assumption by
Ocwen of pound sterling 7.2 million of CSC-UK's liabilities. The price paid by
Ocwen is subject to adjustment to account for the actual balances on the closing
date of the loan portfolio and the assumed liabilities. As a result of the sale,
the Company received net proceeds of approximately $102 million, less the costs
of approximately $16 million related to the disposal of UK discontinued
operations.
Accordingly, the operating results of CSC-UK and its subsidiaries have
been segregated from continuing operations and reported as a separate line item
on the Company's financial statements. In addition, net assets of CSC-UK have
been reclassified on the Company's financial statements as investment in
discontinued operations. The Company has restated its prior financial statements
to present the operating results of CSC-UK as a discontinued operation.
LAWSUITS
Beginning in September 1997, a number of class action lawsuits have
been filed against the Company and certain of its officers and directors on
behalf of all purchasers of the Common Stock. In these actions, plaintiffs
allege that the Company and its senior officers engaged in securities fraud by
affirmatively misrepresenting and failing to disclose material information
regarding the lending practices of the Company's UK subsidiary, and the impact
that these lending practices would have on the Company's financial results.
Plaintiffs allege that a number of public filings and press releases issued by
the Company were false or misleading. In each of the complaints, plaintiffs have
asserted violations of Section 10(b) and Section 20(a) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Plaintiffs seek
unspecified damages, including pre-judgment interest, attorneys' and
accountants' fees, and court costs. See Part II, Item 1 for this and other legal
proceedings. Although no assurance can be given as to the outcome of these
lawsuits, the Company believes that the allegations in each of the actions are
without merit and that its disclosures were proper, complete and accurate. The
Company intends to defend vigorously against these actions and seek their early
dismissal. These lawsuits, however, if decided in favor of plaintiffs, could
have a material adverse effect on the Company.
DILUTION OF COMMON STOCK
In April 1997 and again in September 1997, the Company issued Preferred
Stock (as defined below) in exchange for aggregate gross proceeds of $100.0
million. The Company's Preferred Stock may be converted into Common Stock based
on a conversion price related to a discounted market price of the Common Stock.
As a result of the drop in the trading price of the Common Stock, the number of
shares of Common Stock outstanding has increased substantially from 29,744,322
as of March 25, 1997 to 52,810,782 as of May 11, 1998 primarily as a result of
such conversions. As of May 11, 1998, an aggregate of 4,374 shares and 392
shares of Series A Preferred Stock and Series B Preferred Stock, respectively,
had been converted (626 shares and 4,608 shares, respectively remain
outstanding) into an aggregate of 22,083,458 shares of Common Stock. As of May
11, 1998, all of the Series A Warrants and
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Series B Warrants were outstanding. If all of the Series A Preferred Stock and
Series B Preferred Stock were converted into Common Stock, the Company would not
have sufficient authorized shares of Common Stock to satisfy all of such
conversions. In addition, based on changes in the trading price of the Common
Stock and the shares of Preferred Stock that remain outstanding, substantial
dilution could occur in the future. See "Liquidity and Capital Resources --
Convertible Preferred Stock."
NASDAQ DELISTING
In December 1997, the Company was notified by Nasdaq that the Common
Stock would be delisted from the Nasdaq National Market as a result of the
Company's non-compliance with Nasdaq's listing requirements and corporate
governance rules. In January 1998 the Company received notice from Nasdaq that
the Common Stock would be moved from the Nasdaq National Market to the Nasdaq
SmallCap Market subject to the Company achieving a $1.00 per share bid price on
or before May 22, 1998. As a result of the delisting from the Nasdaq National
Market, the Company is subject to certain unfavorable provisions pursuant to the
Certificates of Designations of the Company's Preferred Stock.
On May 1, 1998, the Company was informed by Nasdaq that the Company's
Common Stock would be delisted from the Nasdaq SmallCap Market effective with
the close of business on May 1, 1998, and that the Company does not meet the
criteria necessary for immediate eligibility for quotation on the OTC Bulletin
Board. As a result of this delisting, it is likely that the liquidity of the
Company's Common Stock will be materially impaired which is likely to materially
and adversely affect the price of the Common Stock.
EMPLOYEE ATTRITION
As a result of the difficult environment the Company has recently been
operating in, the Company is experiencing an increase in the rate of attrition
of its employees and an inability to attract, hire and retain qualified
replacement employees. On December 31, 1997, the Company had 837 employees. As
part of its initiatives designed to improve the efficiency and productivity of
the Company's operations, the Company reduced its workforce by 142 employees in
February 1998. Due to additional attrition, however, the Company's workforce was
reduced to 556 employees as of March 31, 1998. Further attrition may hinder the
ability of the Company to operate efficiently which could have a material
adverse effect on the Company's results of operations and financial condition.
No assurance can be given that such attrition will not occur.
RESTRUCTURING
The Company has announced a number of initiatives and the exploration
of strategic alternatives. These initiatives include the disposal of loans
through whole loan sales and increased focus on the Company's higher margin
product lines. The Company has announced that it has begun implementing a
restructuring plan that includes streamlining and downsizing its operations. The
Company has reduced its workforce and has closed its branch operation in
Virginia, significantly reduced its correspondent originations for the
foreseeable future and exited its conventional lending business. Accordingly,
the Company has recorded a restructuring charge during the first quarter of 1998
of $3.2 million.
In addition, the Company has retained CIBC Oppenheimer Corp. ("CIBC")
to explore strategic alternatives. CIBC is advising the Company with respect to
strategic alternatives including the restructuring, refinancing,
recapitalization or reorganization of the Company. No assurance can be given
that the Company will be successful in pursuing strategic alternatives or in
implementing any of its initiatives. Furthermore, even if the Company is
successful in implementing its strategic alternatives and initiatives, no
assurance can be given as to the effect of any such success on the Company's
results of operations or financial condition. In order to enhance the Company's
liquidity position, in January 1998, the Company sold residual certificates and
associated mortgage servicing receivables relating to certain of the Company's
home equity loan products for net proceeds of $26.5 million. Additionally, in
April 1998, the Company completed the UK sale and received net proceeds of
approximately $102 million, less the costs of approximately $16 million related
to the disposal of UK discontinued operations. The Company
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also deferred the May 1, 1998 interest payment on the Convertible Debentures as
part of its plan to reorganize its business.
BUSINESS OVERVIEW
The Company primarily generates income from gain on sale of loans
recognized from premiums on loans sold through whole loan sales to institutional
purchasers, interest earned on loans held for sale, excess mortgage servicing
receivables, origination fees received as part of the loan application process
and fees earned on loans serviced. Historically, the Company also recognized
gain on sale of loans sold through securitizations. Recently, however, the
Company has redirected its efforts to actively pursue the sale of its loans
through whole loan sales rather than through securitizations. By employing whole
loan sales, the Company is better able to manage its cash flow as compared to
disposition of loans through securitizations. During the first quarter of 1998,
all loans were sold through whole loan sales as compared to the first quarter of
1997, when all loans were sold into securitizations. The Company anticipates
that substantially all of its loan production volume will be sold through whole
loan sales in 1998. Whole loan sales produce lower margins than securitizations
and, therefore, will negatively impact the Company's earnings.
Gain on sale of loans through securitizations includes the present
value of the differential between the interest rate payable by an obligor on a
loan over the interest rate passed through to the purchaser acquiring an
interest in such loan, less applicable recurring fees, including the costs of
credit enhancements and trustee fees. For the three months ended March 31, 1997,
gain on sale of loans also included gain on securitization representing the fair
value of the interest-only and residual certificates that the Company received
upon the sale of loans through securitizations which are reflected as trading
securities.
The following table sets forth selected operating data for the Company
for the periods indicated:
THREE MONTHS ENDED
MARCH 31,
---------------------------
1998 1997
---------- ----------
(DOLLARS IN THOUSANDS)
ORIGINATION AND SALE DATA:
Loan originations and purchases:
Core Products(1) $ 81,026 $ 231,047
Sav*-A-Loan(R) Products(2) 98,319 139,911
Discontinued Products(3) 4,336 17,112
---------- ----------
$ 183,681 $ 388,070
========== ==========
Average principal balance per loan
originated and purchased $ 52.3 $ 55.7
Weighted average coupon:
Core Products:
Fixed rate loans 10.3% 11.8%
Variable rate loans 9.2% 10.4%
Sav*-A-Loan(R) Products 13.0% 14.1%
Discontinued Products 9.0% 11.3%
Loans sold $ 251,233 $ 364,218
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AS OF MARCH 31, 1998 AS OF DECEMBER 31, 1997
------------------------ ------------------------
DOLLARS IN % OF SERVICED DOLLARS IN % OF SERVICED
THOUSANDS PORTFOLIO THOUSANDS PORTFOLIO
---------- ---------- ---------- ----------
PORTFOLIO DATA:
Serviced portfolio(4) $1,495,507 100.0% $2,231,519 100.0%
========== ========== ========== ==========
Delinquencies:
30-59 days delinquent $ 39,832 2.7% $ 65,063 2.9%
60-89 days delinquent 15,870 1.0% 30,479 1.4%
90 days or more delinquent 23,932 1.6% 27,808 1.3%
---------- ---------- ---------- ----------
Total delinquencies $ 79,634 5.3% $ 123,350 5.6%
========== ========== ========== ==========
Defaults:
Bankruptcies $ 32,298 2.2% $ 25,131 1.1%
Foreclosures 88,088 5.9% 100,901 4.5%
---------- ---------- ---------- ----------
Total defaults $ 120,386 8.1% $ 126,032 5.6%
========== ========== ========== ==========
REO property $ 12,621 0.8% $ 8,549 0.4%
========== ========== ========== ==========
Charge-offs $ 4,671 0.3% $ 4,734 0.2%
========== ========== ========== ==========
(1) Fixed and adjustable rate residential mortgage loans for refinancing,
educational, home improvement and debt consolidation purposes and fixed
adjustable rate purchase money loans.
(2) Loans generally made to homeowners with little or no equity in their
property but who possess favorable credit profile and debt-to-income ratio
and who often use the proceeds from such loans to repay outstanding
indebtedness as well as make home improvements.
(3) Discontinued in April 1998, includes jumbo loans, conventional home loans,
Title I loans and loans on small multi-family and mixed-use properties.
(4) Excludes loans serviced pursuant to contract servicing agreements.
RESULTS OF OPERATIONS
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31, 1997
During the first three months of 1998, the Company recorded negative
revenues of $7.2 million primarily as a result of a loss on sale of loans of
$4.4 million and the recording of a $7.1 net unrealized loss on the Company's
trading securities. This represents a $52.7 decrease from the first three months
of 1997 primarily as a result of the lower gain recorded on its sale of loans.
For the first three months of 1998, the Company recorded a net loss on
sale of loans totaling $4.4 million. This loss was primarily due to the sale of
$251.2 million of whole loans at an average net premium received of 0.7% as
compared to the average premium paid on such loans of 2.4%. Approximately
$151.0 million of the whole loan sales represented loans sold on a non-recourse
basis into the Company's purchase facility. The Company retains a participation
in future profits on these loans but has not recorded any gain related to this
profit participation. There can be no assurance that the Company will realize
any future profits on these loans. As a result of the Company's significant
reduction in the volume of correspondent originations the Company expects to
continue a reduction in the weighted average premiums paid. During the first
three months of 1997, the Company recognized $26.8 million of gain on sale of
loans representing a weighted average gain of 7.4% on $364.2 million of loans
sold into securitizations. The Company expects that it will continue to sell the
majority of loans through whole loan sales and therefore expects to continue to
recognize lower net margins as compared to the margins recognized in 1997.
The unrealized loss on valuation of residuals of $7.1 million recorded
for the three months ended March 31, 1998, reflects an increase in the expected
default rate on the Company's home equity securitizations. As a result of a
recent increase in the volume of liquidations, and corresponding losses
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experienced on such liquidations, the Company determined that the default rates
implied by the values at December 31, 1997, should be revised from 1.7% per
annum to 3.3% per annum.
Interest income decreased $14.5 million or 81.9% to $3.2 million for
the three months ended March 31, 1998 from $17.7 million for the comparable
period in 1997. This decrease was due primarily to lower average balances of
loans held for sale resulting from more loans sold than originated and purchased
for the three months ended March 31, 1998 as compared to the comparable period
in 1997.
Mortgage origination income increased $115,178 or 14.7% to $899,308 for
the three months ended March 31, 1998 from $784,130 for the comparable period in
1997. This increase was due primarily to an increased average application fee
charged on core brokered loan products.
Other income decreased $61,428 or 20.9% to $233,012 for the three
months ended March 31, 1998 from $294,440 for the comparable period in 1997.
This decrease was due primarily to decreased servicing income primarily due to
the continued attrition of the loans that were sold with servicing retained
prior to the Company's adoption of SFAS No. 122, "Accounting for Mortgage
Servicing Rights."
Total expenses increased $10.4 million or 31.1% to $43.8 million for
the three months ended March 31, 1998 from $33.4 million for the comparable
period in 1997. This increase was due primarily to increased other operating
expenses relating to increased professional fees as well as $3.3 million of
restructuring charges and $2.0 million relating to the settlement of a lawsuit.
Salaries and employee benefits decreased $1.0 million or 9.3% to $9.8
million for the three months ended March 31, 1998 from $10.8 million for the
comparable period in 1997. This decrease was due primarily to decreased staffing
levels to 556 employees at March 31, 1998 with an average of 654 employees
during the first quarter of 1998, as compared to 809 employees as of March 31,
1997 with an average of 731 employees during the first quarter of 1997. This
decrease was primarily a result of the Company's restructuring and streamlining
efforts.
Interest expense decreased $1.4 million or 9.0% to $14.2 million for
the three months ended March 31, 1998 from $15.6 million for the comparable
period in 1997. This decrease was due primarily to a lower average balance of
loans on the warehouse finance lines due to lower originations during the three
months ended March 31, 1998 as compared to the same period in 1997.
Selling and other expenses increased $9.7 million or 138.6% to $16.7
million for the three months ended March 31, 1998 from $7.0 million for the
comparable period in 1997. This increase was due primarily to increased
operating costs of $9.3 million or 145.3% to $15.7 million for the three months
ended March 31, 1998 from $6.4 million for the comparable period in 1997 from
increased professional fees as a result of the Company's restructuring and
streamlining efforts as well as a $2.0 million charge due to the settlement of a
lawsuit.
During the three months ended March 31, 1998, the Company recorded a
restructuring charge of $3.2 million. This charge was related to a restructuring
plan that includes streamlining and downsizing the Company's operations. The
Company has closed its branch operation in Virginia and significantly reduced
its correspondent originations for the foreseeable future and has exited its
conventional lending business. Of the $3.2 million, $1.1 million represents
severance payments made to 142 former employees; and $2.1 million represents
costs incurred with lease obligations and write-offs of assets no longer in
service.
The Company recorded a net loss applicable to common stock of $55.8
million for the three months ended March 31, 1998 as compared to net earnings
applicable to common stock of $16.8 million for the three months ended March 31,
1997. This loss was due primarily to a $51.2 million loss from continuing
operations due to decreased loan originations, as well as decreased gain on sale
of loans due to the Company's strategy of selling loans through whole loan sales
instead of through securitizations. Additionally, during the first quarter of
1998, the Company did not record any earnings from discontinued operations of
CSC-UK, as compared to earnings from CSC-UK of $9.3 million during the first
quarter of 1997. An increase in the liquidation preference of the preferred
stock in lieu of dividends and default
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payments of $4.6 million was recorded during the first quarter of 1998 further
increasing the net loss applicable to common stock.
FINANCIAL CONDITION
March 31, 1998 Compared to December 31, 1997
Cash and cash equivalents increased $0.5 million or 19.2% to $3.1
million at March 31, 1998 from $2.6 million at December 31, 1997.
Mortgage servicing receivables decreased $2.2 million or 23.2% to $7.3
million at March 31, 1998 from $9.5 million at December 31, 1997. This decrease
was the result of the sale of the mortgage servicing receivables associated with
the sale of the residuals in January 1998.
Trading securities, which consist of interest-only and residual
certificates, decreased $30.1 million or 23.8% to $96.4 million at March 31,
1998 from $126.5 million at December 31, 1997. This decrease was due primarily
to the Company's sale of residual certificates and related mortgage servicing
receivables relating to certain of the Company's home equity loan products for
net proceeds of $26.5 million during the first quarter of 1998 to enhance the
Company's liquidity position. Additionally, the Company recorded a write-down of
$7.1 million resulting from an increase in the expected default rate used to
value such residuals reflecting the Company's recent increase in losses on
liquidation of non-performing loans in its home equity portfolio.
Mortgage loans held for sale, net decreased $73.6 million or 78.9% to
$19.7 million at March 31, 1998 from $93.3 million at December 31, 1997. This
decrease was due primarily to the volume of loans sold exceeding the volume of
loans originated during the first three months of 1998.
Mortgage loans held for investment, net increased $1.7 million or 26.2%
to $8.2 million at March 31, 1998 from $6.5 million at December 31, 1997. This
increase was due primarily to $1.7 million of loans reclassified from mortgages
held for sale primarily due to the Company's inability to sell such loans.
During the first quarter, the Company sold $2.1 million of mortgage loans held
for investment, net at a price equated to the book value at December 31, 1997.
As a percentage of total assets, mortgage loans held for investment, net
increased to 2.8% at March 31, 1998 from 1.6% at December 31, 1997.
Other assets increased $0.6 million or 2.2% to $27.9 million at March
31, 1998 from $27.3 million at December 31, 1997. This increase was due
primarily to an increase in accounts receivable of $4.3 million partially offset
by decreases in accrued interest receivable and deferred debt issuance costs.
Warehouse financing facilities outstanding decreased $65.2 million or
84.1% to $12.3 million at March 31, 1998 from $77.5 million at December 31,
1997. This decrease was due primarily to the decreased origination volume as
well as the volume of loans sold exceeding the volume of loans originated during
the first three months of 1998.
Accounts payable and other liabilities increased $9.6 million or 15.1%
to $73.0 million at March 31, 1998 from $63.4 million at December 31, 1997. This
increase was due primarily to the increased accrued interest payable relating to
the Notes, as well as the recording of an accrued liability relating to the
settlement of a lawsuit.
Allowance for losses increased $2.7 million or 58.7% to $7.3 million at
March 31, 1998 from $4.6 million at December 31, 1997. This increase was due
primarily to an increase in the expected losses on the Company's home equity
loan pools and the costs associated with servicing such pools.
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The stockholders' deficit increased $51.2 million or 29.0% to a deficit
of $228.0 million at March 31, 1998 as compared to a stockholders' deficit of
$176.8 million at December 31, 1997. This increase in the deficit was the result
of a net loss of $51.2 million for the three months ended March 31, 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business requires substantial cash to support its
operating activities. The Company's principal cash requirements include the
funding of loan production, payment of interest expenses, operating expenses and
income taxes. The Company uses its cash flow from whole loan sales, loans sold
through securitizations, loan origination fees, processing fees, net interest
income and borrowings under its loan warehouse and purchase facilities to meet
its working capital needs. There can be no assurance that existing lines of
credit can be extended or refinanced or that funds generated from operations
will be sufficient to satisfy obligations. In October 1997, the Company
announced that it was exploring strategic alternatives for the Company's ability
to continue as a going concern. In April 1998, the Company completed the UK Sale
and received net proceeds of approximately $102 million, less the costs of
approximately $16 million related to the disposal of UK discontinued operations.
The Company believes that its future success is dependent upon its ability to
(i) access loan warehouse or purchase facilities, (ii) successfully sell loans
in the whole loan sales market, (iii) restructure its balance sheet, (iv)
streamline its operations and (v) retain an adequate number and mix of its
employees. No assurance can be given that the Company will be able to achieve
these results. The implementation of any of these or other liquidity initiatives
is likely to have a negative impact on the Company's profitability. The
Company's liquidity is dependent upon its continued access to funding sources
and can be negatively affected by a number of factors including conditions in
the whole loan sale market and the Company's ability to sell certain assets. No
assurances can be given as to such continued access or the occurrence of such
factors. In addition, the Company will be required to restructure its balance
sheet in the near term in order to meet its longer term liquidity needs.
The Company has operated, and expects to continue to operate, on a
negative cash flow basis. During the three months ended March 31, 1998 and 1997,
the Company was provided net cash of $75.4 million and used net cash of $40.2
million from continuing operations, respectively. Additionally, in the three
months ended March 31, 1998 and 1997, the Company was provided $1.2 million and
used $2.3 million, respectively, in investing activities. During 1997, the
Company's sale of loans through securitizations has resulted in a gain on sale
of loans through securitizations recognized by the Company. The recognition of
this gain on sale had a negative impact on the cash flow of the Company because
significant costs are incurred upon closing of the transactions giving rise to
such gain and the Company is required to pay income taxes on the gain on sale in
the period recognized, although the Company does not receive the cash
representing the gain until later periods as the related loans are repaid or
otherwise collected. During the three months ended March 31, 1998 and 1997, the
Company used cash from financing activities of $65.2 million and received cash
from financing activities of $53.1 million, respectively. During the three
months ended March 31, 1998 and 1997, the Company used net cash in discontinued
operations of $10.9 million and $10.8 million, respectively.
The Company is required to comply with various operating covenants as
defined in the agreements described below. The covenants include restrictions,
on among other things, the ability to (i) incur or suffer the existence of
indebtedness, (ii) incur or suffer to exist liens or other encumbrances on
certain assets, (iii) to engage in dissolutions, consolidations,
reorganizations, mergers, sales, transfers of assets or certain changes of
control (iv) incur or suffer to exist any lease obligations on real or personal
property, (v) engage in sale-leaseback transactions, (vi) declare, pay or set
apart funds for dividends, distributions or the acquisition of capital stock, or
redeem, repurchase or otherwise acquire for value the capital stock of the
Company, CSC or certain affiliates, (vii) make investments, loans or purchase or
otherwise acquire an interest in another Person, (viii) engage in derivatives or
hedging transactions, (ix) assume, guarantee or become directly or contingently
responsible for the obligations of another Person, (x)
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enter into transactions with any affiliate, (xi) make bulk purchase of mortgage
loans, (xii) forgive indebtedness, (xiii) create subsidiaries, (xiv) limit the
transfer of property or assets, the payment of dividends or the lending of funds
among affiliates and (xv) change its line of business.
In May 1998, Moody's lowered its rating of the Company's Notes to Ca
from Caa3, as well as its ratings on the Company's Convertible Debentures to C
from Ca. Also, in May 1998, S&P withdrew its CCC counterparty credit rating on
the Company and placed its CCC rating on the Company's Notes on "CreditWatch".
These reductions in the ratings of the Company's debt will likely increase the
Company's future borrowing costs.
Credit Facilities
Greenwich Warehouse Facility. In January 1997, the CSC entered into a
secured warehouse credit facility with Greenwich Capital Financial Products,
Inc., an affiliate of Greenwich Capital Markets, Inc. (referred to herein,
including any affiliates as "Greenwich") to provide a $400.0 million warehouse
facility under which CSC borrows funds on a short-term basis to support the
accumulation of loans prior to sale (the "Greenwich Facility"). Advances under
the Greenwich Facility bore interest at a rate of LIBOR plus 150 basis points.
The Greenwich Facility is secured by certain residual securities pledged by CSC.
This facility was terminated on December 31, 1997, at which time CSC and
Greenwich entered into an extension agreement through May 31, 1998 (as amended,
the "Extension Agreement"). The Extension Agreement provides for a maximum
credit line of $150.0 million, subject to adjustment by Greenwich, at an
interest rate of LIBOR plus 200 basis points (7.75% at March 31, 1998) and a fee
of 0.25% of the aggregate principal balance of loans to be paid to Greenwich in
connection with any sale or securitization of any other transfer to any third
party of loans funded under this agreement. As of March 31, 1998, $4.7 million
was outstanding under this agreement. There can be no assurance that CSC can
extend the term of the Greenwich Facility or obtain any replacement financing
beyond May 31, 1998.
CIT Warehouse Facility. On February 3, 1998, CSC entered into a
revolving credit facility with the CIT Group/Equipment Financing, Inc. (the "CIT
Facility") to finance CSC's origination and purchase of mortgage loans, the
repayment of certain indebtedness and, subject to certain limits, other general
corporate purposes. The CIT Facility is guaranteed by the Company, and bears
interest at the prime rate plus 50 basis points. Pursuant to the CIT Facility,
CSC has available a secured revolving credit line in an amount equal to the
lesser of (i) $30.0 million or (ii) a commitment calculated as a percentage
(generally 80% or 85%) of the mortgage loans securing the CIT Facility. The CIT
Facility is also subject to sublimits on the amount of certain varieties of
mortgage loan products that may be used to secure advances thereunder. In
addition, the CIT Facility is secured by a pledge of 65% of the capital stock of
CSC-UK and certain residual securities pledged by the Company. The CIT Facility
terminates on February 3, 2000. As of March 31, 1998, the outstanding balance on
the CIT Facility was $7.6 million.
LOAN SALES
Company disposed of all of its loan production through whole loan sales
where the Company receives a cash premium at the time of sale. In 1997, 1996,
1995 and the first quarter of 1998, the Company sold $518.4 million, $73.5
million, $185.8 million and $251.2 million, respectively, in whole loan sales,
accounting for 31.7%, 5.6%, 24.8% and 100.0% of all loan sales in the respective
periods. As a result of the Company's financial condition, the Company is
currently unable to sell its loans through securitizations and expects to sell
its loans through whole loan sales during 1998.
The Company uses overcollateralization accounts as a means of providing
credit enhancement for its securitizations. This mechanism slows the flow of
cash to the Company and causes some or all of the amounts otherwise
distributable to the Company as cash flow in excess of amounts payable as
current interest and principal on the securities issued in its securitizations
to be deposited in an overcollateralization account for application to cover
certain losses or to be released to the Company later if not so used. This
temporary or permanent redirection of such excess cash flows reduces the present
value of such cash flows, which are the principal component of the gain on the
sale of the securitized loans recognized by the Company in connection with each
securitization.
The Company has derived a significant portion of its income by
recognizing gains upon the sale of loans through securitizations based on the
fair value of the interest-only and residual certificates that the
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Company receives upon the sale of loans through securitizations and on sales
into loan purchase facilities. In loan sales through securitizations, the
Company sells loans that it has originated or purchased to a trust for a cash
purchase price and interests in such trust consisting of interest-only regular
interest and the residual interest which are represented by the interest-only
and residual certificates. The cash purchase price is raised through an offering
by the trust of pass-through certificates representing regular interests in the
trust. Following the securitization, the purchasers of the pass-through
certificates receive that principal collected and the investor pass-through
interest rate on the principal balance, while the Company recognizes as current
revenue the fair value of the interest-only and residual certificates.
Since it adopted SFAS No. 122, "Accounting for Mortgage Servicing
Rights" in October 1995, the Company recognizes as an asset the capitalized
value of mortgage servicing receivable based on their fair value. The fair value
of these assets is determined based on various economic factors, including loan
types, sizes, interest rates, dates of origination, terms and geographic
locations. The Company also uses other available information applicable to the
types of loans the Company originates and purchases (giving consideration to
such risks as default and collection) such as reports on prepayment rates,
interest rates, collateral value, economic forecasts and historical default and
prepayment rates of the portfolio under review. The Company estimates the
expected cash flows that it will receive over the life of a portfolio of loans.
These expected cash flows constitute the excess of the interest rate payable by
the obligors of loans over the interest rate passed through to the purchaser,
less applicable recurring fees and credit losses. The Company discounts the
expected cash flows at a discount rate that it believes is consistent with the
required risk-adjusted rate of return of an independent third party purchaser of
the interest-only and residual certificates or mortgage servicing receivables.
As of March 31, 1998, the Company's balance sheet reflected the fair value of
interest-only and residual certificates and mortgage servicing receivables of
$96.4 million and $7.3 million less an allowance for losses of $7.3 million,
respectively.
Realization of the value of these interest-only and residual
certificates and mortgage servicing receivables in cash is subject to the
prepayment and loss characteristics of the underlying loans and to the timing
and ultimate realization of the stream of cash flows associated with such loans.
If actual experience differs from the assumptions used in the determination of
the asset value, future cash flows and earnings could be negatively affected and
the Company could be required to write down the value of its interest-only and
residual certificates and mortgage servicing receivables. In addition, if
prevailing interest rates rose, the required discount rate might also rise,
resulting in impairment of the value of the interest-only and residual
certificates and mortgage servicing receivables.
CONVERTIBLE DEBENTURES
In May 1996, the Company issued $143.8 million of 6% Convertible
Subordinated Debentures due 2006, convertible at any time prior to redemption of
maturity, at the holder's option, into shares of the Company's Common Stock at a
conversion price of $26.25, subject to adjustment. The Convertible Debentures
may be redeemed, at the option of the Company, in whole or in part, at any time
after May 15, 1999 at predetermined redemption prices together with accrued and
unpaid interest to the date fixed for redemption. The coupon at 6% per annum, is
payable semi-annually on each May 1 and November 1, having commenced November 1,
1996. The Company deferred the May 1, 1998 interest payment as part of its plan
to reorganize the business. The terms of the indenture governing the Convertible
Debentures do not limit the incurrence of additional indebtedness by the
Company, nor do they limit the Company's ability to make payments such as
dividends.
In April 1997, the Company induced the conversion of $14.0 million
aggregate principal amount of its Convertible Debentures resulting in the
issuance upon conversion of 533,332 shares of the Common Stock (at a conversion
price of $26.25 per share) pursuant to the terms of the Convertible Debentures.
To induce conversion, the Company issued an additional 342,708 shares of Common
Stock and paid the holders of the induced Convertible Debentures $420,000 in
cash. In the second quarter of 1997, these transactions resulted in the
reduction of Convertible Debentures by $14.0 million, a charge to interest
expense of $4.7 million related to the fair market value of the 342,708
inducement shares ($4.3 million) and the cash payment and an increase in
stockholders' equity of $18.2 million due to the issuance of the conversion
shares and the inducement shares. The net effect of these transactions was an
increase of $13.6 million to stockholders' equity in the second quarter of 1997.
During 1997, an aggregate of $14.1 million
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of Convertible Debentures had been converted into Common Stock, including the
induced conversion described above. As of May 11, 1998, there were $129.6
million of Convertible Debentures outstanding.
SENIOR NOTES
In May 1997, the Company issued $300.0 million aggregate principal
amount of 12-3/4% Senior Notes due 2004 in a private placement. Such Notes are
not redeemable prior to maturity except in limited circumstances. The coupon at
12-3/4% per annum, is payable semi-annually on each June 1 and December 1,
having commenced December 1, 1997. In September 1997, the Company completed the
exchange of such Notes for a like principal amount of 12-3/4% Series A Senior
Notes due 2004 (the "Notes") which have the same terms in all material respects,
except for certain transfer restrictions and registration rights.
CONVERTIBLE PREFERRED STOCK
In April 1997, the Company completed the private placement of 5,000
shares of its 6% Convertible Preferred Stock, Series A (the "Series A Preferred
Stock"), with an initial liquidation preference (the "Liquidation Preference")
of $10,000 per share, and related five-year warrants (the "Series A Warrants")
to purchase 500,000 shares of Common Stock with an exercise price of $20.625 per
share. Dividends on the Series A Preferred Stock are cumulative at the rate of
6% of the Liquidation Preference per annum payable quarterly. Dividends are
payable, at the option of the Company, (i) in cash, (ii) in shares of Common
Stock valued at the closing price on the day immediately preceding the dividend
payment date or (iii) by increasing the Liquidation Preference in an amount
equal to and in lieu of the cash dividend payment.
In March 1998, the Company elected to add an amount equal to the
dividend to the Liquidation Preference of the Series A Preferred Stock in lieu
of payment of such dividend. In addition, amounts equal to 3% of the Liquidation
Preference for each 30-day period (prorated for shorter periods) was added to
the Liquidation Preference due to the delisting of the Company's Common Stock
from the Nasdaq National Market on January 29, 1998 (as discussed below). As of
March 31, 1998, the new Liquidation Preference varies up to $11,104 per share.
The Series A Preferred Stock is redeemable at the option of the Company
at a redemption price equal to 120% of the Liquidation Preference under certain
circumstances. The Series A Preferred Stock is convertible into shares of Common
Stock, subject to redemption rights, at a conversion price equal to the lowest
daily sales price of the Common Stock during the four consecutive trading days
(or with respect to conversions from December 24, 1997 through the earlier of
the tenth day after the effective date of a registration statement or July 24,
1998, 187 calendar days) immediately preceding such conversion, discounted by up
to 4% and subject to certain adjustments.
As of May 11, 1998, an aggregate of 4,374 shares of the Series A
Preferred Stock had been converted (626 shares remain outstanding) into an
aggregate of 12,681,270 shares of Common Stock. As of May 11, 1998, all Series A
Warrants were outstanding.
In September 1997, the Company completed the private placement of 5,000
shares of 6% Convertible Preferred Stock, Series B (the "Series B Preferred
Stock"), with an initial Liquidation Preference of $10,000 per share, and
related five-year warrants (the "Series B Warrants") to purchase 500,000 shares
of Common Stock with an exercise price per share equal to the lesser of (i)
$14.71 or (ii) 130% of the average closing sales prices over the 20 trading day
period ending on the trading day immediately prior to the first anniversary of
the original issuance of the Series B Warrants. Dividends on the Series B
Preferred Stock are cumulative at the rate of 6% of the Liquidation Preference
per annum payable quarterly. Dividends are payable, at the option of the
Company, (i) in cash, (ii) in shares of Common Stock valued at the closing price
on the day immediately preceding the dividend payment date or (iii) by
increasing the Liquidation Preference in an amount equal to and in lieu of the
cash dividend payment.
In March 1998, the Company elected to add an amount equal to the
dividend to the Liquidation Preference of the Series B Preferred Stock in lieu
of payment of such dividend. In addition, amounts equal
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to 3% of the Liquidation Preference for each 30-day period (prorated for shorter
periods) was added to the Liquidation Preference due to the delisting of the
Company's Common Stock from the Nasdaq National Market on January 29, 1998. As
of March 31, 1998, the new Liquidation Preference is $11,133 per share.
The Series B Preferred Stock is redeemable at the option of the Company
at a redemption price equal to 120% of the Liquidation Preference under certain
circumstances. In addition, the Series B Preferred Stock is redeemable at a
redemption price equal to 115% of the Liquidation Preference upon notice of, or
the announcement of the Company's intent to engage in a change of control event,
or, if such notice or announcement occurs on or after March 14, 1998, the
redemption price will equal 125% of the Liquidation Preference. The Series B
Preferred Stock is convertible into shares of Common Stock, subject to certain
redemption rights and restrictions, at a conversion price equal to the lowest
daily sales price of the Common Stock during the four consecutive trading days
immediately preceding such conversion, discounted up to 4% and subject to
certain adjustments.
As of May 11, 1998, an aggregate of 392 shares of Series B Preferred
Stock had been converted (4,608 shares remain outstanding) into an aggregate of
9,402,188 shares of Common Stock. As of May 11, 1998, all Series B Warrants were
outstanding.
As of May 11, 1998, if all of the outstanding shares of the Series A
Preferred Stock and Series B Preferred Stock were converted into Common Stock,
the Company would not have sufficient authorized shares of Common Stock to
satisfy such conversions.
Pursuant to the terms of the Company's Series A Preferred Stock and the
Company's Series B Preferred Stock (together the "Preferred Stock"), the Company
is required to continue the listing or trading of the Common Stock on Nasdaq or
certain other securities exchanges. As a result of the delisting of the Common
Stock from the Nasdaq National Market, (i) the conversion restrictions that
apply to the Series B Preferred Stock are lifted (prior to the delisting, no
more than 50% of the 5,000 shares of Series B Preferred Stock initially issued
could be converted) and (ii) the conversion period is increased to 15
consecutive trading days and the conversion discount is increased to 10% (prior
to the delisting, the conversion price was equal to the lowest daily sales price
of the Common Stock during the four consecutive trading days immediately
preceding conversion, discounted by up to 5.5%). In addition, as a result of the
delisting of the Common Stock and during the continuance of such delisting, (i)
the dividend rate is increased to 15% and (ii) the Company is obligated to make
monthly cash payments to the holders of the Preferred Stock equal to 3% of the
$10,000 liquidation preference per share of the Preferred Stock, as adjusted,
provided that if the Company does not make such payments in cash, such amounts
will be added to the Liquidation Preference. Based on the current market price
of the Common Stock, the Company does not have available a sufficient number of
authorized but unissued shares of Common Stock to permit the conversion of all
of the shares of the Preferred Stock.
SALE OF RESIDUAL CERTIFICATES AND MORTGAGE SERVICING RECEIVABLES
In order to enhance the Company's liquidity position, in January 1998,
the Company sold residual certificates and associated mortgage servicing
receivables relating to certain of the Company's home equity loan products for
net proceeds of $26.5 million (which equated to the book value at December 31,
1997).
The description above of the covenants contained in the Company's
credit facilities and other sources of funding does not purport to be complete
and is qualified in its entirety by reference to the actual agreements, which
are filed by the Company with the Commission and can be obtained from the
Commission. The continued availability of funds provided to the Company under
these agreements is subject to the Company's continued compliance with these
covenants. In addition, the Notes, the Convertible Debentures, the Series A
Preferred Stock and the Series B Preferred Stock permit the holders of such
securities to require the Company to purchase such securities upon a change of
control (as defined in the respective Indenture or Certificate of Designations,
as the case may be).
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All references herein to "$" are to United States dollars; all
references to "pound sterling" are to British Pounds Sterling. Unless otherwise
specified, translation of amounts from British Pounds Sterling to United States
dollars has been made herein using exchange rates at the end of the period for
which the relevant statements are prepared for balance sheet items and the
weighted average exchange rates for the relevant period for statement of
operations items, each based on the noon buying rate in New York City for cable
transfers in foreign currencies as certified for customs purposes by the Federal
Reserve Bank of New York.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of business, aside from the matters discussed
below, 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 financial position or the results of operations of
the Company.
On or about September 29, 1997, a putative class action lawsuit (the
"Ceasar Action") was filed against the Company and two of its officers and
directors in the United States District Court for the Eastern District of New
York (the "Eastern District") on behalf of all purchasers of the Company's
Common Stock during the period from April 1, 1997 through August 15, 1997.
Between approximately October 14, 1997 and December 3, 1997, nine additional
class action complaints were filed against the same defendants, as well as
certain additional Company officers and directors. Four of these additional
complaints were filed in the Eastern District and five were filed in the United
States District Court for the Southern District of New York (the "Southern
District"). On or about October 28, 1997, the plaintiff in the Ceasar Action
filed an amended complaint naming three additional officers and directors as
defendants. The amended complaint in the Ceasar Action also extended the
proposed class period from November 4, 1996 through October 22, 1997. The
longest proposed class period of any of the complaints is from April 1, 1996
through October 22, 1997. On or about February 2, 1998, an additional lawsuit
brought on behalf of two individual investors, rather than on behalf of a
putative class of investors, was filed against the Company and certain of its
officers and directors in federal court in New Jersey (the "New Jersey Action").
In these actions, plaintiffs allege that the Company and its senior
officers engaged in securities fraud by affirmatively misrepresenting and
failing to disclose material information regarding the lending practices of the
Company's UK subsidiary, and the impact that these lending practices would have
on the Company's financial results. Plaintiffs allege that a number of public
filings and press releases issued by the Company were false or misleading. In
each of the putative class action complaints, plaintiffs have asserted
violations of Section 10(b) and Section 20(a) of the Exchange Act. Plaintiffs
seek unspecified damages, including pre-judgment interest, attorneys' and
accountants' fees and court costs.
The complaints filed in the Southern District actions have all been
transferred to the Eastern District. On December 5, 1997, the Eastern District
plaintiffs filed a motion for appointment of lead plaintiffs and approval of
co-lead counsel. The court has not yet ruled on plaintiffs' motion. The Company
anticipates that, at a minimum, all of the putative class action complaints will
be consolidated with the Ceasar Action in the Eastern District. In addition,
plaintiffs in the New Jersey Action have consented to pre-trial consolidation of
their case with the class actions currently pending in the Eastern District.
Accordingly, on March 25, 1998, the Company and its defendant officers and
directors filed a motion with the federal Judicial Panel for Multidistrict
Litigation, which seeks consolidation of all current and future securities
actions, including the New Jersey Action, for pre-trial purposes before Judge
Sterling Johnson in the Eastern District.
In November 1997, Resource Mortgage Banking, Ltd., Covino and Company,
Inc. and LuxMac LLC filed against the Company, CSC and two of the Company's
officers and directors in state court in Connecticut an application for a
prejudgment remedy. The object of the application for the prejudgment remedy was
to obtain a court order granting these plaintiffs prejudgment attachment against
assets of the Company and CSC in Connecticut pending resolution of plaintiffs'
underlying claims. Plaintiffs proposed to file an 18 count complaint against the
defendants seeking $60 million in purported damages, injunctive relief, treble
damages and punitive damages in an unspecified sum. In February 1998, Judge
William B. Lewis orally granted defendants' motion to dismiss on the ground of
forum non conveniens and entered a judgment of dismissal, and shortly
thereafter, set in a memorandum of decision his reasons for granting the motion
to dismiss. Plaintiffs did not file an appeal of the order of dismissal.
In February 1998, Resource Mortgage Banking, Ltd., Covino and Company,
Inc. and LuxMac LLC filed an action against the Company, CSC and two of the
Company's officers and directors in state court in New York seeking $60 million
in purported damages, injunctive relief, treble damages and punitive damages in
an unspecified sum.
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In March 1998, plaintiffs sought a preliminary injunction to prevent
the Company and CSC from selling certain assets known as strip, residuals,
excess servicing and/or servicing rights and their substantial equivalent having
as constituent any mortgage loan exceeding $350,000 generated by the Company or
CSC between September 2, 1994, and April 1, 1997, and any mortgage loan
exceeding $500,000 generated by the Company or CSC from April 1, 1997 to the
present. The New York Court signed a temporary restraining order that required
the Company and CSC to refrain from the specified sales.
Settlement discussions commenced after plaintiffs' motion for
preliminary injunction was fully submitted. Settlement negotiations were
concluded and the litigation was settled shortly after the New York Court issued
a decision in plaintiffs' favor. The Company paid and expensed $2.0 million to
plaintiffs, and the Company, CSC and the defendant officers and directors gave
releases in favor of the plaintiffs. Plaintiffs agreed to discontinue their
claims with prejudice, withdraw as moot their motion for injunctive relief,
consent to vacatur of injunctive relief in the litigation and gave releases in
favor of the Company, CSC and the defendant officers and directors.
In February 1998, a putative class action lawsuit (the "Simpson
Action") was filed against the Company in the U.S. District Court for the
Northern District of Mississippi (Greenville Division). The Simpson Action is a
class action brought under the anti-kickback provisions of Section 8 of the Real
Estate Settlement Procedures Act ("RESPA"). The complaint alleges that, on
November 19, 1997, plaintiff Laverne Simpson, through the services of Few
Mortgage Group ("Few"), a mortgage broker, obtained refinancing for the mortgage
on her residence in Greenville, Mississippi. Few secured financing for plaintiff
through Cityscape. In connection with the financing, Cityscape is alleged to
have paid a premium to Few in the amount of $1,280.00. Plaintiff claims that the
payment was a referral fee and duplicative payment prohibited under Section 8 of
RESPA. Plaintiff is seeking compensatory damages for the amounts "by which the
interest rates and points charges were inflated." Plaintiff also claims to
represent a class consisting of all other persons similarly situated, that is,
persons (a) who secured mortgage financing from Cityscape through mortgage
brokers from an unspecified period to date (claims under Section 8 of RESPA are
governed by a one year statute of limitations), and (b) to whose mortgage broker
Cityscape paid a fee to the mortgage broker who originated the class member's
loan. Plaintiff is seeking to recover compensatory damages, on behalf of the
putative class, which is alleged to be "numerous," for the amounts that "the
interest rates and points charges were inflated" in connection with each class
member's mortgage loan transaction. The Company answered the complaint and
Plaintiff has not yet moved for class certification. As of May 14, 1998, there
had been no ruling on the merits of either plaintiff's individual claim or the
claims of the putative class.
In April 1998, the Company was named as a defendant in an Amended
Complaint filed against 59 separate defendants in the Circuit Court for
Baltimore City entitled Peaks v. A Home of Your Own, Inc., et al. This action is
styled as a class action and alleges various causes of action (including
Conspiracy to Defraud, Fraud, Violation of Maryland Consumer Protection Act and
Unfair Trade Practices, Negligent Misrepresentation, and Negligence) against
multiple parties relating to 89 allegedly fraudulent mortgages made on
residential real estate in Baltimore, Maryland. The Company is alleged to have
purchased at least 8 of the loans (and may have purchased 15 of the loans) at
issue in the Complaint. The Company has not yet been involved in any discovery
and has yet to file its response.
Although no assurance can be given as to the outcome of these lawsuits,
the Company believes that the allegations in each of the actions are without
merit and that its disclosures were proper, complete and accurate. The Company
intends to defend vigorously against these actions and seek their early
dismissal. These lawsuits, however, if decided in favor of plaintiffs, could
have a material adverse effect on the Company.
In January 1998, the Company commenced a breach of contract action in
the Southern District against Walsh Securities, Inc. ("Walsh"). The action
alleges that Walsh breached certain obligations that it owed to the Company
under an agreement whereby Walsh sold mortgage loans to the Company. The Company
claims damages totaling in excess of $11.9 million. On March 5, 1998, Walsh
filed a motion to dismiss or, alternatively, for summary judgement. On May 4,
1998, the Company served papers that opposed Walsh's motion and moved for
partial summary judgement on certain of the loans. Walsh has 30 days to reply.
On April 24, 1998, the Company filed an action in the US District Court
for the District of Maryland against multiple parties entitled Cityscape Corp.
vs. Global Mortgage Company, et al. The Company is in the process of serving the
complaint on the defendants. To date the Company has yet to receive any
responsive pleadings. The complaint seeks damages of $4.0 million stemming from
a series of 145 allegedly fraudulent residential mortgages which the Company
previously acquired. The Company has previously reserved for losses against such
loans.
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OTHER
In April 1996, CSC-UK acquired all of the outstanding capital stock of
J&J Securities Limited ("J&J"), a London-based mortgage lender, in exchange for
pound sterling15.3 million ($23.3 million based on the Noon Buying Rate on the
date of such acquisition) in cash and 548,000 shares of Common Stock valued at
$9.8 million based upon the closing price of the Common Stock on the date of
such acquisition less a discount for restrictions on the resale of such stock
and incurred closing costs of $788,000 (the "J&J Acquisition").
In June 1996, CSC-UK acquired all of the outstanding capital stock of
Greyfriars Group Limited (formerly known as Heritable Finance Limited and
referred to herein as "Greyfriars"), a mortgage lender based in Reading, England
in exchange for pound sterling41.8 million ($64.1 million based on the Noon
Buying Rate on the date of such acquisition) in cash and 99,362 shares of Common
Stock valued at $2.5 million based upon the closing price of the Common Stock on
the date of such acquisition and incurred closing costs of $2.3 million (the
"Greyfriars Acquisition").
In October 1996, the Company received a request from the staff of the
Commission for additional information concerning the Company's voluntary
restatement of its financial statements for the quarter ended June 30, 1996. The
Company initially valued the mortgage loans in the J&J Acquisition and the
Greyfriars Acquisition at the respective fair values which were estimated to
approximate par (or historical book value). Upon the subsequent sale of the
mortgage portfolios, the Company recognized the fair value of the mortgage
servicing receivables retained and recorded a corresponding gain for the fair
value of such mortgage servicing receivables. Upon subsequent review, the
Company determined that the fair value of such mortgage servicing rights should
have been included as part of the fair value of the mortgage loans acquired as a
result of such acquisitions. The effect of this accounting change resulted in a
reduction in reported earnings of $26.5 million. Additionally, as a result of
this accounting change, the goodwill initially recorded in connection with such
acquisitions was reduced resulting in a reduction of goodwill amortization of
approximately $496,000 from the previously reported figure for the second
quarter. On November 19, 1996, the Company announced that it had determined that
certain additional adjustments relating to the J&J Acquisition and the
Greyfriars Acquisition should be made to the financial statements for the
quarter ended June 30, 1996. These adjustments reflect a change in the
accounting treatment with respect to restructuring charges and deferred taxes
recorded as a result of such acquisitions. This caused an increase in the amount
of goodwill recorded which resulted in an increase of amortization expense as
previously reported in the second quarter of 1996 of $170,692. The staff of the
Commission has requested additional information from the Company in connection
with the accounting related to the J&J Acquisition and the Greyfriars
Acquisition. The Company is supplying such requested information. In mid-October
1997, the Commission authorized its staff to conduct a formal investigation
which, to date, has continued to focus on the issues surrounding the restatement
of the financial statements for the quarter ended June 30, 1996. The Company is
continuing to cooperate fully in this matter.
As a result of the Company's recent negative operating results, the
Company has received inquiries from the New York State Department of Banking
regarding the Company's qualifications to continue to hold a mortgage banking
license. In connection with such inquiries, the Company was fined $50,000 and
has agreed to provide the banking department with specified operating
information on a timely basis and to certain restrictions on its business.
Although the Company believes it complies with its licensing requirements, no
assurance can be given that additional inquiries by the banking department or
similar regulatory bodies will not have an adverse effect on the licenses that
the Company holds which in turn could have a negative effect on the Company's
results of operations and financial condition.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
2.1 Agreement for the Sale and Purchase of the Business of CSC-UK and its
Subsidiaries and the Entire Issued Share Capital of City Mortgage
Receivables 7 Plc dated March 31, 1998 by and among CSC-UK, J&J
Securities Limited, City Mortgage Financial Services Limited,
Greyfriars Group Limited, Greyfriars Financial Services Limited,
Assured Funding Corporation Limited, Cityscape (UK) Limited, Home and
Family Finance Limited, Home Funding Corporation Limited, Home Mortgage
Corporation Limited, Home Mortgages Limited, Homestead Finance Limited,
Homeowners Finance Limited, Mortgage Management Limited, Secured
Funding Limited, City Mortgage Servicing Limited, Midland & General
Direct Limited, Ocwen, the Company, City Mortgage Funding 1 Limited and
City Mortgage Collateral Reserve No. 1 Limited, incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form 8-K
filed April 3, 1998.
3.1 Certificate of Incorporation of the Company, as amended, incorporated
by reference to Exhibit 3.1 to the Company's Registration Statement on
Form S-1 as declared effective by the Commission on December 20, 1995.
3.2 Bylaws of the Company, as amended, incorporated by reference to Exhibit
3.2 to the Company's Registration Statement on Form S-1 as declared
effective by the Commission on December 20, 1995.
10.1* Second Renewal Agreement, dated as of April 30, 1998, between CSC and
Greenwich Financial Products, Inc.
11.1* Computation of Earnings Per Share
27.1* Financial Data Schedule
- ----------
* Filed herewith
(b) Reports on Form 8-K
1. Form 8-K dated February 10, 1998 reporting various items including (i)
actions taken in regard to the Revised Non-Status Guidelines received by CSC-UK,
(ii) domestic and UK credit facilities, (iii) sale of residuals, (iv) various
initiatives and the exploration of strategic alternatives, (v) the movement of
the Company's Common Stock from the Nasdaq National Market to the Nasdaq
SmallCap Market and (vi) litigation filed against the Company.
2. Form 8-K dated February 17, 1998 reporting the resignations of the Managing
Director and Financial Director of CSC-UK.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Cityscape Financial Corp.
(Registrant)
Date: May 15, 1998 By: /s/ Tim S. Ledwick
------------------ ----------------------------------
Tim S. Ledwick
Title: Vice President and
Chief Financial Officer
(as chief accounting officer and
on behalf of the registrant)
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