1
===============================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the period from ________ to ________
Commission file number 1-7067
UNITED COMPANIES FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Louisiana 71-0430414
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4041 Essen Lane 70809
Baton Rouge, Louisiana (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code (504) 987-0000
Indicate by check mark 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
The number of shares of $2.00 par value common stock issued and
outstanding as of November 3, 1998 was 28,808,211, excluding 1,180,117 treasury
shares.
===============================================================================
2
UNITED COMPANIES FINANCIAL CORPORATION AND SUBSIDIARIES
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
PAGE
PART I - FINANCIAL INFORMATION
Financial Statements:
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997......................................................... 2
Consolidated Statements of Income
Three months and nine months ended September 30, 1998 and 1997................................... 3
Consolidated Statements of Cash Flows
Nine months ended September 30, 1998 and 1997.................................................... 4
Notes to Consolidated Financial Statements.......................................................... 5-13
Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................................................14-32
Review by Independent Accountants................................................................... 33
Independent Accountants' Review Report.............................................................. 34
PART II - OTHER INFORMATION
Exhibits and Reports on Form 8-K.................................................................... 35
Signatures.......................................................................................... 36
Index to Exhibits................................................................................... 37
3
UNITED COMPANIES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30,
1998 December 31,
Assets (Unaudited) 1997
------------ ------------
Cash and cash equivalents ...................................................... $ 233,020 $ 582
Interest-only and residual certificates-- net .................................. 1,010,023 882,116
Loans - net .................................................................... 161,490 172,207
Investment securities
Held-to-maturity ........................................................... 1,836 --
Available-for-sale ......................................................... 9,793 16,853
Accrued interest receivable .................................................... 100,439 85,258
Property - net ................................................................. 60,829 62,050
Capitalized mortgage servicing rights .......................................... 64,571 48,760
Other assets ................................................................... 106,192 65,494
Net assets of discontinued operations .......................................... 2,441 5,282
------------ ------------
Total assets ........................................................ $ 1,750,634 $ 1,338,602
============ ============
Liabilities and Stockholders' Equity
Notes payable .................................................................. $ 1,025,715 $ 691,826
Deferred income taxes payable .................................................. 100,002 95,385
Managed cash overdraft ......................................................... -- 13,625
Other liabilities .............................................................. 120,097 57,137
------------ ------------
Total liabilities ................................................... 1,245,814 857,973
------------ ------------
Stockholders' equity:
Preferred stock, $2 par value;
Authorized - 20,000,000 shares;
Issued - 1,898,070 shares of 6 3/4% PRIDES(sm) ($44 per share
liquidation preference) ............................................. 3,796 3,796
Common stock, $2 par value;
Authorized - 100,000,000 shares;
Issued - 29,991,288 and 29,971,356 shares ........................... 59,977 59,943
Additional paid-in capital ................................................. 187,082 187,418
Net unrealized gain on securities .......................................... 46 98
Retained earnings .......................................................... 273,586 250,429
Treasury stock ............................................................. (7,409) (7,409)
ESOP debt .................................................................. (12,258) (13,646)
------------ ------------
Total stockholders' equity ................................................. 504,820 480,629
------------ ------------
Total liabilities and stockholders' equity .......................... $ 1,750,634 $ 1,338,602
============ ============
See notes to consolidated financial statements.
2
4
UNITED COMPANIES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
Revenues:
Loan sale gains ......................................... $ 82,329 $ 74,760 $ 203,355 $ 175,113
Finance income, fees earned and other
loan income ........................................ 30,709 41,321 81,140 121,304
Investment income ....................................... 19,557 6,195 37,379 17,076
Other ................................................... 1,822 2,026 6,291 6,271
---------- ---------- ---------- ----------
Total ........................................... 134,417 124,302 328,165 319,764
---------- ---------- ---------- ----------
Expenses:
Personnel ............................................... 37,466 32,741 105,867 86,789
Interest ................................................ 18,978 14,942 53,155 39,764
Other operating ......................................... 36,063 33,502 108,743 83,558
---------- ---------- ---------- ----------
Total ........................................... 92,507 81,185 267,765 210,111
---------- ---------- ---------- ----------
Income from continuing operations before
income taxes ............................................ 41,910 43,117 60,400 109,653
Provision for income taxes ................................. 16,109 15,384 23,397 39,324
---------- ---------- ---------- ----------
Income from continuing operations .......................... 25,801 27,733 37,003 70,329
Income (loss) from discontinued operations
Income (loss) from discontinued operations, net of
income tax expense (benefit) of $419, $395,
$(830) and $595, respectively ......................... (614) (684) (1,541) 637
Loss on disposal, net of income tax benefit of
$700 .................................................. (1,300) -- (1,300) --
---------- ---------- ---------- ----------
Total ........................................... (1,914) (684) (2,841) 637
---------- ---------- ---------- ----------
Net income ................................................. $ 23,887 $ 27,049 $ 34,162 $ 70,966
========== ========== ========== ==========
Basic Earnings per share:
Income from continuing operations ....................... $ 0.82 $ 0.89 $ 1.18 $ 2.25
Income (loss) from discontinued operations .............. (0.06) (0.02) (0.09) 0.02
---------- ---------- ---------- ----------
Net income ...................................... $ 0.76 $ 0.87 $ 1.09 $ 2.27
========== ========== ========== ==========
Diluted earnings per share:
Income from continuing operations ....................... $ 0.80 $ 0.85 $ 1.15 $ 2.16
Income (loss) from discontinued operations .............. (0.06) (0.02) (0.09) 0.02
---------- ---------- ---------- ----------
Net income ...................................... $ 0.74 $ 0.83 $ 1.06 $ 2.18
========== ========== ========== ==========
See notes to consolidated financial statements.
3
5
UNITED COMPANIES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Nine Months Ended September 30,
------------------------------
1998 1997
------------ ------------
Cash flows from operating activities:
Income from continuing operations .................................... $ 37,003 $ 70,329
Adjustments to reconcile income from continuing operations
to net cash used by continuing operating activities:
Increase in accrued interest receivable .......................... (15,181) (12,840)
Increase (decrease) in other assets .............................. (3,237) (5,025)
Increase in other liabilities .................................... 62,837 32,516
Increase in interest-only and residual certificates .............. (127,907) (229,560)
Increase in capitalized mortgage servicing rights ................ (27,741) (22,773)
Amortization of capitalized mortgage servicing rights ............ 11,930 6,305
Loan loss provision on owned loans ............................... 3,780 2,957
Amortization and depreciation .................................... 5,220 5,055
Deferred income taxes ............................................ 4,645 28,817
Investment gains ................................................. (14,369) --
Proceeds from sales and principal collections of loans
held for sale .................................................. 2,687,803 1,905,922
Originations and purchases of loans held for sale ................ (2,659,072) (1,948,114)
Decrease in trading securities ................................... -- 17,418
------------ ------------
Net cash used by continuing operating activities ........... (34,289) (148,993)
------------ ------------
Cash flows from discontinued operations ................................... (37,461) (19,959)
------------ ------------
Cash flows from investing activities:
Proceeds from sales of available-for-sale securities ............. 9,327 1,375
Purchase of available-for-sale securities ........................ (125) (1,242)
Proceeds from maturity of held-to-maturity securities ............ 4,005 --
Purchase of held-to-maturity securities .......................... (5,837) --
Proceeds from sale of property ................................... 1,750 --
Capital expenditures ............................................. (15,650) (16,927)
------------ ------------
Net cash used by investing activities ...................... (6,530) (16,794)
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of subordinated notes ..................... -- 146,855
Payment on senior note ........................................... (100,000) --
Increase in revolving credit facilities .......................... 439,300 95,400
Proceeds from construction loan .................................. -- 3,846
Decrease in subordinated debentures .............................. (3,000) --
Payments on construction and mortgage loans ...................... -- (12,612)
Decrease in debt with maturities of three months or less ......... -- (47,100)
Decrease in warehouse loan facility .............................. (1,316) (18,136)
Proceeds from ESOP debt .......................................... -- 850
Payments on ESOP debt ............................................ (1,137) (1,137)
Cash dividends paid .............................................. (11,005) (11,086)
Increase (decrease) in managed cash overdraft .................... (13,625) 15,610
Increase (decrease) in unearned ESOP compensation ................ 1,388 (777)
Proceeds from exercise of stock options .......................... 113 105
------------ ------------
Net cash provided by financing activities .................. 310,718 171,818
------------ ------------
Increase (decrease) in cash and cash equivalents ..................... 232,438 (13,928)
Cash and cash equivalents at beginning of period ..................... 582 14,510
------------ ------------
Cash and cash equivalents at end of period ................................ $ 233,020 $ 582
============ ============
See notes to consolidated financial statements.
4
6
UNITED COMPANIES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION.
In the opinion of the Company's management, the accompanying unaudited
consolidated financial statements contain all adjustments, consisting of
only normal accruals, except for discontinued operations, necessary to
present fairly the financial position, the results of operations and the
cash flows for the interim periods presented.
These notes reflect only the major changes from those disclosures contained
in the Company's Annual Report on Form 10-K for the year ended December 31,
1997, filed with the United States Securities and Exchange Commission ("the
Commission").
The consolidated results of operations for the nine months ended September
30, 1998 are not necessarily indicative of the results to be expected for
the full year. Certain 1997 amounts have been reclassified to conform with
the current year presentations. Such reclassifications had no effect on net
income.
2. DISCONTINUED OPERATIONS.
On October 27, 1998, the Company made a decision to discontinue the
operations of United Companies Funding, Inc. ("UCFI"), a wholly owned
subsidiary of the Company. UCFI was organized in 1995 to originate
manufactured housing loan products made primarily to finance the purchase
of new or used manufactured homes. In reaching the decision to discontinue
the operations of UCFI, the Company considered the less than anticipated
results of UCFI's operations and the funding required, and the impact
thereof on the Company's liquidity, to continue its operations. The Company
has estimated the loss that will occur from the discontinuance, and the
operating losses that will occur during phaseout, of UCFI and, accordingly,
has accrued for such losses in its financial statements for the three
months ended September 30, 1998. The results of operations of UCFI have
been classified as discontinued operations and the prior year financial
statements have been restated accordingly.
In connection with the decision to discontinue the operations of UCFI, the
Company recorded a net loss of $1.9 million and $2.8 million in its
financial statements for the three months and nine months ended September
30, 1998, respectively. Total revenues of UCFI for the nine months ended
September 30, 1998 and 1997 were $29.6 million and $20.8 million,
respectively, and net income (loss) for such periods was $(2.8 million) and
$.6 million, respectively. Total assets of UCFI at September 30, 1998 and
December 31, 1997 were $75.4 million and $37.1 million, respectively. The
assets related to manufactured housing contracts sold in public
asset-backed securitization transactions, consisting primarily of
Interest-only and residual certificates totaling approximately $73 million,
have been retained by the Company, and therefore, are excluded from "Net
assets of discontinued operations".
3. INTEREST-ONLY AND RESIDUAL CERTIFICATES -- NET.
A summary analysis of the changes in the Company's Interest-only and
residual certificates for home equity loans for the periods indicated is as
follows:
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
(in thousands)
Balance, beginning of period .................................... $ 882,116 $ 604,474
Interest-only and residual certificates on loans sold ........... 307,204 355,743
Net increase in allowance for losses on loans sold .............. (63,504) (33,462)
Net increase in cash reserve accounts ........................... 61,026 138,070
Amortization of Interest-only and residual certificates ......... (176,819) (182,709)
------------ ------------
Balance, end of period .......................................... $ 1,010,023 $ 882,116
============ ============
5
7
The following table sets forth the components of the Interest-only and
residual certificates owned by the Company, which are recorded at fair
value, at September 30, 1998 and December 31, 1997:
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
(IN THOUSANDS)
Certificated interests ........................... $ 729,811 $ 599,426
Temporary investments - reserve accounts ......... 450,279 389,253
Allowance for losses on loans serviced ........... (170,067) (106,563)
------------ ------------
Total .................................. $ 1,010,023 $ 882,116
============ ============
The prepayment assumptions used by the Company as of September 30, 1998, in
computing loan sale gains and the carrying value of the Interest-only and
residual certificates related to its home equity products were as follows:
o With its fixed rate product, the Company assumes a life-to-date
prepayment speed of 24.1% based on a seasoning curve that begins at 9%
in month one, increases to 27% in month 12, increases to 30% in month 20
and stays constant until month 36, ramps down to 17% by month 53 and
remains constant at this rate until maturity. At September 30, 1998, the
Company had $3.7 billion in fixed rate home equity loans in its
servicing portfolio.
o The Company assumes a life-to-date prepayment speed of 29.5%, based on a
seasoning curve, for its adjustable rate product ("ARMs"). The curve
begins at 14% in month one, peaks at 39% in month 12, decreases slightly
to 34% by month 19 and stays constant until month 28 when it declines to
33% and remains at this rate until month 48, then ramps down to 17% by
month 56 and remains constant at this rate until maturity. At September
30, 1998, the Company had $1.0 billion in ARMs in its servicing
portfolio.
o The Company assumes a life-to-date prepayment speed of 25.1%, based on a
seasoning curve, for its hybrid loan products, i.e., products that have
rates fixed for two or three years and become adjustable thereafter. The
curve begins at 4% in month one, increases to 27% in month 12, continues
to increase to 30% in month 30 and stays constant until month 40, ramps
down to 20% by month 56 and remains constant at this rate until
maturity. At September 30, 1998, the Company had $1.7 billion in hybrid
loans in its servicing portfolio, of which $1.4 billion have rates fixed
for three years.
In addition, in its loan sale gain calculations, the Company uses a
discount rate assumption of 10% on gross cash flows until they are
collected by the Company (as servicer) and deposited into the reserve
account in the related securitization trust. The reserve for loan losses
is generally discounted at approximately 6%. The combination of these two
rates produces a net cash flow discount rate of approximately 11%. The
cash in the reserve account is discounted at a rate of 50 basis points
over the earnings rate of the reserve account. The Company uses projected
cumulative losses of approximately 250 basis points for its fixed rate
products and 200 basis points for its adjustable rate and hybrid loan
products.
Realization of the value of these Interest-only and residual certificates
and Capitalized mortgage servicing rights 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. Although management of the Company believes that it has made
reasonable estimates in its computations of loan sale gains, it should be
recognized that the rate of prepayment and the amount of defaults utilized
by the Company are estimates and actual experience may vary from these
estimates. If actual experience differs from the estimates used by the
Company at the time of sale of the loans in its determination of the value
of these assets, (i) future cash flows
6
8
and earnings could be negatively impacted, (ii) the Company could be
required to write down the value of its Interest-only and residual
certificates and Capitalized mortgage servicing rights and (iii) different
estimates could result which may lower the income recorded as loan sale
gains by the Company on future loan securitizations. The Company believes
that there is no active market for the sale of its Interest-only and
residual certificates or its Capitalized mortgage servicing rights. No
assurance can be given that these assets could be sold at their respective
stated values on the balance sheet, if at all, and the difference could
be material.
Certificated interests at September 30, 1998 and December 31, 1997 includes
$36.5 million and $5.6 million, respectively, of subordinated securities
retained by the Company in connection with manufactured housing contract
securitizations.
During the first quarter of 1998, the Company entered into a $1.0 billion
notional amount interest rate cap transaction for hybrid home equity loans
sold in securitization transactions prior to 1998 to mitigate its exposure
during the initial two or three year period following the date of sale when
the coupon rates on the loans are fixed and the rates on the asset-backed
certificates backed by such loans are floating. In November 1998, the
Company entered into another interest rate cap transaction in the notional
amount of $1.6 billion for hybrid home equity loans sold in securitization
transactions prior to September 30, 1998, for the same purpose.
The following data provides certain contractual delinquency and default
data with respect to home equity loans serviced by the Company as of the
dates indicated.
---------------------------------------------------------------------------------------------------
DEFAULTS TOTAL
------------------------------
CONTRACTUAL DELINQUENCY
--------- ------------------------------------- FORECLOSURES BANK- DELINQUENCY
BALANCE 30-59 60-89 90+ TOTAL IN PROCESS RUPTCY TOTAL & DEFAULTS
--------- ------- -------- ------- ------- ---------- ------- -------- -----------
(DOLLARS IN THOUSANDS)
September 30, 1998 $6,431,877 2.60% .98% .86% 4.44% 4.20% 2.18% 6.38% 10.82%
December 30, 1997 5,528,923 3.20% 1.05% .85% 5.10% 3.43% 2.10% 5.53% 10.63%
The following table provides certain pool factors and cumulative losses
with respect to the Company's home equity loans by year of production for
the periods indicated:
CUMULATIVE
YEAR HOME-EQUITY NET LOSSES AS
OF LOAN POOL % OF
PRODUCTION PRODUCTION FACTOR(1) PRODUCTION
- --------------- --------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
FIXED
1993 $ 500,900 18.64% 2.30%
1994 $ 837,901 25.59% 2.86%
1995 $ 1,130,715 34.34% 2.11%
1996 $ 1,383,714 49.23% 0.51%
1997 $ 1,373,984 67.96% 0.02%
1998 $ 1,358,089 93.87% 0.00%
ARM
1993 $ 38,968 13.92% 1.73%
1994 $ 70,920 11.58% 0.90%
1995 $ 410,922 30.30% 1.35%
1996 $ 860,744 42.61% 0.38%
1997 $ 1,513,667 72.55% 0.02%
1998 $ 1,237,995 93.60% 0.00%
(1) Pool Factor - Percentage of the year's production
remaining outstanding at September 30, 1998.
4. LOANS -- NET.
Loans Owned. The following schedule sets forth the components of Loans --
net owned by the Company at September 30, 1998 and December 31, 1997:
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
(IN THOUSANDS)
Loans held for sale ...................... $ 38,343 $ 120,311
Other loans .............................. 126,723 52,802
------------ ------------
Total ............................ 165,066 173,113
Real estate owned:
Home equity ......................... 5,820 6,365
Commercial and other ................ 2,577 3,173
Nonrefundable loan fees .................. (1,804) (2,760)
Other .................................... (5,855) (3,993)
------------ ------------
Total ............................ 165,804 175,898
------------ ------------
Less:
Allowance for loan losses ........... (4,314) (3,691)
------------ ------------
$ 161,490 $ 172,207
============ ============
Included in Other loans at September 30, 1998 and December 31, 1997 were
nonaccrual loans totaling $10.9 million and $10.1 million, respectively.
7
9
Loans Serviced. The following table sets forth the loans serviced by the
Company for third parties at September 30, 1998 and December 31, 1997, by
type of loan. Substantially all of these loans were originated by the
Company:
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- --------------
(IN THOUSANDS)
Home equity................................................ $ 6,295,108 $ 5,353,429
Manufactured housing contracts(1).......................... 717,548 295,012
Other...................................................... 24,448 33,319
--------------- --------------
Total............................................ $ 7,037,104 $ 5,681,760
=============== ==============
(1) At December 31, 1997, approximately $135.9 million
land-and-home contracts were included in home equity loans
that are classified as manufactured housing contracts at
September 30, 1998.
5. NOTES PAYABLE.
Notes payable consisted of the following at the dates indicated:
September 30, DECEMBER 31,
1998 1997
------------ ------------
(IN THOUSANDS)
Senior debt
7% Senior unsecured notes due July, 1998 ................ $ -- $ 100,000
9.35% Senior unsecured notes due November, 1999 ......... 125,000 125,000
7.7% Senior unsecured notes due January, 2004 ........... 100,000 100,000
Revolving credit facility ............................... 631,850 192,550
Warehouse facilities .................................... 3,349 4,665
ESOP debt ............................................... 9,329 10,466
------------ ------------
Total Senior debt ................................ 869,528 532,681
------------ ------------
Subordinated debt
8.375% Subordinated unsecured notes due July, 2005 .... 149,187 149,145
Subordinated debentures ............................... 7,000 10,000
------------ ------------
Total ............................................. $ 1,025,715 $ 691,826
============ ============
The revolving credit facility is a $850 million facility provided by a
group of banks which matures in April 2000. In order to help maintain a
continuing source of bank credit for its lending operations, the Company
has reached agreement with the agent bank for the bank group on the terms
of a restructure of the presently unsecured revolving credit facility into
a secured warehouse/interest receivable warehouse facility, to mature in
two years, and a secured residual-financing credit facility, to mature in
April 2000, aggregating $850 million. The agent bank has orally advised the
Company that the terms have been approved by all of the participating
banks, subject to the preparation and completion of acceptable definitive
documents. There can be no assurance that the restructure of the bank
credit facility will be consummated pursuant to the terms agreed upon by it
and the banks.
The revolving credit facility (the "Credit Facility") and the senior and
subordinated notes (the "Notes") require the Company to maintain a minimum
consolidated fixed charge coverage ratio. The Company has experienced a
declining trend in this ratio. At September 30, 1998, the Company was in
compliance with this and all other covenants of its Credit Facility and the
Notes. Management of the Company presently expects that results of
operations for the 1998 fourth quarter will not result in a decline in this
ratio below the amount required by the Credit Facility and the Notes.
However, in the event the consolidated fixed charge coverage ratio as of
8
10
December 31, 1998 is less than the minimum required, an event of default
will occur under the Credit Facility and the Notes and payment of the
outstanding principal balance thereof will be due unless, prior to the
expiration of cure periods provided therein, waivers are obtained by the
Company.
6. CASH PAID FOR INTEREST AND INCOME TAXES.
During the nine months ended September 30, 1998 and 1997, the Company paid
interest on Notes payable in the amount of $54.7 million and $30.4 million,
respectively. During the nine months ended September 30, 1998 and 1997, the
Company paid income taxes in the amount of $.4 million and $5.6 million,
respectively.
7. EARNINGS PER SHARE.
The following table sets forth the computations of basic and diluted
earnings per share for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Basic Earnings Per Share
Income available to common shareholders:
Income from continuing operations ..................... $ 25,801 $ 27,733 $ 37,003 $ 70,329
Income (loss) from discontinued operations ............ (1,914) (684) (2,841) 637
---------- ---------- ---------- ----------
Total ................................................. $ 23,887 $ 27,049 $ 34,162 $ 70,966
========== ========== ========== ==========
Weighted average number of common and
common equivalent shares:
Average common shares outstanding ..................... 28,121 27,979 28,099 27,985
Add: Dilutive effect of preferred stock
after application of "if converted" method ..... 3,136 3,230 3,136 3,230
---------- ---------- ---------- ----------
Total ................................................. 31,257 31,209 31,235 31,215
========== ========== ========== ==========
Earnings per share:
Income from continuing operations ..................... $ 0.82 $ 0.89 $ 1.18 $ 2.25
Income (loss) from discontinued operations ............ (0.06) (.02) (0.09) 0.02
---------- ---------- ---------- ----------
Total ................................................. $ 0.76 $ 0.87 $ 1.09 $ 2.27
========== ========== ========== ==========
Diluted Earnings Per Share
Income available to common shareholders:
Income from continuing operations ..................... $ 25,801 $ 27,733 $ 37,003 $ 70,329
Income (loss) from discontinued operations ............ (1,914) (684) (2,841) 637
---------- ---------- ---------- ----------
Total ................................................. $ 23,887 $ 27,049 $ 34,162 $ 70,966
========== ========== ========== ==========
Weighted average number of common and
all dilutive shares:
Average common shares outstanding ..................... 28,121 27,979 28,099 27,985
Add: Dilutive effect of stock options after
application of treasury stock method ........... 418 727 469 624
Dilutive effect of preferred stock
after application of "if converted" method ..... 3,796 3,910 3,796 3,910
---------- ---------- ---------- ----------
Total ................................................. 32,335 32,616 32,364 32,519
========== ========== ========== ==========
Earnings per share:
Income from continuing operations ..................... $ 0.80 $ 0.85 $ 1.15 $ 2.16
Income (loss) from discontinued operations ............ (0.06) (.02) (0.09) 0.02
---------- ---------- ---------- ----------
Total ................................................. $ 0.74 $ 0.83 $ 1.06 $ 2.18
========== ========== ========== ==========
9
11
The weighted average anti-dilutive shares that were excluded from the
computation of diluted earnings per share were 1,542,665 and 94,349 for the
three months ended September 30, 1998 and 1997, respectively, and 1,475,154
and 408,057 for the nine months ended September 30, 1998 and 1997,
respectively.
8. COMMITMENTS AND CONTINGENCIES.
At September 30, 1998, Cash and cash equivalents includes $150.9 million of
temporarily restricted cash related to a commitment to deliver, prior to
October 20, 1998, loan documentation on loans sold in a private
securitization transaction in September 1998. Upon delivery of such
documentation, the Company applied substantially all of such cash to reduce
the outstanding balance of its revolving credit facility.
As discussed in Notes 12 and 13 of the Company's Annual Report on Form 10-K
for the year ended December 31, 1997, the Company has certain contingencies
in connection with the sale, during 1996, of its investment in United
General Title Insurance Company. There were no material changes in these
contingencies in the first nine months of 1998.
The Company used a prefunding feature in connection with its securitization
transactions during the third quarter of 1998. At September 30, 1998,
approximately $101.8 million was held in a prefunding account for the
purchase of the Company's home equity loans during the fourth quarter of
1998. In addition, at September 30, 1998, approximately $24.6 million was
held in a prefunding account for purchase of the Company's manufactured
housing contracts during the fourth quarter of 1998. Such manufactured
housing contracts were delivered in October, 1998 and it is anticipated
that such home equity loans will be delivered in November, 1998.
In a class action lawsuit pending in Alabama state district court involving
910 home equity loans alleged to be subject to the Alabama Mini Code,
Autrey v. United Companies Lending Corporation, the Alabama Supreme Court,
acting on an interlocutory appeal by the Company, upheld the ruling of the
trial court on a pre-trial motion that retroactive application of the 1996
amendments to the Alabama Mini Code would be unconstitutional as applied to
the plaintiff's class. The 1996 amendments, which in general limited the
remedy for finance charges in excess of the maximum permitted by the
Alabama Mini Code, were expressly made retroactive by the Alabama
legislature. The Company strenuously disagreed with this holding and sought
a rehearing by the Alabama Supreme Court. The request for a rehearing has
been denied by the Alabama Supreme Court and the matter will be returned to
the trial court for a trial on the merits. The Company believes that the
liability, if any, should be limited to $495,000, the amount of the
aggregated finance charges allegedly exceeding the maximum permitted by the
Alabama Mini Code, plus interest thereon. The Company intends to continue
its vigorous defense of this matter. If unsuccessful in its defense at a
trial on the merits and related appeals, the Company presently estimates
that the liability of its subsidiary could be approximately $15 million.
The U.S. Department of Justice ("DOJ") and the U.S. Department of Housing
and Urban Development ("HUD") recently issued a letter to the Company and
its subsidiary United Companies Lending Corporation notifying them that
they were initiating a joint investigation of their lending and pricing
practices, initially in Philadelphia, PA-NJ PMSA. The investigation focuses
on compliance by the Company and its subsidiary with the federal Fair
Housing Act and Equal Credit Opportunity Act and the federal Real Estate
Settlement Procedures Act ("RESPA"). Specifically, DOJ seeks to determine
whether the lending and pricing practices of the Company and its subsidiary
discriminate against applicants based on race, national origin, sex, or
age. The Company believes this investigation by DOJ is part of an overall
initiative by that agency to review the practices of several large subprime
lenders and does not stem from any findings of wrongdoing by the Company.
HUD will be investigating whether relationships of the Company and its
subsidiary with mortgage brokers, home improvement dealers or other third
parties may violate the anti-kickback and anti-referral fee prohibitions of
RESPA. The Company is cooperating with the joint investigation and
management of the Company believes that both agencies will ultimately
determine that no violations of law have occurred.
10
12
In October 1998, the Company reached a settlement in an enforcement action
suit pending in Massachusetts state court alleging violations by the
Company of certain regulations promulgated by the Massachusetts Attorney
General relating to, among other things, loan origination fees, also known
as "points", with respect to loans originated in Massachusetts. The
settlement, involving payments and other terms by the Company aggregating
approximately $1.2 million, followed a decision by a federal district court
in Massachusetts upholding the validity of the regulations and finding
violations thereof by the Company's subsidiary. The Company had maintained
that the Massachusetts regulations were void because they conflicted with
the efforts of the Massachusetts legislature to supplant the strict
regulation of points with disclosure requirements, and were inconsistent
with the policies and interpretations of the Federal Trade Commission as to
what constitutes unfair and deceptive trade practices. The federal district
court found that the Attorney General's regulations did not contravene the
intent of the Massachusetts legislature and are not inconsistent with
applicable federal law. The settlement has been accrued in the consolidated
financial statements at September 30, 1998.
9. ACCOUNTING STANDARDS.
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes disclosure
standards for reporting comprehensive income in a full set of general
purpose financial statements. Comprehensive income for the three months and
nine months ended September 30, 1998 and 1997 was $27.1 million and $23.8
million (net of income taxes) and $34.1 million and $71.0 million (net of
income taxes), respectively.
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employer's Disclosures about Pensions and Other
Postretirement Benefits -- an amendment of FASB Statements Nos. 87, 88 and
106" ("SFAS No. 132") which is effective for fiscal years beginning after
December 15, 1997. SFAS No. 132 establishes standards for disclosures about
pension and other postretirement benefit plans and does not change the
current methods of measurement or recognition of those plans. The adoption
of this standard is not expected to have a material impact on the Company's
financial statement presentation and related disclosures.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting for
derivative instruments, including certain derivative instruments embedded
in other contracts and for hedging activities. It requires that an entity
recognize, at fair value, all derivatives as either assets or liabilities.
The accounting for changes in the fair value of a derivative is dependent
upon the intended use of the derivative. SFAS No. 133 is effective for all
periods beginning after June 15, 1999. Earlier application of the
provisions of SFAS No. 133 is encouraged, but is permitted only as of the
beginning of any quarter that begins after issuance of the Statement.
Retroactive application is not allowed. The Company is reviewing the
provisions of this pronouncement but has not yet determined the effect of
its implementation on the Company's financial condition or results of
operations.
In October 1998, the FASB issued Statement of Financial Account Standards
No. 134, "Accounting for Mortgage- Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise" ("SFAS No. 134"), which is effective for the first fiscal
quarter beginning after December 15, 1998. Early application is encouraged
and is permitted as of the issuance of the statement. SFAS No. 134 requires
that, after the securitization of mortgage loans held for sale, any
retained investment in mortgage-backed securities be classified in
accordance with the provisions of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities", based on the entity's ability
and intent to sell or hold the investment. Prior to SFAS No. 134, the
Company was required to classify its retained interests as a trading
security even though it had no intent to dispose of the security. Upon
adoption, the Company intends to classify its Interest-only and residual
certificates as "available-for-sale" and subsequent adjustments in carrying
value will result in such adjustments being made in stockholders' equity on
the Company's balance sheet and will be reflected as a component in the
Company's Comprehensive Income Statement. However, the effects of changes
11
13
in default assumptions would still have to be recognized in income
immediately. Securities subject to substantial prepayment risk, such as the
Interest-only and residual certificates, cannot be classified as
held-to-maturity. The Company is reviewing the provisions of this
pronouncement but has not yet determined the effect of its implementation
on the Company's financial condition or results of operations.
The Financial Accounting Standards Board is completing SFAS No. 125
Guidance which may affect the way the Company discounts the expected
"cash-out" of trust under Statement of Financial Accounting Standards No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities". If issued, this Guidance could have the
effect of causing a revaluation of the carrying value of the Interest-only
and residual certificates and, on a going forward basis, lower the income
recorded as loan sale gains on future loan securitizations. The Company
cannot determine the impact, if any, of the Guidance until its is
finalized.
10. SUBSEQUENT EVENTS.
On October 28, 1998, the Company announced that it will implement a
restructuring plan that will focus on its most cost efficient and
profitable business units while reducing the Company to a size which can be
supported by its existing capital and funding base.
In July 1998, the Company announced it was seeking a potential strategic
partnership to improve its access to capital and accelerate its growth, but
efforts as of the date of the October 28, 1998 announcement have been
unsuccessful. After a thorough analysis of the then current circumstances,
the Board of Directors of the Company determined that it was necessary and
advisable to move forward at that time on a new business plan intended to
create a streamlined, more focused Company. The objectives of the
restructuring are to: 1) generate positive cash flow from operations and
sufficient earnings; 2) maintain a sound capital base; and 3) compete in
the market place through the Company's most competitive and cost efficient
production and servicing systems.
Under the plan, the Company has taken steps immediately to sell or close
down its wholesale, manufactured housing and credit card units, which will
result in a reduction of Company personnel and overhead expenses by more
than 30%. Nationwide employee levels will be reduced from approximately
3,350 to 2,280. In addition to the sale or closing of the three business
units, approximately $150 million of non-core assets of the Company will be
sold, including the sale of the Company's real estate investment
properties. The Company does not anticipate that it will incur any material
loss on disposition of these non-core assets.
United Companies Lending Corporation will close 32 underperforming retail
locations and emphasis will be placed on increasing the production levels
of the remaining 200 higher performing branches. The Company has estimated
that the costs of the downsizing will range from $4 million to $6 million.
The plan is designed to achieve an annual home-equity loan production level
of $2.4 billion.
The plan also provides that future dividends on the Company's common and
preferred stock will be suspended indefinitely. Dividends on the Company's
outstanding shares of preferred stock (the "PRIDES(sm)") will accrue
without interest whether or not such dividends are declared. In the event
that dividends on the PRIDES(sm) are in arrears and unpaid for six
quarterly dividend periods, the holders of the PRIDES(sm) , voting
separately as a class, are entitled to vote for the election of two
preferred stock directors, such directors to be in addition to the number
of directors constituting the Board of Directors immediately prior to the
accrual of such right and such right shall continue until all dividends in
arrears on the PRIDES(sm) shall have been paid in full. Upon mandatory
conversion of the PRIDES(sm) into common stock on July 1, 2000, in
accordance with their terms, any dividends in arrears on the PRIDES(sm) are
payable in cash by the Company from funds legally available therefor.
Factors that will affect the Company's ability to accomplish the
restructuring plan include its ability to: (i) generate and maintain
adequate liquidity for a sufficient period of time to execute the plan;
(ii) complete the new
12
14
proposed restructured primary bank credit facility (discussed in Note 5
above); (iii) maintain compliance with the financial covenants under the
Company's primary bank credit facility and public unsecured notes; (iv)
continue to securitize on a quarterly basis its home equity loan production
in which the asset-backed securities are insured by third-party certificate
insurers; (v) achieve the loan production levels projected by the plan; and
(vi) timely implement the downsizing and other requirements of the plan. In
addition, increases in prepayment rates and loan losses above historical
levels could adversely affect the Company's ability to implement the plan.
13
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following analysis should be read in conjunction with the Company's
Consolidated Financial Statements and accompanying Notes presented elsewhere
herein and identifies the major factors which influenced the results of
operations of the Company during the indicated periods.
FORWARD LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for certain forward-looking statements. The statements contained herein
that are not historical facts are forward-looking statements based on the
Company's current expectations and beliefs concerning future developments and
their potential effects on the Company. There can be no assurance that future
developments affecting the Company will be those anticipated by the Company.
Actual results may differ from those projected in the forward-looking
statements. These forward- looking statements involve significant risks and
uncertainties (some of which are beyond the control of the Company) and are
subject to change based upon various factors, including but not limited to the
following risks and uncertainties: changes in the asset securitization industry
and in the performance of the financial markets, in the demand for and market
acceptance of the Company's products, and in general economic conditions,
including interest rates; the presence of competitors with greater financial
resources and the impact of competitive products and pricing; the effect of the
Company's policies, including the amount and rate of growth of Company expenses;
the continued availability to the Company of adequate funding sources; actual
prepayment rates and credit losses on loans sold as compared to prepayment rates
and credit losses assumed by the Company at the time of sale for purposes of its
gain on sale computations; the effect of changes in market interest rates on the
spread between the coupon rate on loans sold and the rate on the asset-backed
securities backed by such loans issued by the Company in securitization
transactions and on the discount rate assumed by the Company in its gain on sale
computations; timing of loan sales; the quality of the Company's owned and
serviced loan portfolio including levels of delinquencies, customer bankruptcies
and charge-offs; ratings; and various legal, regulatory and litigation risks.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as the result of new information, future
events or otherwise. For a more detailed discussion of some of the foregoing
risks and uncertainties, see "Investment Considerations" below as well as other
Company filings with the Securities and Exchange Commission.
RESULTS OF OPERATIONS
The Company's financial statements present United Companies Funding, Inc.
("UCFI") as discontinued operations (see Note 2 to Consolidated Financial
Statements, and "Discontinued Operations" and "Subsequent Events" below). In
addition to these matters, the Company's results of continuing operations for
the periods presented are discussed below.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
The Company's operations primarily consist of the production (by
origination or purchase), sale and servicing of first mortgage,
non-conventional, home equity loans ("loans"). The principal home equity loan
products are fixed rate, adjustable rate ("ARM") and hybrid (i.e., the rate is
fixed for a specified period and becomes adjustable thereafter). Fundamental to
the profitability and funding of the Company's operations has been the sale of
loans with servicing rights retained. The majority of the Company's revenue is
derived from the gain recognized on the sale of loans and the recognition of net
loan fees at the time of sale of the loans.
The Company has sold substantially all of its loan production in
securitization transactions. During the first nine months of 1998 and 1997, the
Company sold $2.629 billion and $1.827 billion, respectively, of its home equity
loans.
14
16
The weighted average interest spread on home equity loans sold to third
parties (the difference between the stated rate on the loan and the rate paid to
purchasers of the securities backed by these loans, less recurring fees) was
4.61% and 4.78% in the first nine months of 1998 and 1997, respectively. The
weighted average interest spread on loans sold is determined without regard to
credit losses, which are provided for separately by the Company.
Net income for the nine months ended September 30, 1998 was $34.2 million
($1.06 per diluted share based on 32.4 million weighted average shares
outstanding) compared to $71.0 million for the same period of 1997 ($2.18 per
diluted share based on 32.5 million weighted average shares outstanding). The
decrease in net income in the first nine months of 1998 resulted primarily from
a $42.6 million increase in the provision for losses on loans serviced. In
addition, during the second quarter of 1998 the Company recorded a $10 million
negative adjustment to the valuation of the Company's Interest-only and residual
certificates. Further, net income for the first nine months of 1997 was
increased by $4.5 million as the result of the implementation by the Company of
Statement of Financial Accounting Standards No. 125 "Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS No.
125"). Net income for the three months and nine months ending September 30, 1998
was positively affected by non-recurring gains aggregating $7.3 million (net of
income tax) on the sale of certain non-core assets, consisting of a real estate
property and a stock investment, owned by the Company.
Revenues. The following table sets forth information regarding the
components of the Company's revenues for the periods indicated:
Nine Months Ended September 30,
-----------------------------------
1998 1997
------------- -------------
(IN THOUSANDS)
Loan sale gains............................................... $ 203,355 $ 175,113
Finance income, fees earned and other loan income............. 81,140 121,304
Investment income............................................. 37,379 17,076
Other......................................................... 6,291 6,271
------------- -------------
Total............................................... $ 328,165 $ 319,764
============= =============
The Company sells substantially all loans which it originates or purchases
and generally retains the servicing rights on loans sold. Under the
sales/servicing agreements, the buyer receives the principal collected on the
loan and an agreed upon rate on the outstanding principal balance, and the
Company retains the excess of the interest at the contractual rate over the sum
of the rate paid to the buyer (the "investor" rate), a normal servicing fee and,
where applicable, the trustee fee and surety bond fee. At the time of sale, the
Company allocates a portion of its basis in the loans to mortgage servicing
rights which is recorded as an asset (Capitalized mortgage servicing rights),
records as an asset the fair value of the excess interest retained by it
(Interest-only and residual certificates), makes a provision for an allowance
for losses on the loans sold for which it retains the servicing, and recognizes
the resulting loan sale gain as revenue. The fair value of the Company's
Interest-only and residual certificates, which is net of the allowance for loan
losses on serviced loans, is determined at the time of sale by the Company by
computing the present value of the cash flows of the excess interest retained by
the Company expected to be received by it (using the expected dates that such
interest is to be released from the related reserve accounts), discounted at
interest rates as described below. These amounts are calculated using prepayment
and default assumptions based on the actual experience of the Company's owned
and serviced portfolio for home equity loans. On a quarterly basis, the Company
reviews the fair value of the Interest-only and residual certificates by
analyzing its prepayment and other assumptions in relation to its actual
experience, and, if necessary, adjusts the carrying value of the Interest-only
and residual certificates to such fair value through a charge or credit to
earnings.
During the second quarter of 1998, the Company increased the prepayment
("CPR") assumptions used to calculate loan sale gains and value the
Interest-only and residual certificates on its ARM and hybrid products. These
revised assumptions were applied to all securitized loans. The Company made no
changes in the assumptions used by it in such calculations and valuations during
the third quarter of 1998.
15
17
The prepayment assumptions used by the Company as of September 30, 1998, in
computing loan sale gains and the carrying value of the Interest-only and
residual certificates related to its home equity products were as follows:
o With its fixed rate product, the Company assumes a life-to-date
prepayment speed of 24.1% based on a seasoning curve that begins at 9%
in month one, increases to 27% in month 12, increases to 30% in month
20 and stays constant until month 36, ramps down to 17% by month 53
and remains constant at this rate until maturity. At September 30,
1998, the Company had $3.7 billion in fixed rate home equity loans in
its servicing portfolio.
o The Company assumes a life-to-date prepayment speed of 29.5%, based on
a seasoning curve, for its adjustable rate product ("ARMs"). The curve
begins at 14% in month one, peaks at 39% in month 12, decreases
slightly to 34% by month 19 and stays constant until month 28 when it
declines to 33% and remains at this rate until month 48, then ramps
down to 17% by month 56 and remains constant at this rate until
maturity. At September 30, 1998, the Company had $1.0 billion in ARMs
in its servicing portfolio.
o The Company assumes a life-to-date prepayment speed of 25.1%, based on
a seasoning curve, for its hybrid loan products, i.e., products that
have rates fixed for two or three years and become adjustable
thereafter. The curve begins at 4% in month one, increases to 27% in
month 12, continues to increase to 30% in month 30 and stays constant
until month 40, ramps down to 20% by month 56 and remains constant at
this rate until maturity. At September 30, 1998, the Company had $1.7
billion in hybrid loans in its servicing portfolio, of which $1.4
billion have rates fixed for three years.
The following table provides life-to-date prepayment rates and pool factors
as of September 30, 1998, with respect to the Company's home equity loan
securitizations by year of securitization for the years indicated:
Fixed ARM Hybrid
------------------------------ ------------------------------ -----------------------------------
Life- Life- Life-
Year of Original to-Date Pool Original to-Date Pool Original to-Date Pool
Securitization Balance CPR Factor (1) Balance CPR Factor (1) Balance CPR Factor (1)
- -------------- ----------- --------- -------- --------- --------- --------- ----------- ------- -----------
(dollars in thousands)
1993 $ 415,525 27% 16.98% $ 34,990 37% 9.96% -- -- --
1994 935,568 26% 26.56% 74,987 38% 14.85% -- -- --
1995 1,030,698 26% 35.87% 391,652 31% 32.63% -- -- --
1996 1,350,058 25% 52.31% 732,762 33% 44.83% 142,308 33% 41.29%
1997 1,224,998 23% 74.14% 479,294 36% 63.83% 1,020,707 21% 79.70%
1998 699,984 14% 94.67% 71,474 24% 88.99% 228,525 17% 92.53%
(1) Pool Factor - Percentage of the principal balance of the securitization
remaining outstanding at September 30, 1998.
In addition, in its loan sale gain calculations, the Company uses a
discount rate assumption of 10% on gross cash flows until they are collected by
the Company (as servicer) and deposited into the reserve account in the related
securitization trust. The reserve for loan losses is generally discounted at
approximately 6%. The combination of these two rates produces a net cash flow
discount rate of approximately 11%. The cash in the reserve account is
discounted at a rate of 50 basis points over the earnings rate of the reserve
account. The Company uses projected cumulative losses of approximately 250 basis
points for its fixed rate
16
18
products and 200 basis points for its adjustable rate and hybrid loan products.
See "Investment Considerations" below.
Loan sale gains constitute the largest component of the Company's revenues.
The increase in the amount of loan sale gains in the first nine months of 1998
compared to the same period of 1997 was due primarily to a $800 million increase
in the amount of home equity loans sold. Loan sale gains are reduced by
estimated future credit losses on loans sold, transaction expenses and loan
acquisition premiums. Loan sale gains for the nine months ended September 30,
1998 and 1997 were reduced by $63.5 million and $26.8 million, respectively, to
provide for estimated future losses on loans sold. The capitalization of
mortgage servicing rights is also included in loan sale gains and totaled $27.7
million during the first nine months of 1998 compared to $22.8 million for the
same period of 1997.
The following table presents information regarding loan sale transactions
for the periods indicated:
HOME EQUITY LOANS
----------------------------------
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------
1998 1997
-------------- --------------
(DOLLARS IN THOUSANDS)
Loans sold servicing retained ..... $ 2,506,376 $ 1,827,357
Average coupon .................... 10.56% 11.11%
Interest spread retained .......... 4.61% 4.78%
Loans sold servicing released ..... $ 122,575 --
Loan sale gains ................... $ 203,355 $ 175,113
The Company has securitized certain home equity loans that have a fixed
coupon rate for two or three years and then convert into an adjustable rate for
the remaining lives of the loans ("hybrid loans") of which $1.7 billion were
outstanding as of September 30, 1998. The investor rate on the asset-backed
securities backed by these hybrid loans is based on a floating interest rate and
is calculated monthly by reference to the London interbank offered rate for
one-month U.S. dollar deposits ("1-month LIBOR"). During the first quarter of
1998, the Company entered into a $1.0 billion notional amount interest rate cap
transaction for hybrid loans securitized prior to 1998 to mitigate its exposure
during the initial two or three year period when the coupon rates are fixed and
the investor rates are floating. In November 1998, the Company entered into
another interest rate cap transaction in the notional amount of $1.6 billion for
hybrid home equity loans sold in securitization transactions prior to September
30, 1998, for the same purpose. In addition, certain classes of the asset-backed
securities of the Company's 1996, 1997 and 1998 securitizations backed by fixed
rate home equity loans provide for floating investor rates based on 1-month
LIBOR. These securitizations were structured so that the maturity of these
floating investor rate securities is anticipated to be approximately one year.
As of September 30, 1998, $85 million of such 1997 securities and $372 million
of such 1998 securities remain outstanding. The change in fair value of the
interest rate caps is reflected each quarter in the statement of income and
amounted to a write down of $1.3 million for the quarter ended September 30,
1998 and $2.7 million for the nine months ended September 30, 1998.
Realization of the value of Interest-only and residual certificates and
Capitalized mortgage servicing rights 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. Although
management of the Company believes that it has made reasonable estimates in its
computations of loan sale gains, it should be recognized that the rate of
prepayment and the amount of defaults utilized by the Company are estimates and
actual experience may vary from these estimates. If actual experience differs
from the estimates used by the Company at the time of sale of the loans in its
determination of the value of these assets, (i) future cash flows and earnings
could be negatively impacted, (ii) the Company could be required to write down
the value of its Interest-only and residual certificates and Capitalized
mortgage servicing rights and (iii) different estimates could result which may
lower the income recorded as loan sale gains by the Company on future loan
securitizations. The Company believes that there is no active market for the
sale of its Interest-only and residual certificates or its Capitalized mortgage
servicing rights. No assurance can be given that these assets could be sold at
their respective stated values on the balance sheet, if at all.
17
19
Fluctuations in and the level of market interest rates will impact the
interest spread retained by the Company on loans sold and, potentially, the
amount of its loan sale gains. As reflected in the table above, the average
coupon on loans originated during the first nine months of 1998 has declined,
compared to the first nine months of 1997, which decline the Company believes
resulted from a lower interest rate environment in a very competitive market.
In connection with loan securitization transactions, the Company has used a
prefunding feature which "locks in" the rate that the Company will pay to the
investor on a predetermined amount of loans for future delivery. The Company is
obligated for the difference between the investment earnings on the prefunded
amount and the interest at the investor rate paid to the investor during the
period from the date of the closing of the securitization transaction until the
date of delivery of the loans. In connection with the securitization
transactions which closed in the third quarter of 1998, approximately $101.8
million was held in prefunding accounts, at September 30, 1998, for purchase of
the Company's home equity loans. It is anticipated that such home equity loans
will be delivered in November, 1998.
Finance income, fees earned and other loan income, which constitutes the
second largest component of the Company's revenues, was comprised of the
following items for the periods indicated:
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1998 1997
----------- -----------
(in thousands)
Servicing fees and excess interest collected............................. $ 192,159 $ 141,075
Loan origination fees.................................................... 109,080 79,343
Loan interest............................................................ 2,549 14,980
Other loan income........................................................ 11,581 10,465
Amortization of Interest-only and residual certificates.................. (176,553) (115,062)
Amortization of Capitalized mortgage servicing rights.................... (11,930) (6,305)
Provision for losses on serviced loans................................... (45,746) (3,192)
----------- -----------
Total.......................................................... $ 81,140 $ 121,304
=========== ===========
The increase in servicing fees and excess interest collected reflects the
growth in the portfolio of loans serviced for third party investors. The average
portfolio of loans serviced for third party investors was $6.4 billion and $4.6
billion for the nine months ended September 30, 1998 and 1997, respectively.
Loan origination fees in excess of direct origination costs on each loan
originated by the Company are recognized over the life of the loan or earlier at
the time of sale of the loan to a third party. During the first nine months of
1998 and 1997, the Company sold approximately $2.6 billion and $1.8 billion,
respectively, in home equity loans and recognized approximately $102.0 million
and $71.6 million, respectively, in loan origination fees (which relate
primarily to fixed rate retail production) in connection with these sales.
The increase in servicing fees earned and loan origination fees for the
first nine months ended September 30, 1998, as compared to the same period of
1997, was offset by a $61.5 million increase in amortization of Interest-only
and residual certificates and a $5.6 million increase in amortization of
Capitalized mortgage servicing rights, primarily as the result of an increase in
the amount of loans refinanced or prepaid.
The provision for losses on serviced loans increased $42.6 million during
the first nine months of 1998 compared to the same period of 1997 as the result
of an increase in loans charged off and an additional $21 million provision for
loan losses during 1998 on loans securitized. The Company's allowance for loan
losses as a percent of the home equity serviced loan portfolio increased to 2.1%
at September 30, 1998 compared to 1.5% at September 31, 1997.
18
20
The Company estimates that nonaccrual loans reduced finance income for the
first nine months of 1998 and 1997 by approximately $39.6 million and $27.9
million, respectively. The Company is generally obligated to advance interest on
delinquent loans serviced for third party investors until satisfaction of the
note, liquidation of the collateral or charge off of the delinquent loan. During
the first nine months of 1998, the average amount of nonaccrual loans owned
and/or serviced by the Company was approximately $444 million compared to $282
million in the same period of 1997.
Investment income totaled $37.4 million for the first nine months of 1998
compared to investment income of $17.1 million during the same period of 1997.
Investment income is primarily related to interest earned on temporary
investments in reserve accounts established in connection with loan sales in
securitization transactions. During the third quarter of 1998, the Company sold
certain non-core assets, consisting of a real estate property and a stock
investment having a carrying value of approximately $12.8 million, and
recognized non-recurring gains of approximately $11.9 million in connection with
such sales. Such gains are included in investment income.
Other income relates to income earned by the Company's telecommunications
business and property management with respect to its office park and overhead
reimbursement from discontinued operations prior to their disposition.
Expenses. The following table presents the components of the Company's
expenses for the periods indicated:
NINE MONTHS ENDED
September 30,
----------------------------------
1998 1997
----------- -----------
(IN THOUSANDS)
Personnel........................................ $ 105,867 $ 86,789
Interest......................................... 53,155 39,764
Other operating.................................. 108,743 83,558
----------- -----------
Total.................................. $ 267,765 $ 210,111
=========== ===========
The increase in personnel costs were primarily associated with the
expansion of the Company's lending operations during the indicated periods. The
remaining increase was primarily incentive compensation paid to employees in the
Company's retail division related to an increase in home equity loan production.
Interest expense for the first nine months of 1998 increased approximately
$13.4 million compared to the same period of 1997 principally due to an increase
in the average amount of debt outstanding.
Other operating expenses increased approximately $25.2 million during the
first nine months of 1998 compared to the same period of 1997 primarily as the
result of costs associated with the expansion of the Company's lending
operations. During the nine months ended September 30, 1998 and 1997,
advertising expense totaled $36.9 million and $24.8 million and occupancy and
equipment expenses were $24.5 million and $18.3 million, respectively.
DISCONTINUED OPERATIONS
On October 27, 1998, the Company made a decision to discontinue the
operations of United Companies Funding, Inc. ("UCFI"), a wholly owned subsidiary
of the Company. UCFI was organized in 1995 to originate manufactured housing
loan products made primarily to finance the purchase of new or used manufactured
homes. In reaching the decision to discontinue the operations of UCFI, the
Company considered the less than anticipated results of UCFI's operations and
the funding required, and the impact thereof on the Company's liquidity, to
continue its operations. The Company has estimated the loss that will occur from
the discontinuance, and the operating losses that will occur during phaseout, of
UCFI and, accordingly, has accrued for such loss in its financial statements for
the three months ended September 30, 1998. The results of operations of UCFI
have been classified as discontinued operations and the prior year financial
statements have been restated accordingly.
19
21
In connection with the decision to discontinue the operations of UCFI, the
Company recorded a net loss of $1.9 million and $2.8 million in its financial
statements for the three months and nine months ended September 30, 1998,
respectively. Total revenues of UCFI for the nine months ended September 30,
1998 and 1997 were $29.6 million and $20.8 million, respectively, and net income
(loss) was $(2.8 million) and $.6 million, respectively. Total assets of UCFI at
September 30, 1998 and December 31, 1997 were $75.4 million and $37.1 million,
respectively. The assets related to manufactured housing contracts sold in
public asset-backed securitization transactions, consisting primarily of
Interest-only and residual certificates totaling approximately $73 million, have
been retained by the Company, and therefore, are excluded from "Net assets of
discontinued operations" on the Company's Consolidated balance sheet as of
September 30, 1998.
The following table presents loan sale information regarding the
manufactured housing contracts originated by UCFI for the periods indicated:
Loan Sale Transactions
THREE MONTHS ENDED NINE MONTHS ENDED
September 30, SEPTEMBER 30,
--------------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
(DOLLARS IN THOUSANDS)
Manufactured housing contracts sold ......... $ 152,973 $ 81,388 $ 338,172 $ 225,974
Average coupon .............................. 8.43% 10.53% 8.79% 10.82%
Interest spread retained .................... 1.82% 3.54% 2.02% 3.63%
Loan sale gains ............................. $ (877) $ 4,877 $ 1,683 $ 15,443
The following table provides life-to-date prepayment rates and pool factors
as of September 30, 1998, with respect to UCFI's manufactured housing contract
securitizations by year of securitization for the years indicated:
Real Estate Chattel
--------------------------------------------- ---------------------------------------------
Year of Original Life-to-Date Pool Original Life-to-Date Pool
Securitization Balance CPR Factor (1) Balance CPR Factor (1)
- --------------- ------------ ------------ ------------- ------------- -------------- -----------
(dollars in thousands)
1996 $ 55,031 21% 62.04% $ 109,968 8% 83.52%
1997 100,403 17% 83.36% 204,573 7% 91.47%
1998 71,576 4% 98.58% 138,423 7% 97.97%
(1) Pool Factor - Percentage of the principal balance of the securitization
remaining outstanding at September 30, 1998.
Asset Quality
The following two tables provide certain contractual delinquency, default
and loss experience information for manufactured housing contracts owned by the
Company and contracts serviced for others as of the dates
20
22
indicated in the first table and for the periods indicated in the second table:
SEPTEMBER 30, DECEMBER 31,
-------------------------- --------------------------
1998 1997 1997 1996
---------- ---------- ---------- ----------
Number of manufactured
housing contracts ............................ 19,933 12,097 13,816 5,412
Delinquency period (1)(2)(3)
30-59 days .................................. 3.01% 2.43% 3.13% 1.88%
60-89 days .................................. 1.14 0.78 1.11 .57
90 days and over ............................ 1.99 1.00 1.49 .16
---------- ---------- ---------- ----------
6.14% 4.21% 5.73% 2.61%
========== ========== ========== ==========
Dollar amount (in thousands) of
manufactured housing contracts in
repossession at the end of period(3) ......... $ 8,558 $ 2,617 $ 4,797 $ 725
(1) As a percentage of the number of manufactured housing contracts as of
the date indicated and excluding contracts already in repossession.
(2) The delinquency period is based on the number of days payments are
contractually past due (assuming 30-day months). Therefore, a
manufactured housing contract with a payment due on the first day of a
month is not 30 days delinquent until the first day of the next month.
The information includes as current those manufactured housing
contracts whose borrowers have entered bankruptcy proceedings and had
their scheduled payment changed under a bankruptcy payment plan,
provided that the borrowers are current under their bankruptcy payment
plan.
(3) Manufactured housing contracts in the process of foreclosure but not
yet repossessed have been included in the appropriate delinquency
period.
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
--------------------------- ---------------------------
1998 1997 1997 1996
---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
Dollar amount of manufactured housing
contracts outstanding at end of period ...... $ 770,052 $ 388,254 $ 456,937 $ 170,869
========== ========== ========== ==========
Net Losses
Gross Losses (1) ........................ $ 4,000 $ 557 $ 866 $ 32
Recoveries (2) .......................... (26) (4) (7) (10)
---------- ---------- ---------- ----------
Net Losses .............................. $ 3,974 $ 553 $ 859 $ 22
========== ========== ========== ==========
Net Losses for the last four quarters as a
percentage of average amount outstanding .... 0.76% 0.26% 0.27% 0.03%
(1) "Gross Losses" are amounts which have been determined to be
uncollectible relating to manufactured housing contracts for each
respective period.
(2) "Recoveries" are recoveries from liquidation proceeds and deficiency
judgments.
ASSET QUALITY AND RESERVES
The quality of the loans owned and those serviced for third parties
significantly affects the profitability of the Company. The values of and
markets for these assets are dependent on a number of factors, including without
limitation general economic conditions, interest rates and governmental
regulations. Adverse changes in such factors, which become more pronounced in
periods of economic decline, may affect the quality of these assets and the
Company's resulting ability to sell these assets for acceptable prices. General
economic deterioration can result
21
23
in increased delinquencies on existing loans and reductions in collateral
values. See "Investment Considerations" below.
Substantially all of the home equity loans and manufactured housing
contracts produced by the Company have been sold in securitization transactions
in which securities backed by these loans and contracts ("asset-backed
securities") are sold, with servicing rights retained. In public securitization
transactions consummated through shelf registration statements of the Company's
subsidiaries, the purchasers of the asset-backed securities receive a security
which is credit enhanced, in part, in such home equity loan securitizations and
one manufactured housing contract securitization, through a guaranty provided by
a third party insurer or, in connection with the other manufactured housing
contract securitizations, through a senior/subordinated structure. Credit
enhancement for such home equity asset-backed securities is also provided by
subordinating a cash deposit and the excess interest spread retained by the
Company, up to a specified amount (the "Subordinated Amount"), to the payment of
scheduled principal and interest on the securities. The subordination of the
cash deposit and the excess interest spread retained by the Company relates to
credit losses which may occur after the sale of the loans and generally
continues until the earlier of the payment in full of the loans or termination
of the agreement pursuant to which the loans were sold. If cumulative payment
defaults exceed the Subordinated Amount, a third party insurer is obligated to
pay any further losses experienced by the owners of the asset-backed securities.
Except for one manufactured housing contract securitization in which credit
enhancement is provided by a third party insurer and subordination of the
retained excess interest spread, such losses are borne first by the subordinated
asset-backed securities in the Company's manufactured housing contract
securitizations. The Company has retained some of the subordinated securities in
such securitizations. In a sale by the Company of approximately $203 million of
loans pursuant to a private securitization transaction in the third quarter of
1998, credit enhancement for the asset-backed securities sold thereunder was
provided by subordination of the excess interest spread retained by the Company
and limited recourse against the Company.
The Company is also obligated to cure, repurchase or replace loans and
contracts which may be determined after the sale to violate representations and
warranties relating to them and which are made by the Company at the time of the
sale. The Company regularly evaluates the quality of the loan portfolio and
estimates its risk of loss based upon historical loss experience, prevailing
economic conditions, estimated collateral value and such other factors which, in
management's judgment, are relevant in estimating the credit risk in owned
and/or serviced loans. For loans and contracts sold, the Company records a
provision for the estimated amount of credit losses at the time of sale, and
records such amount on its balance sheet in the allowance for loan losses as a
reduction of the Interest-only and residual certificates. Estimated losses on
the owned portfolio are also provided for by an increase in the allowance for
loan losses through a charge to current operating income. At September 30, 1998,
the allowance for loan losses on loans serviced was $170 million and $4.3
million on loans owned by the Company. The maximum recourse associated with
sales of home equity loans and manufactured housing contracts according to terms
of the sale agreements totaled approximately $1.6 billion at September 30, 1998,
substantially all of which relates to the subordinated cash and excess interest
spread. Should credit losses on loans and contracts sold materially exceed the
Company's estimates for such losses, such consequence will have a material
adverse impact on the Company's operations.
At September 30, 1998, the contractual balance of home equity loans
serviced was approximately $6.4 billion, substantially all of which are owned by
and serviced for third party investors. The portfolio is geographically
diversified. Although the Company services loans in 50 states and the District
of Columbia, at September 30, 1998 a substantial portion of the home equity
loans serviced were originated in California (9.6%), Louisiana (7.8%), Florida
(7.0%), Ohio (6.2%) and North Carolina (5.2%), respectively, and no other state
accounted for more than 4.6% of the serviced portfolio. In addition, at
September 30, 1998, the Company serviced approximately $770 million of
manufactured housing contracts, 16.2% of which were originated in South
Carolina, 14.5% in Texas and 13.3% in North Carolina. The risk inherent in
geographic concentrations is dependent not only upon regional and general
economic stability which affects property values, but also the financial
well-being and creditworthiness of the borrower.
The following two tables set forth information relating to certain
contractual delinquency, default and loss experience for home equity loans
serviced as of the dates indicated in the first table and for the periods
indicated in the second table, including loans owned by the Company and loans
serviced for others. See "Discontinued
22
24
Operations" above for similar information with respect to manufactured housing
contracts owned and/or serviced by the Company.
SEPTEMBER 30, 1998 DECEMBER 31, 1997
----------------------------------- -----------------------------------
% OF % OF
CONTRACTUAL CONTRACTUAL CONTRACTUAL CONTRACTUAL
BALANCE BALANCE BALANCE BALANCE
-------------- -------------- -------------- --------------
(DOLLARS IN THOUSANDS)
Home equity loans
serviced ................................... $ 6,431,877 $ 5,528,923
============== ==============
Delinquency
30-59 days ................................. $ 167,190 2.60% $ 176,882 3.20%
60-89 days ................................. 63,159 0.98 57,975 1.05
90+ days ................................... 55,553 0.86 46,873 .85
-------------- -------------- -------------- --------------
285,902 4.44 281,730 5.10
-------------- -------------- -------------- --------------
Defaults
Foreclosures in process .................... 270,062 4.20 189,801 3.43
Bankruptcy ................................. 140,050 2.18 115,856 2.10
-------------- -------------- -------------- --------------
410,112 6.38 305,657 5.53
-------------- -------------- -------------- --------------
Total delinquency
and defaults .............................. $ 696,014 10.82% $ 587,387 10.63%
============== ============== ============== ==============
NINE MONTHS ENDED YEAR ENDED
September 30, DECEMBER 31,
----------------------------------- -----------------------------------
1998 1997 1997 1996
-------------- -------------- -------------- --------------
(IN THOUSANDS) (IN THOUSANDS)
Average dollar amount of home equity loans
outstanding during period .................. $ 5,710,816 $ 4,311,766 $ 4,784,531 $ 3,370,810
============== ============== ============== ==============
Net losses
Gross losses(1) ......................... $ 37,963 $ 23,263 $ 32,984 $ 19,484
Recoveries(2) ........................... (1,765) (1,499) (1,937) (2,371)
-------------- -------------- -------------- --------------
Net Losses .............................. $ 36,198 $ 21,764 $ 31,047 $ 17,113
============== ============== ============== ==============
Net losses for the last four quarters as a
percentage of average amount outstanding ... 0.80% 0.62% 0.65% 0.51%
(1) "Gross Losses" are amounts which have been determined to be
uncollectible relating to home equity loans for each respective period.
(2) "Recoveries" are recoveries from liquidation proceeds and deficiency
judgments.
The contractual balances exclude home equity real estate owned and/or
serviced which totaled $121.1 million and $98.9 million at September 30, 1998
and December 31, 1997, respectively. The Company believes that the increase in
the total percentage of delinquencies and defaults at September 30, 1998
compared to December 31, 1997 is not attributable to any single factor, but
rather reflects a combination of factors, including the seasonal nature of
delinquencies inherent in the portfolio.
23
25
The following tables provide certain contractual delinquency and
default data with respect to home equity loans serviced by the Company, by year
of loan origination, as of the dates indicated:
SEPTEMBER 30, 1998
---------------------------------------------------------------------------------------------------
DEFAULTS TOTAL
------------------------------
CONTRACTUAL DELINQUENCY
--------- ------------------------------------- FORECLOSURES BANK- DELINQUENCY
YEAR OF ORIGINATION BALANCE 30-59 60-89 90+ TOTAL IN PROCESS RUPTCY TOTAL & DEFAULTS
- ------------------- --------- ------- -------- ------- ------- ---------- ------- -------- -----------
(DOLLARS IN THOUSANDS)
1992 & prior ...... $ 84,247 4.06% 1.14% 1.52% 6.72% 5.68% 5.69% 11.37% 18.09%
1993 .............. 98,770 3.86% 1.25% 1.19% 6.30% 5.60% 6.14% 11.74% 18.04%
1994 .............. 222,672 3.30% 0.96% 1.53% 5.79% 7.05% 7.72% 14.77% 20.56%
1995 .............. 512,807 4.09% 1.76% 1.55% 7.40% 9.63% 7.18% 16.81% 24.21%
1996 .............. 1,047,924 4.12% 1.57% 1.49% 7.18% 8.97% 4.25% 13.22% 20.40%
1997 .............. 2,031,815 3.22% 1.21% 1.03% 5.46% 4.35% 1.36% 5.71% 11.17%
1998 .............. 2,433,642 0.95% 0.36% 0.21% 1.52% 0.51% 0.12% 0.63% 2.15%
----------
Total ......... $6,431,877 2.60% 0.98% 0.86% 4.44% 4.20% 2.18% 6.38% 10.82%
==========
DECEMBER 30, 1998
---------------------------------------------------------------------------------------------------
DEFAULTS TOTAL
------------------------------
CONTRACTUAL DELINQUENCY
--------- ------------------------------------- FORECLOSURES BANK- DELINQUENCY
YEAR OF ORIGINATION BALANCE 30-59 60-89 90+ TOTAL IN PROCESS RUPTCY TOTAL & DEFAULTS
- ------------------- --------- ------- -------- ------- ------- ---------- ------- -------- -----------
(DOLLARS IN THOUSANDS)
1991 & prior ...... $ 75,114 4.79% 1.06% 1.56% 7.41% 4.92% 5.72% 10.64% 18.05%
1992 .............. 43,134 5.21% 1.72% 2.28% 9.21% 4.82% 5.23% 10.05% 19.26%
1993 .............. 135,399 4.59% 1.12% 1.01% 6.72% 4.79% 5.30% 10.09% 16.81%
1994 .............. 302,819 4.95% 1.54% 1.47% 7.96% 6.17% 6.79% 12.96% 20.92%
1995 .............. 710,685 5.04% 1.59% 1.46% 8.09% 7.80% 5.66% 13.46% 21.55%
1996 .............. 1,544,278 4.54% 1.50% 1.22% 7.26% 5.39% 2.28% 7.67% 14.93%
1997 .............. 2,717,494 1.62% 0.58% 0.35% 2.55% 0.74% 0.23% 0.97% 3.52%
---------
Total ......... $5,528,923 3.20% 1.05% 0.85% 5.10% 3.43% 2.10% 5.53% 10.63%
==========
The following table provides certain pool factors and cumulative losses
with respect to the Company's home equity loans by year of production for the
periods indicated:
CUMULATIVE
YEAR HOME-EQUITY NET LOSSES AS
OF LOAN POOL % OF
PRODUCTION PRODUCTION FACTOR(1) PRODUCTION
- --------------- --------------- --------------- ---------------
(DOLLARS IN THOUSANDS)
FIXED
1993 $ 500,900 18.64% 2.30%
1994 $ 837,901 25.59% 2.86%
1995 $ 1,130,715 34.34% 2.11%
1996 $ 1,383,714 49.23% 0.51%
1997 $ 1,373,984 67.96% 0.02%
1998 $ 1,358,089 93.87% 0.00%
ARM
1993 $ 38,968 13.92% 1.73%
1994 $ 70,920 11.58% 0.90%
1995 $ 410,922 30.30% 1.35%
1996 $ 860,744 42.61% 0.38%
1997 $ 1,513,667 72.55% 0.02%
1998 $ 1,237,995 93.60% 0.00%
(1) Pool Factor - Percentage of the year's production
remaining outstanding at September 30, 1998.
24
26
The following tables reflect, as of the periods indicated, the allowance
for loan losses for loans owned by the Company and loans serviced for third
parties. These allowance accounts are deducted in the Company's balance sheet
from the asset to which they apply.
NINE MONTHS ENDED SEPTEMBER 30, 1998
------------------------------------
OWNED SERVICED TOTAL
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Allowance for loan losses, beginning of period ................................. $ 3,691 $ 106,563 $ 110,254
Provision for loan losses ...................................................... 3,780 100,898 104,678
Net loans charged off .......................................................... (3,157) (37,394) (40,551)
---------- ---------- ----------
Allowance for loan losses, end of period ....................................... $ 4,314 $ 170,067 $ 174,381
========== ========== ==========
NINE MONTHS ENDED SEPTEMBER 30, 1997
------------------------------------
OWNED SERVICED TOTAL
---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Allowance for loan losses, beginning of period ................................. $ 6,484 $ 44,970 $ 51,454
Provision for loan losses ...................................................... (178) 30,362 30,184
Net loans charged off .......................................................... (3,482) (9,750) (13,232)
Reserve reclassification ....................................................... 2,241 -- 2,241
---------- ---------- ----------
Allowance for loan losses, end of period ....................................... $ 5,065 $ 65,582 $ 70,647
========== ========== ==========
The above delinquency, default and loan loss experience represents the
Company's experience for the periods reported. However, the delinquency, default
and loss percentages may be affected by the increase in the size and aging of
the portfolio. In addition, the Company can neither quantify the impact of
property value declines, if any, on the home equity loans and manufactured
housing contracts nor predict whether or to what extent or how long such
declines may exist. In a period of such declines, the rates of delinquencies,
defaults and losses on the home equity loans and manufactured housing contracts
could be higher than those theretofore experienced in the sub-prime residential
mortgage and manufactured housing lending industries in general. Adverse
economic conditions (which may or may not affect real property values) may
affect the timely payment by borrowers of scheduled payments of principal and
interest on the home equity loans and manufactured housing contracts and,
accordingly, the actual rates of delinquencies, defaults and losses. As a
result, the information in the above tables should not be considered as the only
basis for assessing the likelihood, amount or severity of delinquencies,
defaults or losses in the future and no assurance can be given that the
delinquency, default and loss experience presented in the tables will be
indicative of such experience.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal cash requirements arise from loan originations,
deposits to reserve accounts, repayments of debt borrowed under the Company's
senior and subordinated notes and credit facilities, payments of operating and
interest expenses, and income taxes. The Company uses the proceeds of its
presently unsecured revolving credit facility (the "Credit Facility") as the
primary source of funding of loan production pending sales in securitizations.
In July, 1998, the commitment amount of the Credit Facility was increased from
$800 million to $850 million. Proceeds of the Credit Facility may be used for
general corporate purposes, including the interim funding of loan originations,
and to refinance existing debt. The Company's borrowings are in turn repaid with
cash proceeds received from selling such loans through securitizations. The
Credit Facility is provided by a group of 22 banks, matures in April 2000, and
provides for revolving loans and letters of credit. During 1997 and the first
nine months of 1998, the Credit Facility was primarily used to fund the
origination of home equity loans and manufactured housing contracts. These
borrowings were repaid upon the delivery of the loans and contracts into the
securitization transactions. As a result of the March, 1998 downgrade by
Standard and Poor's, a division of McGraw-Hill Companies, Inc. ("S&P"), of its
ratings of the Company's long-term unsecured debt, the rate of interest payable
by the Company under the terms of the Credit Facility has increased. See
"Ratings" below. At September 30, 1998, letters of credit in the aggregate
maximum amount of $100 million (of which the available draw amount at September
30, 1998 was $78.2 million) were outstanding under the Credit Facility for the
Company's account and were deposited in lieu of cash into the related reserve
accounts established in connection with the Company's home equity loan
securitization transactions.
25
27
In order to help maintain a continuing source of bank credit for its
operations, the Company has reached agreement with the agent bank for the bank
group on the terms of a restructure of the Credit Facility into a secured
warehouse/interest receivable warehouse facility, to mature in two years, and a
secured residual-financing credit facility, to mature in April 2000, aggregating
$850 million. The agent bank has orally advised the Company that the terms have
been approved by all of the participating banks, subject to the preparation and
completion of acceptable definitive documents. There can be no assurance that
the restructure of the bank credit facility will be consummated pursuant to the
terms agreed upon by it and the banks. The Company's ability to accomplish the
restructuring plan discussed below will be affected by a number of factors,
including completion of the restructuring of the Credit Facility. See
"Subsequent Events" and "Investment Considerations" below.
In addition to the Credit Facility, the Company has previously maintained
four sources of financing for its home equity loan originations: a master
repurchase facility provided by a major national bank (the "Master Repo"), a
warehouse facility provided by the investment banker which acted as lead
underwriter for the Company's 1998 third quarter fixed home equity loan
securitization (the "Investment Bank Warehouse"), a private securitization
facility provided by the investment banker which acted as lead underwriter for
the Company's 1998 third quarter adjustable rate home equity loan securitization
(the "Private Securitization Facility"), and a warehouse facility provided by
United Companies Life Insurance Company ("UCLIC"). The Master Repo provides
funding for up to $300 million of eligible home equity loans and is committed
until April, 2000. As of September 30, 1998, no repurchase obligations were
outstanding under the Master Repo. The Investment Bank Warehouse was directly
related to the 1998 third quarter fixed rate home equity loan securitization,
initially provided for funding up to $400 million of eligible home equity loans
for such securitization and terminated upon the closing of the last delivery of
loans under the prefunding account related to the fixed rate securitization. As
of September 30, 1998, $150 million was available and no amounts were
outstanding under the Investment Bank Warehouse. At September 30, 1998,
approximately $645 million of the Private Securitization Facility was unused and
available during the 1998 fourth quarter. The UCLIC warehouse facility which was
established upon the sale of UCLIC in 1996, provides for the purchase of up to
$150 million in first mortgage residential loans and has a maturity of July,
1999. The Company has the right for a limited time to repurchase certain loans
which are eligible for securitization and as of September 30, 1998, $3.3 million
in loans eligible for securitization were funded under this facility. At
September 30, 1998, the Company had outstanding $125 million and $100 million of
senior unsecured notes which mature in November, 1999 and January, 2004,
respectively, and $150 million of unsecured subordinated notes maturing in July,
2005 (such senior and subordinated unsecured notes collectively referred to as
the "Notes"). During July 1998, the Company utilized the Credit Facility to pay
$100 million of senior unsecured notes which matured July 15, 1998.
The Credit Facility and the Notes require the Company to maintain a minimum
consolidated fixed charge coverage ratio. The Company has experienced a
declining trend in this ratio. At September 30, 1998, the Company was in
compliance with this and all other covenants of its Credit Facility and the
Notes. Management of the Company presently expects that results of operations
for the 1998 fourth quarter will not result in a decline in this ratio below the
amount required by the Credit Facility and the Notes. However, in the event the
consolidated fixed charge coverage ratio as of December 31, 1998 is less than
the minimum required, an event of default will occur under the Credit Facility
and the Notes and payment of the outstanding principal balance thereof will be
due unless, prior to the expiration of cure periods provided therein, waivers
are obtained by the Company. The Company's ability to maintain compliance with
the financial covenants under the Credit Facility and the Notes is one of the
factors that will affect the Company's ability to accomplish the restructuring
plan discussed below. See "Subsequent Events" and "Investment Considerations"
below.
On October 28, 1998, the Company announced that its efforts to seek a
potential strategic partnership to improve its access to capital and accelerate
its growth had to that date been unsuccessful. Without additional capital
through a potential strategic partnership or its historical sources through the
corporate debt and equity markets, which were at that time and continue to be
unavailable, the Company implemented a restructuring plan to reduce its size to
one which can be supported by its existing capital and funding base. The plan is
intended to make the Company cash flow positive from operations by the first
quarter of 1999. It provides that future dividends on the Company's common and
preferred stock will be suspended indefinitely. It also provides that the $125
million of Notes due November 1999 will be paid from internally generated cash
flows. Upon mandatory conversion of the PRIDES(sm) into common stock on July 1,
2000, in accordance with their terms, any dividends in arrears on the PRIDES(sm)
are payable in cash by the Company from funds legally available therefor. One of
a number of factors that will affect the ability of the Company to accomplish
the restructuring plan is its ability to generate and maintain
26
28
adequate liquidity for a sufficient period of time to execute the plan. See
"Subsequent Events" and "Investment Considerations" below.
In the conduct of its operations, substantially all of the home equity
loans and manufactured housing contracts originated or acquired by the Company
are sold. Net cash from operating activities of the Company in the first nine
months of 1998 and 1997 reflects approximately $2.7 billion and $1.9 billion,
respectively, in cash used for loan originations and acquisitions of home equity
loans and manufactured housing contracts. The primary source of funding for loan
originations is derived from the reinvestment of proceeds from the ultimate sale
of these products in the secondary market which totaled approximately $2.7
billion and $1.9 billion in the first nine months of 1998 and 1997,
respectively. In connection with the home equity loan and one manufactured
housing contract transactions in the secondary market, third-party surety bonds
and subordination of cash deposits and excess interest retained by the Company
have been provided as credit enhancements. The loan sale transactions have
required the subordination of certain cash flows retained by the Company from
the loans sold to the payment of principal and interest due to holders of the
asset-backed securities. In connection with these transactions, the Company has
been required, in some instances, to fund an initial deposit, and thereafter, in
each transaction, other than the private securitization transaction consummated
in the third quarter of 1998, a portion of the amounts receivable by the Company
from the excess interest spread has been required to be placed and maintained in
a reserve account to the extent of the subordination requirements. The
subordination requirements generally provide that the excess interest spread is
payable to a reserve account until a specified level of cash, which is less than
the maximum subordination amount, is accumulated therein. The excess spread
retained by the Company is subject to being utilized first to replenish cash
paid from the reserve account to fund shortfalls in collections from borrowers
who default on the payment of principal or interest on the loans and contracts
underlying the asset-backed securities issued until the total of the Company's
deposits into the reserve account equal the maximum subordination amount. After
the Company's deposits into the reserve account equal the maximum subordination
amount for a transaction, the subordination of the related excess interest
spread (including the guarantee fee payable therefrom) for these purposes is
terminated. The excess interest spread required to be deposited and maintained
in the respective reserve accounts will not be available to support the cash
flow requirements of the Company until such amount exceeds the maximum
subordinated amount (other than amounts, if any, in excess of the specified
levels required to be maintained in the reserve accounts, which may be
distributed periodically to the Company). In certain home equity loan
securitizations, the excess interest spread on the fixed rate loans included
therein is utilized initially to cover current losses, and then to pay down the
principal of the related asset-backed securities until a specified level of
overcollateralization is reached, and thus is unavailable to the Company until
such time. With respect to certain home equity loan securitization transactions
for which the aggregate unpaid principal balance as of September 30, 1998 of the
loans sold thereby was approximately $860 million, the delinquency and loss
experiences of such loans, pursuant to levels thereof set forth in the related
pooling and servicing agreements, have resulted in an increase in the required
amount of excess interest spread to be maintained in the related reserve
accounts. As a result, the Company's cash flow has been negatively affected by
the increased minimum reserve account requirements. At September 30, 1998, the
amounts on deposit in reserve accounts totaled $450 million, exclusive of the
letters of credit issued under the Credit Facility in the amount of $100 million
discussed above. The Company's ability to accomplish the restructuring plan
announced on October 28, 1998, will be affected by a number of factors,
including its ability to continue to securitize on a quarterly basis its home
equity loan production in which the asset-backed securities are insured by
third-party certificate insurers. See "Subsequent Events" above and "Investment
Considerations" below.
RATINGS.
On October 7, 1998, Fitch IBCA lowered the rating of the Company's senior
notes to BB from BBB- at June 30, 1998, and its subordinated notes to BB- from
BB+ at June 30, 1998.
On October 9, 1998, Moody's Investor Service ("Moody's") downgraded the
Company's senior unsecured debt rating to B3 from Ba3 at June 30, 1998, and its
subordinated debt to Caa2 from B2 at June 30, 1998. Moody's rating outlook
remained negative.
On October 23, 1998, Standard & Poor's ("S&P") lowered the counterparty
credit rating and senior unsecured debt rating to BB- from BB+ at June 30, 1998,
its subordinated debt to B from BB- at June 30, 1998, and its preferred stock to
B- from B+ at June 30, 1998. All ratings were removed from S&P's CreditWatch,
where they
27
29
were placed with developing implications in August 1998 following the Company's
announcement that it had retained Salomon Smith Barney to explore potential
strategic alternatives.
On October 28, 1998, Duff & Phelps Credit Rating Co. ("DCR") downgraded the
senior, subordinated, and preferred stock ratings of the Company to "B", "B-",
and "CCC", respectively. The ratings remain on DCR's Rating Watch--Down, pending
further information and DCR's analysis of the Company's proposed restructuring
plan. DCR also stated that the preferred stock rating will be lowered to DP
(Preferred Stock with Dividend Arrearage) if the dividend payment scheduled for
January 1, 1999, is not honored.
The lower ratings of the Company by the rating agencies negatively affect
the ability of the Company to access the corporate debt and equity financial
markets, thus limiting its sources of additional liquidity and capital
resources, and increase the Company's borrowing costs, thereby negatively
impacting its profitability.
YEAR 2000
As discussed in Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Company's Report on Form 10-K for the
year ended December 31, 1997, the Company has constituted a Year 2000 task force
(the "Task Force") with members of its Management Information Services and
Internal Audit departments as well as other employees of the Company.
The Task Force has developed and is now implementing a Year 2000 Project
Plan that follows the Federal Financial Institutions Examination Council
guidelines. The plan is comprised of five phases: (1) Awareness; (2) Assessment;
(3) Renovation; (4) Validation/Testing; and, (5) Implementation. As of September
30, 1998 the Awareness and Assessment phases were complete, and Renovation,
Validation/Testing, and implementation phases are in process. As part of the
Awareness and Assessment phases of the plan, the Company has inventoried,
prioritized, and evaluated the impact of the Year 2000 on all systems of the
Company including hardware, software, internal and external systems,
environmental systems dependent on embedded microchips, such as security
systems, elevators and vaults. In October 1998, the Task Force reported to the
Audit Committee of the Board of Directors of the Company that testing of mission
critical systems (applications or systems that are vital to the successful
continuance of a core business activity) continues and that testing of internal
mission critical systems is scheduled to be substantially complete by December
31, 1998. Testing of external mission critical systems is scheduled to be
complete by March 31, 1999. The Company has received commitments from third
party vendors that they will render their systems fully Year 2000 compliant. The
Task Force also reported that contingency plans are in place for mission
critical systems in the event that any are not Year 2000 compliant on January 1,
2000. These contingency plans are unique for each individual system, but in
general call for utilizing manual processes until such time as the system could
be repaired or replaced with a compliant system. Alternative systems and service
providers have been identified for these mission critical systems should
circumstances necessitate a long-term replacement.
The Company has budgeted $639,000, not including personnel costs, to
address Year 2000 issues. As of September 30, 1998, the Company had spent
$264,318 in furtherance of the Year 2000 Project Plan.
While the Company's management believes that the Year 2000 Project Plan
will be completed on schedule and therefore reduce the risk that a Year 2000
problem will cause an interruption in or failure of certain normal business
activities, the inability of the Company or its third party vendors to
effectuate solutions to their Year 2000 issues on a timely and cost effective
basis may have a material adverse effect on the Company.
SUBSEQUENT EVENTS.
On October 28, 1998, the Company announced that it will implement a
restructuring plan that will focus on its most cost efficient and profitable
business units while reducing the Company to a size which can be supported by
its existing capital and funding base.
In July 1998, the Company announced it was seeking a potential strategic
partnership to improve its access to capital and accelerate its growth, but
efforts as of the date of the October 28, 1998 announcement have been
unsuccessful. After a thorough analysis of the then current circumstances, the
Board of Directors of the Company determined that it was necessary and advisable
to move forward at that time on a new business plan intended to create a
streamlined, more focused Company. The objectives of the restructuring are to:
1) generate positive cash
28
30
flow from operations and sufficient earnings; 2) maintain a sound capital base;
and 3) compete in the market place through the Company's most competitive and
cost efficient production and servicing systems.
Under the plan, the Company has taken steps immediately to sell or close
down its wholesale, manufactured housing and credit card units, which will
result in a reduction of Company personnel and overhead expenses by more than
30%. Nationwide employee levels will be reduced from approximately 3,350 to
2,280. In addition to the sale or closing of the three business units,
approximately $150 million of non-core assets of the Company will be sold,
including the sale of the Company's real estate investment properties. The
Company does not anticipate that it will incur any material loss on disposition
of these non-core assets.
United Companies Lending Corporation will close 32 underperforming retail
locations and emphasis will be placed on increasing the production levels of the
remaining 200 higher performing branches. The Company has estimated that the
costs of the downsizing will range from $4 million to $6 million. The plan is
designed to achieve an annual home-equity loan production level of $2.4 billion.
The plan also provides that future dividends on the Company's common and
preferred stock will be suspended indefinitely. Dividends on the Company's
outstanding shares of preferred stock (the "PRIDES(sm)") will accrue without
interest whether or not such dividends are declared. In the event that dividends
on the PRIDES(sm) are in arrears and unpaid for six quarterly dividend periods,
the holders of the PRIDES(sm) , voting separately as a class, are entitled to
vote for the election of two preferred stock directors, such directors to be in
addition to the number of directors constituting the Board of Directors
immediately prior to the accrual of such right and such right shall continue
until all dividends in arrears on the PRIDES(sm) shall have been paid in full.
Upon mandatory conversion of the PRIDES(sm) into common stock on July 1, 2000,
in accordance with their terms, any dividends in arrears on the PRIDES(sm) are
payable in cash by the Company from funds legally available therefor.
Factors that will affect the Company's ability to accomplish the
restructuring plan include its ability to: (i) generate and maintain adequate
liquidity for a sufficient period of time to execute the plan; (ii) complete the
new proposed restructured primary bank credit facility (discussed in "Liquidity
and Capital Resources" above); (iii) maintain compliance with the financial
covenants under the Company's primary bank credit facility and public unsecured
notes; (iv) continue to securitize on a quarterly basis its home equity loan
production in which the asset- backed securities are insured by third-party
certificate insurers; (v) achieve the loan production levels projected by the
plan; and (vi) timely implement the downsizing and other requirements of the
plan. In addition, increases in prepayment rates and loan losses above
historical levels could adversely affect the Company's ability to implement the
plan.
LEGAL DEVELOPMENTS
In a class action lawsuit pending in Alabama state district court involving
910 home equity loans alleged to be subject to the Alabama Mini Code, Autrey v.
United Companies Lending Corporation, the Alabama Supreme Court, acting on an
interlocutory appeal by the Company, upheld the ruling of the trial court on a
pre-trial motion that retroactive application of the 1996 amendments to the
Alabama Mini Code would be unconstitutional as applied to the plaintiff's class.
The 1996 amendments, which in general limited the remedy for finance charges in
excess of the maximum permitted by the Alabama Mini Code, were expressly made
retroactive by the Alabama legislature. The Company strenuously disagreed with
this holding and sought a rehearing by the Alabama Supreme Court. The request
for a rehearing has been denied by the Alabama Supreme Court and the matter will
be returned to the trial court for a trial on the merits. The Company believes
that the liability, if any, should be limited to $495,000, the amount of the
aggregated finance charges allegedly exceeding the maximum permitted by the
Alabama Mini Code, plus interest thereon. The Company intends to continue its
vigorous defense of this matter. If unsuccessful in its defense at a trial on
the merits and related appeals, the Company presently estimates that the
liability of its subsidiary could be approximately $15 million.
The U.S. Department of Justice ("DOJ") and the U.S. Department of Housing
and Urban Development ("HUD") recently issued a letter to the Company and its
subsidiary United Companies Lending Corporation notifying them that they were
initiating a joint investigation of their lending and pricing practices,
initially in Philadelphia, PA-NJ PMSA. The investigation focuses on compliance
by the Company and its subsidiary with the federal Fair Housing Act and Equal
Credit Opportunity Act and the federal Real Estate Settlement Procedures Act
("RESPA"). Specifically, DOJ seeks to determine whether the lending and pricing
practices of the Company and its subsidiary discriminate against applicants
based on race, national origin, sex, or age. The Company believes this
investigation by DOJ is part of an overall initiative by that agency to review
the practices of several large subprime lenders and does not stem from any
findings of wrongdoing by the Company. HUD will be investigating whether
relationships of the Company and
29
31
its subsidiary with mortgage brokers, home improvement dealers or other third
parties may violate the anti-kickback and anti-referral fee prohibitions of
RESPA. The Company is cooperating with the joint investigation and management of
the Company believes that both agencies will ultimately determine that no
violations of law have occurred.
In October 1998, the Company reached a settlement in an enforcement action
suit pending in Massachusetts state court alleging violations by the Company of
certain regulations promulgated by the Massachusetts Attorney General relating
to, among other things, loan origination fees, also known as "points", with
respect to loans originated in Massachusetts. The settlement, involving payments
and other terms by the Company aggregating approximately $1.2 million, followed
a decision by a federal district court in Massachusetts upholding the validity
of the regulations and finding violations thereof by the Company's subsidiary.
The Company had maintained that the Massachusetts regulations were void because
they conflicted with the efforts of the Massachusetts legislature to supplant
the strict regulation of points with disclosure requirements, and were
inconsistent with the policies and interpretations of the Federal Trade
Commission as to what constitutes unfair and deceptive trade practices. The
federal district court found that the Attorney General's regulations did not
contravene the intent of the Massachusetts legislature and are not inconsistent
with applicable federal law. The settlement has been accrued in the
consolidated financial statements at September 30, 1998.
INVESTMENT CONSIDERATIONS
The Company has a continuing need for capital to finance its lending
operations. Currently, the principal cash requirements of the Company's lending
operations arise from loan originations, deposits to reserve accounts,
repayments of debt borrowed under its credit facilities and its outstanding
unsecured notes, payments of operating and interest expenses, and income taxes
related to securitization transactions. Loan production is funded principally
through proceeds of the Company's revolving credit facility with a bank group
and warehouse facilities pending sales in securitizations. The Company's
borrowings are in turn repaid with the proceeds received by the Company from
selling such loans through securitizations. The revolving credit facility is a
$850 million facility provided by a group of banks which matures in April 2000.
In order to help maintain a continuing source of bank credit for its lending
operations, the Company has reached agreement with the agent bank for the bank
group on the terms of a restructure of the presently unsecured revolving credit
facility into a secured warehouse/interest receivable warehouse facility, to
mature in two years, and a secured residual-financing credit facility, to mature
in April 2000, aggregating $850 million. The agent bank has orally advised the
Company that the terms have been approved by all of the participating banks,
subject to the preparation and completion of acceptable definitive documents.
There can be no assurance that the restructure of the bank credit facility will
be consummated pursuant to the terms agreed upon by it and the banks. Although
management of the Company is optimistic that the restructure of the bank credit
facility will be consummated pursuant to the terms agreed upon by it and the
banks, there can be no assurance as to this outcome or that such facilities will
continue to be available on terms reasonably satisfactory to the Company or at
all. Any failure to renew or obtain adequate funding under these financing
facilities or other financing arrangements, or any substantial reduction in the
size of or increase in the cost of such facilities, could have a material
adverse effect on the Company's results of operations, financial condition and
cash flows.
The Company's ability to accomplish the restructuring plan discussed above
in "Subsequent Events" will be affected by a number of factors, including its
ability to: (i) generate and maintain adequate liquidity for a sufficient period
of time to execute the plan; (ii) complete the new proposed restructured primary
bank credit facility (discussed above); (iii) maintain compliance with the
financial covenants under the Company's primary bank credit facility and public
unsecured notes; (iv) continue to securitize on a quarterly basis its home
equity loan production in which the asset-backed securities are insured by
third-party certificate insurers; (v) achieve the loan production levels
projected by the plan; and (vi) timely implement the downsizing and other
requirements of the plan. In addition, increases in prepayment rates and loan
losses above historical levels could adversely affect the Company's ability to
implement the plan.
The lower ratings of the Company discussed in "Ratings" above negatively
affect the ability of the Company to access the corporate debt and equity
financial markets, thus limiting its sources of additional liquidity and capital
resources, and increase the Company's borrowing costs, thereby negatively
impacting its profitability.
30
32
The Company has relied significantly upon quarterly securitizations, in
which the asset-backed securities issued by the Company are insured by a
third-party certificate insurer, to generate cash proceeds for repayment of
borrowings under its credit facilities and warehouse facilities and to create
availability to originate and purchase additional loans. The ability of the
Company to sell loans and/or asset-backed securities in the secondary market, or
an alternative source of funding loan production, is essential for continuation
of the Company's loan origination operations. Several factors affect the
Company's ability to complete securitizations, including conditions in the
securities markets generally, conditions in the asset-backed securities market,
specifically, the credit quality of the Company's portfolio of loans and the
Company's ability to obtain credit enhancement. A reduction in the size of the
secondary market for home equity loans may adversely affect the Company's
ability to sell its loan originations and/or asset-backed securities in the
secondary market with a consequent adverse impact on the Company's liquidity,
profitability and future originations. Moreover, market and other considerations
could affect the timing of the Company's securitization transactions and delays
in such sales could reduce the amount of gains recognized from the sale of loans
in a given quarter thereby negatively impacting the ability of the Company to
meet the financial covenants in its credit facilities and public unsecured
notes.
In its securitization transactions, the Company retains as an investment
the Interest-only and residual certificates created as a result of such
securitizations. In addition, under Statement of Financial Accounting Standards
No. 125 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" ("SFAS No. 125"), the Company also recognizes as
an asset the capitalized value of mortgage servicing rights. These assets
constitute a substantial portion of the Company's total assets and the loan sale
gains resulting from securitizations represent a substantial portion of its
income.
Realization of the value of these Interest-only and residual certificates
and Capitalized mortgage servicing rights 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. Although
management of the Company believes that it has made reasonable estimates in its
computations of loan sale gains, it should be recognized that the rate of
prepayment and the amount of defaults utilized by the Company are estimates and
actual experience may vary from these estimates. If actual experience differs
from the estimates used by the Company at the time of sale of the loans in its
determination of the value of these assets, (i) future cash flows and earnings
could be negatively impacted, (ii) the Company could be required to write down
the value of its Interest-only and residual certificates and Capitalized
mortgage servicing rights and (iii) different estimates could result which may
lower the income recorded as loan sale gains by the Company on future loan
securitizations. The Company believes that there is no active market for the
sale of its Interest-only and residual certificates or its Capitalized mortgage
servicing rights. No assurance can be given that these assets could be sold at
their respective stated values on the balance sheet, if at all.
The Interest-only and residual certificates have been required to be
classified as trading securities and fluctuations in the interest rate
environment can also affect the carrying value of these assets, with the
adjustments in unrealized gain or loss recorded in the results of operations in
the period of change in value. However, the Financial Accounting Standards Board
("FASB") recently adopted a pronouncement that would permit the Company to
classify this type of asset as "available-for-sale" securities which would
result in such adjustments being made to stockholders' equity on the Company's
Consolidated balance sheet and will be reflected as a component in the Company's
Comprehensive Income Statement. However, the effects of changes in default
assumptions would still have to be recognized in income immediately. (See Note 9
to the Consolidated Financial Statements). The Company is reviewing the
provisions of this pronouncement but has not yet determined the effect of its
implementation on the Company's financial condition or results of operations.
As a purchaser and originator of sub-prime loan products, the Company faces
increasing competition. Certain large national finance companies, commercial
banks, thrifts, credit card originators and conforming mortgage originators,
with greater capitalization and financial resources, have adapted their
origination programs and allocated resources to the origination of sub-prime
loans. A large bank holding company recently completed the acquisition of a
major sub-prime lender with nationwide operations. In addition, Fannie Mae and
Freddie Mac have taken actions which indicate an interest in becoming involved
in the secondary market for home equity loans. Such actions include the issuance
of securities backed by loans of a lower credit quality than historically has
been the case and the implementation of automated underwriting systems that
could be used to originate home equity loans. The entrance of these competitors
into the Company's market could have a material adverse effect on the Company's
financial condition, results of operations and cash flows.
31
33
The quality of the loans owned and those serviced for third parties by the
Company significantly affects the profitability of the Company. The values of
and markets for these assets are dependent on a number of factors, including
without limitation general economic conditions, interest rates and governmental
regulations. Adverse changes in such factors, which become more pronounced in
periods of economic decline, may affect the quality of these assets and the
Company's resulting ability to sell these assets for acceptable prices. General
economic deterioration can result in increased delinquencies on existing loans
and reductions in collateral values. In addition, as the Company is required to
advance delinquent interest on loans which it has securitized, increased
delinquencies of such loans negatively impacts the Company's liquidity.
The Company's operations and origination activities are subject to
extensive laws, regulations, supervision and licensing by federal and state
authorities. Regulated matters include, without limitation, maximum interest
rates and fees which may be charged by the Company, disclosure in connection
with loan originations, credit reporting requirements, servicing requirements,
anti-discrimination requirements, federal and state taxation, and multiple
qualification and licensing requirements for doing business in various
jurisdictions. In addition, the nature of the Company's business is such that it
is routinely involved in litigation and is a party to or subject to other items
of pending or threatened litigation. (See also "Legal Developments" above.)
There are currently proposed various laws, rules and regulations, which if
adopted, could impact the Company. There can be no assurance that these proposed
laws, rules and regulations, or other such laws, rules or regulations, will not
be adopted in the future which could make compliance much more difficult or
expensive, restrict the Company's ability to originate or sell loans, further
limit or restrict the amount of commissions, interest and other charges earned
on loans originated or sold by the Company, or otherwise adversely affect the
business or prospects of the Company.
The Company's operations are interest rate sensitive and, therefore,
fluctuations in and the level of interest rates can have a variety of effects on
the Company's profitability. Significant changes in interest rates may impact
the volume of loans produced, and will influence the funding costs of such
production and the amount of gain recognized on loans sold in the secondary
market. Although historically a lower interest rate environment has not resulted
in a significant increase in the level of prepayment of loans originated and
serviced by the Company, a significant and sustained reduction in interest rates
could cause prepayments to increase, and thereby result in a contraction of the
amount of loans owned and serviced and a reduction in the fair value of the
Interest-only and residual certificates retained by the Company in connection
with loan sales. Increased prepayments reduce the time period during which the
Company receives excess servicing income and other servicing income with respect
to prepaid loans. As stated above, adjustments to the fair value of the
Interest-only and residual certificates have been reflected as a current charge
to earnings. Likewise, if delinquencies or liquidations were to occur sooner in
the portfolio of loans sold by the Company and/or with greater frequency than
was initially assumed, such would have an adverse effect on servicing income in
the period of such adjustment. In contrast, an increase in the level of interest
rates for an extended period of time could adversely affect the ability of the
Company to originate loans, as well as the profitability of the loan origination
program, by increasing the cost of funding and reducing the interest spread on
loans retained and loans sold. If actual prepayments with respect to loans sold
occur more slowly than estimated by the Company at the time of sale, total
income would exceed previously estimated amounts and positive adjustments would
generally be made on the Company's consolidated balance sheet and statement of
income.
32
34
REVIEW BY INDEPENDENT ACCOUNTANTS
The Company's independent accountants, Deloitte & Touche LLP, have performed a
review of the accompanying unaudited consolidated balance sheet as of September
30, 1998 and the related consolidated statements of income for the three months
and nine months and cash flows for the nine months ended September 30, 1998 and
1997, and previously audited and expressed an unqualified opinion dated March 4,
1998 on the consolidated financial statements of the Company and its
subsidiaries as of December 31, 1997, from which the consolidated balance sheet
as of this date is derived.
33
35
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
United Companies Financial Corporation:
We have reviewed the accompanying consolidated balance sheet of United Companies
Financial Corporation and subsidiaries as of September 30, 1998 and the related
consolidated statements of income for the three-month and nine-month periods and
cash flows for the nine-month periods then ended. These financial statements are
the responsibility of the Corporation's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with generally accepted accounting principles.
As emphasized in Note 3, the financial statements include a net Interest only
and residual certificate balance of approximately $1.0 billion which has been
determined by management of the Company using various assumptions and estimates.
However, because of the inherent uncertainty of valuations, these estimated
values may differ significantly from the values that would have been used had a
ready market for such assets existed, and the difference could be material.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of United Companies Financial
Corporation and subsidiaries as of December 31, 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for the
year then ended (not presented herein); and in our report dated March 4, 1998,
we expressed an unqualified opinion on those consolidated financial statements.
In our opinion, the information set forth in the accompanying consolidated
balance sheet as of December 31, 1997 is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
/s/ DELOITTE & TOUCHE LLP
Baton Rouge, Louisiana
November 13, 1998
34
36
PART II
OTHER INFORMATION
Items 1 - 5. Inapplicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - (10) First Amendment to Credit Agreement
- (15) Letter of Deloitte & Touche LLP
- (27) Financial Data Schedule
(b) Reports on Form 8-K
Subsequent to September 30, 1998, the Company filed a
Current Report on Form 8-K dated October 28, 1998 which
contains the following exhibits:
(i) Press release dated October 28, 1998, United
Companies Reports Income of $23.9 million for the
Third Quarter
(ii) Press release dated October 28, 1998, United
Companies Announces Restructuring Plan.
35
37
SIGNATURES
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.
UNITED COMPANIES FINANCIAL CORPORATION
Date: 11/13/98 By: /s/ J. Terrell Brown
-----------------------------------------------------
J. Terrell Brown
President and Chief Executive Officer
Date: 11/13/98 By: /s/ Dale E. Redman
-----------------------------------------------------
Dale E. Redman
Executive Vice President and Chief Financial Officer
36
38
UNITED COMPANIES FINANCIAL CORPORATION AND SUBSIDIARIES
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
10 First Amendment to Credit Agreement
15 Letter of Deloitte & Touche LLP
27 Financial Data Schedule
37