Item 1. Business
General
We are one of the nation's largest mortgage finance companies, providing first
and second mortgage products to borrowers nationwide through our operating
subsidiaries. We offer mortgage products designed for borrowers who generally do
not satisfy the credit, documentation or other underwriting standards prescribed
by conventional mortgage lenders and loan buyers, such as Fannie Mae and Freddie
Mac. We originate and purchase loans on the basis of the borrower's ability to
repay the mortgage loan, the borrower's historical pattern of debt repayment and
the amount of equity in the borrower's property (as measured by the borrower's
loan-to-value ratio, or LTV). We have been originating and purchasing these
types of loans since 1996 and believe we have developed a comprehensive and
sophisticated process of credit evaluation and risk-based pricing that allows us
to effectively manage the potentially higher risks associated with this segment
of the mortgage industry.
Our borrowers generally have considerable equity in the properties securing
their loans, but have impaired or limited credit profiles or higher
debt-to-income ratios than traditional mortgage lenders allow. Our borrowers
also include individuals who, due to self-employment or other circumstances,
have difficulty verifying their income through conventional methods, and who
prefer the prompt and personalized service we provide.
We originate and purchase loans through our wholesale network of 21,600
independent mortgage brokers and through our retail network of 72 branch offices
located in 26 states, as well as our central retail telemarketing unit. We
process and close loans through our 20 regional processing centers located in 14
states. Although a significant percentage of our loans are originated in
California, we are authorized to do business in all 50 states and regularly
originate and purchase loans throughout the country.
In 2003, we originated 91.8% of our loans through our wholesale channel and 8.2%
through our retail channel. Of the loans that we originated, 75.1% were
refinances of existing mortgages and 24.9% were for the purchase of residential
property. Of the refinance transactions, 85.6% were cash-out refinances in which
the borrower receives additional proceeds to pay off other debt or meet other
financial needs.
In 2003, we adopted a secondary marketing strategy where we sell approximately
80% of our loans for cash in the whole loan market and hold the remaining 20% of
our production for investment through on-balance sheet securitizations. We refer
to this as our 80-20 secondary marketing strategy. In 2003, we sold 80.8% of our
loans through whole loan sale transactions for cash and securitized 19.2% in
five transactions totaling $4.9 billion, using the on-balance sheet structure.
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Recent Operating Highlights
We achieved several significant operational milestones during 2003, including
the following:
Significantly Higher Loan Production Volume. We increased our loan
origination volume to $27.4 billion in mortgage loans in 2003, a
92.8% increase over 2002 volume of $14.2 billion.
Increased Market Share. According to Inside B&C Lending, our
share of the non-prime mortgage market increased from 6.7% in
2002 to 8.3% in 2003, a 24.0% increase.
Improved Cash Position. Cash and cash equivalents, including
restricted cash, of $386.4 million at December 31, 2003 represented
a 111% increase over 2002 year-end cash and cash equivalents of
$182.9 million.
Geographic Diversification. We expanded our production on the East
Coast significantly during 2003. Loan production for 2003 in the 13
targeted eastern seaboard states increased from 21% to 27% of total
production, a 29% increase over 2002.
Balance Sheet Growth. During 2003, we completed five securitizations
structured as financings (on-balance sheet securitizations) totaling
$4.9 billion in mortgage loans.
Increased Web-based Originations. Our FastQual Web site provides
mortgage brokers an automated system designed to improve service
through quick, consistent loan answers. Our Wholesale Division's
fourth quarter 2003 FastQual originations of $5.4 billion represented
a 209% increase over the same period in 2002. Likewise, our Retail
Division's Web-based originations of $290.1 million in the fourth
quarter of 2003 represented a 494% increase over the same period in
2002. Retail Web-based originations come from a direct mail program
using our Web site to provide the information to prospective
borrowers and to allow them to complete an application online.
Credit Mix. During 2003, we originated a larger percentage of our
production in our top two credit grades. 81.1% of our 2003
production consisted of loans in our top two credit grades,
compared to 58.6% for 2002. During the same period, production in
our bottom two credit grades decreased from 4.8% of total
production in 2002 to 3.3% in 2003. The weighted average Fair,
Isaac & Company score of our loans originated increased to 612 in
2003 from 597 during 2002.
Servicing. In October 2002, we re-established our mortgage servicing
operations. Our total mortgage loan servicing portfolio as of December
31, 2003 consisted of $11.6 billion in mortgage loans, including $3.4
billion in mortgage loans held for sale, $5.1 billion in mortgage
loans sold with servicing retained (including our mortgage loans held
for investment), and $3.1 billion in loans that we are servicing
temporarily on behalf of the purchasers thereof.
Discounted Loan Sales. Our discounted loan sales for 2003 were 1.2%
of total sales, which represented a 47% decrease from 2002.
Recent Financing Highlights
Expanded Credit Facilities. During 2003, we expanded our warehouse
and aggregation credit facilities from $3.5 billion to $7.4 billion,
including an asset-backed commercial paper facility totaling
$2.0 billion that we established during the third quarter of 2003.
Convertible Debt Transaction. In July 2003, we closed a private
offering of $210 million of Convertible Senior Notes due in July 2008.
The notes bear interest at a rate of 3.50% per year and are convertible
into our common stock at a conversion price of $34.80 per share upon
the occurrence of certain events. The proceeds from the transaction
were used to finance securitizations, to continue our stock repurchase
program, and for other general corporate purposes.
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Growth and Operating Strategies
In 2004, we plan to grow the business while at the same time positioning New
Century to provide more stable, predictable earnings even when the origination
environment becomes less favorable. We plan to do this through several key
strategies: (i) strengthening our production franchise, (ii) building our
balance sheet, (iii) exploring diversification strategies and (iv) evaluating
stockholder return initiatives.
The key tactics for pursuing these strategies include:
Strengthening our Production Franchise. We intend to continue to
expand our total loan production, market share, and volume on the
East Coast and in other metropolitan areas outside of California. We
also plan to use technology such as a new loan origination system and
our FastQual Web site to maintain low loan origination costs while
providing high levels of service.
Building our Balance Sheet. We intend to increase our portfolio of
on-balance sheet securitizations during 2004 by securitizing
approximately 20% of 2004 production. At the same time we plan to
strengthen our cash and liquidity position to protect our franchise
and provide the ability to respond to disruptions in the market or
other adverse conditions. Strong liquidity allows us to hold loans
longer in the event that the secondary market for our loans weakens or
becomes unstable due to a temporary disruption. One source of cash and
liquidity that supports our business is the sale of 80% of our loans
for cash through whole loan sales.
Exploring Diversification Strategies. We intend to further diversify
our earnings sources by:
Expanding our Loan Servicing Program. We plan to increase the
size of our servicing portfolio and to pursue the rating of our
servicing platform by one or more of the major credit rating
agencies during 2004.
Increasing Commercial Lending. We began to originate small balance
commercial loans (loan amounts of up to $3,000,000) in 2003. We
plan to increase our commercial loan production volume during 2004.
Pursuing Business Development Opportunities. We plan to evaluate and
execute strategic acquisitions and new business opportunities as
available.
Evaluating Stockholder Return Initiatives. We plan to declare a cash
dividend of at least $0.16 per share each quarter. Depending on
market conditions, our share price, our cash position and other
factors, we may also continue our stock repurchase program. We have
also announced that we are evaluating the advantages and
disadvantages of converting into a Real Estate Investment Trust. We
expect to conclude our analysis in early April 2004.
Strengths and Competitive Advantages
We believe that we have several strengths and competitive advantages that allow
us to compete effectively in our business, including:
High Quality Customer Service. We strive to make the origination
process easy for our borrowers and brokers by providing prompt
responses, consistent and clear procedures and an emphasis on ease
of use through technology.
Strong Secondary Market Relationships. We have developed strong
relationships with a variety of large institutional loan buyers,
including Morgan Stanley, Credit Suisse First Boston, UBS Warburg,
Residential Funding, Bear Stearns, Deutsche Bank, and Goldman Sachs,
who consistently bid on and buy large loan pools from us.
Performance-Based Compensation Structure. We have implemented a
performance-based compensation structure, which allows us to attract,
retain and motivate qualified personnel.
FastQual Loan Underwriting Engine. Our Wholesale Division has
developed a proprietary Web-based loan underwriting engine, FastQual
, generally providing our brokers and their customers with a
response in less than 12 seconds.
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CloseMore University. CloseMore University, our Wholesale
Division's sales training program for brokers, enables us to
establish relationships with new brokers and expand our relationship
with existing brokers.
Advanced Technology for Credit Evaluation. The implementation of our
proprietary credit grading and pricing engine has allowed us to
produce a more consistent and predictable portfolio of loans.
State-of-the-Art Loan Performance Technology. The asset-backed security
performance section of our Web site, www.ncen.com, employs new
technology to enhance user access to our loan securitization and
portfolio information. The site provides data distilled from monthly
statements to certificate holders, pre-packaged reports, user-definable
data views, deal documents and dynamic data analysis tools that enable
users to examine the performance of the loans supporting each of our
securitized transactions.
Quality Control/Quality Assurance. We have developed a variety of
automated and manual pre-funding controls (Quality Control) and
post-funding reviews (Quality Assurance) in order to increase the
likelihood that we originate loans that comply with applicable laws,
as well as with our own internal underwriting guidelines and secondary
market requirements.
Management Experience and Depth. The members of our senior
management team have, on average, over 20 years of experience in
the consumer finance sector.
Product Types
We offer both fixed-rate loans and adjustable-rate loans, or ARMs. We also offer
loans with an interest rate that is initially fixed for a period of time and
subsequently converts to an adjustable rate. At each interest rate adjustment
date, we adjust the rate subject to certain limitations on the amount of any
single adjustment and a cap on the aggregate of all adjustments.
In addition, our products are available at different interest rates and with
different origination and application points and fees, depending on the
particular borrower's risk classification. See "Business-Underwriting
Standards." Borrowers may choose to increase or decrease their interest rate
through the payment of different levels of origination fees. Our maximum loan
amount is generally $500,000 with a loan-to-value ratio of up to 90%. We do,
however, offer larger loans with lower loan-to-value ratios through a special
jumbo program. We also offer products that permit a loan-to-value ratio of up to
95% for selected borrowers with an internal risk classification of "A+" or of up
to 90% for selected borrowers with an internal risk classification of "A-". We
also offer our "AA" product designed to appeal to borrowers of higher credit
quality.
Loans originated or purchased by us during 2003 had an average loan amount of
approximately $167,000 and an average loan-to-value ratio of 82.1%. If permitted
by applicable law and agreed to by the borrower, a loan originated by us may
also include a prepayment charge that is triggered by the loan's full or
substantial prepayment early in the loan term. Approximately 80% of the loans we
originated or purchased during 2003 included some form of prepayment charge.
Loan Originations and Purchases
Our Wholesale Division originates and purchases loans through a network
of independent mortgage brokers and correspondent lenders solicited by
our account executives. Our account executives provide on-site customer
service to the broker to facilitate the loan's funding. In addition, the
Wholesale Division originates mortgage loans through its FastQual Web
site at www.newcentury.com, where a broker can upload a loan request and
receive a response generally within 12 seconds.
Our Retail Division originates loans directly to the consumer through
72 retail branch offices located in 26 states and a central retail
telemarketing unit that originates loans nationwide through one
central office. Leads are generated through radio, direct mail,
telemarketing and the Internet.
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Our Wholesale Division
During 2003, our wholesale originations and purchases totaled $25.1 billion, or
91.8% of our total loan production. As of December 31, 2003, our Wholesale
Division operated through 20 regional operating centers located in 14 states and
employed 486 account executives.
As of December 31, 2003, we had approved over 21,600 mortgage brokers to submit
loans to us. Of the total approved mortgage brokers, we originated loans through
approximately 15,400 brokers during 2003. During this period, our ten largest
producing brokers originated 7.0% of our wholesale production.
We have designed and implemented a detailed procedure for qualifying, approving
and monitoring our network of approved mortgage brokers. We require all brokers
to complete an application which requests general business information and
copies of all licenses. Upon receipt of the application and supporting
documentation, our Broker Services Department scrutinizes the materials for
completeness and accuracy. Our Broker Services Department then independently
verifies the information contained in the application through (i) a public
records Web site to verify the validity and status of licenses and (ii) the
Mortgage Asset Research Institute, or MARI, which provides background
information from both the public and private sectors.
To be approved, a broker must enter into our standard broker agreement with New
Century Mortgage Corporation pursuant to which the broker agrees to abide by the
provisions of our Policy on Fair Lending and our Brokers' Code of Conduct. Each
broker also agrees to comply with applicable state and federal lending laws and
agrees to submit true and accurate disclosures with regard to loan applications
and loans. In addition, we employ a risk management team that regularly reviews
and monitors the loans submitted by our brokers.
In wholesale loan originations the broker's role is to identify the applicant,
assist in completing the loan application form, gather necessary information and
documents and serve as our liaison with the borrower through our lending
process. We review and underwrite the application submitted by the broker,
approve or deny the application, set the interest rate and other terms of the
loan and, upon acceptance by the borrower and satisfaction of all conditions
imposed by us, fund the loan. Because brokers conduct their own marketing and
employ their own personnel to complete loan applications and maintain contact
with borrowers, originating loans through our Wholesale Division allows us to
increase loan volume without incurring the higher marketing, labor and other
overhead costs associated with increased retail originations.
Mortgage brokers can submit loan applications in two ways: (i) through an
account executive in one of our sales offices or (ii) through FastQual , our
Web-based loan underwriting engine, at www.newcentury.com.
In either case, the mortgage broker will forward the original loan package to
the closest regional operating center where the loan is logged in for regulatory
compliance purposes, underwritten and, in most cases, approved or denied within
24 hours of receipt. If approved, we issue a "conditional approval" to the
broker with a list of specific conditions that have to be met (for example,
credit verifications and independent third-party appraisals) and additional
documents to be supplied prior to the funding of the loan. An account manager
and the account executive work directly with the submitting mortgage broker who
originated the loan to collect the requested information and to meet the
underwriting conditions and other requirements. In most cases, we fund loans
within 30 days from the date of approval of an application.
FastQual generally provides the broker with a response in less than 12 seconds.
Loan information from the brokers' own loan operating systems can be
automatically uploaded to FastQual . The system provides all loan products for
which the borrower qualifies and thus enables brokers to offer their customers
many options. Our FastQual Web site enables mortgage brokers to evaluate loan
scenarios for borrowers, submit loan applications, order credit reports,
automatically credit grade the loan, obtain pricing and track the progress of
the loan through funding.
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Our Wholesale Division also purchases closed loans on an individual or "flow"
basis from independent mortgage bankers and financial institutions known as
correspondent lenders. We review an application for approval from each lender
that seeks to sell us a closed loan. We analyze the mortgage banker's
underwriting guidelines to ensure conformance with our guidelines. We also
review their financial condition and licenses. We require each mortgage banker
to enter into a purchase and sale agreement with customary representations and
warranties regarding the loans the mortgage banker will sell to us. These
representations and warranties are comparable to those given by us to the
purchasers of our loans. Once the correspondent is approved, we underwrite each
loan submitted by them.
The following table sets forth selected information relating to loan
originations and purchases through our Wholesale Division during the periods
shown:
For the Quarters Ended
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
Principal balance (in millions) $ 4,236.6 5,319.0 7,991.1 7,581.9
Average loan amount (in thousands) 163 166 182 172
Combined weighted average initial
loan-to-value ratio 80.9 % 82.3 % 81.8 % 83.9 %
Percent of first mortgage loans 98.8 % 98.4 % 98.8 % 98.3 %
Property securing loans:
Owner occupied 94.4 % 94.6 % 95.1 % 94.5 %
Nonowner occupied 5.6 % 5.4 % 4.9 % 5.5 %
Weighted average interest rate:
Fixed-rate 7.83 % 7.86 % 6.78 % 7.46 %
ARMs-initial rate 7.58 % 7.42 % 7.15 % 7.18 %
ARMs-margin over index 6.05 % 5.52 % 5.65 % 5.70 %
Our Retail Division
During 2003, our Retail Division originated $2.3 billion in loans, or 8.2% of
our total loan production. As of December 31, 2003, our Retail Division,
including the central retail telemarketing unit, employed 678 retail loan
officers. These employees were located in three regional processing centers and
72 sales offices in 28 states.
By creating a direct relationship with the borrower, retail lending provides a
more sustainable loan origination franchise and greater control over the lending
process. Loan origination fees contribute to profitability and cash flow and
offset the higher costs of retail lending.
The following table sets forth selected information relating to loan
originations through our Retail Division during the periods shown:
For the Quarters Ended
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
Principal balance (in millions) $ 452.8 484.0 648.7 669.7
Average loan amount (in thousands) 123 118 124 126
Combined weighted average initial
loan-to-value ratio 78.0 % 78.8 % 80.4 % 79.8 %
Percent of first mortgage loans 99.3 % 99.0 % 97.0 % 99.4 %
Property securing loans:
Owner occupied 96.5 % 96.6 % 95.6 % 93.3 %
Nonowner occupied 3.5 % 3.4 % 4.4 % 6.7 %
Weighted average interest rate:
Fixed-rate 8.33 % 8.15 % 7.66 % 7.55 %
ARMs-initial rate 8.11 % 7.92 % 7.81 % 7.72 %
ARMs-margin over index 6.61 % 6.45 % 6.22 % 6.23 %
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In January 2004, we merged the loan processing functions of both our Wholesale
and Retail Divisions into 20 regional processing centers located in 14 states.
The combination of our processing centers is expected to improve consistency and
reduce costs.
Marketing
Wholesale Marketing
Our Wholesale Division's marketing strategy focuses on the sales efforts of its
account executives and on providing prompt, consistent service to mortgage
brokers and other customers. Our Wholesale Division supplements its strategy
with direct mail and fax programs to brokers, advertisements in trade
publications, in-house production of collateral sales material, seminar
sponsorships, tradeshow attendance, periodic sales contests and its e-commerce
Web site, www.newcentury.com.
Another marketing strategy created by our Wholesale Division is CloseMore
University("CMU"), an exclusive, one-day interactive workshop. CMU travels to
major cities in the United States and invites mortgage brokers in those cities
to participate in the workshop. The workshop includes industry specific speakers
presenting on topics ranging from how to market to your customer to how to
process loans more efficiently. Brokers that attend the seminar are also
introduced to our Wholesale Division's FastQual system and are provided training
on the Web site. This additional marketing strategy has fueled the growth of
FastQual during 2003. The CMU Web site address is at www.closemoreu.com.
Retail Marketing
Our Retail Division's branch operations unit relies primarily on targeted direct
mail and outbound telemarketing to attract borrowers. Our direct mail programs
are managed by a centralized staff who create a targeted mailing list for each
branch market and oversee the completion of mailings by a third party mailing
vendor. All calls or written inquiries from potential borrowers that result from
the mailings are tracked centrally and then forwarded to a branch location and
handled by branch loan officers.
The direct mail program uses the Retail Division's Web site,
www.newcenturymortgage.com, to provide information to prospective borrowers and
to allow them to complete an application online. Under the Central Telemarketing
Program, the telemarketing staff solicits prospective borrowers, makes a
preliminary evaluation of the applicant's credit and the value of the collateral
property and refers qualified leads to loan officers in the retail branch
closest to the customer.
Our Retail Division's central retail telemarketing unit solicits prospective
borrowers through a variety of direct response advertising methods, such as
purchased leads from aggregators, radio advertising, direct mail, search engine
placement, banner ads, e-mail campaigns and links to related Web sites. The
central retail telemarketing unit also markets to our current customer base
through direct mail and outbound telemarketing, although such solicitations are
not made within the first 12 months after loan origination. In addition, this
unit maintains a comprehensive database on all customers with whom it has had
contact and markets to these potential customers as well.
Financing Loan Originations and Loans Held for Sale
We require access to credit facilities in order to originate and purchase
mortgage loans and to hold them pending their sale or securitization.
We use our credit facilities totaling $5.4 billion provided by Bank of America,
UBS Warburg, CDC Mortgage Capital, Bear Stearns, Morgan Stanley, Greenwich
Capital, and Citigroup Global Markets Realty to finance the actual funding of
our loan originations and purchases. We also fund loans through our $2.0 billion
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asset-backed commercial paper note facility established in September 2003. We
then sell the loans through whole loan sales or securitizations within two to
three months and pay down the financing facilities with the proceeds. See
"-Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources."
Underwriting Standards
The loans we originate or purchase generally do not satisfy conventional
underwriting standards, such as those of Fannie Mae or Freddie Mac. Therefore,
our loans are likely to have higher delinquency and foreclosure rates than
portfolios of mortgage loans underwritten to conventional Fannie Mae and Freddie
Mac standards.
Our underwriting guidelines take into account the applicant's credit history and
capacity to repay the proposed loan as well as the secured property's value and
adequacy as collateral for the loan. Each applicant completes an application
that includes personal information on the applicant's liabilities, income,
credit history and employment history. Based on review of the loan application
and other data from the applicant against our underwriting guidelines, we
determine the loan terms, including the interest rate and maximum loan-to-value
ratio.
Credit History
Our underwriting guidelines require a credit report on each applicant from a
credit reporting company. In evaluating an applicant's credit history, we
utilize credit bureau risk scores, generally known as a FICO score, which is a
statistical ranking of likely future credit performance developed by Fair, Isaac
& Company and the three national credit data repositories-Equifax, TransUnion
and Experian.
Collateral Review
A qualified independent appraiser inspects and appraises each mortgage property
and verifies that it is in acceptable condition. Following each appraisal, the
appraiser prepares a report that includes a market value analysis based on
recent sales of comparable homes in the area and, when appropriate, replacement
cost analysis based on the current cost of constructing a similar home. All
appraisals must conform to the Uniform Standards of Professional Appraisal
Practice adopted by the Appraisal Foundation's Appraisal Standards Board and are
generally on forms acceptable to Fannie Mae and Freddie Mac. Our underwriting
guidelines require a review of the appraisal by one of our qualified employees
or by a qualified review appraiser that we have retained. Our underwriting
guidelines then require our underwriters to be satisfied that the value of the
property being financed, as indicated by the appraisal, currently supports the
outstanding loan balance.
Income Documentation
Our underwriting guidelines include three levels of income documentation
requirements, referred to as the "full documentation," "limited documentation"
and "stated income documentation" programs. Under the full documentation
program, we generally require applicants to submit two written forms of
verification of stable income for at least 12 months. Under the limited
documentation program, we generally require applicants to submit 12 consecutive
monthly bank statements on their individual bank accounts. Under the stated
income documentation program, an applicant may be qualified based upon monthly
income as stated on the mortgage loan application if the applicant meets certain
criteria. All of these documentation programs require that, with respect to
salaried employees, the applicant's employment be verified by telephone. In the
case of a purchase money loan, we require verification of the source of funds,
if any, to be deposited by the applicant into escrow. Under each of these
programs, we review the applicant's source of income, calculate the amount of
income from sources indicated on the loan application or similar documentation,
review the applicant's credit history, and calculate the debt service-to-income
ratio to determine the applicant's ability to repay the loan. We also review the
type, use and condition of the property being financed. Our underwriters use a
qualifying rate that is equal to the initial interest rate on the loan to
determine the applicant's ability to repay an adjustable-rate loan. We use a
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qualifying rate that is 3% higher than the start rate for determining the
repayment ability of applicants for our interest-only product.
Underwriting Requirements
In general, the maximum loan amount for our mortgage loans is $500,000. Our
underwriting guidelines permit loans on owner-occupied, one-to-four-family
residential properties to have:
a loan-to-value ratio at origination of up to 95% with respect to
non-conforming first liens; and
a combined loan-to-value ratio at origination of up to 100% with
respect to conforming and non-conforming second liens.
The applicability of these ratios depends on the purpose of the mortgage loan,
the borrower's credit history, the borrower's repayment ability and debt
service-to-income ratio, and the type and use of the property. The loan-to-value
ratio of a mortgage loan that is secured by mortgaged property acquired by a
borrower under a "lease option purchase" is determined in one of two ways. If
the "lease option price" was set less than 12 months prior to origination, the
loan-to-value ratio of the related mortgage loan is based on the lower of the
appraised value at the time of origination of the mortgage loan and the sale
price of the related mortgaged property. If the "lease option price" was set at
least 12 months or more prior to origination, the loan-to-value ratio of the
related mortgage loan is based on the appraised value of the related mortgaged
property at the time of origination.
Our underwriting guidelines for first lien mortgage loans have the following
categories and criteria for grading the potential likelihood that an applicant
will satisfy the repayment obligations of a mortgage loan:
Summary of Principal Underwriting Guidelines(1)
AA Risk A+Risk A-Risk B Risk C Risk C-Risk
Existing and prior No 30-day late Maximum one 30-day Maximum three Maximum one 60-day Maximum one 90-day Maximum of two
mortgage history payments w/in last late payment and no 30-day late late payment within late payment within 90-day late
12 months; must 60-day late payments and no last 12 months; must last 12 months; must payments and one
have an LTV of 95% payments w/in last 60-day late have an LTV of 85% have an LTV of 80% 120-day late
or less; no 12 months; must payments w/in last or or payment w/in last
evidence of default have an LTV of 95% 12 months; must less; no evidence of less; no evidence of 12 months; must
in 3 years. or less; no have an LTV of 90% default in 2 years. default in 1 year. have an LTV of
evidence of default or less; no 70% or less; no
in 3 years. evidence of default current default.
in 3 years.
Consumer credit Minimum credit Minimum credit Minimum credit Minimum credit score Minimum credit score Minimum credit
score of 500; LTVs score of 500; LTVs score of 500; LTVs of 500; LTVs over of 500; LTVs over score of 500.
over 80% have over 80% have over 80% have 80% have higher 75% have higher
higher credit score higher credit score higher credit score credit score credit score
minimums. minimums. minimums. minimums. minimums.
Bankruptcy filings Generally, no Generally, no Generally, no Generally, no Generally, no Chapter 7
Chapter 7 or 13 Chapter 7 or 13 Chapter 7 Chapter 7 Bankruptcy Chapter 7 Bankruptcy discharged and
Bankruptcy Bankruptcy Bankruptcy discharged in last discharged in the Chapter 13
discharged in last discharged in last discharged in the 18 months or Chapter last year or any discharged or
2 years. 2 years. last 2 years or any 13 Bankruptcy filed Chapter 13 discharged at
Chapter 13 in the last 18 Bankruptcy filed in funding.
Bankruptcy filed in months. the last year.
the last 2 years.
Total debt
service-to-income
ratio 50% to 55% 50% to 55% 50% to 55% 50% to 55% 55% 55%
Maximum
loan-to-value ratio
(LTV)(2):
Owner occupied: 95% 95% 90% 85% 80% 70%
Single family;
detached PUD,
or 2-unit:
Owner occupied: 90% 90% 85% 80% 75% 65%
Condo/three-to-four
unit:
Nonowner occupied: 85% 85% 80% 75% 70% 60%
(1) The letter grades applied to each risk classification reflect our
internal standards and do not necessarily correspond to the
classifications used by other mortgage lenders.
(2) The maximum LTV set forth in the table is for borrowers providing
full documentation. The LTV is reduced 5% for stated income
applications, if applicable.
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Interest Only ARM Program
For our Interest Only ARM Program, which attracts a higher credit quality
borrower, we assess the borrower's mortgage repayment history, any incidents of
bankruptcy, mortgage default or major derogatory credit, and we require a
minimum credit score of 660, which is substantially higher than our traditional
product requirements. This program is restricted to owner-occupied properties
and second homes, single units, two units, condominiums or detached planned unit
developments ("PUDs"), with no rural or unique properties allowed. We have
limitations on loan amount, loan-to-value ratio, income documentation type, and
the amount of "cash out" allowed on refinances. We assign a unique 4-level grade
classification based on the credit score range for the primary borrower. The
debt ratio is calculated at 3% higher than the start rate and the program
requires verified liquid reserves. The loan term is 25 years with an option for
interest only payments the first 10 years, converting to a 15-year fully
amortized ARM in years 11 through 25.
"Niche" or Special Programs
We have several programs that we have designated as "niche" or special programs.
These programs are the Special Jumbo Product, the 80/20 Combo Product and the
100% High LTV Product. In general, all of these programs require the borrower to
have an excellent mortgage history over the last 12 months. In addition to
credit score minimums, these programs require a more in-depth analysis of
consumer credit, and both the Special Jumbo Product and the 100% High LTV have
requirements for verification of liquid reserves. Overall the minimum credit
score for these products is 600, although the 80/20 Combo Product allows a
minimum credit score of 580 with other restrictions and limitations. Maximum
loan amounts or combined loan amounts on these products range from $600,000 to
$1,000,000. Higher loan amounts have higher credit score minimums and are
subject to other restrictions and limitations.
Home Saver Program
We had established a sub-category of our C- credit grade, which was eliminated
from our program offerings in mid-2003, for borrowers faced with at least one of
the following credit scenarios: (i) the borrower had an existing mortgage that
was currently in foreclosure; (ii) the borrower was subject to a notice of
default filing or (iii) the borrower had a serious mortgage delinquency for more
than one 120-day period in the prior 12 months or was more than 90 days late at
the time of funding. This sub-category was known as our Home Saver Program. The
Home Saver Program was available only to Full Documentation borrowers and
permitted a maximum LTV ratio of 65% and a maximum debt service-to-income ratio
of 55%. The maximum loan amount was $300,000 and all derogatory credit report
items must have been brought current or paid with the loan proceeds. A maximum
of 3% of the loan proceeds was allowed to the borrower in cash. If the borrower
was in an open Chapter 13 bankruptcy, the bankruptcy must have been discharged
with the proceeds of the loan. For the year ended December 31, 2003, Home Saver
loans accounted for less than 1% of total loan originations and purchases. We no
longer originate loans under this program.
Exceptions
The categories and criteria described in our underwriting guideline table above
are guidelines only. On a case-by-case basis, we may determine that an applicant
warrants a LTV ratio exception, a debt service-to-income ratio exception, or
another exception. We may allow such an exception if the application reflects
certain compensating factors such as low LTV, a maximum of one 30-day late
payment on all mortgage loans during the last 12 months, and stable employment
or ownership of the current residence. We may also allow an exception if the
applicant places in escrow a down payment of at least 20% of the purchase price
of the mortgage property or if the new loan reduces the applicant's monthly
aggregate mortgage payment. Our automated credit grading system aids in
identifying and managing underwriting exceptions. Certain of our loan programs
and risk grade classifications limit the approval of exceptions to higher loan
approval authority levels. For 2003, our overall underwriting exception rate was
14.9% on total production of $27.4 billion. For 2002, our overall underwriting
exception rate was 18.5% on total production of $14.2 billion.
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We evaluate our underwriting guidelines on an ongoing basis and periodically
modify them to reflect our current assessment of various underwriting issues. We
also maintain separate underwriting guidelines appropriate to our non-conforming
second lien mortgage loans and adopt new underwriting guidelines appropriate to
new loan products we may offer.
Loan Production by Borrower Risk Classification
The following table sets forth information concerning the characteristics of our
fixed-rate and adjustable-rate loan production by borrower risk classification
for the periods shown:
For the Quarters Ended
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
AA Risk Grade:
Percent of total purchases and originations
(1) 27.1 % 63.2 % 73.8 % 70.3 %
Combined weighted average initial
loan-to-value ratio 83.8 84.5 83.4 86.4
Weighted average interest rate:
Fixed-rate 7.9 7.8 6.7 7.4
ARMs-initial rate 7.2 7.1 7.0 7.0
ARMs-margin over index 5.3 5.3 5.5 5.6
A+ Risk Grade:
Percent of total purchases and originations
(1) 44.2 % 17.0 % 11.6 % 12.0 %
Combined weighted average initial
loan-to-value ratio 82.3 80.5 79.5 80.0
Weighted average interest rate:
Fixed-rate 7.7 7.8 7.2 7.5
ARMs-initial rate 7.4 7.5 7.3 7.3
ARMs-margin over index 6.2 5.7 5.9 5.9
A- Risk Grade:
Percent of total purchases and originations 13.5 % 9.7 % 7.3 % 8.2 %
Combined weighted average initial
loan-to-value ratio 77.0 77.6 76.7 76.9
Weighted average interest rate:
Fixed-rate 8.2 8.2 7.5 7.8
ARMs-initial rate 7.9 7.8 7.6 7.6
ARMs-margin over index 6.5 6.0 6.0 6.0
B Risk Grade:
Percent of total purchases and originations 11.7 % 6.5 % 4.6 % 6.0 %
Combined weighted average initial
loan-to-value ratio 74.7 74.8 74.6 74.8
Weighted average interest rate:
Fixed-rate 8.3 8.8 8.1 8.1
ARMs-initial rate 8.3 8.4 8.1 8.0
ARMs-margin over index 6.7 6.3 6.3 6.2
C/C- Risk Grade:
Percent of total purchases and originations 3.5 % 3.6 % 2.7 % 3.5 %
Combined weighted average initial
loan-to-value ratio 68.8 69.0 68.8 68.3
Weighted average interest rate:
Fixed-rate 9.8 9.8 9.0 8.9
ARMs-initial rate 9.7 9.3 9.0 8.7
ARMs-margin over index 7.0 6.5 6.6 6.6
(1) The increase in AA production and decrease in A+ production
from the first quarter to the second quarter resulted from a
change in our credit risk grading.
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Geographic Distribution
The following table sets forth by state the aggregate dollar amounts (in
thousands) and the percentage of all loans we originated or purchased for the
periods shown:
For the Quarters Ended
March 31, 2003 June 30, 2003 September 30, 2003 December 31, 2003
California $ 1,841,366 39.3 % $ 2,348,874 40.5 % $ 3,702,465 42.9 % $ 3,335,617 40.4 %
Florida 303,342 6.5 % 361,704 6.2 % 507,009 5.9 % 481,261 5.8 %
New York 248,257 5.3 % 286,645 4.9 % 563,711 6.5 % 534,131 6.5 %
Illinois 239,004 5.1 % 290,565 5.0 % 370,026 4.3 % 330,935 4.0 %
Texas 207,589 4.4 % 250,531 4.3 % 345,883 4.0 % 331,002 4.0 %
Massachusetts 166,491 3.6 % 190,096 3.3 % 288,079 3.3 % 298,494 3.6 %
New Jersey 160,256 3.4 % 204,914 3.5 % 298,598 3.5 % 221,745 2.7 %
Michigan 184,005 3.9 % 220,101 3.8 % 233,875 2.7 % 224,593 2.7 %
Washington 92,767 2.0 % 111,910 1.9 % 188,254 2.2 % 234,458 2.8 %
Colorado 142,611 3.0 % 124,605 2.1 % 151,651 1.8 % 130,393 1.6 %
Other 1,103,783 23.5 % 1,413,052 24.5 % 1,989,257 22.9 % 2,128,933 25.9 %
Total $ 4,689,471 100.0 % $ 5,802,997 100.0 % $ 8,638,808 100.0 % $ 8,251,562 100.0 %
Loan Sales and Securitizations
We conduct our secondary marketing operations through one of our subsidiaries,
NC Capital Corporation. NC Capital buys loans from New Century Mortgage,
generally within a week or two after origination, paying a price that
approximates the loans' secondary market value. NC Capital then sells the loans
through whole loan sales or securitizations. NC Capital is responsible for
determining when and through which channel to sell the loans, and bears the
risks of market fluctuations in the period between purchase and sale.
Whole Loan Sales
As of December 31, 2003, whole loan sales accounted for $20.8 billion, or 80.8%
of our total secondary market transactions. The weighted average premiums
received on whole loan sales during 2003 was equal to 4.18% of the original
principal balance of the loans sold, including premiums received for servicing
rights.
We seek to maximize our premiums on whole loan sales by closely monitoring
requirements of institutional purchasers and focusing on originating or
purchasing the types of loans that meet those requirements and for which
institutional purchasers tend to pay higher premiums. During the year ended
December 31, 2003, we sold $11.3 billion of loans to Morgan Stanley and $4.4
billion of loans to Credit Suisse First Boston, which represented 54.2% and
21.1%, respectively, of total loans sold. While over three-fourths of our loans
were sold to these two investors, our loans are sold through a competitive bid
process which generally includes many more potential buyers.
We sell whole loans on a non-recourse basis pursuant to a purchase agreement in
which we give customary representations and warranties regarding the loan
characteristics and the origination process. Therefore, we may be required to
repurchase or substitute loans in the event of a breach of these representations
and warranties. In addition, we generally commit to repurchase or substitute a
loan if a payment default occurs within the first month or two following the
date the loan is funded, unless we make other arrangements with the purchaser.
Securitizations
Off-Balance Sheet Securitizations
In an off-balance sheet securitization, we sell a pool of loans to a trust for a
cash purchase price and a certificate evidencing our residual interest ownership
in the trust and the transaction is accounted for as a sale
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under generally accepted accounting principles. The trust raises the cash
portion of the purchase price by selling senior certificates representing senior
interests in the loans in the trust. Following the securitization, purchasers of
senior certificates receive the principal collected, including prepayments, on
the loans in the trust. In addition, they receive a portion of the interest on
the loans in the trust equal to the specified "investor pass-through interest
rate" on the principal balance. We receive the cash flows from the residual
interests after payment of servicing fees, guarantor fees and other trust
expenses if the specified over-collateralization requirements are met.
Over-collateralization requirements are generally based on a percentage of the
original or current unpaid principal balance of the loans and may be increased
during the life of the transaction depending upon actual delinquency or loss
experience. A net interest margin, or NIM, transaction, through which
certificates are sold that represent a portion of the spread between the coupon
rate on the loans and the investor pass-through rate, may also occur
concurrently with or shortly after a securitization. A NIM transaction allows us
to receive a substantial portion of the gain in cash at the closing of the NIM
transaction, rather than over the actual life of the loans.
During 2002, we completed one off-balance sheet securitization totaling $845.5
million of mortgage loans. We did not complete any off-balance sheet
securitizations during 2003.
On-Balance Sheet Securitizations
During 2003, we completed five securitizations totaling $4.9 billion, all of
which were structured as on-balance sheet securitizations for financial
reporting purposes under generally accepted accounting principles. This
"portfolio-based" accounting treatment is designed to more closely match the
recognition of income with the receipt of cash payments. Also, on-balance sheet
securitizations are consistent with our strategy to generate primarily
cash-based earnings rather than non-cash gain on sale revenue. Because we do not
record gain on sale revenue in the period in which the on-balance sheet
securitization occurs, the use of such portfolio-based accounting structures
will result in lower income in the period in which the securitization occurs
than would a traditional off-balance sheet securitization. However, the
recognition of income as interest payments are received on the underlying
mortgage loans is expected to result in higher income recognition in future
periods than would an off-balance sheet securitization.
Loan Servicing and Delinquencies
Servicing
Loan servicing includes activities which seek to ensure that each loan in a
mortgage servicing portfolio is repaid in accordance with its terms. Such
activities are generally performed pursuant to servicing contracts we enter into
with investors or their agents in connection with whole loan sales or
securitizations. The servicing functions performed typically include: collecting
and remitting loan payments, making required advances, accounting for principal
and interest, holding escrow or impound funds for payment of taxes and insurance
and, if applicable, contacting delinquent borrowers and supervising foreclosures
and property dispositions in the event of un-remedied defaults. For performing
these functions we generally receive a servicing fee of 0.50% annually of the
outstanding principal balance of each loan in the mortgage servicing portfolio.
The servicing fees are collected from the monthly payments made by the
mortgagors. In addition, we generally receive other remuneration consisting of
float benefits derived from collecting and remitting mortgage payments, as well
as mortgagor-contracted fees such as late fees, reconveyance charges and, in
some cases, prepayment penalties.
We conducted servicing operations from July 1998 through mid-2001 on our
in-house servicing platform. In March 2001, we sold our portfolio of mortgage
loan servicing rights to Ocwen Federal Bank. From March 2001 to September 2002,
we contracted with Ocwen to perform sub-servicing functions for our mortgage
loans held for sale. During that period, we either sold loans on a
servicing-released basis or we sold the servicing rights to third parties.
In October 2002, we re-established mortgage servicing operations. As of December
31, 2003, the balance of our loan servicing portfolio was $11.6 billion,
consisting of $4.7 billion in mortgage loans held for investment,
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$3.4 billion in mortgage loans held for sale, $3.1 billion in interim servicing,
and $0.4 billion in servicing rights owned.
Servicing rights owned are loans sold to whole loan investors for which we
retained the servicing rights. Interim servicing represents loans sold to whole
loan investors that we have agreed to service temporarily pending their
transfer.
Servicing Operations
Once we originate or purchase a mortgage loan we begin the process of servicing
the loan. We originated $27.4 billion in mortgage loans during 2003, all of
which were serviced by us on an interim servicing basis prior to sale or were
included in one of our on-balance sheet securitizations. During 2003, an average
of approximately 14,000 new loans per month were boarded to our servicing
platform and an average of 10,000 loans per month were transferred to other
servicers as a result of whole loan sales.
During 2003, several key servicing platform initiatives were completed.
Technology initiatives completed in 2003 include the deployment of a proprietary
database to enhance the management of the disposition of real estate properties
acquired through foreclosure, the deployment of a risk scoring model to assist
in predicting and preventing delinquencies, an upgrade to our comprehensive call
management and borrower contact software and the implementation of a data
warehouse within the servicing division that provides loan level data to
management.
We establish early relationships with our borrowers from a servicing
perspective. An introductory "welcome" phone call is made to each borrower
following funding in order to introduce New Century to the borrower and verify
critical loan and contact information. During the welcome call, our customer
service agents verify with the customer the amount of the loan, first payment
due date, the interest rate, the payment amount and customer receipt of their
first billing statement. Additionally, information is provided to the borrower
on how to contact New Century in the event they have additional questions or
concerns regarding their loan.
While the vast majority of our customers make their payments in a timely manner,
in the event a borrower becomes delinquent, our loan counselors and default
personnel assist the borrower in finding a resolution and bringing the loan
current. As a matter of course, by the 35th day of delinquency, depending on
state specific timelines, but no earlier than the 32nd day of delinquency, a
breach of contract notice is issued. Such notices allow the borrower the
opportunity to cure the delinquency within the next 30 days in order to avoid
referral to foreclosure.
Accounts that are referred to our Foreclosure Department are simultaneously
referred to our Loss Mitigation Department for outbound solicitation using our
predictive dialer. Various loss mitigation opportunities are explored with the
borrower, including the possibility of forebearance agreements, listing the
property for sale, deeds in lieu of foreclosure and full reinstatement of the
loan. Loss mitigation strategies are designed to minimize the loss to both the
borrower and investor, and are structured, where possible, to insure that the
loan performs in a manner that supports the avoidance of foreclosure, while at
the same time minimizing fees and costs.
In the event that foreclosure is the only resolution available, we will engage
local attorneys to assist with managing the legal processes mandated by various
state and local statutes. Foreclosure timelines are state and locality specific,
and have been programmed in our primary timeline management software and our
loan servicing system. Properties for which the foreclosure sale has been
completed and have exceeded their redemption periods (which are state specific)
are transferred to our Real Estate Owned Department where the ultimate
disposition is managed by our in-house asset managers. Once the properties have
been vacated and are available for sale, the property is listed and marketed for
sale. The resulting sales price and overall recovery are closely monitored by
management in order to minimize the loss incurred.
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We intend to continue to retain servicing rights on a substantial percentage of
the loans we sell in future periods. During 2004, we will seek approval for our
servicing platform from one or more ratings agencies. If we receive such
approval, we expect we will be able to grow the platform more quickly.
Delinquency Reporting
The following table sets forth loan performance data of the loans on our
mortgage loan servicing platform at December 31, 2003 (dollars in thousands):
Delinquency
Weighted Average ------------------------------------------------
Pool Type Balance Coupon FICO <90 days 90+ REO Total
Mortgage loans held
for investment $ 4,727,504 7.16 % 624 0.66 % 0.58 % 0.02 % 1.26 %
Mortgage loans held
for sale 3,383,266 7.22 % 617 0.08 % 0.26 % 0.01 % 0.35 %
Interim servicing 3,103,480 7.25 % 622 0.07 % 0.02 % 0.00 % 0.09 %
Servicing rights
owned 351,884 8.08 % 591 2.61 % 4.11 % 0.18 % 6.90 %
Total $ 11,566,134 7.23 % 621 0.39 % 0.44 % 0.02 % 0.85 %
Interest Rate Risk Management Strategies
We try to mitigate interest rate risk through a variety of strategies. For
instance, the interest rate that will be charged to our borrowers is locked on
the day the loan funds. This generally allows us to price our pipeline of
approved loans with current market rates. In addition, we may elect to use
various derivative financial instruments such as swaps, forwards, options and
futures contracts to mitigate interest rate risk. We often use forward loan sale
commitments with a predetermined price and delivery date to sell our unsold loan
inventory, which protects us from interest rate increases.
In order to mitigate the adverse effects resulting from interest rate increases
on our residual interests, certain mortgage loans held for sale and mortgage
loans held for investment, we utilize derivative financial instruments such as
Euro Dollar Futures contracts and interest rate caps. It is not our policy to
use derivatives to speculate on interest rates. These derivative instruments
have an active secondary market and are intended to provide income and cash flow
to offset potential reduced interest income and cash flow under certain interest
rate environments. Certain of our interest rate management activities qualify
for hedge accounting in accordance with Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"), as amended and interpreted. The derivative financial
instruments and any related margin accounts are reported on our consolidated
balance sheets at their fair value. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Critical Accounting Policies."
Competition
We continue to face intense competition in the business of originating,
purchasing and selling mortgage loans. Our competitors include other consumer
finance companies, mortgage banking companies, commercial banks, credit unions,
thrift institutions, credit card issuers and insurance finance companies. Other
large financial institutions have gradually expanded their "non-prime" or
"sub-prime" lending capabilities. Many of these companies have greater access to
capital at a cost lower than our cost of capital under our warehouse,
aggregation, and asset backed commercial paper facilities. Federally chartered
banks and thrifts can preempt some of the state and local lending laws to which
we are subject, thereby giving them a competitive advantage. In addition, many
of these competitors have considerably greater technical and marketing resources
than we have.
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Competition among industry participants can take many forms, including
convenience in obtaining a loan, customer service, marketing and distribution
channels, amount and term of the loan, loan origination fees and interest rates.
Additional competition may lower the rates we can charge borrowers, thereby
potentially lowering gain on future loan sales and securitizations. In 2003, the
most significant form of competition was pricing pressure among wholesale
mortgage originators. Some of our competitors lowered rates and fees to preserve
or expand their market share.
Our results of operations, financial condition and business prospects could be
materially adversely affected if competition intensifies or if any of our
competitors significantly expands its activities in our markets. Fluctuations in
interest rates and general economic conditions may also affect our competitive
position. During periods of rising rates, competitors that have locked in low
borrowing costs may have a competitive advantage. During periods of declining
rates, competitors may solicit our customers to refinance their loans.
Regulation
Our business is regulated by federal, state, and local government authorities
and is subject to extensive federal, state and local laws, rules and
regulations. We are also subject to judicial and administrative decisions that
impose requirements and restrictions on our business. At the federal level,
these laws and regulations include the:
Equal Credit Opportunity Act;
Federal Truth and Lending Act and Regulation Z;
Home Ownership and Equity Protection Act;
Real Estate Settlement Procedures Act;
Fair Credit Reporting Act;
Fair Debt Collection Practices Act;
Home Mortgage Disclosure Act;
Fair Housing Act;
Telephone Consumer Protection Act;
Gramm-Leach-Bliley Act;
Fair and Accurate Credit Transactions Act;
CAN-SPAM Act;
Sarbanes-Oxley Act; and
USA PATRIOT Act.
These laws, rules and regulations, among other things:
impose licensing obligations and financial requirements on us;
limit the interest rates, finance charges, and other fees that we may charge;
prohibit discrimination;
impose underwriting requirements;
mandate disclosures and notices to consumers;
mandate the collection and reporting of statistical data regarding
our customers;
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regulate our marketing techniques and practices;
require us to safeguard non-public information about our customers;
regulate our collection practices;
require us to prevent money-laundering or doing business with suspected
terrorists; and
impose corporate governance, internal control and financial
reporting obligations and standards.
Our failure to comply with these laws can lead to:
civil and criminal liability;
loss of approved status;
demands for indemnification or loan repurchases from buyers of our loans;
class action lawsuits; and
administrative enforcement actions.
Compliance, Quality Control and Quality Assurance
We regularly monitor the laws, rules and regulations that apply to our business
and analyze any changes to them. We integrate many legal and regulatory
requirements into our automated loan origination system to reduce the prospect
of inadvertent non-compliance due to human error. We also maintain policies and
procedures, and summaries and checklists to help our origination personnel
comply with these laws.
Our training programs are designed to teach our personnel about the significant
laws, rules and regulations that affect their job responsibilities. We also
maintain a variety of pre-funding quality control procedures designed to detect
compliance errors prior to funding.
In addition, we also subject a statistically valid sampling of our loans to
post-funding quality assurance reviews and analysis. We track the results of the
quality assurance reviews and report them back to the responsible origination
units. To the extent refunds or other corrective actions are appropriate, we
deduct those amounts from the internal profit and loss calculation for that
origination unit. Many of our managers have their compensation tied partly to
the quality assurance results of their units.
Our loans and practices are also reviewed regularly in connection with the due
diligence that our loan buyers and lenders perform. Our state regulators also
review our practices and loan files regularly and report the results back to us.
Since our inception, we have undergone over 85 state examinations. To date, the
state examinations have never resulted in findings of material violations or
imposition of penalties.
Licensing
As of December 31, 2003, we were licensed or exempt from licensing requirements
by the relevant state banking or consumer credit agencies to originate first
mortgages in all 50 states and the District of Columbia and second mortgages in
48 states and the District of Columbia.
Regulatory Developments
During 2003, federal and state legislators and regulators adopted a variety of
new or expanded regulations, particularly in the areas of privacy and consumer
protection.
Privacy
The federal Gramm-Leach-Bliley financial reform legislation imposes additional
obligations on us to safeguard the information we maintain on our borrowers.
Regulations have been proposed by several agencies
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that may affect our obligations to safeguard information. In addition,
regulations that could affect the content of our notices are being considered by
several federal agencies. Also, several states are considering even more
stringent privacy legislation. California has passed legislation known as the
California Financial Information Privacy Act and the California On-Line Privacy
Protection Act. Both pieces of legislation are effective July 1, 2004, and will
impose additional notification obligations on us that are not pre-empted by
existing federal law. If other states choose to follow California and adopt a
variety of inconsistent state privacy legislation, our compliance costs could
substantially increase.
Fair Credit Reporting Act
The Fair Credit Reporting Act provides federal preemption for lenders to share
information with affiliates and certain third parties and to provide
pre-approved offers of credit to consumers. Congress acted in late 2003 to make
this preemption permanent, otherwise it would have expired at the end of the
year and states could have imposed more stringent and inconsistent regulations
regarding the use of pre-approved offers of credit and other information
sharing. Congress also amended the Fair Credit Reporting Act to place further
restrictions on the use of information shared between affiliates, to provide new
disclosures to consumers when risk based pricing is used in the credit decision,
and to help protect consumers from identity theft. All of these new provisions
impose additional regulatory and compliance costs on us and reduce the
effectiveness of our marketing programs.
Home Mortgage Disclosure Act
In 2002, the Federal Reserve Board adopted changes to Regulation C promulgated
under the Home Mortgage Disclosure Act ("HMDA"). Among other things, the new
regulations require lenders to report pricing data on loans with annual
percentage rates that exceed the yield on treasury bills with comparable
maturities by 3%. The expanded reporting takes effect in 2004 for reports filed
in 2005. We anticipate that a majority of our loans would be subject to the
expanded reporting requirements.
The expanded reporting does not provide for additional loan information such as
credit risk, debt-to-income ratio, loan-to-value ratio, documentation level or
other salient loan features. As a result, lenders like us are concerned that the
reported information may lead to increased litigation as the information could
be misinterpreted by third parties.
Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003
The CAN-SPAM Act of 2003 applies to businesses, such as ours, that use
electronic mail for advertising and solicitation. This law, generally
administered by the Federal Trade Commission, preempts state laws to the
contrary, and establishes, among other things, a national uniform standard that
gives consumers the right to stop unwanted emails. New requirements are imposed
for the header caption in emails, as well as return email addresses, and
consumers are granted the right to 'opt out' from receiving further emails from
the sender. These new provisions impose additional regulatory and compliance
costs on us and reduce the effectiveness of our marketing programs.
The Alternative Mortgage Transaction Parity Act
This law was enacted to enable state chartered housing creditors, like New
Century, to make, purchase and enforce alternative mortgage transactions (i.e.,
loans that are not fixed rate, fully amortized) without regard to any state law
on the subject, so long as these creditors complied with the same regulatory
guidelines as federally chartered housing lenders. The Office of Thrift
Supervision, under whose guidelines we operate, amended its regulations,
effective July 1, 2003, to eliminate from the preemptive effect of the Act the
regulation of prepayment and late charges on alternative mortgage loans. States
can now regulate prepayment penalty and late charge provisions on alternative
mortgage loans, and so on July 1, 2003, in less than a dozen states, we became
subject to more restrictive state laws as to these issues.
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Telephone Consumer Protection Act and Telemarketing Consumer Fraud and Abuse
Prevention Act
These laws, enacted in 1991 and 1994, respectively, are designed to restrict
unsolicited advertising using the telephone and facsimile machine. Since they
were enacted, however, telemarketing practices have changed significantly due to
new technologies that make it easier to target potential customers while at the
same time making it more cost effective to do so. The Federal Communications
Commission and the Federal Trade Commission have responsibility for regulating
various aspects of these laws, such as regulating unwanted telephone
solicitations and the use of automated telephone dialing systems, prerecorded or
artificial voice messages, and telephone facsimile machines. In 2003, both
agencies adopted 'do-not-call' registry requirements, which, in part, mandate
that companies such as us maintain and regularly update lists of consumers who
have chosen not to be called. These requirements also mandate that we do not
call consumers who have chosen to be on the list. During this same time, over 25
states have also adopted similar laws, with which we also comply. As with other
regulatory requirements, these provisions impose additional regulatory and
compliance costs on us and reduce the effectiveness of our marketing programs.
Predatory Lending Legislation
The Home Ownership and Equity Protection Act of 1994 ("HOEPA") identifies a
category of mortgage loans and subjects them to more stringent restrictions and
disclosure requirements. In addition, liability for violations of applicable law
for loans covered by HOEPA extends not only to the originator, but also to the
purchaser of the loans. HOEPA generally covers loans with either (i) total
points and fees upon origination in excess of the greater of eight percent of
the loan amount or $499 (an annually adjusted dollar amount), or (ii) an annual
percentage rate (APR) of more than eight percentage points higher than United
States Treasury securities of comparable maturity on first mortgage loans, and
ten percentage points above Treasuries of comparable maturity for junior
mortgage loans.
We do not originate loans covered by HOEPA because of the higher legal risks as
well as the potential negative perception of originating loans that are
considered to be "high cost" under federal law.
Several federal, state and local laws and regulations have been adopted or are
under consideration that are intended to eliminate so-called "predatory" lending
practices. Many of these laws and regulations go beyond targeting abusive
practices by imposing broad restrictions on certain commonly accepted lending
practices, including some of our practices. In addition, some of these laws
impose liability on assignees of mortgage loans such as loan buyers, lenders and
securitization trusts. Such provisions deter loan buyers from purchasing loans
covered by the applicable law. For example, the Georgia Fair Lending Act that
took effect in October 2002 resulted in our withdrawal from the Georgia market,
until the law was amended in early 2003, because our lenders and loan buyers
refused to finance or purchase loans covered by that law. The recent enactment
of similar laws late in 2003 in New Jersey and New Mexico has resulted in
significant interruption in the secondary market, with some participants no
longer purchasing home loans originated in those states, and some not purchasing
just those loans covered by these new laws. We have eliminated making loans that
are deemed high cost under these laws, and remain able to finance or sell those
loans we do make.
However, there can be no assurance that other similar laws, rules or
regulations, won't be adopted in the future. Adoption of these laws and
regulations could have a material adverse impact on our business by
substantially increasing the costs of compliance with a variety of inconsistent
federal, state and local rules, or by restricting our ability to charge rates
and fees adequate to compensate us for the risk associated with certain loans.
Adoption of these laws could also have a material adverse effect on our loan
origination volume, especially if our lenders and secondary market buyers elect
not to finance or purchase loans covered by the new laws.
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Efforts to Avoid Abusive Lending Practices
In an effort to prevent the origination of loans containing unfair terms or
involving predatory practices, we have adopted many policies and procedures,
including the following:
Product Policies
We do not fund or purchase "high cost loans" as defined by HOEPA.
We do not make or purchase loans containing single premium credit
life, disability or accident insurance.
We do not make or purchase loans containing balloon payments,
negative amortization, mandatory arbitration clauses or interest rate
increases triggered by borrower default.
We offer loans with and without prepayment penalties. When a
borrower opts for a loan with a prepayment charge, the borrower
benefits from a lower interest rate or pays lower upfront fees.
Our prepayment penalties do not extend beyond three years from the
origination date. On fixed rate loans, the maximum prepayment
penalty term is three years. Prepayment penalties on adjustable
rate loans do not extend beyond the first adjustment date.
We do not originate loans that pay off zero interest rate mortgages
provided by charitable organizations or the government without
borrower third-party counseling.
Loan Processing Policies
We only approve loan applications that evidence a borrower's ability
to repay the loan.
We consider whether the loan terms are in the borrower's best
interests and document our belief that the loan represents a
tangible benefit to the borrower.
We do not solicit our loan portfolio within twelve months of loan
origination.
We price loans commensurate with risk.
We use an electronic credit grading system to help ensure consistency.
We do not ask appraisers to report a predetermined value or withhold
disclosure of adverse features. Appraisers are paid for their work
regardless of whether or not the loans are closed.
We employ electronic and manual systems to protect against adverse
practices like "property flipping." Loan origination systems are
designed to detect red flags such as inflated appraisal values,
unusual multiple borrower activity or rapid loan turnover.
Customer Interaction and Education
We market our loans with a view to encouraging a wide range of
applicants strongly representative of racial, ethnic and economic
diversity of the markets we serve throughout the nation.
We provide a helpful, easy-to-follow brochure to all our loan
applicants to educate them on the loan origination process, explain
basic loan terms, help them obtain a loan that suits their needs and
advise them on how to find a HUD-approved loan counselor.
We distribute our Fair Lending Policy to all newly hired employees
and hold them accountable for treating borrowers fairly and
equally.
We provide fair lending training to employees having direct contact
with borrowers or loan decision-making authority.
We require brokers to sign an agreement indicating that they are
knowledgeable about and will abide by fair lending laws and our
Broker Code of Conduct.
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We monitor broker performance and strive to hold brokers
accountable for fair and equal treatment of borrowers.
Our Retail Division conducts regular customer satisfaction surveys
of all newly funded loans.
We also conduct periodic randomly selected satisfaction surveys of
customers who receive loans through a mortgage broker.
A network of well-trained consumer relations staff in each division
is dedicated to resolving consumer complaints in a timely and fair
manner.
Our Loan Servicing Department contacts each borrower prior to the
first payment to confirm that the borrower understands the loan
terms.
When appropriate, we also offer loss mitigation counseling to
borrowers in default and provide opportunities to enter into mutually
acceptable reasonable repayment plans.
We report borrower monthly payment performance to major credit repositories.
Evaluation and Compliance
We subject a significant statistical sampling of our loans to a
rigorous quality assurance of borrower qualification, validity of
information, and verified property value determination.
Our Fair Lending Officer provides an independent means of reporting
or discussing fair lending concerns through consumer and employee
hotlines.
The Fair Lending Officer monitors production fair lending
performance, including loan file analysis and reporting, and
coordinates community outreach programs.
We engage independent firms to review internal controls and
operations to help ensure compliance with accepted federal and
state lending regulations and practices.
We adhere to high origination standards in order to sell our loan
products in the secondary mortgage market.
We treat all customer information as confidential and consider it to
be nonpublic information. We maintain systems and procedures to
ensure that access to nonpublic consumer information is granted only
to legitimate and valid users.
We believe that our commitment to responsible lending is good business.
We put our commitment into action and will continue to look for
ways to promote highly ethical standards throughout our industry.
We plan to continue to review, revise and improve our practices to enhance our
fair lending efforts and support the goal of eliminating predatory lending
practices.
Environmental
In the course of our business, we may acquire properties securing loans that are
in default. There is a risk that hazardous or toxic waste could be found on such
properties. If this occurs, we could be held responsible under applicable law
for the cost of cleaning up or removing the hazardous waste. This cost could
exceed the value of the underlying properties.
Employees
At December 31, 2003, we employed 3,725 full-time employees and 27 part-time
employees. None of our employees is subject to a collective bargaining
agreement. We believe that our relations with our employees are satisfactory.
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Available Information
We make available, free of charge, on the Investor Relations Section of our Web
site (http:/www.ncen.com/companyinformation/investorrelations/index.htm) our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, Section 16 reports and any amendments to those reports as soon as
reasonably practicable after such reports or amendments are electronically filed
with or furnished to the SEC.
22
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information about our executive officers:
Name Age Position
-------------------- --- ----------------------------------------------------
Executive Officers:
Robert K. Cole 57 Chairman of the Board of Directors and Chief
Executive Officer of New Century Financial; Director
of New Century Mortgage(1)
Brad A. Morrice 47 Vice Chairman of the Board of Directors, President
and Chief Operating Officer of New Century
Financial; Chairman of the Board of Directors and
Chief Executive Officer of New Century Mortgage(1);
Chairman of the Board of Directors of NC Capital(2)
Edward F. Gotschall 49 Vice Chairman of the Board of Directors and Chief
Financial Officer of New Century Financial;
Executive Vice President and Director of New Century
Mortgage(1); Chief Financial Officer and Director of
NC Capital(2)
Patrick J. Flanagan 39 Executive Vice President of New Century Financial;
President and Director of New Century Mortgage(1);
Chief Executive Officer and Director of NC
Capital(2)
Patrick H. Rank 59 Executive Vice President of New Century Financial;
Director of New Century Mortgage
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(1) New Century Mortgage is a wholly-owned subsidiary of New Century Financial.
(2) NC Capital is a wholly-owned subsidiary of New Century Mortgage.
Robert K. Cole, one of our co-founders, has been our Chairman of the Board of
Directors and Chief Executive Officer since December 1995 and one of our
directors since November 1995. Mr. Cole also serves as a director of New Century
Mortgage. From February 1994 to March 1995, he was the President and Chief
Operating Officer-Finance of Plaza Home Mortgage Corporation, a publicly traded
savings and loan holding company specializing in the origination and servicing
of residential mortgage loans. In addition, Mr. Cole served as a director of
Option One Mortgage Corporation, a subsidiary of Plaza Home Mortgage
specializing in the origination, sale and servicing of non-prime mortgage loans.
Previously, Mr. Cole was the President of operating subsidiaries of NBD Bancorp
and Public Storage, Inc. Mr. Cole received a Masters of Business Administration
degree from Wayne State University.
Brad A. Morrice, one of our co-founders, has been a Vice Chairman of our Board
of Directors since December 1996, our President and one of our directors since
November 1995 and our Chief Operating Officer since January 2001. Mr. Morrice
also served as our General Counsel from December 1995 to December 1997 and our
Secretary from December 1995 to May 1999. In addition, Mr. Morrice serves as
Chairman of the Board of Directors and Chief Executive Officer of New Century
Mortgage, Chairman of the Board of Directors of NC Capital and from 1999 to
December 2003 was Chairman of the Board of Directors of The Anyloan Company.
From February 1994 to March 1995, he was the President and Chief Operating
Officer-Administration of Plaza Home Mortgage, after serving as its Executive
Vice President, Chief Administrative Officer since February 1993. In addition,
Mr. Morrice served as General Counsel and a director of Option One. From August
1990 to January 1993, Mr. Morrice was a partner in the law firm of King, Purtich
& Morrice, where he specialized in the legal representation of mortgage banking
companies. Mr. Morrice previously practiced law at the firms of Fried, King,
Holmes & August and Manatt, Phelps & Phillips. He received his law degree from
the University of California, Berkeley (Boalt Hall) and a Masters of Business
Administration degree from Stanford University.
Edward F. Gotschall, one of our co-founders, has been a Vice Chairman of our
Board of Directors since December 1996, our Chief Financial Officer since August
1998, our Chief Operating Officer Finance/ Administration from December 1995 to
August 1998 and one of our directors since November 1995. Mr.
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Gotschall also serves as Executive Vice President and a director of New Century
Mortgage and was its Chief Financial Officer until February 2002. Mr. Gotschall
is also Chief Financial Officer and a director of NC Capital and from 1999 to
December 2003 was Chief Financial Officer and Treasurer of The Anyloan Company.
From April 1994 to July 1995, he was the Executive Vice President/Chief
Financial Officer of Plaza Home Mortgage and a director of Option One. In
December 1992, Mr. Gotschall was one of the co-founders of Option One and served
as its Executive Vice President/Chief Financial Officer until April 1994. From
January 1991 to July 1992, he was the Executive Vice President/Chief Financial
Officer of The Mortgage Network, Inc., a retail mortgage banking company. Mr.
Gotschall received his Bachelors of Science Degree in Business Administration
from Arizona State University.
Patrick J. Flanagan has been the President of New Century Mortgage since
February 2002 and has been a director of New Century Mortgage since May 1997. He
has also served as Executive Vice President of New Century Financial since
August 1998 and is Chief Executive Officer and a director of NC Capital. From
January 1997 to February 2002, Mr. Flanagan served as Executive Vice President
and Chief Operating Officer of New Century Mortgage. Mr. Flanagan initially
joined New Century Mortgage in May 1996 as Regional Vice President of Midwest
Wholesale and Retail Operations. From August 1994 to April 1996, Mr. Flanagan
was a Regional Manager with Long Beach Mortgage. From July 1992 to July 1994, he
was an Assistant Vice President for First Chicago Bank, from February 1989 to
February 1991, he was Assistant Vice President for Banc One in Chicago, and from
February 1991 to July 1992, he was a Business Development Manager for
Transamerica Financial Services. Mr. Flanagan received his Bachelor of Arts
degree from Monmouth College.
Patrick H. Rank has been an Executive Vice President of New Century Financial
and a director of New Century Mortgage since May 2002. He served as President of
Retail Operations of New Century Mortgage from August 2001 to December 2003. He
was also President, Chief Executive Officer and a director of The Anyloan
Company from August 2001 to December 2003. Prior to joining New Century, Mr.
Rank was the President of H&R Block Mortgage, a subsidiary of Option One
Mortgage, and H&R Block Financial Services. Mr. Rank was one of the original
co-founders of Option One Mortgage and was its original Chief Executive Officer.
Prior to joining Option One, Mr. Rank was the Chief Administrative Officer of
Long Beach Mortgage. Mr. Rank has over 36 years of financial services industry
experience.
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RISK FACTORS
Stockholders and prospective purchasers of our common stock should carefully
consider the risks described below before making a decision to buy our common
stock. If any of the following risks actually occurs, our business could be
harmed. In that case, the trading price of our common stock could decline, and
you may lose all or part of your investment. When determining whether to buy our
common stock, stockholders and prospective purchasers should also refer to the
other information in this Form 10-K, including our financial statements and the
related notes.
A prolonged economic slowdown or a lengthy or severe recession could hurt our
operations, particularly if it results in a decline in the real estate market.
The risks associated with our business are more acute during periods of economic
slowdown or recession because these periods may be accompanied by decreased
demand for consumer credit and declining real estate values. Declining real
estate values reduce the ability of borrowers to use home equity to support
borrowings because they negatively affect loan-to-value ratios of the home
equity collateral. In addition, because we make a substantial number of loans to
credit-impaired borrowers, the actual rates of delinquencies, foreclosures and
losses on these loans could be higher during economic slowdowns. Any sustained
period of increased delinquencies, foreclosures or losses could adversely affect
our ability to sell loans, the prices we receive for our loans, the value of our
mortgage loans held for investment or our residual interests in securitizations,
which could have a material adverse effect on our results of operations,
financial condition and business prospects.
Our earnings may decrease because of increases or decreases in interest rates.
Our profitability may be directly affected by changes in interest rates. The
following are some of the risks we face related to an increase in interest
rates:
An interest rate increase may affect our earnings by reducing
the spread between the interest we receive on our loans and our
funding costs.
A substantial and sustained increase in interest rates could
adversely affect our loan origination volume because refinancing an
existing loan would be less attractive and qualifying for a
purchase loan may be more difficult.
During periods of rising interest rates, the value and profitability
of our loans may be negatively affected between the date of
origination or purchase and the date we sell or securitize the loan.
When we securitize loans, the value of residual interests we retain
and the income we receive from the securitizations structured as
financings are based primarily on the London Inter-Bank Offered Rate
("LIBOR"). This is because the interest on the underlying mortgage
loans is based on fixed rates payable on the loans for the first two
or three years while the bondholders are generally paid based on an
adjustable LIBOR-based yield. An increase in LIBOR reduces the net
income we receive from, and the value of, these mortgage loans and
residual interests.
Our adjustable-rate mortgage loans have periodic and lifetime interest
rate caps above which the interest rate on the loans may not rise. In
the event of general interest rate increases, the rate of interest on
these mortgage loans could be limited, while the rate payable on the
senior certificates representing interests in a securitization trust
into which these loans are sold may be uncapped. This would reduce the
amount of cash we receive over the life of the loans in
securitizations structured as financings and our residual interests,
and could require us to reduce the carrying value of our residual
interests.
We are also subject to risks from decreasing interest rates. For example, a
significant decrease in interest rates could increase the rate at which loans
are prepaid, which also could require us to reduce the carrying value of our
residual interests. If prepayments are greater than expected, the cash we
receive over the life of our
25
residual interests would be reduced. Higher-than-expected prepayments could also
have a negative effect on the value of our servicing portfolio.
Any such changes in interest rates could have a material adverse effect on our
results of operations, financial condition and business prospects.
An interruption or reduction in the securitization and whole loan markets would
hurt our financial position.
We are dependent on the securitization market for the sale of our loans because
we securitize loans directly and many of our whole loan buyers purchase our
loans with the intention to securitize them. The securitization market is
dependent upon a number of factors, including general economic conditions,
conditions in the securities market generally and conditions in the asset-backed
securities market specifically. In addition, poor performance of our previously
securitized loans could harm our access to the securitization market.
Accordingly, a decline in the securitization market or a change in the market's
demand for our loans could have a material adverse effect on our results of
operations, financial condition and business prospects.
If we are unable to maintain adequate financing sources, our earnings and our
financial position will suffer and jeopardize our ability to continue
operations.
We require substantial cash to support our operating activities and growth
plans. Our primary sources of cash are our warehouse and aggregation credit
facilities, our asset-backed commercial paper facility and the proceeds from the
sales and securitizations of our loans. We also sometimes finance our residual
interests in securitization transactions using Net Interest Margin, or NIM,
structures; however, we have not recently relied on NIM financing as much as we
have in prior years. As of December 31, 2003, we had nine short-term warehouse
and aggregation credit facilities plus our asset-backed commercial paper
facility providing us with approximately $6.7 billion of committed and $650
million of uncommitted borrowing capacity to fund loan originations and
purchases pending the pooling and sale of such loans. If we cannot maintain or
replace these facilities on comparable terms and conditions, we may incur
substantially higher interest expense that would reduce our profitability.
During volatile times in the capital and secondary markets, access to warehouse,
aggregation and residual financing as well as access to the securitization and
secondary markets for the sale of our loans has been severely constricted. If we
are unable to maintain adequate financing or other sources of capital are not
available, we would be forced to suspend or curtail our operations, which would
have a material adverse effect on our results of operations, financial condition
and business prospects.
A material difference between the assumptions used in the determination of the
value of our residual interests and our actual experience could negatively
affect our financial position.
As of December 31, 2003, the value on our balance sheet of our residual
interests from securitization transactions was $179.5 million. The value of
these residuals is a function of the delinquency, loss, prepayment speed and
discount rate assumptions we use. It is extremely difficult to validate the
assumptions we use in valuing our residual interests. In the future, if our
actual experience differs materially from the assumptions, future cash flows and
earnings could be negatively affected.
New legislation could restrict our ability to make mortgage loans, which could
adversely impact our earnings.
Several states and cities are considering or have passed laws, regulations or
ordinances aimed at curbing predatory lending practices. The federal government
is also considering legislative and regulatory proposals in this regard. In
general, these proposals involve lowering the existing federal Homeownership and
Equity
26
Protection Act thresholds for defining a "high-cost" loan, and establishing
enhanced protections and remedies for borrowers who receive such loans. However,
many of these laws and rules extend beyond curbing predatory lending practices
to restrict commonly accepted lending activities, including some of our
activities. For example, some of these laws and rules prohibit any form of
prepayment charge or severely restrict a borrower's ability to finance the
points and fees charged in connection with his or her loan. In addition, some of
these laws and regulations provide for extensive assignee liability for
warehouse lenders, whole loan buyers and securitization trusts. Because of
enhanced risk and for reputational reasons, many whole loan buyers elect not to
purchase any loan labeled as a "high cost" loan under any local, state or
federal law or regulation. Accordingly, these laws and rules could severely
constrict the secondary market for a significant portion of our loan production.
This would effectively preclude us from continuing to originate loans that fit
within the newly defined thresholds. For example, after the October 1, 2002
effective date of the Georgia Fair Lending Act, our lenders and secondary market
buyers refused to finance or purchase our Georgia loans. As a result, we were
forced to cease providing mortgages in Georgia until the law's amendment a few
months later. Similar laws have gone into effect in New Jersey, as of November
27, 2003 ("New Jersey Home Ownership Act of 2002"), and in New Mexico, as of
January 1, 2004 ("New Mexico Home Loan Protection Act"), that have impacted our
ability to originate loans in those states. The potential long term impact could
be as much as a 40% reduction in loans in New Jersey and 60% in New Mexico from
previous loan origination volumes. Moreover, some of our competitors who are
national banks or federally chartered thrifts may not be subject to these laws
and may as a consequence be able to capture market share from us and other
lenders. For example, the Office of the Comptroller of the Currency recently
issued regulations effective January 7, 2004 that preempt state and local laws
that seek to regulate mortgage lending practices. Passage of such laws could
increase compliance costs, reduce fee income and reduce origination volume, all
of which would have a material adverse effect on our results of operations,
financial condition and business prospects.
We are no longer able to rely on the Alternative Mortgage Transactions Parity
Act to preempt certain state law restrictions on prepayment penalties, which
could adversely impact our earnings.
The value of a mortgage loan depends, in part, upon the expected period of time
that the mortgage loan will be outstanding. If a borrower pays off a mortgage
loan in advance of this expected period, the holder of the mortgage loan does
not realize the full value expected to be received from the loan. A prepayment
penalty payable by a borrower who repays a loan earlier than expected helps
offset the reduction in value resulting from the early payoff. Consequently, the
value of a mortgage loan is enhanced to the extent the loan includes a
prepayment penalty, and a mortgage lender can offer a lower interest rate and/or
lower loan fees on a loan which has a prepayment penalty. Prepayment penalties
are an important feature used to obtain value on the loans we originate.
Certain state laws restrict or prohibit prepayment penalties on mortgage loans,
and until July 2003, we relied on the federal Alternative Mortgage Transactions
Parity Act (the "Parity Act") and related rules issued in the past by the Office
of Thrift Supervision (the "OTS") to preempt state limitations on prepayment
penalties. The Parity Act was enacted to extend to financial institutions, other
than federally chartered depository institutions, the federal preemption that
federally chartered depository institutions enjoy. However, on September 25,
2002, the OTS released a new rule that reduced the scope of the Parity Act
preemption and, as a result, we are no longer able to rely on the Parity Act to
preempt state restrictions on prepayment penalties. The effective date of the
new rule, originally January 1, 2003, was subsequently extended by the OTS until
July 1, 2003 in response to concerns from interested parties about the burdens
associated with compliance. The elimination of this federal preemption has
required us to comply with state restrictions on prepayment penalties. These
restrictions prohibit us from charging any prepayment penalty in eight states
and limit the amount or other terms and conditions of our prepayment penalties
in several other states. This may place us at a competitive disadvantage
relative to financial institutions that continue to enjoy federal preemption of
such state restrictions. Such institutions are able to charge prepayment
penalties without regard to state restrictions and, as a result, may be able to
offer loans with interest rate and loan fee structures that are more attractive
than the interest rate and loan fee structures that we are able to offer.
27
The scope of our lending operations exposes us to risks of noncompliance with an
increasing and inconsistent body of complex laws and regulations at the federal,
state and local levels.
Because we are licensed to originate mortgage loans in 50 states, we must comply
with the laws and regulations, as well as judicial and administrative decisions,
for all of these jurisdictions, as well as an extensive body of federal law and
regulations. The volume of new or modified laws and regulations has increased in
recent years, and, individual cities and counties have begun to enact laws that
restrict non-prime loan origination activities in those cities and counties. The
laws and regulations of each of these jurisdictions are different, complex and,
in some cases, in direct conflict with each other. As our operations continue to
grow, it may be more difficult to comprehensively identify, to accurately
interpret and to properly program our technology systems and effectively train
our personnel with respect to all of these laws and regulations, thereby
potentially increasing our exposure to the risks of noncompliance with these
laws and regulations.
Our failure to comply with these laws can lead to:
civil and criminal liability;
loss of approved status;
demands for indemnification or loan repurchases from purchasers of our loans;
class action lawsuits; or
administrative enforcement actions.
Any of these results could have a material adverse effect on our results of
operations, financial condition and business prospects.
If warehouse lenders and securitization underwriters face exposure stemming from
legal violations committed by the companies to whom they provide financing or
underwriting services, this could increase our borrowing costs and negatively
affect the market for whole loans and mortgage-backed securities.
In June 2003, a California jury found a warehouse lender and securitization
underwriter liable in part for fraud on consumers committed by a lender to whom
it provided financing and underwriting services. The jury found that the
investment bank was aware of the fraud and substantially assisted the lender in
perpetrating the fraud by providing financing and underwriting services that
allowed the lender to continue to operate, and held the bank liable for 10% of
the plaintiff's damages. This is the first case we know of in which an
investment bank was held partly responsible for violations committed by the
bank's mortgage lender customer. If other courts or regulators adopt this
theory, investment banks may face increased litigation as they are named as
defendants in lawsuits and regulatory actions against the mortgage companies
with which they do business. Some investment banks may exit the business, charge
more for warehouse lending or reduce the prices they pay for whole loans in
order to build in the costs of this potential litigation. This could, in turn,
have a negative effect on our results of operations, financial condition and
business prospects.
High delinquencies or losses on the mortgage loans in our securitizations may
decrease our cash flows or impair our ability to sell or securitize loans in the
future.
Loans we make to lower credit grade borrowers, including credit-impaired
borrowers, entail a higher risk of delinquency and higher losses than loans we
make to borrowers with better credit. Virtually all of our loans are made to
borrowers who do not qualify for loans from conventional mortgage lenders. No
assurance can be given that our underwriting criteria or methods will afford
adequate protection against the higher risks associated with loans made to lower
credit grade borrowers. We continue to be subject to risks of default and
foreclosure following the sale of loans through securitization. To the extent
such losses are greater than expected, the cash flows we receive through
residual interests and from our securitizations structured as financings would
be reduced. Increased delinquencies or losses may also reduce our ability to
sell or securitize loans in the future.
28
Any such reduction in our cash flows or impairment in our performance could have
a material adverse effect on our results of operations, financial condition and
business prospects.
Our inability to realize cash proceeds from loan sales and securitizations in
excess of the loan acquisition cost could adversely affect our financial
position.
The net cash proceeds received from loan sales consist of the premiums we
receive on sales of loans in excess of the outstanding principal balance, plus
the cash proceeds we receive from securitizations, minus the discounts on loans
that we have to sell for less than the outstanding principal balance. If we are
unable to originate loans at a cost lower than the cash proceeds realized from
loan sales, our results of operations, financial condition and business
prospects could be materially adversely affected.
Our warehouse and aggregation financing is subject to margin calls based on the
lender's opinion of the value of our loan collateral. An unanticipated large
margin call could adversely affect our liquidity.
The amount of financing we receive under our warehouse and aggregation financing
agreements depends in large part on the lender's valuation of the mortgage loans
that secure the financings. Our asset-backed commercial paper f