-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BWnSoQPM/R8S8XBEEOhN7XR5e7gqb4idrgJBjkH/J7cso7Ojj8EWNqXLJ9Fyi9DY UecP1V9qyS3lTP3tYnYZrg== 0000892569-98-002674.txt : 19980929 0000892569-98-002674.hdr.sgml : 19980929 ACCESSION NUMBER: 0000892569-98-002674 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980928 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: BNC MORTGAGE INC CENTRAL INDEX KEY: 0001003213 STANDARD INDUSTRIAL CLASSIFICATION: MORTGAGE BANKERS & LOAN CORRESPONDENTS [6162] IRS NUMBER: 330661303 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 333-38651 FILM NUMBER: 98716109 BUSINESS ADDRESS: STREET 1: 1740 E GARRY AVE STREET 2: SUITE 109 CITY: SANTA ANA STATE: CA ZIP: 92705 BUSINESS PHONE: 7142606000 MAIL ADDRESS: STREET 1: 1740 EAST GARRY AVE STREET 2: STE 109 CITY: SANTA ANA STATE: CA ZIP: 92705 10-K405 1 FORM 10-K405 DATED JUNE 30, 1998 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 ------------------------ FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________ . COMMISSION FILE NUMBER 000-23725 BNC MORTGAGE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 33-0661303 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1063 MCGAW AVENUE, IRVINE, CALIFORNIA 92614-5532 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE) (949) 260-6000 (REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: TITLE OF EACH CLASS COMMON STOCK, PAR VALUE $0.001 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]. The aggregate market value of the voting stock held by non-affiliates of Registrant, as of September 14, 1998, was $28,352,292, based upon the closing price of Registrant's Common Stock on that date. For purposes of this disclosure, shares of common stock held by directors and executive officers of Registrant are assumed to be "held by affiliates"; this assumption is not to be deemed to be an admission by such persons that they are affiliates of Registrant. As of September 14, 1998, Registrant had outstanding 5,729,779 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE The information required by Part III, Items 10, 11, 12 and 13 is incorporated by reference to BNC Mortgage, Inc's. proxy statement which will be filed with the Commission not more than 120 days after June 30, 1998. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 BNC MORTGAGE, INC. TABLE OF CONTENTS TO FORM 10-K FOR THE YEAR ENDED JUNE 30, 1998 PART I Item 1. Business.................................................... 3 Item 2. Properties.................................................. 38 Item 3. Legal Proceedings........................................... 38 Item 4. Submission of Matters to a Vote of Security Holders......... 38 PART II Item 5. Market for Registrant's Common Equity and Related 39 Stockholder Matters....................................... Item 6. Selected Financial Data..................................... 40 Item 7. Management's Discussion and Analysis of Financial Condition 41 and Results of Operations................................. Item 7A. Quantitative and Qualitative Disclosures about Market 46 Risk...................................................... Item 8. Financial Statements and Supplementary Data................. 46 Item 9. Changes in and Disagreements With Accountants on Accounting 46 and Financial Disclosure.................................. PART III Item 10. Directors and Executive Officers of the Registrant.......... 46 Item 11. Executive Compensation...................................... 46 Item 12. Security Ownership of Certain Beneficial Owners and 46 Management................................................ Item 13. Certain Relationships and Related Transactions.............. 47 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 47 8-K....................................................... Signatures.................................................. 48
2 3 BNC MORTGAGE, INC. PART I ITEM 1. BUSINESS This Report contains certain "forward-looking statements" which represent the Company's expectations or beliefs, including, but not limited to, statements concerning industry performance and the Company's operations, performance, financial condition, prospects, growth and strategies. For this purpose, any statements contained in this Report except for historical information may be deemed to be forward-looking statements. Without limiting the generality of the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue" or the negative or other variations thereof or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, certain of which are beyond the Company's control, and actual results may differ materially depending on a variety of important factors, including those described in the "Risk Factors" section and elsewhere in this Report. GENERAL BNC Mortgage, Inc. ("BNC" or the "Company"), is a specialty finance company engaged in the business of originating, purchasing and selling, on a whole loan basis for cash, non-conforming and, to a lessor extent, conforming, residential mortgage loans secured by one-to-four family residences. The term "non- conforming loans" as used herein means (i) subprime loans, which are loans made to borrowers who are unable or unwilling to obtain mortgage financing from conventional mortgage sources, whether for reasons of credit impairment, income qualification, credit history or a desire to receive funding on an expedited basis and (ii) non-conforming loan products for primarily high credit borrowers whose credit scores equal or exceed levels required for the sale or exchange of their mortgage loans through the Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC"), but where the loan itself fails to meet conventional mortgage guidelines, such as the principal balance exceeds the maximum loan limit of $227,150 or the loan structure documentation does not conform to agency requirements. The Company's loans are made primarily to refinance existing mortgages, consolidate other debt, finance home improvements, education and other similar needs, and, to a lesser extent, to purchase single family residences. The Company has three divisions: (i) a wholesale subprime division which has relationships with approximately 3,200 approved independent loan brokers and which to date has accounted for substantially all of the Company's total loan originations, (ii) a wholesale prime division which originates conforming loans that meet FNMA, FHLMC and other conventional mortgage guidelines and non-conforming loan products which are not subprime loans, and (iii) a retail division which markets loans directly to homeowners. Since it commenced operations in August 1995, the Company has experienced significant growth in loan originations, with approximately $788.5 million of originations in 42 states during fiscal year 1998 compared to $532.6 million of originations in 33 states and $200.0 million in 21 states during years ended June 30, 1997 and 1996, respectively. This growth in originations has produced annual net earnings of $7.2 million in 1998 compared to annual net earnings of $7.5 million and $417,000 in 1997 and 1996, respectively. The Company currently sells substantially all of its mortgage loans through whole loan sales resulting in cash gain on sale of mortgage loans. For the year ended June 30, 1998 and the years ended June 30, 1997 and 1996, the Company had mortgage loans sales of $744.4 million, $519.9 million and $156.6 million, respectively, with resulting cash gain on sale of mortgage loans of $30.4 million, $21.9 million and $4.2 million, respectively. For the year ended June 30, 1998, 96.6% of the loans originated by the Company were subprime loans. Substantially all loans originated by the Company are secured by a first priority mortgage on the subject property. During the year ended June 30, 1998, less than 1% the principal balance of the loans originated were secured by second priority mortgages; none of such loans were originated for the years ended June 30, 1997 or 1996. The Company's core borrower base consists of individuals who do not qualify for traditional "A" credit because their credit history, income or other factors cause them not to conform to standard agency lending 3 4 criteria. Even though substantially all of the loans originated by the Company for the year ended June 30, 1998 were subprime loans during the years ended June 30, 1998, 1997 and 1996, approximately 62.2%, 57.5% and 51.6% of the principal balance of the subprime loans originated by the Company, respectively, were to borrowers with a Company risk classification of "A+" or "A-" while the remainder were to borrowers with a Company risk classification of "B," "C+," "C" or "C-," respectively, representing approximately 37.8%, 42.5% and 48.4% of the total principal amount of loans originated by the Company. Borrowers with a Company risk classification of "A+" or "A-" have a very good credit history within the last 12 to 24 months with minor late payments allowed on a limited basis. Borrowers with a "B" Company risk classification generally have good credit within the last 12 months with some late payments. Borrowers with a "C+" risk classification have some significant derogatory credit in the past 12 months while those in the "C" category have frequent derogatory consumer credit. Borrowers with a Company risk classification of "C-" have numerous derogatory credit items up to and including a bankruptcy in the most recent 12 month period. During each of the years ended June 30, 1998, 1997 and 1996, approximately 3.7%, 3.9% and 2.7% of the principal balance of the subprime loans originated by the Company were to borrowers with a Company risk classification of "C-." For a tabular presentation of the Company's loan production by borrower risk classification, see "Loan Production by Borrower Risk Classification." The Company believes that its primary strengths are (i) the experience of its management, account executives and staff in the non-conforming lending industry, which enhances the Company's ability to establish and maintain long-term relationships with mortgage brokers, (ii) its service oriented sales culture whereby the Company strives to respond quickly and efficiently to customer needs and market demands, (iii) its operating philosophy to create stable and deliberate loan origination growth by utilizing consistent and prudent underwriting guidelines designed to produce mortgage products readily saleable in the secondary market and (iv) its availability to manage and control operating costs in order for it to remain a low cost originator. The Company enters into a mortgage broker agreement with each of its independent mortgage brokers. For a description of the contractual nature of the Company's relationships with its independent mortgage brokers, see "-- Mortgage Loan Originations -- Wholesale Subprime Division". GROWTH & OPERATING STRATEGY The Company's growth and operating strategy is based upon the following key elements: Whole Loan Sales for Cash. The Company sells substantially all of its originated mortgage loans monthly for cash, historically at a premium over the principal balance of the mortgage loans. The Company enhances earnings and cash flows from whole loan sales by tailoring the composition of its whole loan pools to meet the investment preferences of specific buyers. This strategy, as opposed to securitizations, in which a residual interest in future payments on the loans is retained, provides certain benefits. The Company receives cash revenue, rather than recognizing non-cash revenue attributable to residual interests, as is the case in securitizations, thereby avoiding the risk of having to adjust revenue in future periods to reflect a lower realization on residual interests because actual prepayments or defaults exceeded levels assumed at the time of securitization. By selling its originated loans, the Company also reduces its exposure to default risk (other than certain first payment defaults) and the prepayment risk normally inherent in a mortgage lender's business. Management believes that the cash received in loan sales provides the Company greater flexibility and operating leverage than a traditional portfolio lender, which holds the loans it originates, by allowing the Company to generate income through interest on loans held for sale and gain on loans sold. This strategy of frequent loan sales has been an important factor in generating the Company's earnings, creating cash flow to fund operations, decreasing the need for other forms of financing and reducing the level of interest rate and default risk borne by the Company. Continuing Growth of Subprime Wholesale Production. The Company intends to continue the growth of its Wholesale Subprime Division through greater penetration in existing markets and selective geographic expansion. Greater market penetration is expected to be accomplished through additional sales personnel to existing origination locations in order to provide continued high levels of service to brokers to increase loan origination and further the basis for repeat business, referral and other future lending opportunities. For each of the years ended June 30, 1998, 1997 and 1996, the Company's loan originations primarily were in 4 5 California, Illinois, Florida, Hawaii, Utah, Wisconsin, Colorado, Massachusetts, Maryland, Oregon, Washington, Ohio and Indiana. The Company will seek to improve and enhance relationships with mortgage brokers by continuing to (i) improve response times to loan applications, (ii) streamline wholesale origination and funding activities and (iii) provide a broad selection of attractive product offerings. The Company anticipates that short-term geographic expansion will focus on the development of lending operations in Texas, Pennsylvania, Virginia, Tennessee, Arizona, New Mexico and Nevada. Management intends to focus further expansion on those geographic regions which it believes represent the most attractive markets for the Company's products. Continuing Growth of Wholesale Prime Production. The Company established a Wholesale Prime Division in 1998 to originate conforming mortgage loans that meet FNMA, FHLMC and other conventional mortgage guidelines and non-conforming loans which are not subprime loans. The Company's strategy focus is on originating loans using the same marketing strategies as its Wholesale Subprime Division. The division's operations are coordinated at the Company's executive offices, and to a lesser extent, at its local sales offices. The Company operates under the name Heritage National Mortgage, Inc. and is primarily focused on establishing a California operation, with the goal of becoming a national wholesale lender. Continuing Growth of Retail Production. The Company established a retail loan center to originate mortgage loans, under the name, Simple Mortgage USA, Inc. The retail division is being developed to originate loans directly from borrowers using various marketing telemarketing and advertising methods, including an Internet based lead generator. The Company's Internet address is www.simpleusa.com. Expanding Product Offerings. The Company frequently reviews and tailors its products and pricing for competitiveness, as well as introducing new products to meet the needs of its borrowers and brokers, expand its customer base and diversify its product mix. The Company utilizes long-term relationships with mortgage loan brokers to quickly and efficiently tailor existing products or introduce new products to satisfy its broker and consumer product needs. Also, the Company attempts to anticipate changing demands and formulate new products accordingly. Examples of recently introduced products include loans with higher loan-to-value ratios for borrowers with good credit histories (see "-- Product Types"). The Company believes that these mortgage products enable the Company to increase loan production from brokers who have customers seeking such products and from borrowers identified through the Company's retail marketing efforts. Low Cost Originator of Mortgage Loans. The Company's success has been due in part on its ability to manage and control operating costs. The Company has established a low-cost origination network. For the years ended June 30, 1998, 1997 and 1996, the Company's cost to originate averaged 3.4%, 3.1% and 3.0% of loan volume, respectively. Wholesale expansion strategy; the Company initially penetrates a market with a limited number of employees to recruit brokers for the Company's wholesale network. The Company typically opens an office in a market only after it achieves a minimum loan volume. By utilizing this strategy, the Company believes it can maintain lower overhead expenses compared with companies utilizing a more extensive branch office system. In addition, the Company has the flexibility to expand or contract its operations quickly in response to local demand. Securitization Flexibility. While a substantial majority of the Company's mortgage loan originations will continue to be sold through whole loan sales in cash transactions, the Company may in the future sell a portion of its loans through securitizations. The ability to conduct securitizations may provide the Company with the flexibility to take advantage of favorable pricing differentials between the securitization and whole loan sales markets that may exist from time to time. The Company may seek to enhance earnings by securitizing loans with characteristics which the securitization market considers most favorable. The percentage of loans, if any, sold through securitizations will be based on economic conditions, secondary market conditions and available financial resources. The Company intends to utilize its primary strengths and growth and operating strategy to remain competitive in the mortgage industry. Increased competition in the mortgage industry could have the effect of (i) lowering gains that may be realized on loan sales, (ii) reducing an individual company's volume of loan originations and sales, (iii) increasing demand for experienced personnel increasing the likelihood such personnel will be recruited by competitors and (iv) lowering the industry standard for underwriting guidelines 5 6 as competitors attempt to increase or maintain market share in the face of increased competition. In the past, certain of these factors have caused the revenues and net income of many participants in the mortgage industry, including the Company, to fluctuate from quarter to quarter. MORTGAGE LOAN ORIGINATIONS The Company originates mortgage loans through its Wholesale and Retail Divisions. The Wholesale Divisions originate loans through a network of independent mortgage brokers and the Retail Division solicits loans directly from prospective borrowers. The following table sets forth selected information relating to total mortgage loan originations during the periods shown:
YEAR ENDED JUNE 30, -------------------------------- 1998 1997 1996 -------- -------- -------- (DOLLARS IN THOUSANDS) Mortgage loan originations: Wholesale Subprime Division principal balance.............. $750,406 $507,250 $199,963 Wholesale Prime Division principal balance................. 26,716 -- -- Retail Division principal balance.......................... 11,357 7,451 -- Small Commercial principal balance(1)...................... -- 17,920 -- -------- -------- -------- $788,479 $532,621 $199,963 ======== ======== ======== Number of mortgage loans................................... 7,897 5,425 1,988 Average principal balance per loan......................... $ 100 $ 98 $ 101 Weighted average initial loan-to-value ratio(2)............ 74.4% 69.3% 68.5% Weighted average fixed interest rate....................... 10.2% 10.5% 10.7% Weighted average adjustable interest rate.................. 9.7% 9.2% 8.6% Weighted average fixed/adjustable interest rate............ 9.6% 9.5% 10.0% "A+" and "A-" loans as a percentage of total subprime mortgage loans originated(3)............................. 66.1% 57.5 51.6%
- --------------- (1) The Company discontinued the origination of small commercial loans in April 1997. (2) Determined by dividing the amount of the loan by the lesser of the purchase price or the appraised value of the mortgaged property at origination. (3) Based on initial principal balance, and excludes conforming loans, and non-conforming loans which are not subprime loans originated by the Wholesale Prime Division. Substantially all mortgage loans originated by the Company are secured by a first priority mortgage on the subject property and for the year ended June 30, 1998, less than 1% of the principal balance of the mortgage loans originated were secured by second priority mortgages; none of such mortgage loans were originated for the years ended June 30, 1997 and 1996. WHOLESALE SUBPRIME DIVISION Historically, the Company's primary source of mortgage loans has been its Wholesale Subprime Division, which maintains relationships with approximately 3,200 independent mortgage brokers which, during the year ended June 30, 1998, originated mortgage loans in 42 states. During the years ended June 1997 and 1996, the Company had approximately 1,830 and 620 approved brokers and originated loans in 33 and 21 states, respectively. At June 30, 1998, the Company's wholesale subprime division had 45 origination locations and employed 96 account executives who service mortgage brokers. The states in which the Company had origination locations at June 30, 1998 were California, Illinois, Florida, Hawaii, Utah, Wisconsin, Oregon, Massachusetts, Maryland, Colorado, Indiana, Ohio, Washington, Idaho, Missouri, Michigan, Georgia, South Carolina, Rhode Island, Oklahoma, Pennsylvania, Tennessee, Texas, North Carolina and Minnesota. The Wholesale Subprime Division funded $750.4 millions in loans, or 95.2%, of the Company's total mortgage loan 6 7 production during the year ended June 30, 1998. During the year ended June 30, 1998, the Company's 10 largest producing brokers originated approximately 9.7% of the Company's mortgage loans, with the largest broker accounting for approximately 1.5%. Mortgage loan brokers act as intermediaries between property owners and the Company in arranging mortgage loans. The Company enters into a mortgage broker agreement with each of its independent mortgage brokers. Pursuant to the agreement, the Company and the mortgage broker establish a non-exclusive relationship whereby the mortgage broker will, from time to time and at its option, submit completed mortgage loan application packages from the general public to the Company for funding consideration and facilitate the closing of mortgage loan application packages approved for funding by the Company. The broker's role is to identify the applicant, assist in completing the loan application form, gather necessary information and documents and serve as the Company's liaison with the borrower through the lending process. The Company reviews and underwrites the applications submitted by the broker, approves or denies the application, sets the interest rate and other terms of the loan and, upon acceptance by the borrower and satisfaction of all conditions imposed by the Company, funds the loan. Because brokers conduct their own marketing and employ their own personnel to obtain loan applications and maintain contact with borrowers, originating loans through the Wholesale Subprime Division allows the Company to increase its loan volume without incurring the higher marketing, labor and other overhead costs associated with increased retail originations. The Company has no obligation to pay a mortgage broker any sum owed to the mortgage broker by a borrower, nor does the Company have any obligation to pay a mortgage broker any sum with respect to accounts of any mortgage loan application package which the Company does not fund and close. Loan applications generally are submitted by mortgage brokers to an account executive in one of the Company's sales offices. The loan is logged-in for Federal Real Estate Procedures Settlement Act of 1974, as amended ("RESPA") and other regulatory compliance purposes, underwritten and, in most cases, conditionally approved or denied within 24 hours of receipt. Because mortgage brokers generally submit individual loan files to several prospective lenders simultaneously, the Company attempts to respond to each application as quickly as possible. If approved, a "conditional approval" will be issued to the broker with a list of specific conditions 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. The originating account executive and a production assistant will work directly with the submitting mortgage broker to collect the requested information and to meet the underwriting conditions and other requirements. In most cases, the Company funds loans within 15 to 40 days after approval of the loan application. All independent mortgage brokers who submit loan applications to the Company must be registered or licensed as required by the jurisdiction in which they operate and must be approved by the Company. The Company audits 100% of its brokers on an annual basis in order to confirm possession of a current license, updated financials on file and any changes in broker staff or address. The Company believes that an important element in developing, maintaining and expanding its independent mortgage broker relationships is to provide a high level of product knowledge and customer service to its brokers. Each account executive receives training prior to being assigned to a territory which, in most cases, includes experience in the loan production department so that the account executive will be familiar with all phases of loan origination and production. This training enables the account executive to quickly review a loan application in order to identify the borrower's probable risk classification and then assist the broker in identifying the appropriate product for the borrower, thereby enhancing the likelihood that the loan will be approved at the rate and on the terms anticipated by the borrower. After a loan package is submitted to the Company, the account executive and a production assistant provide assistance to the broker to complete the loan transaction. Account executives are compensated based on the number and the dollar volume of loans funded. WHOLESALE PRIME DIVISION The Company established a Wholesale Prime Division during the quarter ended March 1998 to originate, purchase and sell mortgage loans primarily made to high credit quality borrowers. The Company considers "high credit quality borrowers" to be those whose credit scores equal or exceed levels required for the sale or 7 8 exchange of their mortgage loans through FNMA or FHLMC. The division originates a variety of mortgage loans including (i) loans which qualify for inclusion in guarantee programs sponsored by FNMA or FHLMC, (ii) non-conforming mortgage loans that do not meet agency guidelines, such as the principal balance exceeds the maximum loan limit of $227,150, or the loan structure or documentation does not conform to the agency's requirements, or (iii) other niche loan products. The Company believes that an important element in development, and expanding its service to independent mortgage brokers is the ability to offer conventional mortgage loan products and non-conforming loans which are not subprime loans as well as its subprime products. At June 30, 1998, the Company employed seven account executives who service mortgage brokers located primarily in Southern California. During the year ended June 30, 1998, through its wholesale prime division, the Company originated approximately $26.7 million in loans, or 3.4%, of its Company's total mortgage loan production. The Company has sold its prime loans during the year on a serviced released basis for cash to various investors, and originated substantially all of its loans through independent mortgage loan brokers. The following table sets forth selected information relating to a wholesale loan originations during the periods shown:
YEAR ENDED JUNE 30, -------------------------------- 1998 1997 1996 -------- -------- -------- (DOLLARS IN THOUSANDS) WHOLESALE SUBPRIME DIVISION Principal balance.......................................... $750,406 $507,250 $199,963 Average principal balance per loan......................... $ 99 $ 96 $ 101 Weighted average initial loan-to-value ratio............... 74.4% 69.5% 68.5% Weighted average interest rate............................. 9.7% 9.6% 9.4% Occupancy: Owner occupied........................................... 87.7% 85.1% 86.6% Non-owner occupied....................................... 12.3% 14.9% 13.4%
YEAR ENDED JUNE 30, -------------------------------- 1998 1997 1996 -------- -------- -------- (DOLLARS IN THOUSANDS) WHOLESALE PRIME DIVISION Principal balance.......................................... $ 26,716 -- -- Average principal balance per loan......................... $ 142 -- -- Weighted average initial loan-to-value ratio............... 72.8% -- Weighted average interest rate............................. 7.6% -- -- Occupancy: Owner occupied........................................... 90.4% -- -- Non-owner................................................ 9.6% -- --
RETAIL DIVISION The Company's Retail Division, which markets mortgage loans directly to homeowners, began operations in March 1996. The Company operates the Retail Division, which as of June 30, 1998, consisted of 31 persons, including 13 account executives, to further diversify loan production sources and to capture origination fees typically collected by retail brokers. By creating a direct relationship with the borrower, retail lending provides a sustainable loan origination franchise, offering greater control over the lending process while generating loan origination fees to offset the higher costs of retail lending. The cash gain on sales of retail loans is generally greater than the cash gain on sales of broker-sourced loans because, unlike in the case of broker-sourced originations, a third party does not share in the fees and points paid by the borrower. The Company's Retail Division offers the same products as those of its Wholesale Divisions. 8 9 The Company, while maintaining its focus on its Wholesale Divisions, has recently formulated a low cost retail marketing strategy designed to produce growth in its Retail Division. The Company's strategy focuses on loan originations from borrowers through telemarketing and advertising coordinated by its retail sales staff primarily at the Company's executive offices and, to a lesser extent, at local sales offices. This focus on centralization enables the Company to conduct its retail operations with less overhead than a retail business that operates exclusively through a sales office network. The Company originated through its Retail Division approximately $11.3 million, or 1.4%, and $7.4 million, or 1.4%, of the Company's total mortgage loan production during the years ended June 30, 1998 and 1997, respectively. The following table sets forth selected information relating to retail loan originations during the periods shown:
YEAR ENDED JUNE 30, ---------------------------- 1998 1997 1996(1) ------- ------ ------- (DOLLARS IN THOUSANDS) RETAIL DIVISION Principal balance........................................... $11,357 $7,451 -- Average principal balance per loan.......................... 84 83 -- Weighted average initial loan-to-value ratio................ 73.3% 70.1% -- Weighted average interest rate.............................. 9.1% 9.6% -- Occupancy: Owner occupied............................................ 93.1% 87.8% -- Non-owner occupied........................................ 6.9% 12.2% --
- --------------- (1) The retail division initiated operations in March 1996. PRODUCT TYPES The Company primarily offers subprime loans and, to a lessor extent, conforming mortgage products and non-conforming loans which are not subprime loans. Subprime Mortgages: The Company offers both fixed-rate and adjustable-rate subprime loans, as well as subprime loans with an interest rate that is initially fixed for a period of time and subsequently converts to an adjustable-rate. Most of the adjustable-rate loans originated by the Company are offered at a low initial rate, sometimes referred to as a "teaser" rate. At each interest rate adjustment date, the Company adjusts the rate, subject to certain limitations on the amount of any single adjustment, until the rate charged equals the fully indexed rate. The Company's subprime borrowers fall into six subprime risk classifications and 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 "-- Underwriting"). The Company offers a wide variety of interest rate and points paid combinations on many of its products so that customers may elect to pay higher points at closing to secure a lower rate over the life of the loan or pay a higher interest rate and reduce or eliminate points payable at closing. The interest rate on the Company's subprime adjustable rate mortgages is typically tied to six-month LIBOR and the Company offers 1.0% or 1.5% semi-annual interest rate caps and 6.5% or 7.0% life caps. The Company sets subprime mortgage loan coupons and fees after considering several factors, including the borrower's credit rating, the loan-to-value ratio of the property, the state in which the loan was originated and competitive and market conditions. The Company's maximum subprime loan amounts are generally $500,000 with a loan-to-value ratio of up to 90%. The Company does, however, offer larger subprime loans with lower loan-to-value ratios on a case-by-case basis, and also offers products that permit a loan-to-value ratio of up to 90% for selected borrowers with a Company risk classification of "A+" or "A-". Subprime loans originated by the Company for the year ended June 30, 1998, 1997 and 1996 had an average principal balance per loan of $99,845, $98,179 and $100,585, respectively, and a weighted average initial loan-to-value ratio of 74.3%, 69.3% and 68.5%, respectively. Unless prohibited by state law or otherwise waived by the Company upon the payment by the related borrower of higher origination fees and a higher interest rate, 9 10 the Company generally imposes a prepayment penalty on the borrower. Approximately 58.0%, 58.1% and 51.2% of the subprime loans the Company originated during the years ended June 30, 1998, 1997 and 1996, respectively, provided for the payment by the borrower of a prepayment charge in limited circumstances on certain full or partial prepayments. The Company's current subprime products are as follows: Standard Products: 2-Year or 5-Year Fixed/Adjustable Rate Programs -- A 30-year fully amortized program with the initial interest rate fixed for the first two or five years of the loan. Beginning with the 25th or 61st monthly payment, the loan converts to an adjustable rate, LIBOR-indexed loan. There is no rate cap on the first adjustment (at conversion). Thereafter, all interest rate caps apply as described in the LIBOR loan product. 6-Month LIBOR Adjustable -- An adjustable rate first mortgage program indexed to six-month LIBOR, featuring a semi-annual interest rate cap of 1.0% - 1.5%, and a life cap of 6.5% - 7.0%. This product is fully amortized over a 30-year life. 15- or 30-Year Fixed Rate Program -- A fixed rate first mortgage loan program fully amortized over a 15- or 30-year period. All of the standard mortgage products have prepayment penalties (where legally allowed) for a period of one to five years. Other Products: 90% LTV First Mortgage Loan -- A 30-year fully amortized adjustable rate or fixed rate program. The adjustable rate program is indexed to LIBOR featuring a semi-annual interest rate cap of 1.0% and a life cap of 6.5%. This product is limited to the A+ and A- credit risk categories. Second Mortgage Program -- Fixed rate amortizing and fixed rate with balloon payments are offered. This product is limited to the A+ through B credit risk, with a maximum combined loan-to-value ratio equal to 100%. Underwriting guidelines are similar to that of the Company's standard products. 125% LTV Program -- A fixed rate first or second mortgage with an initial loan-to-value ratio of up to 125% with terms ranging from five to 25 years limited to borrowers with good credit histories. The use of loan proceeds is limited to debt consolidation, home improvements and/or asset purchases. Underwriting guidelines are primarily credit score and mortgage history driven. Prime Mortgages: The Company offers both fixed rate and adjustable rate conforming loan programs that meet the guidelines for purchase by government sponsored entities, such as FNMA and FHLMC, which guarantee mortgage backed securities and permanent investors in mortgage backed securities secured by or representing an ownership interest in such mortgage loans and loans that fail to satisfy the criteria to be a conforming loan for one or more reasons. These loan products can be categorized as follows: Conforming Mortgage Loans -- These mortgage loans satisfy the underwriting criteria for sale or exchange through one of the Agencies. Non-conforming Mortgage Loans which are not Subprime Loans -- These mortgage loans fail to satisfy the criteria to be an Agency mortgage loans for one or more reasons. Certain of these mortgage loans ("Jumbos") generally meet the Agency criteria but exceed the maximum loan size (currently $227,150 for single family, one-unit mortgage loans in the continental United States). Jumbos are generally eligible for sale to one of the national privately-sponsored mortgage conduits. Certain other non-conforming mortgage loans may fail to satisfy other elements of the Agency underwriting criteria, such as those relating to documentation, employment history, income verification, loan-to-value ratios, qualifying ratios or borrower net worth. The Company refers to this category of mortgage loans 10 11 generally as Alternative A ("ALT A") mortgage loans. The Company focuses on an applicant's credit score, in conjunction with other factors, in underwriting its ALT A mortgage loans. While some ALT A mortgage loans exceed the maximum loan size eligible for sale through one of the Agencies, many have principal balances within the Agency limits. Second Mortgage Loans -- Second mortgage loans are generally secured by second liens on the related property. The mortgage loans can take the form of a home equity line of credit ("HELOC") or a closed-end loan. Both types of home equity mortgage loans are designed primarily for high credit quality borrowers and are underwritten according to the Company's criteria for second-lien mortgage loans. These mortgage loans are originated in some instances in conjunction with the Company's origination of a first-lien mortgage loan on the related property. The following table sets forth selected information relating to loan originations by product type for the periods indicated:
YEAR ENDED JUNE 30, 1998 - -------------------------------------------------------------------------------------------------------------- WEIGHTED WEIGHTED AVERAGE PRINCIPAL NUMBER AVERAGE AVERAGE WEIGHTED INITIAL AMOUNT % OF TOTAL OF BALANCE INTEREST AVERAGE LOAN-TO-VALUE TYPE ORIGINATED ORIGINATIONS LOANS PER LOAN RATE(1) MARGIN(2) RATIO ---- ---------- ------------ ------ -------- -------- --------- ------------- (DOLLARS IN THOUSANDS, EXCEPT AVERAGE BALANCE) Subprime Mortgages: 2-Year Fixed............ $539,934 68.5% 5,220 $103,436 9.7% 6.2% 75.4% 6-Month LIBOR Adjustable............ 100,601 12.8 816 123,286 9.7% 6.3% 74.8% 30-Year Fixed........... 83,079 10.5 1,136 73,133 10.2% -- 71.1% 5-Year Fixed............ 22,537 2.9 211 106,810 9.3% 6.3% 71.8% 15-Year Fixed........... 11,825 1.5 231 51,191 10.2% -- 65.1% CLTV125/2ndTD........... 3,787 0.4 95 39,863 13.5% -- 35.5% -------- ----- ----- Subtotal............ 761,763 96.6 7,709 98,815 9.7% -- 74.4% -------- ----- ----- Prime Mortgages(3): Non-conforming.......... 15,957 2.0 84 189,964 7.8% -- 74.6% Conforming.............. 10,119 1.3 85 119,047 7.1% -- 73.4% 2nd TD.................. 640 0.1 19 33,684 10.9% -- 16.8% -------- ----- ----- Subtotal............ 26,716 3.4 188 142,106 7.6% -- 72.8% -------- ----- ----- $788,479 100.0% 7,897 99,845 9.7% 6.2% 74.4% ======== ===== =====
YEAR ENDED JUNE 30, 1997 - -------------------------------------------------------------------------------------------------------------- WEIGHTED WEIGHTED AVERAGE PRINCIPAL NUMBER AVERAGE AVERAGE WEIGHTED INITIAL AMOUNT % OF TOTAL OF BALANCE INTEREST AVERAGE LOAN-TO-VALUE TYPE ORIGINATED ORIGINATIONS LOANS PER LOAN RATE MARGIN RATIO ---- ---------- ------------ ------ -------- -------- --------- ------------- (DOLLARS IN THOUSANDS, EXCEPT AVERAGE BALANCE) Subprime Mortgages: 2-Year Fixed............ $289,549 54.4% 2,838 $102,027 9.5% 6.4% 70.5% 6-Month LIBOR Adjustable............ 110,870 20.8 1,066 104,005 9.2% 6.5% 70.2% 30-Year Fixed........... 74,162 13.9 1,011 73,355 10.5% -- 66.1% 5-Year Fixed............ 30,379 5.7 286 106,221 9.2% 6.5% 67.4% 15-Year Fixed........... 9,741 1.8 198 49,198 10.6% -- 62.6% Small Commercial(4)..... 17,920 3.4 26 689,231 9.8% -- 63.8% -------- ----- ----- $532,621 100.0% 5,425 98,179 9.6% 6.4% 69.3% ======== ===== =====
11 12
YEAR ENDED JUNE 30, 1996 - -------------------------------------------------------------------------------------------------------------- WEIGHTED WEIGHTED AVERAGE PRINCIPAL NUMBER AVERAGE AVERAGE WEIGHTED INITIAL AMOUNT % OF TOTAL OF BALANCE INTEREST AVERAGE LOAN-TO-VALUE TYPE ORIGINATED ORIGINATIONS LOANS PER LOAN RATE MARGIN RATIO ---- ---------- ------------ ------ -------- -------- --------- ------------- (DOLLARS IN THOUSANDS, EXCEPT AVERAGE BALANCE) Subprime Mortgages: 2-Year Fixed............ $ 61,141 30.6% 592 $103,280 10.0% 5.5% 67.6% 6-Month LIBOR Adjustable............ 96,866 48.4 901 107,509 8.6% 5.9% 70.6% 30-Year Fixed........... 29,993 15.0 371 80,843 10.7% -- 65.4% 5-Year Fixed............ 10,020 5.0 94 106,595 10.0% 5.7% 64.9% 15-Year Fixed........... 1,943 1.0 30 64,764 10.7% -- 65.6% -------- ----- ----- $199,963 100.0% 1,988 100,585 9.4% 5.7% 68.5% ======== ===== =====
- --------------- (1) Each fixed rate loan bears interest at a fixed rate set on its date of funding and lasting through the term of the loan. Loans bearing interest at the adjustable rate adjust every six months to a new rate through the term of the loan. The weighted average interest rate for loans bearing interest at an adjustable rate is the weighted average of the rates of such loans during the initial six month period. Loans bearing interest at the fixed/adjustable rate bear interest at a fixed rate for an initial period commencing on the date of funding (e.g., two years or five years) and thereafter adjust to new rates every six months for the remaining term of the loans. The weighted average interest rate for loans bearing interest at a fixed/adjustable rate is the weighted average of the rates of such loans during the initial period. (2) The margin for a loan is a fixed amount set for the life of the loan, which when added to the index (as described below) determines the interest rate on the loan (subject to interest rate floors, ceilings and caps). The index used by the Company is the six-month LIBOR, as published each Monday in the Wall Street Journal. Fixed rate loans have no margin because such loans are not tied to an index. (3) The Company's Wholesale Prime Division commenced operations in March 1998. The division originates loans products for primarily high credit quality borrowers whose credit scores equal or exceed levels required for the sale or exchange of their mortgage loans through FNMA or FHLMC. (4) The Company discontinued the origination of small commercial loans in April 1997. 12 13 GEOGRAPHIC CONCENTRATION The following table sets forth aggregate dollar amounts and the percentage of all loans originated by the Company by state for the periods shown:
FOR THE YEAR ENDED JUNE 30, -------------------------------------------------------------------------------------- 1998 1997 1996 -------------------------- -------------------------- -------------------------- PRINCIPAL PRINCIPAL PRINCIPAL AMOUNT % OF TOTAL AMOUNT % OF TOTAL AMOUNT % OF TOTAL ORIGINATED ORIGINATIONS ORIGINATED ORIGINATIONS ORIGINATED ORIGINATIONS ---------- ------------ ---------- ------------ ---------- ------------ (DOLLARS IN THOUSANDS) California............ $236,735 30.0% $196,526 36.9% $107,063 53.6% Illinois.............. 130,780 16.6 55,351 10.4 13,741 6.9 Florida............... 70,758 9.0 28,597 5.4 7,430 3.7 Hawaii................ 46,740 5.9 63,868 12.0 12,021 6.0 Utah.................. 30,459 3.9 20,486 3.8 6,934 3.5 Wisconsin............. 29,176 3.7 22,174 4.2 5,251 2.6 Colorado.............. 27,386 3.5 24,102 4.5 14,693 7.3 Massachusetts......... 25,904 3.3 6,277 1.2 -- -- Maryland.............. 24,701 3.1 5,010 0.9 -- -- Oregon................ 22,647 2.9 21,123 4.0 12,420 6.2 Washington............ 23,079 2.9 9,495 1.8 9,564 4.8 Ohio.................. 17,442 2.2 19,938 3.7 2,472 1.2 Indiana............... 17,180 2.2 12,757 2.4 -- -- Missouri.............. 14,669 1.9 10,712 2.0 27 0.0 Idaho................. 12,526 1.6 8,314 1.6 2,246 1.1 Michigan.............. 9,700 1.2 2,353 0.4 -- -- Other(1).............. 48,597 6.1 25,538 4.8 6,101 3.1 -------- ----- -------- ----- -------- ------ $788,479 100.0% $532,621 100.0% $199,963 100.0% ======== ===== ======== ===== ======== ======
- --------------- (1) Except for Texas which accounted for 1.3% for the year ended June 30, 1996, no other state accounted for greater than 1.0%. QUALITY CONTROL AND UNDERWRITING The Company has separate and distinct quality controls and underwriting for each of its Wholesale Subprime Division and Wholesale Prime Division. WHOLESALE SUBPRIME DIVISION QUALITY CONTROL The Company has implemented a subprime loan quality control process designed to ensure sound lending practices and compliance with the Company's policies and procedures. Prior to the funding of a subprime loan, the Company performs a "pre-funding quality control audit" which consists of the verification of a borrower's credit and employment, utilizing automated services and verbal verifications. Properties underlying the potential subprime mortgage loans are appraised by an appraiser selected by the submitting broker. Every independent appraisal is reviewed by the Company's chief subprime appraiser (the "Chief Subprime Appraiser"), other Company appraisers or by another independent appraiser approved by the Company's Chief Subprime Appraiser to confirm the adequacy of the property as collateral prior to funding. Subsequent to funding, the Company's quality assurance department audits 100% of all subprime closed loans. The department performs a review of documentation for compliance with established underwriting guidelines and lending procedures along with independent appraisal reviews and recertifications. All funding documents are reviewed for accuracy, completeness and adherence to corporate, state and federal require- 13 14 ments. As a part of this audit process, deficiencies are reported to the Company's senior management to determine trends and the need for additional training of Company personnel. UNDERWRITING The Company originates its subprime mortgage loans in accordance with the underwriting criteria (the "Underwriting Guidelines") described below. The subprime loans the Company originates generally do not satisfy underwriting standards such as those utilized by FNMA and FHLMC; therefore, the Company's subprime loans are likely to result in rates of delinquencies and foreclosures that are higher, and may be substantially higher, than those rates experienced by portfolios of mortgage loans underwritten in a more traditional manner. The Subprime Underwriting Guidelines are intended to evaluate the credit history of the potential borrower, the capacity of the borrower to repay the subprime mortgage loan, the value of the real property and the adequacy of such property as collateral for the proposed loan. Based upon the underwriter's review of the subprime loan application and related data and application of the Underwriting Guidelines, the loan terms, including interest rate and maximum loan-to-value, are determined. The Company employs experienced underwriters and the Company's chief subprime underwriter (the "Chief Subprime Underwriter") must approve the hiring of all underwriters, including those located in the regional offices and branch locations. The Company's underwriters are required to have had either substantial underwriting experience with a consumer finance company or other subprime or non-conforming lender or substantial experience with the Company in other aspects of the subprime or non-conforming mortgage finance industry before becoming part of the Company's underwriting department. As of June 30, 1998, the Company employed 44 underwriters with an average of approximately five years of non-conforming mortgage lending experience. All underwriters participate in ongoing training, including regular supervisory critiques of each underwriter's work. The Company believes that its experienced underwriting personnel have the ability to analyze the specific characteristics of each loan application and make appropriate credit judgments. The underwriting appraisal staff reviews the value of the underlying collateral based on a full appraisal completed by pre-approved qualified licensed independent appraisers. All appraisers are required to conform to the Uniform Standards of Professional Appraisal Practice adopted by the Appraisal Standards Board of the Appraisal Foundation. In addition, every independent appraisal is reviewed by the Company's Chief Subprime Appraiser, other Company appraisers or by another independent appraiser approved by the Company's Chief Subprime Appraiser to confirm the adequacy of the property as collateral. The Underwriting Guidelines include three levels of applicant documentation requirements, referred to as the "Full Documentation," "Lite Documentation" and "Stated Income Documentation" programs. Under each of the programs, the Company reviews the applicant's source of income, calculates the amount of income from sources indicated on the loan application or similar documentation, reviews the credit history of the applicant, calculates the debt service-to-income ratio to determine the applicant's ability to repay the loan, reviews the type and use of the property being financed, and reviews the property. In determining the ability of the applicant to repay the loan, the Company's underwriters use (i) a qualifying rate that is equal to the stated interest rate on fixed-rate subprime loans, (ii) the initial interest rate on subprime loans which provide for two, three or five years of fixed payments before the initial interest rate adjustment, or (iii) one percent above the initial interest rate on other adjustable-rate subprime loans. The Underwriting Guidelines require that subprime mortgage loans be underwritten in a standardized procedure which complies with applicable federal and state laws and regulations and requires the Company's underwriters to be satisfied that the value of the property being financed, as indicated by an appraisal and the appraisal review. In general, the maximum loan amount for subprime mortgage loans originated under the programs is $500,000; however, larger subprime loans may be approved on a case-by-case basis. The Underwriting Guidelines permit one-to-four family residential property subprime loans to have loan-to-value ratios at origination of generally up to 80%, or up to 90% for borrowers in the Company's highest credit grade categories, depending on, among other things, the purpose of the mortgage loan, a borrower's credit history, repayment ability and debt service-to-income ratio, income documentation, as well as the type and use of the property. 14 15 Under the Full Documentation program, applicants are generally required to submit two written forms of verification of stable income for at least 12 months. Under the Lite Documentation program, one such form of verification is required for six months. Under the Stated Income Documentation program, an applicant may be qualified based upon monthly income as stated on the subprime mortgage loan application if the applicant meets certain criteria. All the foregoing programs require that with respect to salaried employees there be a telephone verification of the applicant's employment. Verification of the source of funds required to be deposited by the applicant into escrow in the case of a purchase money loan is generally required under the Full Documentation program guidelines and on all purchase loans where the loan-to-value ratio is greater than 80%. No such verification is required under any of the programs where the loan-to-value ratio is less than 80%. The maximum loan-to-value ratio is reduced by 5% to 10% for the Lite Documentation and Stated Income Documentation programs. The level of documentation percentages of subprime loan originations are as follows:
YEAR ENDED JUNE 30, ----------------------- 1998 1997 1996 ----- ----- ----- Full........................................................ 56.2% 50.5% 50.9% Stated Income............................................... 43.1 48.8 49.1 Lite........................................................ 0.7 0.7 -- ----- ----- ----- 100.0% 100.0% 100.0% ===== ===== =====
15 16 The Company's categories and criteria for grading the credit history of potential borrowers is set forth in the table below. Generally, borrowers in lower credit grades are less likely to satisfy the repayment obligations of a subprime mortgage loan and, therefore, are subjected to lower loan-to-value ratios and are charged higher interest rates and loan origination fees. Subprime Loans made to lower credit grade borrowers, including credit-impaired borrowers, entail a higher risk of delinquency and may result in higher losses than loans made to borrowers who use conventional mortgage sources. The Company believes that the amount of equity present in the collateral securing its subprime loans generally mitigates these risks. UNDERWRITING GUIDELINES(1)
A+ RISK A- RISK B RISK C+ RISK C RISK ----------------- ----------------- ----------------- ----------------- ----------------- Existing Mortgage One 30-day late Maximum of two Maximum of four Maximum six 30- Unlimited number payment in the 30-day late 30-day late day late of 30-day and 60- last 12 months. payments in the payments within payments; or, day late payments last 12 months. the last 12 four 30-days, one and a maximum of months allowed if 60-day and one one 120-day late LTV is greater 90-day late payment within than 80%. Maximum payment in the the last 12 four 30-day late last 12 months if months. There may payments; or, two LTV is 75% or be a current 30-day late less. less. Maximum notice of payments and one five 30-day late default, however 60-day late payments and no the maximum payment in the 60-day late delinquency last 12 months if payments if LTV cannot exceed 120 LTV is 80% or is greater than days. less. 75%. Maximum six 30-day payments if LTV is greater than 65% and loan is under the Stated Income Documentation program. Other Credit Very good to Very good credit Generally good Some significant Frequent excellent credit history within credit within the derogatory credit derogatory within the last the last 12 last 12 months. in the past 12 consumer credit. 24 months. Minor months. Minor Some late months. Collections and late payments late payments payments (not Generally, chargeoffs may (not more than 30 (not more than 60 more than 90 collections and remain open after days) may be days) may be days) may be chargeoffs not funding. allowed on a allowed on a allowed. more than $2,000 limited basis. limited basis. may remain open after closing. Bankruptcy filings Generally, no Generally, no Generally, no Chapter 7 Chapter 7 bankruptcy bankruptcy bankruptcy bankruptcy must Bankruptcy must filings in the filings in the filings in the have been have been last two years. last two years. last two years. discharged at discharged at least 12 months least six months prior to prior to application. application. Chapter 13 Chapter 13 Bankruptcy must Bankruptcy must have been filed have been filed for at least 24 for at least 18 months and months and borrower must borrower must have paid have paid according to the according to the Chapter 13 Plan. Chapter 13 Plan. Chapter 13 Chapter 13 Bankruptcy must Bankruptcy must be paid or be paid or discharged at discharged at closing. closing. Debt service-to- 45% 45% to 90% LTV 45% to 85% LTV 50% to 80% LTV 60% income ratio 50% to 80% LTV 50% to 80% LTV 55% to 75% LTV 55% to 75% LTV 60% to 70% LTV Minimum LTV(2) 90% 90% 85% 80% 70% C- RISK ----------------- Existing Mortgage Unlimited 30- and 60-day late payments and a maximum of one 150-day late payment if LTV is greater than 65%, maximum one 180-day late payment if LTV is less than 65%. Delinquencies more than 180 days may be allowed if LTV is less than 60%. Other Credit Significant credit defaults. Collections and chargeoffs may remain open after closing. Bankruptcy filings Current Bankruptcy. Bankruptcy allowed on a case by case basis; Bankruptcy must be paid or discharged at closing. Debt service-to- 60% income ratio Minimum LTV(2) 70%
- --------------- (1) The letter grade applied to each risk classification reflects the Company's internal standards and does not necessarily correspond to the classifications used by other mortgage lenders. "LTV" means loan-to-value. (2) The maximum LTV set forth in the table is for borrowers providing Full Documentation. The LTV is reduced for Lite Documentation and Stated Income Documentation, if applicable. 16 17 The Company evaluates its Underwriting Guidelines on an ongoing basis and periodically modifies the Underwriting Guidelines to reflect the Company's current assessment of various issues related to an underwriting analysis. In addition, the Company adopts underwriting guidelines appropriate to new loan products, such as those offered by the Retail Division. The conventional mortgage loans and second mortgage loans, including 125% loan-to-value loans, offered by the Retail Division are underwritten to the standards of the intended buyers thereof and utilize information not considered by the Company in its Subprime Underwriting Guidelines, including credit scores. Exceptions. As described above, the Company uses the foregoing categories and characteristics as underwriting guidelines only. On a case-by-case basis, the Company's underwriters may determine that the prospective borrower warrants a risk category upgrade, a debt service-to-income ratio exception, a pricing exception, a loan-to-value exception or an exception from certain requirements of a particular risk category (collectively called an "upgrade" or an "exception"). An upgrade or exception may generally be allowed if the application reflects certain compensating factors, including among others: low loan-to-value ratio; pride of ownership; stable employment; and the length or residence in the subject property. Accordingly, the Company may classify certain mortgage loan applications in a more favorable risk category than other mortgage loan applications that, in the absence of such compensating factors, would only satisfy the criteria of a less favorable risk category. Wholesale Prime Division Quality Control. Underwriting. The Company originates its conforming and nonconforming loans in accordance with the certain underwriting standards to achieve the quality of mortgages required by either the agencies or its secondary market investors. The Company generally performs a pre-funding audit on each mortgage loan. This audit includes a review for compliance with applicable underwriting program guidelines and accuracy of the credit report and telephone verification of employment. The Company performs a post-funding quality control review on a minimum of 10% of the mortgage loans originated or acquired for complete re-verification of employment, income and liquid assets used to qualify for such mortgage loan. Such review also includes procedures intended to detect evidence of fraudulent documentation and/or imprudent activity during the processing, funding or selling of the mortgage loan. Verification of occupancy and applicable information is made by regular mail, or by an independent inspection company. One- to-four-family residential properties are appraised by qualified independent appraisers who are approved by the Company. All appraisals are required to conform to the Uniform Standards of Professional Appraisal Practice adopted by the Appraisal Standards Board of the Appraisal Foundation and must be on forms acceptable to FNMA and FHLMC. As part of the Company's pre-funding quality control procedures, either field or desk appraisal reviews are obtained on 10% of all mortgage loans. Underwriting. Mortgage loan applications must be approved by the Company's underwriters in accordance with its underwriting criteria, including credit scores, loan-to-value ratios, borrower income qualifications, investor requirements, necessary mortgage insurance coverages and property appraisal requirements. Mortgage loan applications are assigned to an underwriter at the Company based upon the size and complexity of the mortgage loan and the underwriter's experience level. Conforming mortgage loans originated for sale to the Agencies must satisfy the underwriting standards for one of the programs sponsored by such entities. All other mortgage loans originated by the Company (including ALT A loans and home equity loans) are underwritten by the Company according to its credit, appraisal and underwriting standards. Such underwriting standards are applied to evaluate the prospective borrower's credit standing and repayment ability and the value and adequacy of the mortgaged property as collateral. These standards, which are summarized below, are applied in accordance with applicable federal and state laws and regulations. Exceptions to the underwriting standards are permitted when compensating factors are present, and/or prior approval by its secondary market investors. The Company's underwriting standards for purchase money or rate/term refinance mortgage loans secured by one- to two-family primary residences generally allow loan-to-value ratios at origination of up to 95% for mortgage loans with original principal balances of up to $400,000, up to 90% for mortgage loans 17 18 secured by one- to four-family primary residences with original principal balances of up to $500,000 and up to 80% for mortgage loans with original principal balances up to $650,000. The loan-to-value ratio for super jumbos generally may not exceed 60%. For cash-out refinance mortgage loans, the maximum loan-to-value ratio generally is 80%, and the maximum "cash out" amount permitted is based in part on the original amount of the related mortgage loan. The Company's underwriting standards for mortgage loans secured by investment properties generally allow loan-to-value ratios at origination of up to 90% for mortgage loans with original principal balances up to $300,000 on no cash-out and purchase transactions. On a cash-out refinance mortgage loan, the loan-to-value is reduced up to 80% with an original principal balance up to $300,000. The Company's underwriting standards permit mortgage loans secured by investment properties to have higher original principal balances if they have lower loan-to-value ratios at origination. For each mortgage loan secured by a first lien with a loan-to-value ratio at origination exceeding 80%, the Company generally requires a private mortgage insurance policy insuring a portion of the balance of the mortgage loan. In certain circumstances, however, the Company does not require private mortgage insurance on mortgage loans with principal balances up to $500,000 that have loan to value ratios exceeding 80% but less than or equal to 90%. All residences, except cooperative and certain high-rise condominium dwellings, are eligible for this program. Each qualifying mortgage loan will be made at an interest rate that is higher than the rate would be if the loan-to-value ratio was 80% or less or if private mortgage insurance was obtained. In determining whether a prospective borrower has sufficient monthly income available (i) to meet the borrower's monthly obligation on the proposed mortgage loan and (ii) to meet monthly housing expenses and other financial obligations, including the borrower's monthly obligations on the proposed mortgage loan, the Company generally considers, when required by the applicable documentation program, the ratio of such amounts to the proposed borrower's acceptable monthly gross income. Such ratios vary depending on a number of underwriting criteria, including loan-to-value ratios, and are determined on a loan-by-loan basis. The Company also examines a prospective borrower's credit report. Generally, each credit report provides a credit score for the borrower. Credit scores generally are available from three major credit bureaus: TRW, Equifax and Trans Union. The Company attempts to obtain for each borrower a credit score from each credit bureau. If three credit scores are obtained, the Company applies the middle score of the primary wage earner. If two scores are obtained, the Company applies the lower score of the primary wage earner. These scores estimate, on a relative basis, which mortgage loans are most likely to default in the future. Lower scores imply higher default risk relative to a higher score. Credit scores are empirically derived from historical credit bureau data and represent a numerical weighing of a borrower's credit characteristics over a two-year period. A credit score is generated through the statistical analysis of a number of credit-related characteristics or variables. Common characteristics include number of credit lines, payment history, past delinquencies, severity of delinquencies, current levels of indebtedness, types of credit and length of credit history. Attributes are the specific values of each characteristic. A scorecard (the model) is created with weights or points assigned to each attribute. An individual mortgage loan applicant's credit score is derived by summing together the attribute weights for that applicant. Generally, the Wholesale Prime Division does not originate mortgages where the borrower's credit score is less than 620. The Company originates and acquires mortgage loans under one of five documentation programs: full documentation, alternative documentation, limited documentation, no ratio loan documentation and no income/no asset verification. Under the full documentation program, the prospective borrower's employment, income and assets are verified through written and telephonic communications. Alternative documentation provides for alternative methods of employment verification generally using W-2 forms or pay stubs. Generally, under a full documentation program, a prospective borrower is required to have a minimum credit score of 620. Under the limited documentation program, certain credit underwriting documentation concerning income or income verification and/or employment verification is waived. The limited documentation program underwriting places more emphasis on the value of the mortgaged property as collateral and other assets of the 18 19 borrower than on credit underwriting. Mortgage loans underwritten using the limited documentation program are limited to borrowers with credit histories that demonstrate an established ability to repay indebtedness in a timely fashion. Under the limited documentation program, a prospective borrower is required to have a minimum credit score of 620. Mortgage loans originated and acquired with limited documentation include cash-out refinance loans, super jumbos and mortgage loans secured by investor-owned properties. Permitted maximum loan-to-value ratios (including secondary financing) under the limited documentation program, which range up to 80%, are more restrictive than mortgage loans originated with full documentation or alternative documentation. Under the no ratio loan documentation program, income ratios for the prospective borrower are not calculated. Mortgage loans underwritten using the no ratio loan documentation program have loan-to-value ratios less than or equal to 80% and meet the standards for the limited documentation program. A minimum credit score of 660 is required for this program. Under the no income/no asset verification program, credit underwriting documentation concerning income, employment verification and asset verification is waived and income ratios are not calculated. Under the no income/no asset verification program, emphasis is placed on the value and adequacy of the mortgaged property as collateral and credit history rather than on verified income and assets of the borrower. Mortgage loans underwritten under no income/no asset verification are limited to borrowers with excellent credit histories. Generally, a minimum credit score of 680 is required. Exceptions. On a case-by-case basis, the Company's underwriters may determine that the prospective borrower warrants an exception from its underwriting guidelines. Such exceptions may include a debt service-to-income ratio exception, a loan-to-value exception or an exception from certain documenation requirements of a particular mortgage loan program. An exception may generally be allowed if the application reflects certain compensating factors, including among others: a high credit score; a low loan-to-value ratio; cash reserves; stable employment; and the length of residence in the subject property. Accordingly, the Company may classify certain mortgage loan applications into a more extensive documentation program than other mortgage loan applications that, in the absence of such compensating factors, would only satisfy the criteria of a less extensive documenation program and may fund mortgage loans that do not satisfy all of the criteria discussed above for any particular documentation program. 19 20 LOAN PRODUCTION BY BORROWER RISK CLASSIFICATION The following tables set forth information concerning the Company's loan production by borrower risk classification for the years ended June 30, 1998, 1997 and 1996.
YEAR ENDED JUNE 30, 1998 ------------------------------------------------------------------------- WEIGHTED WEIGHTED AVERAGE PRINCIPAL % OF NUMBER AVERAGE WEIGHTED INITIAL AMOUNT TOTAL OF INTEREST AVERAGE LOAN-TO-VALUE CREDIT RATING ORIGINATED ORIGINATIONS LOANS RATE(1) MARGIN(2) RATIO ------------- ---------- ------------ ------ -------- --------- ------------- (DOLLARS IN THOUSANDS) Subprime Loans: Adjustable Rate (6-Month LIBOR): A+................................. $ 42,320 42.1% 286 9.1% 5.6% 76.0% A-................................. 22,249 22.1 169 9.5% 6.2% 78.3% B.................................. 20,170 20.0 179 9.8% 6.5% 75.0% C+................................. 6,308 6.3 62 10.6% 6.9% 69.9% C.................................. 4,424 4.4 51 11.2% 7.5% 67.1% C-................................. 5,130 5.1 69 12.5% 7.7% 62.1% -------- ----- ----- $100,601 100.0% 816 9.7% 6.3% 74.8% ======== ===== ===== Fixed/Adjustable Rate (2-Year; 5-Year): A+................................. $239,460 42.6% 1,870 8.9% 5.86% 77.6% A-................................. 123,913 22.0 1,133 9.6% 6.18% 77.3% B.................................. 126,007 22.4 1,348 9.9% 6.31% 73.9% C+................................. 38,283 6.8 543 10.9% 6.93% 69.8% C.................................. 13,517 2.4 227 12.3% 7.44% 64.4% C-................................. 21,211 3.8 309 12.8% 7.58% 61.3% -------- ----- ----- $562,391 100.0% 5,430 9.6% 6.2% 75.3% ======== ===== ===== Fixed Rate (15-Year; 30-Year): A+ $ 41,513 43.7% 501 9.4% -- 71.5% A-................................. 21,256 22.4 294 10.1% -- 71.5% B.................................. 20,195 21.3 313 10.7% -- 71.2% C+................................. 7,137 7.5 152 11.5% -- 66.0% C.................................. 1,940 2.0 50 13.2% -- 59.4% C-................................. 2,943 3.1 58 13.5% -- 59.4% -------- ----- ----- $ 94,984 100.0% 1,368 10.20% -- 70.4% ======== ===== ===== Other: Prime Mortgage Loans(3)............ $ 26,716 87.6% 188 7.60% -- 72.8% LTV125 Mortgage Loans.............. 3,787 12.4 95 13.5% -- 35.5% -------- ----- ----- $ 30,503 100.0% 283 8.3% -- 70.4% ======== ===== ===== $788,479 7,897 9.7% 6.2% 74.4% ======== =====
- --------------- (1) Each fixed rate loan bears interest at a fixed rate set on its date of funding and lasting through the term of the loan. Loans bearing interest at the adjustable rate adjust every six months to a new rate through the term of the loan. The weighted average interest rate for loans bearing interest at an adjustable rate is the weighted average of the rates of such loans during the initial six month period. Loans bearing interest at the fixed/adjustable rate bear interest at a fixed rate for an initial period commencing on the date of funding (e.g., two years or five years) and thereafter adjust to new rates every six months for the 20 21 remaining term of the loans. The weighted average interest rate for loans bearing interest at a fixed/adjustable rate is the weighted average of the rates of such loans during the initial period. (2) The margin for a loan is a fixed amount set for the life of the loan, which when added to the Index (as described below) determines the interest rate on the loan (subject to interest rate floors, ceiling and caps). The index used by the Company is the six-month LIBOR, as published each Monday in The Wall Street Journal. Fixed rate loans have no margin because such loans are not tied to an index. (3) The Company's Wholesale Prime Division commenced operations in the quarter ended March 1998. In general, the credit guidelines for prime mortgage loans exceeds the credit ratings for the Company's subprime mortgage loan, and the borrower's credit scores equal or exceed levels required for the sale or exchange of their mortgage loans through FNMA or FHLMC.
YEAR ENDED JUNE 30, 1997 ------------------------------------------------------------------------- WEIGHTED WEIGHTED AVERAGE PRINCIPAL % OF NUMBER AVERAGE WEIGHTED INITIAL AMOUNT TOTAL OF INTEREST AVERAGE LOAN-TO-VALUE CREDIT RATING ORIGINATED ORIGINATIONS LOANS RATE(1) MARGIN(2) RATIO ------------- ---------- ------------ ------ -------- --------- ------------- (DOLLARS IN THOUSANDS) Adjustable Rate (6-Month LIBOR): A+................................. $ 21,238 19.1% 181 8.0% 6.0% 71.4% A-................................. 32,913 29.7 280 8.5% 6.2% 72.6% B.................................. 24,915 22.5 236 9.0% 6.6% 72.4% C+................................. 16,481 14.9 179 10.0% 6.7% 68.8% C.................................. 9,398 8.5 114 10.9% 7.3% 63.0% C-................................. 5,925 5.3 76 12.7% 8.0% 59.3% -------- ----- ----- $110,870 100.0% 1,066 9.2% 6.5% 70.2% ======== ===== ===== Fixed/Adjustable Rate (2-Year; 5-Year): A+................................. $116,138 36.4% 927 8.5% 6.1% 71.8% A-................................. 82,402 25.8 708 9.2% 6.2% 71.9% B.................................. 60,570 18.9 613 9.7% 6.5% 71.0% C+................................. 32,031 10.0 416 10.8% 6.9% 67.3% C.................................. 16,790 5.2 271 11.9% 7.2% 63.6% C-................................. 11,997 3.7 189 12.4% 7.6% 57.7% -------- ----- ----- $319,928 100.0% 3,124 9.5% 6.4% 70.2% ======== ===== ===== Fixed Rate (15-Year; 30-Year): A+................................. $ 26,249 31.2% 299 9.6% -- 64.2% A-................................. 27,110 32.3 347 10.1% -- 66.4% B.................................. 14,980 17.9 225 10.9% -- 68.3% C+................................. 8,529 10.2 177 11.8% -- 66.9% C.................................. 4,373 5.2 107 13.2% -- 63.5% C-................................. 2,662 3.2 54 13.6% -- 57.9% -------- ----- ----- $ 83,903 100.0% 1,209 10.5% -- 65.7% ======== ===== ===== Small Commercial(3)................ $ 17,920 26 9.8% -- 63.8% ======== ===== $532,621 5,425 9.6% 6.4% 69.3% ======== =====
- --------------- (1) Each fixed rate loan bears interest at a fixed rate set on its date of funding and lasting through the term of the loan. Loans bearing interest at the adjustable rate adjust every six months to a new rate through the term of the loan. The weighted average interest rate for loans bearing interest at an adjustable rate is the weighted average of the rates of such loans during the initial six month period. Loans bearing interest at the fixed/adjustable rate bear interest at a fixed rate for an initial period commencing on the date of funding (e.g., two years or five years) and thereafter adjust to new rates every six months for the 21 22 remaining term of the loans. The weighted average interest rate for loans bearing interest at a fixed/adjustable rate is the weighted average of the rates of such loans during the initial period. (2) The margin for a loan is a fixed amount set for the life of the loan, which when added to the index (as described below) determines the interest rate on the loan (subject to interest rate floors, ceiling and caps). The index used by the Company is the six-month LIBOR, as published each Monday in The Wall Street Journal. Fixed rate loans have no margin because such loans are not tied to an index. (3) The Company discontinued the origination of small commercial loans in April 1997.
YEAR ENDED JUNE 30, 1996 ------------------------------------------------------------------------- WEIGHTED WEIGHTED AVERAGE PRINCIPAL % OF NUMBER AVERAGE WEIGHTED INITIAL AMOUNT TOTAL OF INTEREST AVERAGE LOAN-TO-VALUE CREDIT RATING ORIGINATED ORIGINATIONS LOANS RATE(1) MARGIN(2) RATIO ------------- ---------- ------------ ------ -------- --------- ------------- (DOLLARS IN THOUSANDS) Adjustable Rate (6-Month LIBOR): A+................................. $ 5,788 6.0% 48 7.8% 5.6% 69.1% A-................................. 44,400 45.8 389 8.1% 5.5% 72.3% B.................................. 24,967 25.8 237 8.6% 6.1% 71.8% C+................................. 11,932 12.3 125 9.5% 6.4% 68.1% C.................................. 7,809 8.1 76 10.0% 6.5% 64.4% C-................................. 1,970 2.0 26 10.9% 6.8% 58.9% -------- ----- ----- $ 96,866 100.0% 901 8.6% 5.9% 70.6% ======== ===== ===== Fixed/Adjustable Rate (2-Year; 5-Year): A+................................. $ 12,530 17.6% 117 9.14% 4.9% 65.8% A-................................. 21,899 30.8 197 9.6% 5.2% 6.74% B.................................. 19,717 27.7 171 10.1% 5.8% 70.1% C+................................. 8,680 12.2 105 10.8% 6.1% 66.9% C.................................. 5,960 8.4 66 11.0% 6.3% 64.3% C-................................. 2,375 3.3 30 12.5% 6.7% 58.6% -------- ----- ----- $ 71,161 100.0% 686 10.0% 5.6% 67.2% ======== ===== ===== Fixed Rate (15-Year; 30-Year): A+................................. $ 1,121 3.5% 11 10.3% -- 70.3% A-................................. 17,469 54.7 200 10.2% -- 65.6% B.................................. 7,263 22.7 91 10.9% -- 66.6% C+................................. 3,483 10.9 54 12.0% -- 66.5% C.................................. 1,590 5.0 26 12.2% -- 61.2% C-................................. 1,010 3.2 19 13.1% -- 50.9% -------- ----- ----- $ 31,936 100.0% 401 10.7% -- 65.3% ======== ===== ===== $199,963 1,988 9.4% 5.7% 68.5% ======== =====
- --------------- (1) Each fixed rate loan bears interest at a fixed rate set on its date of funding and lasting through the term of the loan. Loans bearing interest at the adjustable rate adjust every six months to a new rate through the term of the loan. The weighted average interest rate for loans bearing interest at an adjustable rate is the weighted average of the rates of such loans during the initial six month period. Loans bearing interest at the fixed/adjustable rate bear interest at a fixed rate for an initial period commencing on the date of funding (e.g., two years or five years) and thereafter adjust to new rates every six months for the remaining term of the loans. The weighted average interest rate for loans bearing interest at a fixed/adjustable rate is the weighted average of the rates of such loans during the initial period. (2) The margin for a loan is a fixed amount set for the life of the loan, which when added to the index (as described below) determines the interest rate on the loan (subject to interest rate floors, ceiling and 22 23 caps). The index used by the Company is the six-month LIBOR, as published each Monday in The Wall Street Journal. Fixed rate loans have no margin because such loans are not tied to an index. TECHNOLOGY The Company utilizes computer technology to maximize its loan originations. The Company has established a wide area network and is in the process of linking most of the Company's account executives to the Company's computer systems. Through this network, it is expected that an account executive will receive daily status reports regarding pending loans so that he or she can direct efforts to those cases that require attention to complete the processing. Certain account executives, who are not on the network, receive the same data by daily fax communication. The Company has established an Internet website through which brokers and interested parties may access information about the Company's Retail Division and its products. In addition, the Company has reserved the domain name for the Company's main website, which is currently under development. The Company's website addresses are http://www.simpleusa.com and http://www.bncmortgage.com. The Company makes extensive use of computer technology in its underwriting process. Each loan application file is computerized so that it can be accessed immediately by the appropriate persons, thereby eliminating delay that would be caused by not having physical access to the file. The Company has performed a review of its internal systems to identify and resolve the effect of Year 2000 software issues on the integrity and reliability of the Company's financial and operational systems. Based on this review, management believes that its internal systems are substantially compliant with the Year 2000 issues. In addition, the Company is also communicating with its principal service providers to ensure Year 2000 issues will not have an adverse impact on the Company. Based upon its internal review and communications with external service providers, the Company believes that the costs of achieving Year 2000 compliance will not have a material adverse impact on the Company's business, operations or financial condition. FINANCING AND SALE OF LOANS Warehouse Facility Since August 1995, the Company has funded its business primarily through a warehouse line of credit with DLJ Mortgage Capital, Inc. ("DLJ") under which it has borrowed money to finance the origination of loans. The current warehouse line of credit with DLJ, the "DLJ Facility" provides a $150.0 million warehouse line of credit to the Company. Borrowings under the DLJ Facility bear an interest rate of the federal funds rate plus 50 basis points until March 1999 and, thereafter, the federal funds rate plus 100 basis points. The interest rate is subject to increase based on the length of time loans are held by the Company, and that DLJ receives a security interest on all loans, and other rights in connection therewith, originated by the Company. Any loan not purchased by DLJ is not allowed to remain subject to the warehouse line for more than nine months. The term of the DLJ Facility is until March 2000. The DLJ Facility further provides that DLJ does not have the exclusive right to purchase loans from the Company, Company has no obligation to sell any loans to DLJ, and DLJ has no obligation to purchase any loans from the Company. Furthermore, DLJ has agreed to provide the Company with up to $5.0 million of financing through March 10, 1999, for subordinated "interest-only" securities to the extent they are retained by the Company in connection with any future securitizations of loans originated by the Company. Advances will be made only to the extent the Company does not have sufficient cash, in excess of reasonable reserves, to fund the retention of such securities. The Company is currently negotiating with other lenders to obtain additional warehouse lines of credit at interest rates and terms that are consistent with management's objectives. 23 24 Loan Sales The Company follows a strategy of selling for cash substantially all of its loan originations through loan sales in which the Company disposes of its entire economic interest in the loans for a cash price that represents a premium over the principal balance of the loans sold. The Company sold $744.4 million, $519.9 million and $156.6 million of loans through loan sales during the years ended June 30, 1998, 1997 and 1996, respectively. Loan sales are typically made monthly. The Company did not sell any loans directly through securitizations during these periods. DLJ has purchased, and it is contemplated that it may continue to purchase, loans under the master loan purchase agreement with a view towards securitization or other resale transactions in the secondary mortgage market. Since substantially all of the loans historically purchased by DLJ under the master repurchase agreement have been resold by DLJ to institutional purchasers generally within 48 hours of the initial purchase from the Company, DLJ has agreed to allow the Company to assist it in the marketing of loans so resold by DLJ. Prior to the purchase of the loans by DLJ under the master loan purchase agreement, the Company undertakes a process to identify the institutional purchasers who will immediately buy the subject loans from DLJ. This program utilizes a competitive bidding process typically involving two to four potential purchasers (including Wall Street firms, financial institutions and conduits, along with other institutional purchasers) who in most cases have purchased similar resold loans from DLJ in the past. The successful bidder is committed to a minimum quantity of loans at a determined price, and is generally granted the option to purchase more than the minimum quantity at a negotiated price. DLJ then agrees to pay the Company the determined price, minus a certain number of basis points, which represents DLJ's fees. Under the master loan purchase agreement, DLJ will receive no fees in connection with any such purchases through March 10, 1999 and 12.5 basis points through March 10, 2000. As a result of this agreement, Management is able to directly control the sales process of its loans in an effort to obtain more favorable pricing and other terms. A successful bidder is not obligated to purchase loans other than those to which its bid applies. For the years ended June 30, 1998, 1997 and 1996, an aggregate of $2.2 million, $2.1 million and $1.8 million, respectively, was paid to DLJ as fees pursuant to the Master Loan Purchase Agreement. The Master Loan Purchase Agreement, along with the DLJ Facility, terminates on March 10, 2000, or may be terminated earlier by DLJ upon an event of default by the Company, including the occurrence of any proceeding adversely affecting the Company's ability to perform its obligations to DLJ, a material breach by the Company of any related agreement with DLJ or a material adverse change in the Company's business. The Master Loan Purchase Agreement may also be terminated by DLJ if the Company merges, sells substantially all of its assets or fails to meet certain financial criteria as agreed to by DLJ and the Company. The Company, DLJ and a major investment bank have negotiated an agreement whereby the Company will agree to sell (through DLJ) and the bank will agree to purchase, for a period of four months commencing in April 1998, substantially all of Company's adjustable rate, conventional first lien subprime mortgage loans. It is anticipated that the aggregate principal balance of all of the mortgage loans delivered pursuant to the commitment will be approximately $280 million. It is anticipated that the Company (through DLJ) will agree that the mortgage loans will have certain characteristics, including, but not limited to, mortgage loan interest rate, terms of payments and prepayments, achievement of certain credit grades, and that the majority of the properties subject to the loans will be located in California, Illinois and Florida. Cash gain on sale of mortgage loans represented 68.6%, 66.7% and 51.5% of the Company's total revenues for the years ended June 30, 1998, 1997 and 1996, respectively. The Company maximizes its cash gain on sale of mortgage loan revenue by closely monitoring institutional purchasers' requirements and focusing on originating the types of loans that meet those requirements and for which institutional purchasers tend to pay higher rates. During the years ended June 30, 1998, 1997 and 1996, the Company sold loans to DLJ having an aggregate principal balance of $727.1 million, $473.7 million and $153.2 million, respectively. Loan sales are made to DLJ on a non-recourse basis pursuant to the Master Loan Purchase Agreement containing customary representations and warranties by the Company regarding the underwriting criteria and the origination process. The Company is required to provide similar representations and warranties to those institutional purchasers to whom DLJ sells the subject loans. The Company, therefore, may be required to 24 25 repurchase or substitute loans in the event of a breach of its representations and warranties. In addition, the Company sometimes commits to repurchase or substitute a loan if a payment default occurs within the first month following the date the loan is funded. The Company is also required in some cases to repurchase or substitute a loan if the loan documentation is alleged to contain fraudulent misrepresentations made by the borrower. Any claims asserted against the Company in the future by its loan purchasers may result in liabilities or legal expenses that could have a material adverse effect on the Company's results of operations and financial condition. In addition, any material repurchase or substitution may have an adverse effect on the market for and pricing of the Company's loans. Since the Company commenced operations in August 1995 through June 30, 1998, the Company has not been obligated to repurchase or substitute any loan sold to DLJ due to breaches of representations and warranties, fraudulent misrepresentations or borrower default in the first month. During such period, the Company had repurchased loans with an aggregate principal balance of $253,000 from other institutional purchasers. Securitization Capability While the Company has not sold loans directly through securitizations, part of the Company's loan sale strategy may include the sale of loans directly through securitizations in the future if management determines that such sales are more beneficial. Management has significant securitization experience in that several members were involved in securitization prior to their employment with the Company. Typically in a securitization, the issuer aggregates mortgages into a real estate mortgage investment conduit trust. The regular interests or the senior tranches of the trust are investment grade. While the issuer generally retains the residual interests in the trust, it immediately sells the regular interests and generally uses the proceeds to repay borrowings that were used to fund or purchase the loans in the securitized pool. The holders of the regular interests are entitled to receive scheduled principal collected on the pool of securitized loans and interest at the pass-through interest rate on the certificate balance for such interests. The residual interests represent the subordinated right to receive cash flows from the pool of securitized loans after payment of the required amounts to the holders of the regular interests and the cost associated with the securitization. The issuer recognizes non-cash revenue relating to the residual interest at the time of the securitization. SUB-SERVICING While the Company currently sells substantially all of the mortgage loans it originates servicing released (meaning the Company does not retain the servicing rights to such loans), it is required to service the loans from the date of funding through the date of sale. Since the Company conducts whole loan sales monthly, the Company currently does not have a substantial servicing portfolio. Nonetheless, the Company currently contracts for the sub-servicing of all mortgage loans it originates through the date of sale and is subject to risks associated with inadequate or untimely services. To the extent that the Company decides to retain servicing rights in the future or conduct securitizations, it currently intends to contract for the sub-servicing of such mortgage loans, which would expose it to more substantial risks associated with contracted sub-servicing. In such event, it is expected that many of the Company's borrowers will require notices and reminders to keep their mortgage loans current and to prevent delinquencies and foreclosures. A substantial increase in the Company's delinquency rate or foreclosure rate could adversely affect its ability to access profitably the capital market for its financing needs, including any future securitizations. Any of the Company's sub-servicing agreements with its third-party sub-servicers are expected to provide that if the Company terminates the agreement without cause (as defined in the agreement), the Company may be required to pay the third-party sub-servicer a fee. Depending upon the size of the Company's loan portfolio sub-serviced at any point in time, the termination penalty that the Company would be obligated to pay upon termination without cause, may be substantial. INTEREST RATE RISK MANAGEMENT The Company's profits depend, in part, on the difference, or "spread," between the effective rate of interest received by the Company on the loans it originates or purchases and the interest rates payable by the 25 26 Company under its warehouse facilities or for securities issued in any future securitizations. The spread can be adversely affected because of interest rate increases during the period from the date the loans are originated until the closing of the sale or securitization of such loans. Since the Company historically has retained loans for a short period of time pending sale, it has not engaged in hedging activities to date. However, in the future the Company may hedge its variable-rate mortgage loans and any interest-only and residual certificates retained in connection with any future securitizations with hedging transactions which may include forward sales of mortgage loans or mortgage-backed securities, interest rate caps and floors and buying and selling of futures and options on futures. The nature and quantity of hedging transactions will be determined by the Company's management based on various factors, including market conditions and the expected volume of mortgage loan originations and purchases. No assurance can be given that such hedging transactions will offset the risks of changes in interest rates, and it is possible that there will be periods during which the Company could incur losses after accounting for its hedging activities. COMPETITION The Company faces intense competition in the business of originating and selling mortgage loans. The Company's competitors in the industry include other consumer finance companies, mortgage banking companies, commercial banks, credit unions, thrift institutions, credit card issuers and insurance finance companies. Many of these entities are substantially larger and have considerably greater financial, technical and marketing resources than the Company. With respect to other mortgage banking and specialty finance companies, there are many larger companies that focus on the same types of mortgage loans with which the Company directly competes for product. From time to time, one or more of these companies may be dominant in the origination and sale of non-conforming and conforming mortgage loans. In addition, many financial services organizations that are much larger than the Company have formed national loan origination networks offering loan products that are substantially similar to the Company's loan programs. 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. In addition, the current level of gains realized by the Company and its competitors on the sale of non-conforming loans could attract additional competitors into this market. Additional competition may lower the rates the Company can charge borrowers, thereby potentially lowering gain on future loan sales and future securitizations. The Company may in the future also face competition from, among others, government-sponsored entities which may enter the non-conforming mortgage market. Existing or new loan purchase programs may be expanded by FNMA, FHLMC, or Government National Mortgage Association ("GNMA") to include non-conforming mortgages, particularly those in the "Alt A" category, which constitute a significant portion of the Company's loan production. For example, in August 1998, the FHLMC has announced that it has entered, on a limited basis, the non-conforming market (not including subprime loans). Entries of such government-sponsored entities into the non-conforming market may have an adverse effect on loan yields on mortgage loans originated by the Company and reduce or eliminate premiums on loan sales. To the extent any of these competitors significantly expand their activities in the Company's market, the Company could be materially adversely affected. Fluctuations in interest rates and general economic conditions may also affect the Company's competition. 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 the Company's customers to refinance their loans. REGULATION The consumer financing industry is a highly regulated industry. The Company's business is subject to extensive and complex rules and regulations of, and examinations by, various federal, state and local government authorities. These rules impose obligations and restrictions on the Company's loan origination, credit activities and secured transactions. In addition, these rules limit the interest rates, finance charges and other fees the Company may assess, mandate extensive disclosure to the Company's customers, prohibit discrimination and impose multiple qualification and licensing obligations on the Company. Failure to comply 26 27 with these requirements may result in, among other things, loss of approved status, demands for indemnification or mortgage loan repurchases, certain rights of rescission for mortgage loans, class action lawsuits, administrative enforcement actions and civil and criminal liability. Management believes that the Company is in compliance with these rules and regulations in all material respects. The Company's loan origination activities are subject to the laws and regulations in each of the states in which those activities are conducted. For example, state usury laws limit the interest rates the Company can charge on its loans. The Company's lending activities are also subject to various federal laws, including the Truth-in-Lending Act, Homeownership and Equity Protection Act of 1994, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act. The Company is subject to certain disclosure requirements under the Truth-in-Lending Act ("TILA") and Regulation Z promulgated under TILA. TILA is designed to provide consumers with uniform, understandable information with respect to the terms and conditions of loan and credit transactions. TILA also guarantees consumers a three-day right to cancel certain credit transactions, including loans of the type originated by the Company. In addition, TILA gives consumers, among other things, a right to rescind loan transactions in certain circumstances if the lender fails to provide the requisite disclosure to the consumer. With respect to its conforming lending activities, lenders such as the Company are required annually to submit to FNMA and FHLMC audited financial statements, and each regulatory activity has its own financial requirements. The Company's affairs are also subject to examination by FNMA and FHLMC at any time to assure compliance with the applicable regulations, policies and procedures. The Company is also subject to the Homeownership and Equity Protection Act of 1994 (the "High Cost Mortgage Act"), which makes certain amendments to TILA. The High Cost Mortgage Act generally applies to consumer credit transactions secured by the consumer's principal residence, other than residential mortgage transactions, reverse mortgage transactions or transactions under an open end credit plan, in which the loan has either (i) total points and fees upon origination in excess of the greater of eight percent of the loan amount or $400, or (ii) an annual percentage rate of more than ten percent points higher than United States Treasury securities of comparable maturity ("Covered Loans"). The High Cost Mortgage Act imposes additional disclosure requirements on lenders originating Covered Loans. In addition, it prohibits lenders from, among other things, originating Covered Loans that are underwritten solely on the basis of the borrower's home equity without regard to the borrower's ability to repay the loan and including prepayment fee clauses in Covered Loans to borrowers with a debt-to-income ratio in excess of 50% or Covered Loans used to refinance existing loans originated by the same lender. The High Cost Mortgage Act also restricts, among other things, certain balloon payments and negative amortization features. The Company is also required to comply with the Equal Credit Opportunity Act of 1974, as amended ("ECOA") and Regulation B promulgated thereunder, the Fair Credit Reporting Act, as amended, the Real Estate Settlement Procedures Act of 1975, as amended, and the Home Mortgage Disclosure Act of 1975, as amended. ECOA prohibits creditors from discriminating against applicants on the basis of race, color, sex, age, religion, national origin or marital status. Regulation B restricts creditors from requesting certain types of information from loan applicants. The Fair Credit Reporting Act, as amended, requires lenders, among other things, to supply an applicant with certain information if the lender denied the applicant credit. RESPA mandates certain disclosure concerning settlement fees and charges and mortgage servicing transfer practices. It also prohibits the payment or receipt of kickbacks or referral fees in connection with the performance of settlement services. In addition, beginning with loans originated in 1997, the Company must file an annual report with HUD pursuant to the Home Mortgage Disclosure Act, which requires the collection and reporting of statistical data concerning loan transactions. In October 1997, the Department of Housing and Urban Development ("HUD") issued proposed regulations regarding the treatment and disclosure of fees charged and collected by mortgage brokers providing certain safe harbors for the payment of fees by lenders to mortgage brokers and setting forth standards to determine whether payments to mortgage brokers violate RESPA. Whether such regulations will be adopted and the form and content of any final regulations is unknown. 27 28 In the course of its business, the Company may acquire properties securing loans that are in default. There is a risk that hazardous or toxic waste could be found on such properties. In such event, the Company could be held responsible for the cost of cleaning up or removing such waste, and such cost could exceed the value of the underlying properties. Because the Company's business is highly regulated, the laws, rules and regulations applicable to the Company are subject to regular modification and change. There are currently proposed various laws, rules and regulations which, if adopted, could impact the Company. There can be no assurance that these proposed laws, rules and regulations, or other such laws, rules or regulations, will not be adopted in the future which could make compliance much more difficult or expensive, restrict the Company's ability to originate, broker, purchase or sell loans, further limit or restrict the amount of commissions, interest and other charges earned on loans originated, brokered, purchased or sold by the Company, or otherwise adversely affect the business or prospects of the Company. EMPLOYEES At June 30, 1998, the Company employed 422 persons. None of the Company's employees is subject to a collective bargaining agreement. The Company believes that its relations with its employees are satisfactory. RISK FACTORS LIMITED HISTORY OF OPERATIONS LIMITS PRIOR PERFORMANCE AS AN INDICATOR OF FUTURE PERFORMANCE The Company commenced operations in August 1995 and began originating loans in October 1995. Although the Company has been profitable for each fiscal period presented herein and has experienced substantial growth in mortgage loan originations and total revenues, there can be no assurance that the Company will be profitable in the future or that these rates of growth will be sustainable or indicative of future results. Furthermore, the Company has recently begun originating conforming loans and non-conforming loans which are not subprime loans. This is a new type of product and market in which the Company is entering. There can be no assurance that the Company will be profitable and there may be certain risks and uncertainties in which the Company is unfamiliar. Any decline in future profitability or growth rates may adversely affect the market for the Company's Common Stock which could result in volatility or a decline in its market price. Since it commenced operations in August 1995, the Company's growth in originating loans has been significant. In light of this growth, the historical financial performance of the Company may be of limited relevance in predicting future performance. Since the Company historically has sold substantially all loans originated on a whole loan basis, it has not tracked the performance of its loans in the secondary market and thus is unable to determine the history of loan losses associated with such loans. If a material portion of such loans result in loan losses to the holders thereof, the market for and pricing of the Company's loans could be adversely affected, which could materially lower revenues for a subject reporting period. NO ASSURANCE OF PLANNED GROWTH; INABILITY OF THE COMPANY TO GROW COULD ADVERSELY AFFECT THE COMPANY'S OPERATING RESULTS The Company's total revenues and net income have grown significantly since inception, primarily due to increased mortgage loan origination and sales activities. The Company intends to continue to pursue a growth strategy for the foreseeable future. Since the Company expects recent higher levels of mortgage broker compensation, which reduce the cash gain on sale of mortgage loans, to continue for the year ending June 30, 1999 and possibly thereafter, the Company believes that its future operating results will depend largely upon its ability to expand its mortgage origination and sales activities, and, in particular, increased penetration in existing markets. While the Company plans to continue its growth of loan originations through the expansion of its Wholesale Divisions and Retail Division, these plans require additional personnel and assets. To date, the Company has had a relative lack of experience in retail originations, having only originated $18.7 million through its Retail Division from the inception of the division in March 1996 through June 30, 1998. There can be no assurance that the Company will be able to successfully expand and operate such divisions and programs 28 29 profitably. It also is expected that such expansion plans will result in a substantial increase in operating expenses in the short-run. Furthermore, since management expects that there will be a time lag between the expenditure of such monies and the receipt of any revenues from such expansion efforts, the Company's results of operations may be adversely affected in the short-run. There can be no assurance that the Company will anticipate and respond effectively to all of the changing demands that its expanding operations will have on the Company's management, information and operating systems, and the failure to adapt its systems could have a material adverse effect on the Company's results of operations and financial condition. There can be no assurance that the Company will successfully achieve its planned expansion or, if achieved, that the expansion will result in profitable operations. RISK OF VARIATIONS IN QUARTERLY OPERATING RESULTS Several factors affecting the Company's business can cause significant variations in its quarterly results of operations. In particular, variations in the volume of the Company's loan originations, the differences between the Company's costs of funds and the average interest rates of originated loans, the inability of the Company to complete significant loan sales transactions in a particular quarter, and problems generally affecting the mortgage loan industry can result in significant increases or decreases in the Company's revenues from quarter to quarter. A delay in closing a particular loan sale transaction during a particular quarter would postpone recognition of cash gain on sale of loans. In addition, delays in closing a particular loan sale transaction would also increase the Company's exposure to interest rate fluctuations by lengthening the period during which its variable rate borrowings under its warehouse facilities are outstanding. If the Company were unable to sell a sufficient number of its loans at a premium in a particular reporting period, the Company's revenues for such period would decline, resulting in lower net income and possibly a net loss for such period, which could have a material adverse effect on the Company's results of operations and financial condition. DISCONTINUANCE OF EXCLUSIVE ARRANGEMENTS WITH DLJ COULD ADVERSELY AFFECT THE COMPANY'S OPERATING RESULTS The Company commenced operations in August 1995 and prior to its initial public offering in March 1998 has benefitted from its relationship with DLJ. Since commencement of operations, DLJ has provided the Company with a warehouse line of credit to fund loan production which has been the only financing facility the Company used prior to its initial public offering. The Company is substantially dependent upon its access to warehouse lines of credit and other lending facilities in order to fund loan originations. The DLJ Facility provides the Company with a $150.0 million line of credit and expires in March 2000. The interest rate of the DLJ Facility during the first 12 months bears interest at the federal funds rate plus 50 basis points until March 1999 and thereafter the rate will be the federal funds rate plus 100 basis points. It is expected that the DLJ Facility will not be extended beyond the modified term. The Company is seeking to obtain additional and alternative sources of financing on favorable terms to decrease its reliance on DLJ. While the Company is currently negotiating with other lenders to obtain additional warehouse lines of credit, the Company currently has no financing commitment for such lines of credit. Any failure by DLJ to continue to provide financing under the DLJ Facility or the Company's failure to obtain adequate funding under any additional or alternative facilities, on favorable terms or otherwise, could cause the Company to curtail loan origination activities, which would result in a decline in revenues, the effect of which could have a material adverse effect on the Company's operations. In addition, under the Company's master loan purchase agreement with DLJ, since the Company commenced business, DLJ has purchased substantially all of the Company's loan production through whole loan sales. Gain on sales of loans represents the primary source of the Company's revenues and net income. The Company relies almost entirely on proceeds from loan sales to generate cash for repayment of borrowings under the Company's warehouse facilities. There can be no assurance that DLJ will continue to purchase loans originated by the Company or will be willing to purchase such loans on terms under which it had historically purchased the Company's loans. The Company intends to sell loan production to DLJ and other institutional purchasers in the secondary market. While the Company has historically assisted DLJ in identifying purchasers of those loans purchased by DLJ under the Master Loan Purchase Agreement, there 29 30 can be no assurance that the Company would be successful in identifying other institutional purchasers or in negotiating favorable terms for such loan sales. The failure by the Company to timely sell its loans would expose the Company to interest rate fluctuations and greater risks of borrower defaults and bankruptcies, fraud losses and special hazard losses. The failure of the Company to negotiate favorable terms for its loan sales would adversely affect the Company's revenues. SUBSTANTIAL DEPENDENCE ON WHOLESALE BROKERS The Company depends largely on independent mortgage brokers, financial institutions and mortgage bankers for its originations of mortgage loans. Substantially all of the independent mortgage brokers with whom the Company does business deal with multiple loan originators for each prospective borrower. Mortgage loan originators, including the Company, compete for business based upon pricing, service, loan fees and costs and other factors. The Company's competitors also seek to establish relationships with such independent mortgage brokers, financial institutions and mortgage bankers, none of whom is contractually obligated to continue to do business with the Company. In addition, the Company expects the volume of wholesale loans that it originates to increase which will depend in large part on maintaining and expanding its relationships with its independent mortgage brokers. The Company's future results may become increasingly exposed to fluctuations in the volume and cost of its wholesale loans resulting from competition from other originators and purchasers of such loans, market conditions and other factors. SUBSTANTIAL RISKS RELATED TO LENDING TO LOWER CREDIT GRADE BORROWERS The Company's primary focus is lending in the subprime mortgage banking industry, which means that the Company focuses the substantial portion of its marketing efforts on borrowers who may be unable to obtain mortgage financing from conventional mortgage sources. Approximately 3.7% of the total principal amount of subprime loans originated by the Company during the year ended June 30, 1998 were to borrowers with a Company risk classification of "C-," which includes borrowers with numerous derogatory credit items up to and including a bankruptcy in the most recent 12-month period. In addition, for the year ended June 30, 1998, approximately 43.1% of the Company's total subprime loan originations were made under its "Stated Income Documentation" program pursuant to which the Company does not require any income documentation. As a result, the Company does not independently verify in writing the accuracy of the stated income of such borrowers on their mortgage loan applications which may subject the Company to a greater risk of borrower misrepresentations. Also, an undeterminable percentage of the Company's subprime loans and non-conforming loans are made based on exceptions to the Company's underwriting guidelines; any exception may cause a borrower to be placed in a more favorable borrower risk classification and thereby be provided loan terms which such borrower may not have qualified for absent such exception. Loans made to such borrowers generally entail a higher risk of delinquency and higher losses than loans made to borrowers who utilize conventional mortgage sources. Delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. Further, any material decline in real estate values increase the loan-to-value ratios of loans previously made by the Company, thereby weakening collateral coverage and increasing the possibility of a loss in the event of a borrower default. Any sustained period of increased delinquencies, foreclosures or losses after the loans are sold could adversely affect the pricing of the Company's future loan sales and the ability of the Company to sell its loans in the future. In the past, certain of these factors have caused revenues and net income of many participants in the mortgage industry, including the Company, to fluctuate from quarter to quarter. See "Business -- Underwriting." SUBSTANTIAL COMPETITION MAY ADVERSELY AFFECT THE COMPANY'S ABILITY TO ORIGINATE, SELL OR FINANCE MORTGAGE LOANS As an originator of mortgage loans, the Company faces intense competition, primarily from mortgage banking companies, commercial banks, credit unions, thrift institutions and finance companies. Many of these entities are substantially larger and have more capital and other resources than the Company. With respect to other mortgage banking and specialty finance companies, there are many larger companies that focus on the same types of mortgage loans with which the Company directly competes for product. From time to time, one 30 31 or more of these companies may be dominant in the origination and sale of mortgage loans. In addition, many financial services organizations that are much larger than the Company have formed national loan origination networks offering loan products that are substantially similar to the Company's loan programs. 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. If the Company is unable to remain competitive in these areas, the volume of the Company's loan originations may be materially adversely affected as borrowers seek out other lenders for their financing needs. Lower originations may have an adverse effect on the Company's ability to negotiate and obtain sufficient financing under warehouse lines of credit upon acceptable terms. Furthermore, the current level of gains realized by the Company and its competitors on the sale of the type of loans they originate and purchase is attracting and may continue to attract additional competitors into this market with the possible effect of lowering gains that may be realized on the Company's loan sales. Establishing a broker-sourced loan business typically requires a substantially smaller commitment of capital and personnel resources than a direct-sourced loan business. This relatively low barrier to entry permits new competitors to enter the broker-sourced loan market quickly, particularly existing direct-sourced lenders which can draw upon existing branch networks and personnel in seeking to sell products through independent brokers. Competition may be affected by fluctuations in interest rates and general economic conditions. During periods of rising rates, competitors which have locked in low borrowing costs may have a competitive advantage. Increased competition could have the possible effects of (i) lowering gains that may be realized on the Company's loan sales, (ii) reducing the volume of the Company's loan originations and loan sales, (iii) increasing the demand for the Company's experienced personnel and the potential that such personnel will be recruited by the Company's competitors, and (iv) lowering the industry standard for non-conforming underwriting guidelines (i.e., providing for higher loan-to-value ratios) as competitors attempt to increase or maintain market share in the face of increased competition. In the past, certain of these factors have caused revenues and net income of many participants in the mortgage industry, including the Company, to fluctuate from quarter to quarter. There can be no assurance that the Company will be able to continue to compete successfully in the markets it serves. Inability to compete successfully would have a material adverse effect on the Company's results of operations and financial condition. RISK OF COMPETITION IN NEW MARKETS As the Company expands into new geographic markets, it may face competition from lenders with established positions in these locations. There can be no assurance that the Company will be able to successfully compete with such established lenders, the effect of which may have a material adverse effect on the Company's results of operations and financial condition. RISK OF COMPETITION FROM GOVERNMENT-SPONSORED ENTITIES In the future, the Company may also face competition from, among others, government-sponsored entities which may enter the non-conforming mortgage market. Existing or new loan purchase programs may be expanded by the FNMA, FHLMC, or GNMA to include non-conforming mortgages, particularly those in the "Alt A" category, which constitute a significant portion of the Company's loan production. For example, in August 1998, FHLMC announced that it has entered, on a limited basis, the non-conforming mortgage market (not including subprime loans). Entries of such government-sponsored entities into the non-conforming market may have an adverse effect on loan yields on mortgage loans originated by the Company and reduce or eliminate premiums on loan sales. GENERAL ECONOMIC CONDITIONS MAY ADVERSELY AFFECT COMPANY OPERATIONS The Company's business may be adversely affected by periods of economic slowdown or recession which may be accompanied by decreased demand for consumer credit and declining real estate values. Any material decline in real estate values reduces the ability of borrowers to use home equity to support borrowings and 31 32 increases the loan-to-value ratios of loans previously made by the Company, thereby weakening collateral coverage and increasing the possibility of a loss in the event of default. To the extent that the loan-to-value ratios of prospective borrowers' home equity collateral do not meet the Company's underwriting criteria, the volume of loans originated by the Company could decline. Further, delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions. Because of the Company's focus on borrowers who are unable or unwilling to obtain mortgage financing from conventional mortgage sources, whether for reasons of credit impairment, income qualification or credit history or a desire to receive funding on an expedited basis, the actual rates of delinquencies, foreclosures and losses on such loans could be higher under adverse economic conditions than those currently experienced in the mortgage lending industry in general. Any sustained period of such increased delinquencies, foreclosures or losses could adversely affect the pricing of the Company's loan sales whether through whole loan sales or future securitizations. A decline in loan origination volumes could have a material adverse effect on the Company's operations and financial condition. CHANGES IN INTEREST RATES MAY ADVERSELY AFFECT NET INCOME AND PROFITABILITY Profitability may be directly affected by the level of and fluctuations in interest rates which affect the Company's ability to earn a spread between interest received on its loans held for sale and rates paid on warehouse lines. The Company's profitability may be adversely affected during any period of unexpected or rapid change in interest rates due to the fact that the Company does not currently hedge its portfolio of mortgage loans held for sale. A substantial and sustained increase in interest rates could adversely affect the Company's ability to originate loans. Also, a significant decline in interest rates could increase the level of loan prepayments and require the Company to write down the value of the interest-only and residual certificates retained in any future securitizations, thereby adversely impacting earnings. Adjustable-rate mortgage loans originated by the Company amounted to $100.6 million and $110.9 million in principal amount during the years ended June 30, 1998 and 1997, respectively. Substantially all such adjustable-rate mortgage loans included a "teaser" rate, i.e., an initial interest rate significantly below the fully indexed interest rate at origination. Although these loans are underwritten at 1.0% above the initial or start rate at origination, borrowers may encounter financial difficulties as a result of increases in the interest rate over the life of the loan, which may adversely impact the performance of the Company's loans in the secondary market. Any sustained period of increased delinquencies, foreclosures or losses after the loans are sold could adversely affect the pricing of the Company's future loan sales and the ability of the Company to sell its loans in the future. ELIMINATION OF LENDER PAYMENTS TO BROKERS COULD ADVERSELY AFFECT RESULTS OF OPERATIONS Lawsuits have been filed against several mortgage lenders, not including the Company, alleging that such lenders have made certain payments to independent mortgage brokers in violation of RESPA. These lawsuits have generally been filed on behalf of a purported nationwide class of borrowers alleging that payments made by a lender to a broker in addition to payments made by the borrower to a broker are prohibited by RESPA and are therefore illegal. If these cases are resolved against the lenders, it may cause an industry-wide change in the way independent mortgage brokers are compensated. The Company's broker compensation programs permit such payments. The Company makes such payments in the ordinary course of business. Due to competitive conditions, these payments have increased in recent periods, which adversely affected the Company's cash gain on sale of mortgage loans for the year ended June 30, 1998. Management expects this increased level of payments to continue for the year ending June 30, 1999 and possibly thereafter. Although the Company believes that its broker compensation programs comply with all applicable laws and are consistent with long-standing industry practice and regulatory interpretations, in the future new regulatory interpretations or judicial decisions may require the Company to change its broker compensation practices. Such a change may have a material adverse effect on the Company and the entire mortgage lending industry. POTENTIAL ADVERSE EFFECT OF REPRESENTATIONS AND WARRANTIES IN LOAN SALES Loan sales are made to DLJ on a non-recourse basis pursuant to the Master Loan Purchase Agreement containing customary representations and warranties by the Company regarding the underwriting criteria and 32 33 the origination process. The Company is required to provide similar representations and warranties to those institutional purchasers to whom DLJ sells the subject loans. The Company, therefore, may be required to repurchase or substitute loans in the event of a breach of a representation or warranty to DLJ or the institutional purchaser, any misrepresentation during the mortgage loan origination process or, in some cases, upon any fraud or first payment default on such mortgage loans. In an environment of rapid whole loan sales, the Company may not have substitute loans which are not previously committed for sale readily available in which case the Company would be required to effect a repurchase. During the years ended June 30, 1998 and 1997, the Company repurchased $75,000 and $178,000 of loans, respectively; no loans were repurchased during the year ended June 30, 1996. There can be no assurance that such repurchase levels will not substantially increase in future periods. Any claims asserted against the Company in the future by its loan purchasers may result in liabilities or legal expenses that could have a material adverse effect on the Company's results of operations and financial condition. In addition, any material repurchase or substitution of loans may have an adverse effect on the market for and pricing of the Company's loans. DEPENDENCE ON A LIMITED NUMBER OF KEY PERSONNEL The Company's growth and development to date have been largely dependent upon the services of Evan R. Buckley, the Company's Chief Executive Officer, and Kelly W. Monahan, the Company's President and Chief Financial Officer. The loss of Messrs. Buckley's or Monahan's services for any reason could have a material adverse effect on the Company. The Company does not maintain key person life insurance on the lives of any of its employees. In addition, the Company's future success will require it to recruit additional key personnel, including additional sales and marketing personnel. The Company believes that its future success also substantially depends on its ability to attract, retain and motivate highly skilled employees, who are in great demand. There can be no assurance that the Company will be successful in doing so. SUBSTANTIAL RISKS ASSOCIATED WITH FUTURE SECURITIZATIONS The Company may in the future sell loans through securitizations which involve substantial risks, including the following: Inability to Securitize Mortgage Loans. The Company anticipates that it may in the future acquire and accumulate mortgage loans until a sufficient quantity has been acquired for securitization. There can be no assurance that the Company will be successful in securitizing mortgage loans. During the accumulation period, the Company will be subject to risks of borrower defaults and bankruptcies, fraud losses and special hazard losses. In the event of any default under mortgage loans held by the Company, the Company will bear the risk of loss of principal to the extent of any deficiency between the value of the mortgage collateral and the principal amount of the mortgage loan. Also during the accumulation period, the costs of financing the mortgage loans through warehouse lines of credit or reverse repurchase agreements could exceed the interest income on the mortgage loans. It may not be possible or economical for the Company to complete the securitization of all mortgage loans that it acquires, in which case the Company will continue to hold the mortgage loans and bear the risks of borrower defaults and special hazard losses. Potential Recourse Against Company in Securitizations. To the extent that the Company engages in securitizations, the Company intends to transfer loans originated by the Company to a trust in exchange for cash, "interest-only" and residual certificates issued by the trust. The trustee will have recourse to the Company with respect to the breach of standard representations or warranties made by the Company at the time such loans are transferred, the effect of which may have a material adverse effect on the Company's results of operations and financial condition. Value of Interest-only, Principal-only, Residual Interest and Subordinated Securities Subject to Fluctuation. To the extent that the Company engages in securitizations, the Company's assets will likely include "interest-only," "principal-only," residual interest and subordinated securities, which will be valued by the Company in accordance with SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." The Company will record its retained interest in securitizations (including "interest-only," "principal-only" and subordinated securities) as investments classified as trading securities. 33 34 Realization of these "interest-only," "principal-only," residual interest and subordinated securities in cash is subject to the timing and ultimate realization of cash flows associated therewith, which is in turn effected by the prepayment and loss characteristics of the underlying loans. The Company will estimate future cash flows from these "interest-only," "principal-only," residual interest and subordinated securities and will value such securities with assumptions that it believes to be consistent with those that would be utilized by an unaffiliated third-party purchaser. If actual experience differs from the assumptions used in the determination of the asset value, future cash flows and earnings could be negatively impacted, and the Company could be required to reduce the value of its "interest-only," "principal-only," residual interest and subordinated securities in accordance with SFAS 125. The value of such securities can fluctuate widely and may be extremely sensitive to changes in discount rates, projected mortgage loan prepayments and loss assumptions. Risks Regarding Hedging. In the future the Company may hedge its variable-rate mortgage loans and any interest-only and residual certificates retained in connection with any future securitizations with hedging transactions which may include forward sales of mortgage loans or mortgage-backed securities, interest rate caps and floors and buying and selling of futures and options on futures. Hedging techniques involving the use of derivative financial investments are highly complex and may prove volatile. The financial futures contracts and options thereon in which the Company may invest are subject to periodic margin calls that would result in additional costs to the Company. If a hedging instrument utilized by the Company were found to be legally unenforceable, the Company's portfolio of loans held for sale would be exposed to interest rate fluctuations which could materially and adversely affect the Company's business and results of operations. Additionally, hedging strategies have significant transaction costs. The nature and quantity of hedging transactions will be determined by the Company's management based on various factors, including market conditions and the expected volume of mortgage loan originations and purchases. No assurance can be given that such hedging transactions will offset the risks of changes in interest rates, and it is possible that there will be periods during which the Company could incur losses after accounting for its hedging activities. COMPANY PERFORMANCE MAY BE AFFECTED BY CONTRACTED SUB-SERVICING While the Company currently sells substantially all of the mortgage loans it originates servicing released, it is required to service the loans from the date of funding through the date of sale. Since the Company conducts whole loan sales monthly, the Company currently does not have a substantial servicing portfolio. Nonetheless, the Company currently contracts for the sub-servicing of all mortgage loans it originates through the date of sale and is subject to risks associated with inadequate or untimely services. To the extent that the Company decides to retain servicing rights in the future or conduct securitizations, it currently intends to contract for the sub-servicing of such mortgage loans, which would expose it to more substantial risks associated with contracted sub-servicing. In such event, it is expected that many of the Company's borrowers will require notices and reminders to keep their mortgage loans current and to prevent delinquencies and foreclosures. A substantial increase in the Company's delinquency rate or foreclosure rate could adversely affect its ability to access profitably the capital markets for its financing needs, including any future securitizations. Any of the Company's sub-servicing agreements with its third-party sub-servicers are expected to provide that if the Company terminates the agreement without cause (as defined in the agreement), the Company may be required to pay the third-party sub-servicer a fee. Depending upon the size of the Company's loan portfolio sub-serviced at any point in time, the termination penalty that the Company would be obligated to pay upon termination without cause, may be substantial. The Company intends to subcontract with sub-servicers to service the mortgage loans for any of its public securitizations. With respect to such mortgage loans, the related pooling and servicing agreements would permit the Company to be terminated as master servicer under specific conditions described in such agreements, which generally include the failure to make payments, including advances, within specific time periods. Such termination would generally be at the option of the trustee but not at the option of the Company. If, as a result of a sub-servicer's failure to perform adequately, the Company were terminated as master servicer of a securitization, the value of any servicing rights held by the Company would be adversely impacted. In addition, if a new sub-servicer were selected with respect to any such securitization, the change 34 35 in sub-servicing may result in greater delinquencies and losses on the related loans, which would adversely impact the value of any "interest-only," "principal-only," residual interest and subordinated securities held by the Company in connection with such securitization. CONCENTRATION OF OPERATIONS MAY ADVERSELY AFFECT COMPANY OPERATIONS Approximately 30.0%, 36.9% and 53.6% of the dollar volume of loans originated by the Company during the years ended June 30, 1998, 1997 and 1996, respectively, were secured by properties located in California. No other state contained properties securing more than 10% of the dollar volume of loans originated by the Company during such periods, other than Illinois which accounted for 16.6% and 10.4% for the years ended June 30, 1998 and 1997, respectively, and Hawaii which accounted for 12.0% for the year ended June 30, 1997. Although the Company has a growing independent broker network outside of California, the Company is likely to continue to have a significant amount of its loan originations in California for the foreseeable future, primarily because California represents a significant portion of the national mortgage marketplace. Consequently, the Company's results of operations and financial condition are dependent upon general trends in the California economy and its residential real estate market. The California economy experienced a slowdown or recession in recent years that has been accompanied by a sustained decline in the California real estate market. Residential real estate market declines may adversely affect the values of the properties securing loans such that the principal balances of such loans will equal or exceed the value of the mortgaged properties. Reduced collateral value will adversely affect the volume of the Company's loans as well as the pricing of the Company's mortgage loans and the Company's ability to sell its loans. In addition, California historically has been vulnerable to certain natural disaster risks, such as earthquakes and erosion-caused mudslides, which are not typically covered by the standard hazard insurance policies maintained by borrowers. Uninsured disasters may adversely impact borrowers' ability to repay mortgage loans made by the Company, any sustained period of increased delinquencies or defaults could adversely affect the pricing of the Company's future loan sales and the ability of the Company to sell its loans. The existence of adverse economic conditions or the occurrence of such natural disasters in California could have a material adverse effect on the Company's results of operations and financial condition. REAL PROPERTY WITH ENVIRONMENTAL PROBLEMS MAY CREATE LIABILITY FOR THE COMPANY In the course of its business, the Company may acquire real property securing loans that are in default. There is a risk that hazardous substances or waste, contaminants, pollutants or sources thereof could be discovered on such properties after acquisition by the Company. In such event, the Company might be required to remove such substances from the affected properties at its sole cost and expense. The cost of such removal may substantially exceed the value of the affected properties or the loans secured by such properties. There can be no assurance that the Company would have adequate remedies against the prior owners or other responsible parties, or that the Company would not find it difficult or impossible to sell the affected real properties either prior to or following any such removal, the effect of which may have a material adverse effect on the Company's results of operations and financial condition. COMPANY SUBJECT TO EXTENSIVE LEGISLATIVE AND REGULATORY RISKS The Company's business is subject to extensive regulation, supervision and licensing by federal, state and local governmental authorities and is subjected to various laws and judicial and administrative decisions imposing requirements and restrictions on a substantial portion of its operations. The Company's consumer lending activities are subject to the Federal Truth-in-Lending Act and Regulation Z (including the Home Ownership and Equity Protection Act of 1994), the Federal Equal Credit Opportunity Act and Regulation B, as amended ("ECOA"), the Fair Credit Reporting Act of 1970, as amended, RESPA and Regulation X, the Fair Housing Act, the Home Mortgage Disclosure Act and the Federal Debt Collection Practices ACT, as well as other federal and state statutes and regulations affecting the Company's activities. The Company is also subject to the rules and regulations of and examinations by the Department of Housing and Urban Development ("HUD") and state regulatory authorities with respect to originating, processing, underwriting, selling, securitizing and servicing loans. These rules and regulations, among other things, impose licensing 35 36 obligations on the Company, establish eligibility criteria for mortgage loans, prohibit discrimination, provide for inspections and appraisals of properties, require credit reports on loan applicants, regulate assessment, collection, foreclosure and claims handling, investment and interest payments on escrow balances and payment features, mandate certain disclosures and notices to borrowers and, in some cases, fix maximum interest rates, fees and mortgage loan amounts. Failure to comply with these requirements can lead to loss of approved status, termination or suspension of servicing contracts without compensation to the servicer, demands for indemnifications or mortgage loan repurchases, certain rights of rescission for mortgage loans, class action lawsuits and administrative enforcement actions. With respect to its confirming lending activities, lenders such as the Company are required annually to submit to FNMA and FHLMC audited financial statements, and each regulatory activity has its own financial requirements. The Company's affairs are also subject to examination by FNMA and FHLMC at any time to assure compliance with the applicable regulations, policies and procedures. In October 1997, HUD issued proposed regulations regarding the treatment and disclosure of fees charged and collected by mortgage brokers providing certain safe harbors for the payment of fees by lenders to mortgage brokers and setting forth standards to determine whether payments to mortgage brokers violate RESPA. Whether such regulations will be adopted and the form and content of any final regulations is unknown. The Company is subject to licensing by state authorities. In addition, any person who acquires more than 10% of the Company's stock will become subject to certain state licensing regulations requiring such person periodically to file certain financial and other information. If any person holding more than 10% of the Company's stock refuses to adhere to such filing requirements, the Company's existing licensing arrangements could be jeopardized. The loss of required licenses could have a material adverse effect on the Company's results of operations and financial condition. Although the Company believes that it has systems and procedures to facilitate compliance with these requirements and believes that it is in compliance in all material respects with applicable local, state and federal laws, rules and regulations, there can be no assurance that more restrictive laws, rules and regulations will not be adopted in the future that could make compliance more difficult or expensive. Members of Congress and government officials have from time to time suggested the elimination of the mortgage interest deduction for federal income tax purposes, either entirely or in part, based on borrower income, type of loan or principal amount. Because many of the Company's loans are made to borrowers for the purpose of consolidating consumer debt or financing other consumer needs, the competitive advantage of tax deductible interest, when compared with alternative sources of financing, could be eliminated or seriously impaired by such government action. Accordingly, the reduction or elimination of these tax benefits could have a material adverse effect on the demand for loans of the kind offered by the Company. POSSIBLE NEED FOR ADDITIONAL EQUITY FINANCING The Company's primary operating cash requirements include the funding or payment of (i) loan originations, (ii) interest expense incurred on borrowings under warehouse lines of credit, (iii) income taxes, (iv) capital expenditures and (v) other operating and administrative expenses. The Company funds these cash requirements primarily through warehouse lines of credit and whole loan sales. In addition, if the Company conducts securitizations, it would require liquidity to fund its investments in "interest-only" and residual certificates and for fees and expenses incurred with securitizations. The Company's ability to implement its business strategy will depend upon its ability to establish alternative long-term financing arrangements with parties other than DLJ and obtain sufficient financing under warehouse facilities upon acceptable terms. There can be no assurance that such financing will be available to the Company on favorable terms, if at all. If such financing were not available or the Company's capital requirements exceed anticipated levels, then the Company would be required to obtain additional equity financing which would dilute the interests of stockholders who invest in this Offering. The Company cannot presently estimate the amount and timing of additional equity financing requirements because such requirements are tied to, among other things, the 36 37 growth of the Company. If the Company were unable to raise such additional capital, its results of operations and financial condition would be adversely affected. ANY FUTURE ACQUISITIONS OF OTHER SPECIALTY FINANCE COMPANIES, OTHER FINANCE OR MORTGAGE COMPANIES OR ASSETS MAY HAVE ADVERSE EFFECTS ON THE COMPANY'S BUSINESS The Company may, from time to time, engage in the acquisition of other specialty finance companies, other finance or mortgage companies or portfolios of loan assets. Any acquisition made by the Company may result in potentially dilutive issuances of equity securities, the incurrence of additional debt and the amortization of expenses related to goodwill and other intangible assets, any of which could have a material adverse effect on the Company's business and results of operations. The Company also may experience difficulties in the assimilation of the operations, services, products and personnel related to acquired companies or loan portfolios, an inability to sustain or improve the historical revenue levels of acquired companies, the diversion of management's attention from ongoing business operations and the potential loss of key employees of such acquired companies. The Company currently has no formal agreements with regard to any potential acquisition and there can be no assurance that future acquisitions, if any, will be consummated. SIGNIFICANT INFLUENCE OF CURRENT MANAGEMENT The officers and directors of the Company beneficially own 32% of the outstanding Common Stock of the Company. As a result, the Company's current management through its stock ownership and otherwise is able to exert significant influence over the business and affairs of the Company. POSSIBLE VOLATILITY OF STOCK PRICE The trading price of the Company's Common Stock has been in the past and could be in the future subject to significant fluctuations in response to variations in quarterly operating results, changes in analysts' estimates, general conditions in the speciality finance industry and other factors. For example, on April 20, 1998 the price per share was $14.125 and on August 31, 1998 it was $6.125. In addition, for example, companies engaging in securitizations record non-cash gain on sale of mortgage loans from the revenue expected to be obtained from retained residual interests in future payments on the loans. Realization of cash from these residual interests is subject to the timing and ultimate realization of cash flows associated therewith, which in turn is affected by the prepayment and loss characteristics of the underlying loans. Several specialty finance companies recently have been required to "write-down" the value of their retained interests, and therefore reduce or eliminate reported earnings, largely as a result of a higher than anticipated level of prepayments on the underlying loans which has materially adversely affected their stock prices. Stock prices of other specialty finance companies that utilize more conservative assumptions in recording non-cash gain on sale and those, such as the Company, that sell whole loans for cash and do not engage in material securitization activities, also have been adversely impacted by these developments. There can be no assurance the future market price of the Company's Common Stock will not be adversely impacted by the results of operation of, and market reactions to, other specialty finance companies. Furthermore, in September 1998, the Company initiated a stock repurchase program pursuant to which it has, as of September 14, 1998, repurchased 146,200 shares of Common Stock ranging from $7.00 to $7.125 per share. The Company may increase its capital by making additional private or public offerings of its Common Stock, securities convertible into its Common Stock or debt securities. The actual or perceived effect of such offerings, the timing of which cannot be predicted, may be the dilution of the book value or earnings per share of the Common Stock outstanding, which may result in the reduction of the market price of the Common Stock. ANTI-TAKEOVER EFFECT OF DELAWARE LAW The Company is a Delaware corporation and as such is subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. In general, Section 203 prevents an "interested stockholder" (defined generally as a person owning more than 15% or more of the Company's outstanding 37 38 voting stock) from engaging in a "business combination" with the Company for three years following the date that person became an interested stockholder unless the business combination is approved in a prescribed manner. This statute could make it more difficult for a third party to acquire control of the Company. ISSUANCE OF PREFERRED STOCK MAY ADVERSELY AFFECT HOLDERS OF COMMON STOCK The Board of Directors has the authority to issue up to 5,000,000 shares of undesignated Preferred Stock and to determine the rights, preferences, privileges and restrictions of such shares without any further vote or action by the stockholders. Although at present the Company has no plans to issue any of the Preferred Stock, the Preferred Stock could be issued with voting, liquidation, dividend and other rights superior to the rights of the Common Stock. The issuance of Preferred Stock under certain circumstances could have the effect of delaying or preventing a change in control of the Company. SHARES ELIGIBLE FOR FUTURE SALE MAY ADVERSELY AFFECT THE MARKET PRICE OF THE COMPANY'S COMMON STOCK The sales of substantial amounts of the Company's Common Stock in the public market or the prospect of such sales could materially and adversely affect the market price of the Common Stock. As of September 14, 1998, the Company had outstanding 5,729,779 shares of Common Stock. Shares of Common Stock held by affiliates are restricted in nature and are saleable to the extent permitted pursuant to Rule 144 under the Securities Act. The Company's 1997 Stock Option, Deferred Stock and Restricted Stock Plan (the "Stock Option Plan") authorizes the grant of options to purchase, and awards of, 800,000 shares; of this amount, options to acquire 163,265 shares of Common Stock have been granted at a per share exercise price of $6.10; options to acquire 447,402 shares of Common Stock have been granted at a per share exercise of $9.50 and 12,500 options to acquire shares of Common Stock have been granted at a per share exercise price of $11.00. The Company intends to register under the Securities Act shares reserved for issuance pursuant to the Stock Option Plan. In addition, in connection, with the Company's initial public offering, the representatives of the underwriters were sold Representatives' Warrants evidencing the right to purchase from the Company up to 317,319 shares of Common Stock at an exercise price of $10.45 per share. The holders of the Representatives' Warrants are entitled to certain registration rights. ITEM 2. PROPERTIES The Company's executive and administrative offices are located at 1063 McGaw Avenue, Irvine, California 92614, which consists of approximately 54,768 square feet. The lease on the premises expires on November 30, 2002 and the current monthly rent is approximately $71,200. The Company also leases space for its other offices. As of June 30, 1998, these facilities aggregate approximately 50,043 square feet, with monthly aggregate base rental of approximately $70,300. The terms of these leases vary as to duration and rent escalation provisions. In general, the leases expire between October 1998 and March 2003 and provide for rent escalations tied to either increases in the lessor's operating expenses or fluctuations in the consumer price index in the relevant geographical area. ITEM 3. LEGAL PROCEEDINGS The Company occasionally becomes involved in litigation arising from the normal course of business. Management believes that any liability with respect to pending legal actions, individually or in the aggregate, will not have a material adverse effect on the Company's financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the quarter ended June 30, 1998. 38 39 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS In March 10, 1998 the Company's common stock began trading under the symbol BNCM on the Nasdaq National Market. The initial public offering of 3,173,196 shares of common stock at $9.50 per share on March 10, 1998. On March 11, 1998, the underwriters purchased an additional 475,979 shares of common stock at a price of $9.50 per share following their exercise of the over allotment option, resulting in a total of 3,649,175 shares sold in the initial public offering (the "Offering"). The Company received net proceeds of $16,199,000 from the Offering. As of June 30, 1998 of these proceeds, approximately $4.05 million was used to fund loan originations, and the remaining balance has been invested in short term investments. In connection with the Offering, warrants were issued to the representatives of the underwriters to purchase up to 317,319 additional shares of common stock at an exercise price of $10.45 per share, exercisable over a period of four years, commencing one year from March 10, 1998. As of June 30, 1998, the Company had 5,729,779 shares of common stock outstanding. On September 1, 1998, the Company's Board of Directors authorized the Company to repurchase up to $2 million of the Company's common stock, in open market purchases from time to time at the discretion of the Company's management. As of September 14, 1998, the Company had repurchased 146,200 shares of common stock at a cost of $1,040,908. The follow table sets forth the range of high and low closing sale prices of the Company's Common Stock for the periods indicated:
1998 HIGH LOW ---- ------- ------- Quarter ended: March 31, 1998............................... $13.125 $11.625 Quarter ended: June 30, 1998................................ $14.125 $10.625
No dividends have been paid on the Company's common stock. The Company does not anticipate paying dividends in the near future. Any decision made by the Company's Board of Directors to pay dividends in the future will depend upon the Company's future earnings, capital requirements, financial condition and other factors deemed relevant by the Company's Board of Directors. On September 14, 1998, the Company had approximately 17 stockholders of record, (including holders who are nominees for an undetermined number of beneficial owners) of its Common Stock. 39 40 ITEM 6. SELECTED FINANCIAL DATA The following selected statement of operations data and balance sheet data are derived from consolidated financial statements of the Company. The data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the consolidated financial statements and related notes and other financial information included herein. The Company was formed on May 2, 1995 and began operations in August 1995. For the period of May 2, 1995 through June 30, 1995, the Company did not have any revenue and recorded start-up costs of $10,000. Selected statement of operations data and balance sheet data are not presented for the period May 2, 1995 through June 30, 1995, as the operations were not material.
YEAR ENDED JUNE 30, ------------------------------------------------ 1998 1997 1996 ------------ ------------ ------------ (IN THOUSANDS EXCEPT PER SHARE DATA AND RATIOS) STATEMENT OF OPERATIONS DATA Revenues: Gain on sale of mortgage loans....................... $ 30,458 $ 21,855 $ 4,240 Loan origination income.............................. 5,399 5,473 1,978 Interest income...................................... 7,860 5,182 1,960 Other Income......................................... 676 250 52 -------- -------- -------- Total revenues............................... 44,393 32,760 8,230 -------- -------- -------- Expenses: Employees' salaries and commissions.................. 18,828 11,052 3,624 General and administrative expenses.................. 8,028 5,543 2,400 Interest expense..................................... 5,486 3,693 1,452 -------- -------- -------- Total expenses............................... 32,342 20,288 7,476 -------- -------- -------- Income before taxes.................................... 12,051 12,472 754 Income tax expense..................................... 4,815 4,930 337 -------- -------- -------- Net income............................................. $ 7,236 $ 7,542 $ 417 ======== ======== ======== Net income per share: Basic................................................ $ 1.55 $ 1.80 $ 0.14 ======== ======== ======== Diluted.............................................. $ 1.51 $ 1.80 $ 0.14 ======== ======== ======== Shares used in computing net income per share: Basic................................................ 4,654 4,187 2,892 ======== ======== ======== Diluted.............................................. 4,796 4,187 2,892 ======== ======== ======== OPERATING STATISTICS Loan originations: Mortgage loan originations............................. $788,479 $532,621 $199,963 Whole loan sales....................................... $744,365 $519,909 $156,559 Average initial principal balance per loan............. $ 100 $ 98 $ 101 Gain on sale as a percentage of whole loan sales....... 4.1% 4.2% 2.7%
AS OF JUNE 30 ------------------------------------ 1998 1997 1996 -------- -------- -------- BALANCE SHEET DATA Cash and cash equivalents.............................. $ 25,890 $ 8,268 $ 2,452 Restricted cash........................................ 638 -- -- Mortgage loans held for sale........................... 98,717 55,145 42,723 Total assets........................................... 130,555 65,713 46,352 Warehouse line of credit............................... 96,022 54,625 42,723 Total liabilities...................................... 99,704 56,509 44,506 Total stockholders' equity............................. 30,851 9,204 1,846
40 41 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of the financial condition, results of operations and liquidity and capital resources should be read in conjunction with the Company's consolidated financial statements and notes included in Item 14 of this 10-K. GENERAL BNC Mortgage, Inc. is a specialty finance company engaged in the business of originating, purchasing and selling, on a whole loan basis for cash, non-conforming and, to a lessor extent conforming, residential mortgage loans secured by one-to-four family residences. The term "non-conforming loans" as used herein means (i) subprime loans, which are loans made to borrowers who are unable or unwilling to obtain mortgage financing from conventional mortgage sources, whether for reasons of credit impairment, income qualification or credit history or a desire to receive funding on an expedited basis and (ii) non-conforming loan products for primarily high credit borrowers whose credit scores equal or exceed levels required for the sale or exchange of their mortgage loans through FNMA and FHLMC, but where the loan itself fails to meet conventional mortgage guidelines, such as the principal balance exceeds the maximum loan limit of $227,150 or the loan structure documentation does not conform to agency requirements. The Company's loans are made primarily to refinance existing mortgages, consolidate other debt, finance home improvements, education and other similar needs, and, to a lesser extent, to purchase single family residences. The Company has three divisions: (i) a wholesale subprime division which has relationships with approximately 3,200 approved independent loan brokers and which to date has accounted for substantially all of the Company's total loan originations, (ii) a wholesale prime division which originates conforming loans that meet FNMA, FHLMC and other conventional mortgage guidelines and non-conforming loan products which are not subprime loans, and (iii) a retail division which markets loans directly to homeowners. Substantially all of the Company's mortgage loan originations are sold in the secondary market through loan sales in which the Company disposes of its entire economic interest in the loans including the related servicing rights for cash. As a result of this strategy, the Company receives cash revenue, rather than recognizing non-cash revenue attributable to residual interests in future loan payments on the loan, as is the case with securitizations. The following table shows the Company's mortgage loan originations, mortgage loan sales, cash gain on sale of mortgage loans and origination locations with account executives for the periods indicated:
YEAR ENDED JUNE 30, -------------------------------- 1998 1997 1996 -------- -------- -------- (DOLLARS IN THOUSANDS) Mortgage loan originations......................... $788,479 $532,621 $199,963 Mortgage loan sales................................ $744,365 $519,909 $156,559 Gain on sale of mortgage loans..................... $ 30,458 $ 21,855 $ 4,240 Origination locations at end of period............. 53 38 19
Revenues are derived primarily from cash gain on sales of loans and interest income from loans held for sale. The major components of the Company's revenues are (i) the volume of loans originated, (ii) the premium over principal amount received in loan sales, (iii) origination points received or paid, (iv) origination fees received and (v) the differential between the interest rate on borrowings under revolving warehouse credit facilities and the interest rate of loans held for sale. Cash gain on sale of mortgage loans is affected by, among other things, borrower credit risk classification, loan-to-value ratio, interest rate and margin of the loans. Revenues increased 36% and 298% for the years ended June 30 1998 and 1997, respectively. The major components of expenses are employees' salaries and commissions, general and administrative, and interest. Employees' salaries and commissions, for the years ended June 30, 1998, 1997 and 1996 accounted for 58%, 54% and 48% of total expenses, respectively. Employees' salaries and commissions are primarily related to the loan origination volume because the Company's sales force is compensated on a commission basis in addition to salaries. Total expenses were $32.3 million, $20.3 million and $7.5 million for the years ended June 30, 1998, 1997 and 1996, respectively. 41 42 The Company's net income decreased to $7.2 million for the year ended June 30, 1998 compared to $7.5 million and $0.4 million for years ended June 30, 1997 and 1996, respectively. Increased competition in the mortgage industry could have the effect of (i) lowering gains that may be realized on loan sales through lower cash premiums paid for loans or an increase in demand for yield spread premium paid to the mortgage brokers, (ii) reducing an individual company's volume of loan originations and sales, (iii) increasing demand for experienced personnel increasing the likelihood such personnel will be recruited by competitors and (iv) lowering the industry standard for underwriting guidelines as competitors attempt to increase or maintain market share in the face of increased competition. In the past, certain of these factors have caused the revenues and net income of many participants in the mortgage industry, including the Company, to fluctuate from quarter to quarter. RESULTS OF OPERATIONS YEAR ENDED JUNE 30, 1998 COMPARED TO THE YEAR ENDED JUNE 30, 1997 Revenues. The following table sets forth the components of the Company's revenues for the periods indicated:
YEAR ENDED JUNE 30, ---------------------- 1998 1997 --------- --------- (DOLLARS IN THOUSANDS) Gain on sale of mortgage loans.............................. $30,458 $21,855 Loan origination income..................................... 5,399 5,473 Interest income............................................. 7,860 5,182 Other income................................................ 676 250 ------- ------- $44,393 $32,760 ======= =======
The increase in revenues was due primarily to increased mortgage loan originations and cash gain on sales of mortgage loans. Mortgage loan originations increased $255.9 million to $788.5 million for the year ended June 30, 1998 from $532.6 million for the year ended June 30, 1997. Cash gain on sale of mortgage loans increased $8.6 million to $30.5 million for the year ended June 30, 1998 from $21.9 million for the year ended June 30, 1997. The increase was due primarily to a $224.5 million increase in mortgage loan sales to $744.3 from $519.9 million for the years ended June 30, 1998 and 1997, respectively. The weighted average cash gain on sale was 4.1% for the year ended June 30, 1998 and 4.2% for the year ended June 30, 1997. There can be no assurance that the Company will recognize comparable levels of cash gain on sale of mortgage loans in future periods. The Company makes yield spread premium payments to its mortgage broker customers in the ordinary course of business. Due to competitive conditions, these payments have increased in recent periods, which adversely affected the Company's cash gain on sale of mortgage loans for the year ended June 30, 1998. Loan origination income decreased to $5.4 million for the year ended June 30, 1998 from $5.5 million for the year ended June 30, 1997. As a percentage of total revenues, loan origination income for the year ended June 30, 1998 decreased to 12.2% as compared to 16.7% for the year ended June 30, 1997. This decrease was a result of competitive conditions as management was required to lower the amount of origination points and fees charged on its loan products to satisfy mortgage broker and consumer demands. Interest income increased $2.7 million to $7.9 million for the year ended June 30, 1998 from $5.2 million for the year ended June 30, 1997. This increase is due to an increase in loan originations during the period. Other income, which is composed of investment income, prepayment penalties and late charges, increased to $676,000 for the year ended June 30, 1998 as compared to $250,000 for the year ended June 30, 1997 largely as a result of interest received on the net proceeds from the Offering completed March 10, 1998. 42 43 Expenses. The following table sets forth the components of the Company's expenses for the years indicated:
YEAR ENDED JUNE 30, ---------------------- 1998 1997 --------- --------- (DOLLARS IN THOUSANDS) Employees' salaries and commissions......................... $18,828 $11,052 General and administrative expenses......................... 8,028 5,543 Interest expense............................................ 5,486 3,693 ------- ------- $32,342 $20,288 ======= =======
Total expenses increased to $32.3 million for the year ended June 30, 1998 from $20.3 for the year ended June 30, 1997. This increase is related to geographical expansion to 53 origination locations at June 30, 1998 from 38 at June 30, 1997, and to an increase in mortgage loan originations. Employee salaries and commissions increased $7.8 million to $18.8 million during the year ended June 30, 1998 from $11.0 million for the year ended June 30, 1997. This increase is due primarily to an increase in the number of origination locations, geographical expansion and the related increase in mortgage loan originations. General and administrative expenses increased $2.5 million to $8.0 million for the year ended June 30, 1998 from $5.5 million for the year ended June 30, 1997. This increase is due primarily to an increase in the number of origination locations and the related increase in mortgage loan originations. Interest expense increased $1.8 million to $5.5 million for the year ended June 30, 1998 from $3.7 million for the year ended June 30, 1997 and is attributable to the higher levels of warehouse borrowing as a result of the increase in mortgage loan originations. It is expected that the Company's expansion plans including the retail and conforming wholesale divisions will result in an increase in operating expenses in the short-term. Furthermore, management expects that there will be a lag time between the incurrence of such expense and the receipt of any revenues from such expansion efforts, and the results of operations may be adversely affected in the short-term. YEAR ENDED JUNE 30, 1997 COMPARED TO THE YEAR ENDED JUNE 30, 1996 Revenues. The following table sets forth the components of the Company's revenues for the periods indicated:
YEAR ENDED JUNE 30 ----------------------- 1997 1996 ---------- --------- (DOLLARS IN THOUSANDS) Gain on sale of mortgage loans.............................. $21,855 $4,240 Loan origination income..................................... 5,473 1,978 Interest income............................................. 5,182 1,960 Other income................................................ 250 52 ------- ------ $32,760 $8,230 ======= ======
Revenues increased to $32.8 million for the year ended June 30, 1997 from $8.2 million for the year ended June 30, 1996, largely due to increased mortgage loan originations and cash gain on sale of mortgage loans. The increase in mortgage loan originations was due to both increased production from existing branches and expansion into new markets. Origination location increased to 38 at June 30, 1997 from 19 at June 30, 1996. Cash gain on sale of mortgage loans increased $17.7 million to $21.9 million in the year ended June 30, 1997 from $4.2 million for the year ended June 30, 1996. The increase was due primarily to the $332.7 million 43 44 increase in mortgage loan originations for the year ended June 30, 1997 compared to the year ended June 30, 1996. Total loans of $519.9 million and $156.6 million were sold during the period ended June 30, 1997 and 1996 with a weighted average cash gain on sale of 4.2% and 2.7%, respectively. Loan origination income increased to $5.5 million for the year ended June 30, 1997 from $2.0 million for the year ended June 30, 1996, due to increased mortgage loan originations. Interest income increased $3.2 million to $5.2 million for the year ended June 30, 1997 from $2.0 million in the year ended June 30, 1996 due to a higher balance of loans held for sale as a result of the increase in mortgage loan origination. Other income increased to $250,000 for the year ended June 30, 1997 as compared to $52,000 for the year ended June 30, 1996 largely as a result of increased mortgage loan originations and an increase in cash and cash equivalents. Expenses. The following table sets forth the components of the Company's expenses for the period indicated:
YEAR ENDED JUNE 30, ----------------------- 1997 1996 ---------- --------- (DOLLARS IN THOUSANDS) Employees' salaries and commissions......................... $11,052 $3,624 General and administrative expenses......................... 5,543 2,400 Interest expense............................................ 3,693 1,452 ------- ------ $20,288 $7,476 ======= ======
Expenses increased to $20.3 million for the year ended June 30, 1997 from $7.5 million of the year ended June 30, 1996, due to the cost of geographical expansion and in large part to increased compensation and other personnel costs related to the 166% increase in mortgage loan originations. Expenses for the year ended June 30, 1996 included a litigation reserve of $200,000 relating to potential exposure from a lawsuit against the Company which was settled through payment during the year ended June 30, 1997. Employees salaries and commissions increased $7.4 million to $11.1 million in the year ended June 30, 1997 from $3.6 million for the year ended June 30, 1996, primarily due to the increase in employees to 257 at June 30, 1997 from 148 at June 30, 1996 and increases in commissions paid to employees. General and administrative expense increased $3.1 million to $5.5 million for the year ended June 30, 1997 from $2.4 million in the year ended June 30, 1996. The increase was due to the expansion of the Company's loan origination network and related increase in mortgage loan originations. Interest expense increased $2.2 million for the year ended June 30, 1997 from $1.5 million in the year ended June 30, 1996, due to greater borrowings to fund the increased mortgage loan originations. DISCLOSURE ABOUT MARKET RISK The Company's earnings can be affected significantly by the movement of interest rates, which is the primary component of market risk to the Company. The interest rate risk affects the value of the mortgage loans held for sale, net interest income earned on its mortgage inventory, interest income earned on idle cash, interest expense and cash gain on sale of mortgage loans. The Company currently sells its loan production monthly on a whole loan basis for cash. As it relates to lending activities, the Company originates mortgage loans, which are generally presold through forward loan sales commitments. However, between the time that the loan is originated and sold to the ultimate investor, the Company earns interest income. The loans are funded through the use of the DLJ warehouse line of credit and the interest charged by DLJ is generally priced based upon short-term interest rates. Therefore, the net interest income that is earned by the Company is generally dependent upon the spread between long-term mortgage rates and short-term mortgage interest rates. 44 45 The Company currently does not maintain a trading portfolio. As a result, the Company is not exposed to market risk as it relates to trading activities. The majority of the Company's loan portfolio is held for sale which requires the Company to perform quarterly market valuations of its portfolio in order to properly record the portfolio at the lower of cost or market. Therefore, the Company continually monitors the interest rates of its loan portfolio as compared to prevalent interest rates in the market. The Company currently does not enter into any hedging activities as it currently sells its loan production on a monthly basis and the prohibitive cost versus the benefit of any hedging. Based on the information available and the interest environment as of June 30, 1998, the Company believes that a 100 basis point increase in long-term interest rates over a twelve month period, with all else being constant, would have an adverse effect on the pricing for the Company's whole loan sales. Therefore, the Company believes that its net income could be adversely affected in the range of $1.3 to $2.5 million. However, the Company believes that a 100 basis point decrease in long-term interest rates over a twelve-month period may not result in a similar increase in the level of its net income. These estimates are limited by the fact that they are performed at a particular point in time and incorporate many other factors and thus should not be used as a forecast. Therefore, there can be no assurance that the amount of such decrease would not substantially vary from these estimates. YEAR 2000 The Company has performed a review of its internal systems to identify and resolve the effect of Year 2000 software issues on the integrity and reliability of the Company's financial and operational systems. Based on this review, management believes that its internal systems are substantially compliant with the Year 2000 issues. In addition, the Company is also communicating with its principal service providers to ensure Year 2000 issues will not have an adverse impact on the Company. Based upon its internal review and communications with external service providers, the Company believes that the costs of achieving Year 2000 compliance will not have a material adverse impact on the Company's business, operations or financial condition. LIQUIDITY AND CAPITAL RESOURCES The Company's sources of cash flow include cash gain on sale of mortgage loans, origination income, net interest income and borrowings. The Company sells its mortgage loans generally on a monthly basis to generate cash for operations. The Company's uses of cash in the short-term include the funding of mortgage loan originations, payment of interest, repayment of amounts borrowed under warehouse lines of credit, operating and administrative expenses, start-up costs for new origination locations, income taxes and capital expenditures. Long-term uses of cash may also include the funding of securitization activities and selective acquisitions of other specialty finance companies or portfolios of loan assets. The Company currently has no formal agreements with regard to any potential acquisition and there can be no assurance that future acquisitions, if any, will be consummated. Capital expenditures totaled $1.4 million and $448,000 for the years ended June 30, 1998 and 1997, respectively. Capital expenditures were primarily comprised of furniture, fixtures and equipment software and leasehold improvements. Cash and cash equivalents were $25.9 million and $8.3 million at June 30, 1998 and 1997, respectively. The Company invests its cash in short-term investments maintaining flexibility for funding of loan originations and strategic opportunities. In March, 1998 the Company concluded its initial public offering and received net proceeds of $16,199,000 from the Offering. As of June 30, 1998, of these proceeds, approximately $4.05 million was used to fund loan originations, and the remaining balance has been invested in short-term investments. On September 1, 1998, the Company's Board of Directors authorized the Company to repurchase up to $2 million of the Company's common stock in open market purchases from time to time at the discretion of the Company's management. As of September 14, 1998, the Company had repurchased 146,200 shares of Common Stock at a cost of $1,040,908. The Company funds its operations through cash reserves, loan sales, net earnings and a revolving warehouse credit facility with the DLJ Facility, under which it borrows money to finance the origination of mortgage loans. As of June 30, 1998, the DLJ Facility provides borrowings up to $150.0 million and 45 46 terminates on March 16, 2000. The DLJ Facility bears interest at a rate of the federal funds rate plus 50 basis points through March 16, 1999 and thereafter, the federal funds rate plus 100 basis points. It is expected that the DLJ Facility will not be extended beyond the term. The Company is currently negotiating with other lenders to obtain additional warehouse lines of credit with interest rates and terms that are consistent with management's objectives. The Company repays borrowings with proceeds of its loan sales. During the years ended June 30, 1998 and 1997, the Company used cash of $788.5 million and $532.6 million, respectively, for new loan originations. During the same periods, the Company received cash proceeds from the sale of loans of $744.9 million and $519.9 million, respectively, representing the principal balance of loans sold. The Company received cash proceeds from the premiums on such sale of loans of $30.5 million and $21.9 million respectively, for the years ended June 30, 1998 and 1997, respectively. The Company's ability to continue to originate loans is dependent upon a number of factors, including the borrower credit risk classification, loan-to-value ratios and interest rates, general economic conditions, warehouse facility interest rates and governmental regulations. Recently Issued Accounting Considerations. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This Statement is effective for fiscal years beginning after December 15, 1997. The Company has determined that this Statement will not have a significant impact on its financial position or results of operations for fiscal 1999. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this item is contained in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Disclosure About Market Risk," incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Consolidated Financial Statements beginning on Page F-1 of this Annual Report on Form 10-K ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is set forth in the Company's definitive Proxy Statement (the "Proxy Statement"), which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is set forth in the Proxy Statement, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities and Exchange Act of 1934 and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is forth in the Proxy Statement, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated herein by reference. 46 47 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is set forth in the Proxy Statement, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the to Regulation 14A under the Securities Exchange Act of 1934 and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. Consolidated Financial Statements -- See "Index to Consolidated Financial Statements" 2. Exhibits -- See "Exhibit Index" (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of the fiscal year ended June 30, 1998. 47 48 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Irvine, State of California on September 28, 1998. BNC MORTGAGE, INC. By: /s/ EVAN R. BUCKLEY ------------------------------------ Evan R. Buckley Chairman of the Board, Chief Executive Officer, Secretary and Director POWER OF ATTORNEY We, the undersigned Officers and Directors of BNC Mortgage, Inc. do hereby constitute and appoint Evan R. Buckley and Kelly W. Monahan, or either of them, our true and lawful attorneys and agents, to do any and all acts and things in our names in the capacities indicated below, which said attorneys and agents, or either of them may deem necessary or advisable to enable said corporation to comply with the Securities Act of 1934, and as amended, and any rules, regulations, and requirements of the Securities and Exchange Commission, in connection with this Report, including specifically, but without limitation, power and authority to sign for us or any of us in our names and in the capacities indicated below, any and all amendments to this Report; and we do hereby ratify and confirm all that the said attorneys and agents, or either of them, shall do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ EVAN R. BUCKLEY Chairman of the Board, September 28, 1998 - -------------------------------------------------------- Chief Executive Officer, Evan R. Buckley Secretary and Director /s/ KELLY W. MONAHAN President, Chief September 28, 1998 - -------------------------------------------------------- Financial Officer and Kelly W. Monahan Director /s/ KEITH C. HONIG Director September 28, 1998 - -------------------------------------------------------- Keith C. Honig /s/ JOSEPH R. TOMKINSON Director September 28, 1998 - -------------------------------------------------------- Joseph R. Tomkinson
48 49 EXHIBIT INDEX (a) Exhibits
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 2.1* Agreement of Reorganization and Plan of Merger 3.1* Certificate of Incorporation of BNC Mortgage, Inc., a Delaware corporation 3.2* Bylaws of BNC Mortgage, Inc., a Delaware corporation 4.1* Specimen Stock Certificate 10.1* Office Lease, as amended, between the Registrant and Shuwa Investments Corporation dated June 15, 1997 10.2* 1997 Stock Option Plan and form of agreements 10.3* Form of Indemnification Agreement 10.4* Employment Agreement between the Registrant and Evan R. Buckley 10.5* Employment Agreement between the Registrant and Kelly W. Monahan 10.6 (a)* Letter Agreement, dated October 22, 1997, from DLJ Mortgage Capital, Inc. to the Registrant. (b) Commitment Letter, dated March 16, 1998, addressed to the Registrant from DLJ Mortgage Capital, Inc. (c) Whole Loan Financing Facility, dated March 16, 1998, between the Registrant and DLJ Mortgage, Inc. (d) Promissory Note, by the Registrant made in favor of DLJ Mortgage Capital, Inc. (f)* Whole Loan Financing Program Tri-Party Custody Agreement, dated September 26, 1995, among Registrant and DLJ Mortgage Capital, Inc. and Bankers Trust Company (g) Master Mortgage Loan Purchase Agreement, dated March 16, 1998, between the Registrant and DLJ Mortgage Capital, Inc. (h)* Form of Subordinate Certificate Financing Agreement between the Registrant and DLJ Mortgage Capital, Inc. 10.7 Representative's Warrant, dated March 16, 1998, issued by the Registrant to CIBC Oppenheimer Corp. 10.8 Representative's Warrant, dated March 16, 1998, issued by the Registrant to Piper Jaffray Inc. 11.1 Statement re: Computation of Per Share Earnings 21.1 Subsidiaries 24.1 Power of Attorney (included on signature page) 27 Financial Data Schedule
- --------------- * Incorporated by reference to, and all such exhibits have the corresponding exhibit number filed as part of the Registration Statement on Form S-1, as amended (File No. 333-38651) filed with the Securities and Exchange Commission on October 24, 1997. 49 50 BNC MORTGAGE, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Auditors.............................. F-2 Consolidated Balance Sheet as of June 30, 1998 and 1997..... F-3 Consolidated Statement of Income for the Years Ended June 30, 1998, 1997 and 1996................................... F-4 Consolidated Statement of Stockholders' Equity for the Years Ended June 30, 1998, 1997 and 1996.............................. F-5 Consolidated Statement of Cash Flows for Years Ended June 30, 1998, 1997 and 1996................................... F-6 Notes to Consolidated Financial Statements.................. F-7
F-1 51 REPORT OF INDEPENDENT AUDITORS The Board of Directors BNC Mortgage, Inc. We have audited the accompanying consolidated balance sheet of BNC Mortgage, Inc. as of June 30, 1998 and 1997 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BNC Mortgage, Inc. at June 30, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP -------------------------------------- Ernst & Young LLP Orange County, California September 14, 1998 F-2 52 BNC MORTGAGE, INC. CONSOLIDATED BALANCE SHEET ASSETS
JUNE 30, --------------------------- 1998 1997 ------------ ----------- Cash and cash equivalents................................... $ 25,890,000 $ 8,268,000 Restricted cash............................................. 638,000 -- Mortgage loans held for sale................................ 98,717,000 55,145,000 Property and equipment, net................................. 1,533,000 609,000 Deferred income taxes....................................... 2,131,000 1,154,000 Notes receivable from officers.............................. 100,000 -- Other assets................................................ 1,546,000 537,000 ------------ ----------- Total assets...................................... $130,555,000 $65,713,000 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Warehouse line-of-credit.................................. $ 96,022,000 $54,625,000 Accounts payable and accrued liabilities.................. 2,880,000 1,358,000 Income taxes payable...................................... 802,000 526,000 ------------ ----------- Total liabilities................................. 99,704,000 56,509,000 COMMITMENTS AND CONTINGENCIES (NOTE 8) Stockholders' equity: Preferred stock, $.001 par value: Authorized shares -- 50,000,000 Issued and outstanding shares -- none in 1998 and 1997.... -- -- Series A preferred stock, $0.001 par value: Authorized shares -- 1,000 Issued and outstanding shares -- none in 1998 and 160 in 1997................................................... -- 1,575,000 Series A common stock, voting, no par value: Authorized shares -- 2,886,598 Issued and outstanding shares -- none in 1998 and 2,886,598 in 1997...................................... -- -- Series B common stock, nonvoting, no par value: Authorized shares -- 1,237,113 Issued and outstanding shares -- none in 1998 and 1,237,113 in 1997...................................... -- 7,000 Common stock, voting $0.001 par value: Authorized Shares -- 50,000,000 Issued and outstanding shares 5,875,979 in 1998 and none in 1997................................................ 6,000 -- Additional paid in capital................................ 16,193,000 -- Retained earnings......................................... 14,652,000 7,622,000 ------------ ----------- Total stockholders' equity........................ 30,851,000 9,204,000 ------------ ----------- Total liabilities and stockholders' equity........ $130,555,000 $65,713,000 ============ ===========
See accompanying notes. F-3 53 BNC MORTGAGE, INC. CONSOLIDATED STATEMENT OF INCOME
YEAR ENDED JUNE 30, ---------------------------------------- 1998 1997 1996 ----------- ----------- ---------- Revenues: Gain on sale of mortgage loans....................... $30,458,000 $21,855,000 $4,240,000 Loan origination income.............................. 5,399,000 5,473,000 1,978,000 Interest income...................................... 7,860,000 5,182,000 1,960,000 Other income......................................... 676,000 250,000 52,000 ----------- ----------- ---------- Total revenues............................. 44,393,000 32,760,000 8,230,000 ----------- ----------- ---------- Expenses: Employees' salaries and commissions.................. 18,828,000 11,052,000 3,624,000 General and administrative expenses.................. 8,028,000 5,543,000 2,400,000 Interest expense..................................... 5,486,000 3,693,000 1,452,000 ----------- ----------- ---------- Total expenses............................. 32,342,000 20,288,000 7,476,000 ----------- ----------- ---------- Income before income taxes........................... 12,051,000 12,472,000 754,000 Income tax expense................................... 4,815,000 4,930,000 337,000 ----------- ----------- ---------- Net income........................................... $ 7,236,000 $ 7,542,000 $ 417,000 =========== =========== ========== Basic earnings per share............................. $ 1.55 $ 1.80 $ 0.14 =========== =========== ========== Diluted earnings per share........................... $ 1.51 $ 1.80 $ 0.14 =========== =========== ==========
See accompanying notes. F-4 54 BNC MORTGAGE INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
SERIES A PREFERRED STOCK SERIES A COMMON STOCK SERIES B COMMON STOCK COMMON STOCK ------------------------- ---------------------- --------------------- ------------------ SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT -------- ------------- ----------- ------- ---------- ------- --------- ------ Balance at June 30, 1995................ 25 $ 250,000 1,443,299 $-- -- $ -- -- $ -- Issuance of preferred stock... 135 1,325,000 -- -- -- -- -- -- Issuance of common stock............. -- -- 1,443,299 -- 1,072,165 2,000 -- -- Cash dividends on preferred stock... -- -- -- -- -- -- -- -- Net income.......... -- -- -- -- -- -- -- -- ---- ----------- ---------- -- ---------- ------- --------- ------ Balance at June 30, 1996................ 160 1,575,000 2,886,598 -- 1,072,165 2,000 -- -- Issuance of common stock............. -- -- -- -- 185,567 6,000 -- -- Repurchase of common shares............ -- -- -- -- (20,619) (1,000) -- -- Cash dividends on preferred stock... -- -- -- -- -- -- -- -- Net Income.......... -- -- -- -- -- -- -- -- ---- ----------- ---------- -- ---------- ------- --------- ------ Balance at June 30, 1997................ 160 1,575,000 2,886,598 -- 1,237,113 7,000 -- -- Issuance of common stock (less cost of $455,599)...... -- -- -- -- -- -- 5,875,979 6,000 Repurchase of common shares............ -- -- -- -- (1,237,113) (7,000) -- -- Repurchase of preferred shares.. (160) (1,575,000) (2,886,598) -- -- -- -- -- Cash dividends on preferred stock... -- -- -- -- -- -- -- -- Net income.......... -- -- -- -- -- -- -- -- ---- ----------- ---------- -- ---------- ------- --------- ------ Balance at June 30, 1998................ -- $ -- -- $-- -- $ -- 5,875,979 $6,000 ==== =========== ========== == ========== ======= ========= ====== TOTAL ADDITIONAL PAID IN RETAINED STOCKHOLDER'S CAPITAL EARNINGS EQUITY ------------------ ----------- -------------- Balance at June 30, 1995................ $ -- $ (10,000) $ 240,000 Issuance of preferred stock... -- -- 1,325,000 Issuance of common stock............. -- -- 2,000 Cash dividends on preferred stock... -- (138,000) (138,000) Net income.......... -- 417,000 417,000 ----------- ----------- ----------- Balance at June 30, 1996................ -- 269,000 1,846,000 Issuance of common stock............. -- -- 6,000 Repurchase of common shares............ -- -- (1,000) Cash dividends on preferred stock... -- (189,000) (189,000) Net Income.......... -- 7,542,000 7,542,000 ----------- ----------- ----------- Balance at June 30, 1997................ -- 7,622,000 9,204,000 Issuance of common stock (less cost of $455,599)...... 16,193,000 -- 16,199,000 Repurchase of common shares............ -- (131,000) (138,000) Repurchase of preferred shares.. -- -- (1,575,000) Cash dividends on preferred stock... -- (75,000) (75,000) Net income.......... -- 7,236,000 7,236,000 ----------- ----------- ----------- Balance at June 30, 1998................ $16,193,000 $14,652,000 $30,851,000 =========== =========== ===========
See accompanying notes. F-5 55 BNC MORTGAGE, INC. CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, ----------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- OPERATING ACTIVITIES Net income.................................... $ 7,236,000 $ 7,542,000 $ 417,000 Adjustment to reconcile net income to net cash used in operating activities: Depreciation................................ 486,000 250,000 77,000 Origination of mortgage loans held for sale..................................... (788,479,000) (532,621,000) (199,963,000) Sales and principal repayments of mortgage loans held for sale...................... 745,275,000 520,600,000 157,240,000 Deferred loan origination fees.............. (368,000) (401,000) -- Change in other assets...................... (1,009,000) (338,000) (199,000) Change in accounts payable and accrued liabilities.............................. 1,522,000 479,000 879,000 Change in income taxes payable.............. 276,000 (378,000) 904,000 Change in deferred income taxes............. (977,000) (587,000) (567,000) ------------- ------------- ------------- Net cash used in operating activities......... (36,038,000) (5,454,000) (41,212,000) ------------- ------------- ------------- INVESTING ACTIVITIES Capital expenditures.......................... (1,410,000) (448,000) (488,000) Purchase of Simple Mortgage USA, Inc.......... (100,000) -- -- ------------- ------------- ------------- Net cash used in investing activities......... (1,510,000) (448,000) (488,000) ------------- ------------- ------------- FINANCING ACTIVITIES Payment of dividends on preferred stock....... (75,000) (189,000) (138,000) Repurchase of preferred shares................ (1,575,000) -- -- Repurchase of common shares................... (138,000) (1,000) -- Proceeds from issuance of common stock........ 16,199,000 6,000 2,000 Increase in restricted cash................... (638,000) -- 1,325,000 Change in warehouse line of credit............ 41,397,000 11,902,000 42,723,000 ------------- ------------- ------------- Net cash provided by financing activities..... 55,170,000 11,718,000 43,912,000 ------------- ------------- ------------- Net increase in cash and cash equivalents..... 17,622,000 5,816,000 2,212,000 Cash and cash equivalents at beginning of the year........................................ 8,268,000 2,452,000 240,000 ------------- ------------- ------------- Cash and cash equivalents at end of the year........................................ $ 25,890,000 $ 8,268,000 $ 2,452,000 ============= ============= ============= SUPPLEMENTAL CASH FLOW INFORMATION Interest paid................................. $ 5,468,000 $ 3,693,000 $ 1,452,000 ============= ============= ============= Taxes paid.................................... $ 5,515,164 $ 5,351,000 $ -- ============= ============= =============
See accompanying notes. F-6 56 BNC MORTGAGE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS AND BASIS OF PRESENTATION The Company is a specialty finance company engaged in the business of originating, purchasing and selling non-conforming, and to a lesser extent, conforming residential mortgage loans secured by one-to-four family residences. The Company's loans are made to owners of single family residence who typically use the loan proceeds for purposes such as refinancing existing mortgages, debt consolidation, financing of home improvements, education and other similar needs, and, to a lesser extent, to purchase residences. The Company originates loans through its wholesale division, which originates mortgage loans through approved independent loan brokers, and through its retail division, which markets loans directly to homeowners. The Company currently sells all of its mortgage loans to institutional purchasers such as investment banks, real estate investment trusts and other large mortgage bankers for cash through whole loan sales. In connection with the Company's March 10, 1998 initial public offering, the Company reincorporated in Delaware. Further to the reincorporation, the existing California corporation was merged into a newly formed Delaware corporation pursuant to which each outstanding share of Class A and Class B common stock of the existing California corporation was exchanged for 4,123.71134 shares of $.001 par value common stock of the new Delaware corporation. The certificate of incorporation of the new Delaware corporation authorized 50,000,000 shares of common stock and 50,000,000 shares of preferred stock. In November 1997, the Company redeemed all shares of Series A Preferred Stock for $1,575,000. PRINCIPLES OF CONSOLIDATION The consolidated financial statements of the Company include the accounts of the Company and all of its wholly owned subsidiaries. All significant intercompany transactions and balances are eliminated. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of the consolidated financial statements of the Company requires management to make estimates and assumptions that affect reported amounts. These estimates are based on information available as of the date of the financial statements. Therefore, actual results could differ from those estimates. MORTGAGE LOANS HELD FOR SALE Mortgage loans held for sale are stated at the lower of cost or aggregate market value. Market value is determined by purchase commitments from investors and prevailing market prices. LOAN ORIGINATION FEES Loan origination fees and certain direct loan origination costs for mortgage loans held for sale are deferred until the related loans are sold. GAIN ON SALE OF MORTGAGE LOANS HELD FOR SALE Gains or losses on the sale of mortgage loans held for sale are recognized at the date of sale. CASH AND CASH EQUIVALENTS The Company accounts for all highly liquid investments with a maturity of three months or less when purchased as cash equivalents. F-7 57 BNC MORTGAGE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment, consisting primarily of computer hardware and software, is stated at cost, net of accumulated depreciation and amortization. Depreciation is provided using the straight line method over their estimated useful lives of three years. RECENTLY ISSUED ACCOUNTING STANDARD In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. This Statement establishes standards for the reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This Statement is effective for fiscal years beginning after December 15, 1997. The Company has determined that this Statement will not have a significant impact on its financial position or results of operations for fiscal 1999. INCOME TAXES The Company accounts for income taxes using Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (FAS 109). FAS 109 requires the use of the asset and liability method of accounting for taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. NET INCOME PER SHARE As of June 30, 1998, the Company adopted Statement No. 128, Earnings Per Share, and restated all prior period earnings per share (EPS) data, as required. Statement No. 128 replaced the presentation of primary and fully diluted EPS pursuant to APB Opinion No. 15, Earnings Per Share, with the presentation of basic and diluted EPS. Basic EPS excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period and the dilutive effect, if any, of stock options and warrants outstanding for the period. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair values presented in Note 6 are estimates of the fair values of the financial instruments at a specific point in time using available market information and appropriate valuation methodologies. These estimates are subjective in nature and involve uncertainties and significant judgment in the interpretation of current market data. Therefore, the fair values presented are not necessary indicative of amounts the Company could realize or settle currently. 2. MORTGAGE LOANS HELD FOR SALE Mortgage loans held for sale are collateralized by first and second trust deeds on underlying real properties and are used as collateral for the Company's borrowings. Approximately 30% of these properties are located in California. Mortgage loans held for sale include net deferred origination fees of $769,000 and $401,000 at June 30, 1998 and 1997, respectively. Subsequent to June 30, 1998, substantially all of the mortgage loans were sold to DLJ pursuant to the Master Mortgage Loan Purchase Agreement. F-8 58 BNC MORTGAGE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. PROPERTY AND EQUIPMENT Property and equipment consists of the following at June 30:
1998 1997 ---------- --------- Leasehold improvements...................................... $ 251,000 $ -- Furniture and fixtures...................................... 171,000 -- Office equipment............................................ 1,685,000 840,000 Software.................................................... 239,000 96,000 ---------- --------- 2,346,000 936,000 Less accumulated depreciation............................... (813,000) (327,000) ---------- --------- $1,533,000 $ 609,000 ========== =========
4. INCOME TAXES Income tax expense for the years ended June 30, 1998, 1997 and 1996 are summarized as follows:
1998 1997 1996 ---------- ---------- --------- Current: Federal...................................... $4,747,000 $4,119,000 $ 749,000 State........................................ 1,045,000 1,398,000 155,000 ---------- ---------- --------- 5,792,000 5,517,000 904,000 Deferred: Federal...................................... (1,020,000) (603,000) (504,000) State........................................ 43,000 16,000 (63,000) ---------- ---------- --------- (977,000) (587,000) (567,000) ---------- ---------- --------- $4,815,000 $4,930,000 $ 337,000 ========== ========== =========
The reconciliation of income tax expense at the U.S. federal statutory tax rate to the income tax expense for the years ended June 30, 1998 1997, and 1996 are as follows:
1998 1997 1996 ---------- ---------- -------- Tax computed at the statutory rate.............. $4,218,000 $4,365,000 $272,000 State income tax, net of federal income tax benefit....................................... 708,000 665,000 61,000 Other........................................... (111,000) (100,000) 4,000 ---------- ---------- -------- Income tax expense.............................. $4,815,000 $4,930,000 $337,000 ========== ========== ========
F-9 59 BNC MORTGAGE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The components of the Company's deferred income tax assets and liabilities as of June 30, 1998 and 1997 are as follows:
1998 1997 ---------- ---------- Deferred tax assets (liabilities): Depreciation.............................................. $ 21,000 $ (16,000) State income taxes........................................ 371,000 479,000 Reserve for loan repurchases.............................. 234,000 263,000 Accrued vacation.......................................... 195,000 104,000 Accrued compensation...................................... 183,000 -- Litigation reserve........................................ 15,000 15,000 Mark-to-market adjustments................................ 1,786,000 491,000 Deferred loan fees........................................ (682,000) (186,000) Other accrued liabilities................................. 8,000 4,000 ---------- ---------- Total deferred tax assets......................... $2,131,000 $1,154,000 ========== ==========
5. WAREHOUSE LINE-OF-CREDIT The Company has entered into a warehouse line of credit agreement with DLJ, which provides for borrowings up to $150,000,000 with interest payable monthly at the Federal Funds rate plus 50 basis points, (7.0%). The interest rate increases to Federal Funds rate plus 100 basis points at March 16, 1999. At June 30, 1998 and 1997, borrowings under this line of $96,022,000 and $54,625,000 are collateralized by mortgage loans held for sale. The Agreement provides that the amount borrowed under the facility can exceed the maximum amount available from time to time as the Company's production increases so as to enable the Company to continue to fund mortgage loans without delay or interruption. The line-of-credit matures and is subject to renewal on March 16, 2000. The weighted average interest rate for the fiscal year ended June 30, 1998 was 6.4%. Additionally, DLJ has agreed to provide the Company with up to $5.0 million of financing through March 16, 1999 for subordinated "interest-only" securities to the extent they are retained by the Company in connection with any future securitizations of loans originated by the Company. 6. FINANCIAL INSTRUMENTS The following describes the methods and assumptions used by the Company in estimating fair value: Mortgage loans held for sale -- Fair value is estimated using the quoted market prices for securities backed by similar types of loans and investor commitments to purchase loans on a service-released basis. Warehouse line-of-credit -- Fair value is estimated using rates currently available to the Company for debt with similar terms and remaining maturities. The carrying values and the estimated fair values of the Company's financial instruments for which it is practical to calculate a fair value are as follows:
JUNE 30, 1998 JUNE 30, 1997 --------------------------- -------------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE ----------- ------------ ----------- ----------- Mortgage loans held for sale....................... $98,717,000 $102,948,000 $55,145,000 $56,816,000 Warehouse line-of-credit..... 96,022,000 96,022,000 54,625,000 54,625,000
F-10 60 BNC MORTGAGE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. RELATED PARTY TRANSACTION In July 1997, the Company loaned an aggregate of $250,000 to two officers of the Company. The loans accrue interest monthly at the Federal Funds rate and are due upon the sale of common stock. As of June 30, 1998, one loan remained outstanding with a principal balance of $100,000. Interest income of $5,000 was recorded related to this note for the year ended June 30, 1998. For the year ended June 30, 1997, the Company sold $5.8 million of mortgage loans to Impac Funding Corporation ("IFC"), a company of which Joseph R. Tomkinson, a director of the Company, is the Chief Executive Officer, a director and a significant common shareholder. In addition, the Company entered into a $50 million optional delivery master commitment to sell non-conforming mortgage loans to IFC. During the years ended June 30, 1998, 1997, and 1996 the Company sold loans to DLJ having an aggregate principal balance of $727.0 million, $473.7 million and $153.2 million, respectively, pursuant to a Master Loan Purchase Agreement. In connection with such sales, the Company paid fees to DLJ of $2.2 million, $2.1 million and $1.8 million for the years ended June 30, 1998, 1997 and 1996, respectively. On June 1, 1998, the Company acquired Simple Mortgage USA, Inc. ("Simple USA") from Evan R. Buckley, Chairman and Chief Executive Officer of the Company. The Company paid $258,000 for Simple USA, which had a book value of $245,000. At the time of acquisition, Simple USA had $238,000 in cash and had no employees. The purchase price included a cash payment of $100,000 and the forgiveness of a note payable to the Company of $150,000 and accrued interest of $8,000. The excess of the purchase price over the book value was charged to operations in fiscal 1998. 8. COMMITMENTS AND CONTINGENCIES Forward Loan Sales Commitments The Company has entered into a forward loan sale contract with an investment bank under which it has committed to deliver $280 million in loans originated during the period from April 1998 to July 1998. At June 30, 1998, $143,730,581 in loans had been delivered under this commitment and the balance was delivered subsequent to year end. The price received under the commitment includes adjustments for the actual weighted average coupons, weighted average margins and prepayment terms of the loans sold. In June 1998, the Company entered into a $50 million optional delivery master commitment to sell certain nonconforming mortgage loans at current market rates to "IFC". The forward sales commitment is for a 12 month period and provides an option to increase the commitment to $100 million. The Company paid a commitment fee of $63,000 which was recorded as an asset and will be amortized as the loans are sold into the commitment. At June 30, 1998, no loans had been sold under this commitment. Repurchase Obligation The Company engages in bulk loan sales pursuant to agreements that generally require the Company to repurchase or substitute loans in the event of a breach of a representation or warranty made by the Company to the loan purchaser, any misrepresentation during the mortgage loan origination process or, in some cases, upon any fraud or first payment default on such mortgage loans. A reserve for potential repurchases of $500,000 and $503,000 at June 30, 1998 and 1997, respectively, is included in accounts payable and accrued liabilities. Leases The Company's executive and administrative offices are occupied under a noncancelable operating lease which expires in 2002 with aggregate monthly payments of approximately $71,200. The lease agreement requires the Company to maintain a refundable letter of credit to the lessor in the amount of $600,000. Cash deposited into an escrow to secure the letter of credit and accrued interest thereon is classified as restricted cash on the balance sheet. F-11 61 BNC MORTGAGE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company's loan offices are occupied under noncancelable operating leases which expire between October 1998 and March 2003 and provide for rent escalations tied to either increases in the lessor's operating expenses or fluctuations in the consumer price index in the relevant geographical area. The minimum annual rental payments under these operating leases is as follows: 1999..................................................... 1,560,000 2000..................................................... 1,426,000 2001..................................................... 1,121,000 2002..................................................... 910,000 2003..................................................... 384,000 Thereafter............................................... -- ---------- $5,401,000 ==========
Rent expense for the years ended June 30, 1998, 1997 and 1996 was $1,293,000, $597,000 and $169,000, respectively. 9. STOCKHOLDERS' EQUITY PREFERRED STOCK The Board of Directors has the authority, without further action by the stockholders of the Company, to issue up to 50,000,000 shares of Preferred Stock in one or more series, and to fix the designations, rights, preferences, privileges, qualifications and restrictions thereof including dividend rights, conversion rights, voting rights, rights and terms of redemption, liquidation preferences and sinking fund terms, any or all of which may be greater than the rights of the Common Stock. WARRANTS In connection with the initial public offering, the Company issued warrants to purchase 317,319 shares of Common Stock at an exercise price per share equal to $10.45. The warrants are exercisable over a period of four years, commencing one year from March 10, 1998. 401(K) PLAN The Company adopted a 401(k) savings plan (the "401(k) Plan") effective on July 1, 1996. Eligible employees may participate in the 401(k) Plan. Participants in the 401(k) Plan may defer compensation in an amount not in excess of the annual statutory limit ($10,000 in 1998). The Company may make matching contributions in the amount determined annually by the Board of Directors. Matching contributions if any, vest after three years. Contributions made for the years ended June 30, 1998 and 1997 were $74,000 and $37,000, respectively. 10. STOCK OPTION PLAN In October 1997, the Company adopted the 1997 Stock Option, Deferred Stock and Restricted Stock Plan (the Stock Option Plan), which provides for a committee of the Board of Directors (the Committee) to authorize the grant of incentive stock options, nonqualified stock options, deferred stock, restricted stock, stock appreciation rights and limited stock appreciation rights awards to any officer or key employee of the Company. The Stock Option Plan authorizes the grant of options to purchase, and awards of, an aggregate of 800,000 shares. Incentive stock options are granted at a price not less than 100% (110% in the case of incentive stock options granted to an employee who is deemed to own in excess of 10% of the outstanding common stock) of the fair market value of the shares of common stock at the time the option is granted. Incentive stock options and nonqualified stock options become exercisable according to the terms of the grant made by the Committee and remain exercisable until their specified expiration date. F-12 62 BNC MORTGAGE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company has issued nonqualified stock options to an employee for the purchase of 163,265 shares of common stock at $6.10 per share. The options vest ratably over a three year period beginning on October 1, 1997. The difference between the fair market value of the common stock on the date of grant and the exercise price of the options of $555,000 is being recorded as compensation expense over the vesting period of the options. For the year ended June 30, 1998, compensation expense related to these options was $139,000. The Company has issued nonqualified stock options to the non-employee board members for the purchase of 24,000 shares of common stock at $9.50, the fair value at the date of grant. The options vest ratably over a two year period beginning on March 10, 1998. The Company has issued incentive stock options for the purchase of 435,902 shares of common stock at $9.50 - $11.00 per share. The options vest ratably over a three year period beginning on March 10, 1998. The following summarizes stock option activity under the Company's stock plan for the year ended June 30, 1998:
WEIGHTED-AVERAGE OPTIONS EXERCISE PRICE ------- ---------------- Options outstanding at beginning of fiscal year...... -- $ -- Option granted..................................... 623,167 $8.64 Options exercised.................................. -- -- Options cancelled.................................. (1,274) $9.50 ------- Options outstanding at end of fiscal year............ 621,893 $8.64 ======= Exercise price: Per share for options exercised during fiscal year............................................ n/a
OPTIONS JUNE 30, 1998 -------------- Per share for options outstanding at end of fiscal year..... $6.10 - $11.00 Weighted average fair value of options granted Nonqualified stock options................................ 5.32 Incentive stock options................................... 3.01 Weighted average contractual life of option outstanding (in years).................................................... 9.58
As of June 30, 1998, no outstanding options were exercisable. Options available for future grants under the plans were 178,107 as of June 30, 1998. The Company currently follows Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its stock options. Under APB 25, when the exercise price of the Company's employee stock options are equal to the underlying stock on the date of grant, no compensation expense is recognized. The Company intends to follow the provisions of APB 25 for future years. Pro forma information regarding net income and earnings per share is required by FASB Statement No. 123, Accounting for Stock-Based Compensation (FAS 123), and has been determined as if the Company had accounted for its employee stock options under the fair value method of that Statement. The fair value of options at date of grant was estimated using the Black-Scholes model with the following weighted average assumptions:
1998 ---- Expected life (years)....................................... 6 Interest rate............................................... 4.72% Volatility.................................................. 0.31 Dividend yield.............................................. 0.00%
F-13 63 BNC MORTGAGE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The estimated stock-based compensation cost calculated using the assumptions indicated totaled $151,000 for the year ended June 30, 1998. The pro forma net income resulting from the increased compensation cost was $7,085,000 ($1.48 per share) for the year ended June 30, 1998. 11. SIGNIFICANT CUSTOMERS The Company has entered into a number of transactions with two financial companies which each account for more than 10% of the Company's loan sales. These transactions include a whole loan agreement, under which the financial companies agree to periodically purchase certain loans from the Company. During the years ended June 30, 1998, 1997 and 1996, the Company sold a total of $744.4 million, $519.9 million and 156.6 million respectively of loans to these investors under these agreements and recognized gross cash gains on sales of approximately $30.5 million, $21.9 million and 4.2 million, respectively. 12. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
YEAR ENDED JUNE 30, ------------------------------------ 1998 1997 1996 ---------- ---------- ---------- Numerator Net income....................................... $7,236,000 $7,542,000 $ 417,000 ========== ========== ========== Denominator Shares used in computing basic earnings per share......................................... 4,653,836 4,186,662 2,892,000 Effect of stock options treated as equivalents under the treasury stock method............... 142,392 -- -- ---------- ---------- ---------- Denominator for diluted earnings per share....... 4,796,228 4,186,662 2,892,000 ========== ========== ========== Basic earnings per share......................... $ 1.55 $ 1.80 $ 0.14 ========== ========== ========== Diluted earnings per share....................... $ 1.51 $ 1.80 $ 0.14 ========== ========== ==========
13. SUBSEQUENT EVENTS On September 1, 1998, the Company's Board of Directors authorized the Company to repurchase up to $2 million of the Company's common stock, in open market purchases from time to time at the discretion of the Company's management. As of September 14, 1998, the Company had repurchased 146,200 shares of common stock at a cost of $1,040,908. F-14 64 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 2.1* Agreement of Reorganization and Plan of Merger 3.1* Certificate of Incorporation of BNC Mortgage, Inc., a Delaware corporation 3.2* Bylaws of BNC Mortgage, Inc., a Delaware corporation 4.1* Specimen Stock Certificate 10.1* Office Lease, as amended, between the Registrant and Shuwa Investments Corporation dated June 15, 1997 10.2* 1997 Stock Option Plan and form of agreements 10.3* Form of Indemnification Agreement 10.4* Employment Agreement between the Registrant and Evan R. Buckley 10.5* Employment Agreement between the Registrant and Kelly W. Monahan 10.6 (a)* Letter Agreement, dated October 22, 1997, from DLJ Mortgage Capital, Inc. to the Registrant. (b) Commitment Letter, dated March 16, 1998, addressed to the Registrant from DLJ Mortgage Capital, Inc. (c) Whole Loan Financing Facility, dated March 16, 1998, between the Registrant and DLJ Mortgage, Inc. (d) Promissory Note, by the Registrant made in favor of DLJ Mortgage Capital, Inc. (f)* Whole Loan Financing Program Tri-Party Custody Agreement, dated September 26, 1995, among Registrant and DLJ Mortgage Capital, Inc. and Bankers Trust Company (g) Master Mortgage Loan Purchase Agreement, dated March 16, 1998, between the Registrant and DLJ Mortgage Capital, Inc. (h)* Form of Subordinate Certificate Financing Agreement between the Registrant and DLJ Mortgage Capital, Inc. 10.7 Representative's Warrant, dated March 16, 1998, issued by the Registrant to CIBC Oppenheimer Corp. 10.8 Representative's Warrant, dated March 16, 1998, issued by the Registrant to Piper Jaffray Inc. 11.1 Statement re: Computation of Per Share Earnings 21.1 Subsidiaries 24.1 Power of Attorney (included on signature page) 27 Financial Data Schedule
- --------------- * Incorporated by reference to, and all such exhibits have the corresponding exhibit number filed as part of the Registration Statement on Form S-1, as amended (File No. 333-38651) filed with the Securities and Exchange Commission on October 24, 1997. EX-10.6(B) 2 COMMITMENT LETTER DATED MARCH 16, 1998 1 EXHIBIT 10.6(b) March 16, 1998 BNC Mortgage, Inc. 1063 McGaw Avenue Irvine, California 92614 Telephone: 714-260-6000 Facsimile: 714-475-5027 Attention: Kelly W. Monahan This Commitment Letter confirms our agreement between BNC Mortgage Inc. ("Customer") and DLJ Mortgage Capital, Inc. ("DLJ") pursuant to which DLJ shall provide committed financing collateralized by eligible Mortgage Loans in accordance with the terms and conditions hereof and as set forth in the Whole Loan Funding Facility, the Promissory Note (the "Note") and the Pledge Agreement, each dated March 16, 1998 and the Tri-Party Custody Agreement(s) dated September 26, 1995 (collectively, the "Agreements"). The Agreements, together with the Mortgage Loan Purchase Agreement to be entered into between Customer and DLJ, dated as of March 16, 1998 (the "Mortgage Loan Purchase Agreement"), and this Commitment Letter constitute the entire agreement between the parties with respect to DLJ's financing of Customer's Mortgage Loans. Capitalized terms not defined herein shall have the meaning ascribed to them in the Agreements. No amounts may be borrowed from DLJ in excess of that committed herein except in DLJ's sole discretion. Unless otherwise agreed in writing, DLJ will not finance second-lien mortgage loans. I. ELIGIBLE MORTGAGE LOANS: For purposes of this Commitment Letter, "Eligible Mortgage Loans" shall be defined as: A. First-lien residential Mortgage Loans originated or acquired by Customer in its normal course of business within the preceding 30 days of the related Advance which are intended to be sold to DLJ and have the characteristics specified in Customer's underwriting guide, as such guide approved by DLJ ("Program Loans"); and B. First-lien residential Mortgage Loans originated or acquired by Customer in its normal course of business within the preceding 30 days of the related Advance that have been determined by DLJ in its sole discretion not to have the characteristics specified in Customer's underwriting guide and which do not meet the requirements of the Mortgage Loan Purchase Agreement ("Non-Program Loans"). II. DLJ'S COMMITMENT: Subject to the terms and conditions hereof and the Agreements, including the performance by Customer of its obligations set forth below, DLJ hereby commits to: A. Provide Advances under the Agreements for Eligible Mortgage Loans until March 16, 2000 unless terminated earlier pursuant to the terms of the Mortgage Loan Purchase Agreement or this Commitment Letter. B. Calculate the Collateral Value as follows (provided that, in all cases, Market Value as used below shall not exceed the related unpaid principal balance of such Loan): 2 BNC Mortgage, Inc. March 16, 1998 Page 2 1. for each Eligible Mortgage Loan, 100% of the related unpaid principal balance; 2. for each Eligible Mortgage Loan not committed to be purchased by DLJ subject to an Advance for more than ninety (90) days, 103% of the Market Value of such Eligible Mortgage Loan; 3. for each Eligible Mortgage Loan not committed to be purchased by DLJ subject to an Advance for more than six (6) months, 105% of the Market Value of such Eligible Mortgage Loan; 4. for each Eligible Mortgage Loan subject to an Advance that is more than sixty (60) days delinquent as to principal and interest payment, 105% of the Market Value of such Eligible Mortgage Loan; 5. for each Eligible Mortgage Loan subject to an Advance that is more than ninety (90) days delinquent as to principal and interest payment, 110% of the Market value of such Eligible Mortgage Loan; 6. for each Eligible Mortgage Loan subject to an Advance that is in foreclosure or bankruptcy, 115% of the Market Value of such Eligible Mortgage Loan; 7. for each Real Estate Owned, 120% of the Market Value of such Real Estate Owned, provided, however, that such Real Estate Owned must be secured by a first-lien Mortgage Loan, which Mortgage Loan shall then be financed by DLJ. C. Continue to provide Advances by rolling over such Advances, until the earliest of (1) termination of this Commitment Letter; (2) termination of the Mortgage Loan Purchase Agreement; or (3) DLJ is entitled to exercise its remedies in accordance with Paragraph 6 of the Note. D. If applicable, net all Mortgage Loan sale proceeds paid by DLJ against the related Advance; E. Maintain a funding rate as follows: 1. for Program Loans, or for Non-Program Loans subject to an Advance for less than 3 months (i) for the period to March 16, 1999, the opening federal funds rate of comparable maturity, plus 50 basis points, (ii) for the period from March 17, 1999 through March 16, 2000, the opening federal funds rate of comparable maturity, plus 100 basis points. 3 BNC Mortgage, Inc. March 16,1998 Page 3 2. for Non-Program Loans subject to an Advance for more than 3 months, the opening federal funds rate of comparable maturity, plus 125 basis points, and 3. for Non-Program Loans subject to an Advance for more than 6 months, the opening federal funds rate of comparable maturity, plus 150 basis points. III. CONDITIONS TO CONTINUED FUNDING:. The foregoing commitment is subject to the conditions that: A. The total of all Advances involving Wet Transactions may be limited by DLJ in its reasonable discretion (but shall be no less than $5 million) in connection with any decrease in Customer's GAAP net worth. B. DLJ shall be under no obligation to make any additional Advances if an Event of Default has occurred. C. DLJ generally shall underwrite loans on a post-Advance basis. To the extent the aggregate percentage of Non-Program Loans being financed by DLJ exceeds seven and one-half percent (7.5%) of the aggregate number of Eligible Mortgage Loans being financed by DLJ, DLJ shall have the right, but no the obligation, to underwrite all or a portion of the mortgage loans possessing any of the characteristics which are common to such Non-Program Loans prior to an Advance. To the extent that Customer is able to demonstrate its ability to sell such Non-Program Loans above par within 90 days of an Advance, the preceding two sentences shall not apply. DLJ agrees to work with Customer to minimize the number of loans to be underwritten on a pre-Advance basis. IV CUSTOMER COMMITMENT: Customer commits to: A. Provide DLJ, on a daily mark to market basis, collateral consisting of Eligible Mortgage Loans consistent with the applicable Collateral Values stated above; B. Provide evidence acceptable to DLJ that it has, and will continue to maintain, insurance coverage for itself and its subsidiaries that encompasses employee dishonesty, forgery or alteration, theft, disappearance and destruction, robbery and safe burglary, property (other than money and securities), and computer fraud and shall include DLJ Mortgage Capital, Inc. as a Loss Payee; C. Notify DLJ of its intent to borrower under an Advance at least I Business Day prior to such Advance if the amount contemplated to be borrower varies by more than $5 million from the previous day's Advances; 4 BNC Mortgage, Inc. March 16, 1998 Page 4 D. Immediately repay DLJ for each Advance related to Non-Program Loan that is subject to an Advance for a period of such months, which period may be extended by DLJ in its sole discretion for up to three additional months; E. At the request of DLJ, immediately pay off any Advance related to any Mortgage Loan that DLJ determines is not an Eligible Mortgage Loan; F. Establish and maintain an underwriting and approval process, which shall be supervised by an officer of the Customer reasonably acceptable to DLJ, in conformity with the criteria and standards set forth in the Mortgage Loan Purchase Agreement; G. Continue to maintain an acceptable status as a mortgage approved by the Department of Housing and Urban Development. H. To the extent it utilizes or involved DLJMC in the sale of Eligible Mortgage Loans in whole loan format (or through securitization to the extent Customer elects to securitize loans), to pay DLJ on all such dispositions a fee equal to (i) zero (0) for dispositions relating to mortgage loans originated after the date on which Customer's stock is initially issued through a public offering (the "IPO Date") but prior to the date occurring one year after the IPO Date of the IPO (the "Fee Waiver Period") and (ii) twelve and a half (12.5) basis points times the outstanding balance of the related loans for dispositions with respect to mortgage loans originated after the Fee Waiver Period but prior to the maturity date of the facility. Notwithstanding anything herein to the contrary, Customer may elect to sell its Eligible Mortgage Loans to or through another entity, without utilizing DLJMC or payment of any fee to DLJMC, upon notice to that effect. V. TERMINATION PROVISIONS: DLJ shall have the right to terminate this Commitment Letter, and DLJ shall no longer be obligated to make Advances to Customer under this Commitment Letter and may accelerate the maturity dates of all Advances then outstanding, upon the occurrence of a Commitment Letter Termination Event. Upon such termination, DLJ shall have no obligation to return any fees collected and may utilize any remedy provided in the Agreements. A Commitment Letter Termination Event shall include any one or more of the following. A. An "Event of Default" shall have occurred under the Agreements and DLJ is entitled to exercise its remedies in accordance with paragraph 6 of the Note; B. Customer shall have materially breached any agreement or commitment contained in the Mortgage Loan Purchase Agreement or this Commitment Letter, including the items set forth under "Required Financial Statement" and such breaches have not been cured pursuant to applicable grace periods; C. There occurs any litigation or proceeding affecting Customer and its affiliates that is likely to be adversely determined and which, if adversely determined, would have a material adverse effect on the Collateral or the ability of Customer to pay and perform on the Obligations. 5 BNC Mortgage, Inc. March 16, 1998 Page 5 D. There occurs any event set forth under "Financial Requirements", in Annex A attached hereto; E. A "Material Adverse Change" shall have occurred in the business or operations of Customer or an affiliate thereof which is defined as the occurrence of any of the events or circumstances set forth under "Financial Requirements" in Annex A. F. There occurs a catastrophic event or events resulting in the effective absence of a "repo market" for a period of at least 30 consecutive days respecting mortgage loans and the same results in DLJ not being able to finance any Advance through the repo market with DLJ's traditional repo counterparties. Please acknowledge your agreement to the foregoing by signing and returning the enclosed DLJplicate of this letter, whereby this Commitment Letter shall become a binding agreement between DLJ and Customer. Sincerely, DLJ MORTGAGE CAPITAL, INC. By: /s/ N. Dante LaRocca ----------------------------------- Name: --------------------------------- Title: -------------------------------- BNC MORTGAGE, INC. By: /s/ Kelly Monahan ----------------------------------- Name: Kelly Monahan --------------------------------- Title: President -------------------------------- 6 ANNEX A 1. FINANCIAL REQUIREMENTS: A change in Customer's business, operations or financial condition that would materially and adversely affect the ability of Customer to perform its obligations under this Commitment Letter and the Agreements as determined in good faith by DLJ; Customer, directly or indirectly, engages in business other than the mortgage banking business; Customer uses the proceeds of the Advances for any purpose other than to fund the related mortgage loans; Customer guarantees the debt obligation of any other entity; Customer sells any material asset other than in its ordinary course of its business for less than current fair market value. Customer falls to submit within 90 days of the date of this commitment, and within 90 days of the beginning of each of Customer's respective fiscal years, a business plan acceptable to DLJ (the "Business Plan"), which Business Plan shall set out, among other things, (i) financial targets for Tangible Net Worth for fiscal year 1998 and for each fiscal year thereafter; and (ii) a provision whereby Customer shall establish and maintain a working capital reserve fund of $5 million or more. 2. REQUIRED FINANCIAL STATEMENTS: (a) Customer shall deliver to DLJ within 120 days after the last day of its fiscal year, its audited consolidated statement of income and statement of changes in cash flow for such year and balance sheet as of the end of such year in each case presented fairly in accordance with GAAP accompanied, in all cases, by an unqualified report of a firm of independent certified public accountants acceptable to DLJ. (b) Customer shall deliver to DLJ within 60 days after the last day of each of the first three fiscal quarters in any fiscal year of Customer, its consolidated statements of income and statement of changes in cash flow for such quarter and balance sheet as of the end of such quarter, presented fairly in accordance with GAAP for interim period financial statements. (c) Customer shall cause to be delivered to DLJ within 60 days after the last day of each of the first three fiscal quarters in any fiscal year, its unaudited consolidated statements of income and statement of changes in cash flow for such quarter and balance sheet as of the end of such quarter. (d) Customer shall deliver to DLJ within 60 days after the last day of each calendar month in any fiscal year of Customer, (i) its consolidated statement of income for such month and balance sheet as of the end of such month accompanied in each case by a certificate of the chief financial officer or treasurer of Customer stating that such financial statements are presented fairly in accordance with GAAP, and (ii) an officer's certificate from its chief financial officer or treasurer certifying that there does not exist an event of default in the Agreements or in this Annex. 7 (e) as soon as available copies of all proxy statements, financial statements, ad reports which Customer sends to its stockholders, and copies of all regular periodic and special reports, and all registration statements, if any, under the Securities Act of 1933, as amended, which it files with the Securities and Exchange Commission or any governmental authority which may be substituted therefor, or with any national securities exchange. (f) Customer shall deliver to DLJ as soon as the same are available copies of all regular, periodic and special audit reports conducted by GNMA, FNMA and/or FHLMC with respect to Customer's operations. -2- 8 CUSTOMER LETTERHEAD Date Ms. Patricia Robins Senior Credit Analyst Donaldson, Lufkin & Jenrette 277 Park Avenue New York, NY 10172 Re: Commitment Letter between BNC Mortgage, Inc. ("Customer") and DLJ Mortgage Capital, Inc.("DLJ") dated March 16 1998 (the "Commitment Letter") Dear Ms. Robins: This Compliance Certificate is furnished pursuant to the Commitment Letter. Capitalized terms to defined herein shall have the meanings ascribed to them in the Commitment Letter. The following is true, correct and complete: I am a member of the management of Customer holding the office indicated below; I have reviewed the terms of the Commitment Letter and I have made, or have caused to be made under my supervision, a detailed review of the transactions and conditions of Customer during the period from the date of the last Compliance Certificate to the date hereof. The examinations did not disclose, and I have no knowledge of, the existence of any condition or event with constitutes a Default or Event of Default during or at the end of the referenced period or as of the date of this Compliance Certificate; and Schedule 1 attached hereto sets forth financial data and computations evidencing Customer's compliance with the financial covenants set forth in the Commitment Letter and such other information as DLJ shall have reasonably requested in writing. The foregoing certifications are made and delivered this_____day of_____________,199____. - -------------------------------------- Office of Customer Name: --------------------------------- Title: -------------------------------- 9 COMPLIANCE CERTIFICATE (Date) - -------------------- 1. GAAP NET WORTH Actual $ =================== II. OTHER INFORMATION ORIGINATION YEAR TO DATE ------------------- ADDITIONAL, INFORMATION REQUESTED BY DLJ: ----------------------------------------- ----------------------------------------- ----------------------------------------- EX-10.6(C) 3 WHOLE LOAN FINANCING FACILITY 1 EXHIBIT 10.6(c) WHOLE LOAN FINANCING FACILITY CONFORMING AND NONCONFORMING MORTGAGE LOANS BNC Mortgage, Inc. Dated: March 16, 1998 1063 McGaw Avenue Irvine, California 92614 Gentlemen: DLJ Mortgage Capital, Inc. ("DLJ") is pleased to advise you of the availability of a whole loan financing facility (the "Facility") secured by mortgage loans on the terms set forth in this letter. Capitalized terms not defined herein shall have the respective meanings given such terms in the Pledge Agreement, dated the date hereof, between you and DLJ (the "Pledge Agreement"). 1. THE ADVANCES. DLJ agrees to consider from time to time your requests that DLJ make advances (each, an "Advance", and, collectively, the "Advances") to you in an aggregate principal amount outstanding at any one time not to exceed the amount of the Promissory Note (the "Maximum Credit"). Unless otherwise agreed in writing, this Facility is not a commitment to lend, but rather this Facility sets forth the procedures to be used in connection with periodic requests for Advances. You hereby acknowledge that DLJ is under no obligation to agree to make or to make any Advance pursuant to this Facility. All Advances made by DLJ hereunder shall be evidenced by the promissory note duly executed by you (the "Promissory Note"). The Promissory Note shall be dated the date of issue, and the stated amount shall be equal to the Maximum Credit. Interest in respect thereof shall be payable only for the periods during which the Advances evidenced thereby are outstanding. The Promissory Note shall be enforceable against you only to the extent of the unpaid aggregate principal amount of the Advances then outstanding, plus accrued and unpaid thereon, plus any other amounts due thereunder. 2. MAKING THE ADVANCES. (a) On any day you desire to borrow funds from DLJ under this Facility, you shall notify DLJ that you wish to borrow money on a specified date, in a specified principal amount and for a specified term. (b) Upon receipt of your request for an Advance, DLJ may make an offer to you specifying the terms for such Advance, including the interest rate per annum (the "Quoted Rate") to be paid by you in respect of such Advance. You shall immediately notify DLJ as to whether or not you elect to borrow such an Advance. Each such election by you shall be evidenced by a notice (each, a "Notice of Borrowing") substantially in the form attached hereto or as otherwise determined by DLJ, with the blanks appropriately completed and duly executed. On the date of such Advance, as so agreed by you and DLJ, DLJ will make its Advance to you subject to and upon the satisfaction of the conditions precedent to such Advance set forth in Section 6 hereof. Promptly thereafter, DLJ will send to you a written confirmation of such Advance (each, a "Confirmation"), and your acceptance of the related proceeds shall constitute your agreement to the terms of such Confirmation. Such Confirmation may be termed a "Repo Confirmation", but for purposes hereof the term "Repo", when used in any such Confirmation, shall be deemed to mean "Advance." 3. PAYMENT OF PRINCIPAL AND INTEREST. Upon each disbursement of funds with respect to each Advance as set forth in Section 2 above you shall have effected a borrowing from DLJ hereunder and shall be indebted to DLJ for the principal amount thereof, plus interest thereon, in accordance with the terms of this Facility, the Promissory Note and the Notice of Borrowing. You shall repay the principal amount of each Advance made to you, and the interest thereon, on the maturity date (the "Maturity Date") specified in the related Notice of Borrowing in United States Dollars and in same day funds. 4. REPRESENTATIONS, WARRANTIES AND COVENANTS. You hereby represent, warrant and covenant as follows: (a) You are a corporation duly organized, validly existing and in good standing under the laws of your jurisdiction of incorporation, your principal place of business, and you are in compliance with applicable law. You are duly licensed, qualified and in good standing in every other jurisdiction in which the failure to take such action would have a material 1 2 adverse effect on your ability to perform your obligations under the Program Documents. (b) You are an approved seller/servicer or issuer in good standing with each Agency to which Agency Mortgage Loans will be submitted. (c) Your execution, delivery and performance of the Program Documents are within your charter and corporate powers, have been duly authorized by all necessary corporate action, and do not contravene (i) your charter or bylaws or (ii) any rule, regulation or other law or contractual restriction binding on or affecting you or your property. (d) Other than the necessary filings with the Agencies regarding the Collateral (to the extent that the Collateral includes Agency Mortgage Loans), no authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for your due execution, delivery and performance of the Program Documents. (e) The Program Documents are your legal, valid and binding obligations, enforceable against you in accordance with their respective terms. (f) The available balance sheets, statements of income and changes in financial condition of you and your subsidiaries as of your most recently completed fiscal year and quarter, fairly present your financial condition and results of operations for the period then ended and are in accordance with generally accepted accounting principles consistently applied, and copies of such statements, together with the most recent opinion with respect to such statements of an independent public accounting firm, have been provided to DLJ, and since such date there has been no material adverse change in such financial condition, operations or business prospects. (g) There is no pending or threatened action or proceeding affecting you or any of your subsidiaries before any court, governmental agency or arbitrator, that may materially and adversely affect the financial condition, operations or business prospects of you or any of your subsidiaries. (h) Unless otherwise agreed, at any time any Advance is made or shall be outstanding, the Collateral Value of the items of Collateral related to such Advance shall be at least 102% of the Advance then outstanding. However, with respect to Nonagency Mortgage Loans (i) to the extent that a Purchase Commitment is in effect, the Collateral Value shall be at least 105% of the principal amount of the Advance then outstanding and (ii) to the extent that a Purchase Commitment is not in effect, the Collateral Value shall be at least 110% of the principal amount of the Advance then outstanding. Notwithstanding the foregoing, DLJ and you may agree upon such other percentage for purposes of determining Collateral Value for any particular Advance. To the extent that a deficiency in Collateral Value exists, you shall promptly cure any such deficiency by delivering cash, securities or other additional Collateral acceptable to DLJ. (i) The Program Documents are not entered into in contemplation of insolvency or with any intent to hinder, delay or defraud any of your creditors. (j) Unless otherwise agreed in writing by DLJ, only Mortgage Loans constituting 1- to 4-family residential first lien Mortgage Loans shall constitute Collateral acceptable to DLJ for purposes of obtaining an Advance. 5. CONDITIONS PRECEDENT. (a) INITIAL ADVANCE. As conditions precedent to the making of the initial Advance, DLJ shall have received on or before the day of such Advance the following, in form and substance satisfactory to DLJ and duly executed by you: (i) The Program Documents; (ii) Evidence that all other actions necessary or, in the opinion of DLJ, desirable to perfect and protect the security interests and liens created by the Pledge Agreement have been taken, including without limitation duly executed Uniform 2 3 Commercial Code financing statements on Form UCC-1 with respect to the Collateral; (iii) A certified copy of your corporate resolution approving the Program Documents and borrowings thereunder (either specifically or by general resolution approving borrowings of the type described in the Program Documents), and all documents evidencing other necessary corporate action or governmental approvals as may be required in connection with the Program Documents; (iv) A certificate of your corporate secretary certifying the names, true signatures and titles of your officers duly authorized to request Advances and sign the Program Documents and the other documents to be delivered thereunder; and (v) A favorable opinion of your counsel, which may be internal counsel, as to such matters as DLJ may reasonably request. (b) EACH ADVANCE. As conditions precedent to making each Advance, DLJ shall have received on or before the day of such Advance the following, in form and substance satisfactory to DLJ and duly executed: (i) A Notice of Borrowing, the related Collateral Receipt and, if any item of Collateral securing such Advance is a Wet Mortgage Loan, the related Wet Closing Notice, each of which must bear the same number; (ii) If the Collateral is subject to a security interest or lien immediately prior to the Advance, a letter from the holder of such security interest or lien releasing the Collateral from such security interest or lien upon receipt of a stated sum that is less than or equal to the related Advance; (iii) If the Collateral consists of Agency Mortgage Loans, either (A) an assignment by you to Donaldson, Lufkin & Jenrette Securities Corporation ("DLJSC") of the related Purchase Commitment, in form and substance acceptable to DLJ in its sole discretion, or (B) evidence that you have instructed the relevant Agency to pay the purchase price for such Agency Mortgage Loans under the related Purchase Commitment directly to DLJ or its designee, unless otherwise agreed by DLJ; (iv) If the Collateral consists of Nonagency Mortgage Loans, evidence that such Nonagency Mortgage Loans are covered by pool insurance and a pool insurance certificate (not a commitment to insure) issued by a Pool Insurer, in form and substance and for such amounts acceptable to DLJ in its sole discretion, unless otherwise agreed by DLJ; and (v) Such other documents as DLJ may reasonably request. 6. DLJ ENTITLED TO RELY. In making any Advance or taking any other action pursuant to the Program Documents, DLJ may conclusively rely upon, and shall incur no liability to you in acting upon, any request or other communication that DLJ believes to have been given or made by a person authorized to borrow on your behalf, whether or not such person is listed on the certificate delivered pursuant to Section 5(a)(iv). 7. TERMINATION. This Facility shall remain in effect until the earlier of two years from the date hereof or such time as it is terminated by either DLJ or you giving written notice of termination hereof to the other. However, no such termination shall affect your obligations with respect to any Advances outstanding at the time of such termination or shall be effective with respect to any Advances made prior to DLJ's receipt of notice thereof. Your obligation to indemnify DU pursuant to this Facility shall survive the termination hereof. 8. ASSIGNMENT; AMENDMENTS, ETC. The Program Documents are not assignable by you. The Program Documents are assignable by DLJ in whole or in part. DLJ may distribute to any prospective assignee any of the Program Documents and any document or other information delivered to DLJ pursuant thereto. No amendment or waiver of any provision of this Facility or the Promissory Note, nor any consent to any failure by you to comply therewith, shall in any event be effective unless the same shall be in writing and signed by DLJ. Any such amendment, waiver or consent shall be effective only in 3 4 the specific instance and for the specific purpose for which given. The Program Documents supersede all other previous agreements between the parties concerning the same subject matter. 10. COMPENSATION. You shall compensate and indemnify DLJ for all reasonable costs, expenses, losses and other liabilities that DLJ may sustain (i) if any repayment of the principal amount of any Advance, together with interest thereon, is not made on the Maturity Date thereof or (ii) in connection with the protection of DLJ's rights under or the enforcement of the Program Documents or any other document received by DLJ or Custodian in connection therewith. 11. NOTICES. All written communications hereunder shall be mailed, telecopied or delivered at the respective addresses as listed in the Custody Agreement or at such other address as shall be designated by a party in a written notice to the other party. All such notices and communications shall be effective when delivered to the party to which such notice is to be given. 12. GOVERNING LAW; CONSENT TO JURISDICTION. This letter shall be construed in accordance with, and governed by, the law of the State of New York, without giving effect to the conflict of law principles thereof. You waive trial by jury. You hereby irrevocably consent to the non-exclusive jurisdiction of any court of the State of New York, or in the United States District Court for the Southern District of New York, arising out of or relating to the Program Documents in any action or proceeding. You hereby submit to, and waive any objection you may have to, personal jurisdiction and venue in the courts of the State of New York and the United States District Court for the Southern District of New York, with respect to any disputes arising out of or relating to the Program Documents. If the terms of this letter are satisfactory to you, please indicate your agreement and acceptance thereof by signing this letter and returning it to us, whereupon this letter shall become an agreement between us as of the date of this letter. Very truly yours, DLJ Mortgage Capital, Inc. By: /s/ N. Dante LaRocca --------------------------------- Name: ------------------------------- Title: ------------------------------ Agreed and Accepted: BNC Mortgage, Inc. - ------------------------------------ By: /s/ Kelly Monahan --------------------------------- Name: Kelly Monahan ------------------------------- Title: President ------------------------------ 4 5 NOTICE OF BORROWING NO. DLJ Mortgage Capital, Inc. 277 Park Avenue New York, NY 10172 Attention: Whole Loan Financing Program Facsimile (212) 504-8072 RE: Agency/Nonagency_______________Identification/Pool #_____________________ Security Rate ____________% Maturity:______________ Pursuant to the Whole Loan Financing Facility, dated March __, 1998, between you and the undersigned (as amended from time to time, the "Facility"), the undersigned hereby gives notice of its election to borrow from you an Advance and in connection therewith sets forth below the following information (each capitalized term used herein shall have the meaning specified therefor in the Facility): 1. The aggregate unpaid principal of the Mortgage Loans is $_______________. 2. The principal amount of this Advance is $_______________. 3. The Quoted Rate for this Advance is ____ % per annum. 4. The beginning Business Day of this Advance is _________,199___. 5. The Maturity Date of this Advance is _________,199___. 6. The Collateral Value of the items of Collateral shall be ________%. The undersigned hereby certifies that the following statements are true and correct on the date hereof and shall be true and correct on the date of the Advance requested herein, before and after giving effect thereto: (a) each of the representations and warranties contained in the Facility and the Pledge Agreement are true and correct in all material respects, (b) no Default or Event of Default (as such terms are defined in the Pledge Agreement) has occurred and is continuing, (c) if applicable, the undersigned has, coincident or prior to this Notice of Borrowing, delivered and validly assigned genuine and enforceable Purchase Commitments to DLJSC for Agency Mortgage Loans or an Agency Security or to DLJ for Nonagency Mortgage Loans, each in an aggregate amount equal to the Face Value of the Pool, and (d) Customer has satisfied all of the conditions precedent in Section 5(b) and all other requirements of the Facility. The Advance made pursuant hereto shall be made in connection with the items of Collateral described in the Collateral Receipt No.__________, dated ______________, 199___ and, if applicable, the Wet Closing Notice of even number and date therewith. ______________________________________________, as Customer By:___________________________________________ Name:_________________________________________ Title:________________________________________ Date:_______________________________, 199_____ EX-10.6(D) 4 PROMISSORY NOTE 1 EXHIBIT 10.6(d) PROMISSORY NOTE $150,000,000 March 16, 1998 New York, New York FOR VALUE RECEIVED, the undersigned, BNC Mortgage, Inc. ("Customer"), HEREBY PROMISES TO PAY to the order of DLJ Mortgage Capital, Inc. ("DLJ"), for the benefit of DLJ and the holders from time to time of interests herein, in lawful money of the United States of America, the lesser of (i) one hundred fifty million dollars ($150,000,000) and (ii) the aggregate unpaid principal amount of all Advances made by DLJ to Customer pursuant to the Whole Loan Financing Facility, dated the date hereof (as amended from time to time, the "Facility"), between DLJ and Customer on the respective Maturity Date for each such Advance, together with interest on each such Advance outstanding, from and including the date on which such Advance is made until the principal amount of such Advance is paid in full on such Maturity Date (and, as to any overdue principal and accrued interest thereon, on demand), at an interest rate per annum with respect to such Advance equal to the Quoted Rate applicable to such Advance and on such overdue amounts as provided herein. Each Advance under this promissory note (the "Promissory Note") shall be made pursuant to an executed Notice of Borrowing. 1. DEFINITIONS. All capitalized terms not otherwise defined herein shall have the meanings ascribed to them in the Whole Loan Financing Facility ("Facility") or the Pledge Agreement ("Pledge Agreement") executed by Customer and dated the date hereof. 2. LATE PAYMENTS. Customer shall pay interest on any overdue principal of each Advance and (to the extent permitted by applicable law) accrued interest thereon, payable daily at a fluctuating interest rate per annum equal to 2% above the rate of interest per annum quoted as the prime rate in The Wall Street Journal (the "Default Rate"), each change in such Default Rate to take effect simultaneously with any change in such prime rate. 3. WHOLE LOAN FINANCING FACILITY. This Promissory Note is the Promissory Note referred to in the Facility and is secured by, entitled to the benefit of, and subject to the provisions of the Facility and the Pledge Agreement. 4. NO PREPAYMENT. Customer shall have no right to prepay any principal amount of any Advance without ten (10) days prior written notice of DLJ. 5. PAYMENTS AND COMPUTATIONS. Customer shall make each payment hereunder on the day when due to DLJ pursuant to DLJ's instructions in same day funds. All computations of interest shall be made by DLJ on the basis of a year of 360 days for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest is payable. Any payment to be made hereunder on a day other than a Business Day shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of payment of interest. 6. EVENTS OF DEFAULT. If any of the following events (each, an "Event of Default") shall occur and be continuing: (a) Customer shall fall to pay when due any principal of, interest on or other amount due and payable under this Promissory Note attributable to any Advance made hereunder; or (b) Customer shall fall to perform or observe any other term, covenant or agreement contained in the Program Documents on its part to be performed or observed when required; or (c) any representation or warranty made by Customer (or any of its officers) in the Program Documents or in any document delivered in connection therewith shall prove to have been incorrect in any material respect when made; or 1 2 (d) Customer or any of its subsidiaries shall fall to pay any of its indebtedness for borrowed money or any interest or premium thereon when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such indebtedness; or any other default under any agreement or instrument relating to any such indebtedness, or any other event, shall occur and shall continue after the applicable grace period, if any, specified in such agreement or instrument, if the effect of such default or event is to accelerate, or to permit the acceleration of, the maturity of such indebtedness; or if any such indebtedness shall be declared to be due and payable, or required to be prepaid (other than by a regularly scheduled required prepayment), prior to the stated maturity thereof; or (e) a custodian, receiver, conservator, liquidator, trustee, sequestrator or similar official for Customer or any of its subsidiaries, or of any of their property, is appointed or takes possession of such property; or Customer or any of its subsidiaries generally fails to pay its debts as they become due; or Customer or any of its subsidiaries is adjudicated bankrupt or insolvent; or an order for relief is entered under the Federal Bankruptcy Code, any successor or similar applicable statute, or any administrative insolvency scheme, against Customer or any of its subsidiaries; or any of their property is sequestered by court or administrative order; or a petition is filed against Customer or any of its subsidiaries under any bankruptcy, reorganization, arrangement, insolvency, readjustment of debt, dissolution or liquidation law of any jurisdiction, whether now or subsequently in effect; or (f) Customer or any of its subsidiaries files a voluntary petition in bankruptcy or seeks relief under any provision of any bankruptcy, reorganization, arrangement, insolvency, readjustment of debt, dissolution or liquidation law of any jurisdiction whether now or subsequently in effect; or consents to the filing of any petition against it under any such law; or consents to the appointment of or taking possession by a custodian, receiver, conservator, trustee, liquidator, sequestrator or similar official for Customer or any of its subsidiaries, or of all or any part of their property; or makes an assignment for the benefit of its creditors; or (g) any Judgment or order for the payment of money in excess of $1,000,000 shall be rendered against Customer or any of its subsidiaries; or (h) any governmental authority or agency or any person, agency or entity acting or purporting to act under governmental authority shall have taken any action to condemn, seize or appropriate, or to assume custody or control of, all or any substantial part of the property of Customer or of any of its subsidiaries, or shall have taken any action to displace the management of Customer or of any of its subsidiaries or to curtail its authority in the conduct of the business of Customer or of any of its subsidiaries, or any Agency takes any action to remove, limit or restrict the approval of Customer as an issuer, lender or a seller/servicer of mortgage loans; or (i) Customer or any of its subsidiaries shall default under, or fail to perform as requested under, or shall otherwise breach the terms of any instrument, agreement or contract between it and DLJ or any of DLJ's affiliates; or (j) any material adverse change occurs in the financial condition, operations, business prospects or corporate structure of Customer or any of its subsidiaries; then, and in any such event, DLJ may (i) by notice to Customer, declare this Promissory Note and all Advances made hereunder, the outstanding principal of and all interest accrued thereon and all other amounts payable under the Program Documents to be immediately due and payable, whereupon this Promissory Note and all such Advances, interest and other amounts shall become and be immediately due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by Customer, and (ii) exercise or cause to be exercised all rights and remedies of DLJ as secured party under the Pledge Agreement; provided, that upon occurrence of any Event of Default described in paragraphs (e) and (f) above, the outstanding principal of and accrued interest on this Promissory Note and all other amounts payable under the Program Documents shall immediately and automatically become due and payable without presentment, demand, protest or notice of any kind. 2 3 7. AMENDMENTS, ETC. No amendment or waiver of any provision of this Promissory Note, nor any consent to any failure by Customer to comply therewith, shall be effective unless the same shall be in writing and signed by DLJ. Any such amendment, waiver or consent shall be effective only in the specific instance and for the specific purpose for which it is given. 8. NOTICES. All written communications hereunder shall be mailed, telecopied or delivered at the respective addresses as listed in the Custody Agreement or at such other address as shall be designated by Customer or DLJ in a written notice to the other. All such notices and communications shall be effective when delivered to the party to which such notice is to be given. 9. NO WAIVER, REMEDIES. No failure on the part of DLJ to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right hereunder preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any other remedies provided in equity or at law. 10. BINDING EFFECT; GOVERNING LAW; VENUE. This Promissory Note shall be binding upon Customer and its successors and assigns, and shall inure to the benefit of DLJ and its successors and assigns. Customer may not assign its obligations under this Promissory Note without the prior written consent of DLJ. DLJ may assign, by bookkeeping entry on DLJ's records or otherwise, all or any part of, or any interest in, DLJ's rights and benefits hereunder, including, without limitation, its right to payments of principal and interest with respect to a particular Advance. To the extent of such assignment, such assignee shall have the same rights and benefits against Customer as it would have had if it were DLJ hereunder. However, nothing contained herein shall preclude DLJ from continuing to exercise all of its rights hereunder for the benefit of any such assignee of DLJ, and Customer shall continue to accept directions and other notices solely from DLJ unless otherwise notified by DLJ in writing. This Promissory Note shall be construed in accordance with, and governed by, the laws of the State of New York, without giving effect to the conflict of law principles thereof. Customer waives trial by jury. Customer hereby irrevocably consents to the non-exclusive jurisdiction of any court of the State of New York, or in the United States District Court for the Southern District of New York, in any action or proceeding arising out of or relating to this Promissory Note. Customer hereby submits to, and waives any objection it may have to, personal jurisdiction and venue in the courts of the State of New York and the United States District Court for the Southern District of New York, with respect to any disputes arising out of or relating to this Promissory Note. Customer consents to service of process by mail at the address specified in the Custody Agreement or otherwise designated pursuant to Section 8 hereof and waives any objection it may have to the sufficiency or adequacy of such method of service of process. IN WITNESS WHEREOF, Customer has caused this Promissory Note to be executed by its officer thereunto duly authorized, as of the date first above written. BNC Mortgage, Inc. ,as Customer - ---------------------------- By: /s/ KELLY W. MONAHAN ------------------------- Name: Kelly W. Monahan ----------------------- Title: President ---------------------- 3 EX-10.6(G) 5 MASTER MORTGAGE LOAN PURCHASE AGREEMENT 1 EXHIBIT 10.6(g) DLJ MORTGAGE CAPITAL, INC. and BNC MORTGAGE, INC. MASTER MORTGAGE LOAN PURCHASE AGREEMENT Dated as of March 16, 1998 FIXED AND ADJUSTABLE RATE MORTGAGE LOANS ================================================================================ 2 TABLE OF CONTENTS
PAGE ---- SECTION 1. Definitions ......................................................... 1 SECTION 2. Agreement to Purchase ............................................... 6 SECTION 3. Conveyance of Mortgage Loans ........................................ 8 SECTION 4. Late Payment Charges and Prepayment Charges; Seller's Repurchase Right ............................................................... 12 SECTION 5. Examination of Mortgage Files and Due Diligence Review .............. 13 SECTION 6. Representations, Warranties and Covenants of the Seller ............. 14 SECTION 7. Cure, Repurchase and Indemnity Obligations of the Seller ............ 16 SECTION 8. Representations and Warranties of the Purchaser ..................... 18 SECTION 9. Closing ............................................................. 19 SECTION 10. Closing Documents .................................................. 19 SECTION 11. Information to be Provided by the Seller ........................... 20 SECTION 12. Indemnification .................................................... 21 SECTION 13. Costs .............................................................. 24 SECTION 14. Servicing .......................................................... 24 SECTION 15. Notices ............................................................ 24 SECTION 16. Severability of Provisions ......................................... 24 SECTION 17. Survival; Third Party Beneficiary .................................. 25 SECTION 18. Governing Law ...................................................... 25 SECTION 19. Successors and Assigns ............................................. 25 SECTION 20. Waiver ............................................................. 25
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PAGE ---- SECTION 21. Headings ........................................................... 25 SECTION 22. Intention of the Parties ........................................... 25 SECTION 23. Counterparts ....................................................... 26 SECTION 24. Further Assurances ................................................. 26
EXHIBIT 1 MORTGAGE LOAN SCHEDULE EXHIBIT 2 OFFICERS' CERTIFICATE EXHIBIT 3 FORM OF RESOLUTIONS EXHIBIT 4 FORM OF OPINION LETTER OF COUNSEL TO THE SELLER EXHIBIT 5 FORM OF CONFIRMATION LETTER EXHIBIT 6 SELLER REPRESENTATIONS AND WARRANTIES EXHIBIT 7 FORM OF CROSS RECEIPT EXHIBIT 8 FORM OF ASSIGNMENT AND CONVEYANCE -ii- 4 MASTER MORTGAGE LOAN PURCHASE AGREEMENT This Master Mortgage Loan Purchase Agreement ("Agreement"), dated as of March 16, 1998, is made between DLJ Mortgage Capital, Inc., a Delaware corporation (the "Initial Purchaser" and the Initial Purchaser or any person or entity, if any, to which the Initial Purchaser has assigned its rights and obligations hereunder as Purchaser with respect to a Mortgage Loan, and each of their respective successors and assigns, the "Purchaser") and BNC Mortgage, Inc., a Delaware corporation (the "Seller"). PRELIMINARY STATEMENT The Seller has agreed to sell, and the Purchaser has agreed to purchase, from time to time certain fixed and adjustable rate, first lien residential mortgage loans pursuant to this Agreement. (The fixed rate mortgage loans and the adjustable rate mortgage loans are referred to herein as the "Fixed Rate Mortgage Loans" and the "Adjustable Rate Mortgage Loans," respectively, and are collectively referred to herein as the "Mortgage Loans.") Certain of the Adjustable Rate Mortgage Loans may be subject to negative amortization (each, a "Negative Amortization Mortgage Loan"), and certain of the Mortgage Loans may include a graduated payment period. The Mortgage Loans to be purchased hereunder will be identified on one or more Mortgage Loan Schedules (as defined herein), each such schedule to be annexed hereto as Exhibit 1 or a supplement thereto, as such schedule may be amended to reflect the Mortgage Loans accepted by the Purchaser pursuant to the terms of Section 5 hereof. The Mortgage Loans will be delivered as whole mortgage loans on one or more Closing Dates (as defined herein) and are expected to be transferred by or on behalf of the Purchaser as part of one or more Whole Loan Transfers or Pass-Through Transfers (each as defined herein) on or subsequent to the related Closing Dates. In consideration of the mutual agreements herein contained, the Purchaser and the Seller hereby agree as follows: SECTION 1. Definitions. Capitalized terms used herein and not otherwise defined herein shall have the following meanings: "Assignment and Conveyance": With respect to each Mortgage Loan, the assignment and conveyance of such Mortgage Loan from the Seller to the Purchaser or its designee, substantially in the form of Exhibit 8 annexed hereto. "Business Day": Any day other than a Saturday or Sunday or a day on which banking institutions and savings and loan associations in the states in which the principal places of business of the Seller, the Purchaser, the Servicer or the Custodian (each as defined herein) are located are authorized or obligated by law or executive order to be closed. "Certificates": The mortgage pass-through certificates to be issued in one or more series by a trust or trusts sponsored by the Purchaser or an affiliate of the Purchaser as part of a 5 -2- Pass-Through Transfer, which certificates evidence an interest in some or all of the Mortgage Loans. "Closing Date": With respect to each Mortgage Loan, the date specified in the related Confirmation Letter or such other date as shall be mutually acceptable to the parties hereto on which such Mortgage Loan is sold to the Purchaser pursuant to this Agreement. "Collateral Value": The appraised value of a Mortgaged Property based upon the lesser of (i) the appraisal (as reviewed and approved by the Seller) made at the time of the origination of the related Mortgage Loan, or (ii) the sales price of such Mortgaged Property at such time of origination. With respect to a Mortgage Loan the proceeds of which were used to refinance an existing mortgage loan, the appraised value of the Mortgaged Property based upon the appraisal (as reviewed and approved by the Seller) obtained at the time of refinancing. "Confirmation Letter": With respect to the Mortgage Loans to be included in any Mortgage Loan Package, a letter agreement between the Purchaser and the Seller, substantially in the form of Exhibit 5 annexed hereto and specifying the terms and conditions contemplated hereby and such other terms and conditions as the Purchaser and the Seller shall agree. "Custodian": Bankers Trust Company of California, N.A. or any other custodian under a custody agreement among any custodian, the Seller and the Purchaser for the custody of the Mortgage Loans and the documents related thereto. "Cut-off Date": With respect to each Mortgage Loan, the day specified as such in the related Assignment and Conveyance. "Gross Margin": With respect to each Adjustable Rate Mortgage Loan, the fixed rate set forth in the related Mortgage Note to be added to the related Index on each Interest Rate Adjustment Date in accordance with the terms of such Mortgage Note to determine the Mortgage Rate for such Mortgage Loan. "Index": With respect to each Adjustable Rate Mortgage Loan, the index set forth in the related Mortgage Note to which the related Gross Margin is added on each Interest Rate Adjustment Date in accordance with the terms of such Mortgage Note to determine the Mortgage Rate for such Mortgage Loan. "Interest Rate Adjustment Date": With respect to each Adjustable Rate Mortgage Loan, the date set forth in the related Mortgage Note on which the Mortgage Rate is adjusted in accordance with the terms of the Mortgage Note. The first Interest Rate Adjustment Date as to each Adjustable Rate Mortgage Loan is set forth in the Mortgage Loan Schedule. "Loan-to-Value Ratio": As of any date, the fraction, expressed as a percentage, the numerator of which is the principal balance of the related Mortgage Loan as of the date of 6 -3- determination and the denominator of which is the Collateral Value of the related Mortgaged Property. "Maximum Principal Amount": With respect to each Negative Amortization Mortgage Loan, the amount set forth in the related Mortgage Note as the maximum principal amount thereunder. "Maximum Rate": With respect to each Adjustable Rate Mortgage Loan, the amount set forth in the related Mortgage Note as the maximum interest rate to which the Mortgage Rate may be increased over the life of the Mortgage Loan as stated in the Mortgage Note. "Minimum Rate": With respect to each Adjustable Rate Mortgage Loan, the amount set forth in the related Mortgage Note as the minimum interest rate to which the Mortgage Rate may be decreased over the life of the Mortgage Loan as stated in the Mortgage Note. "Mortgage": The mortgage, deed of trust or other instrument creating a first lien or a first priority ownership interest in either an estate in fee simple or a leasehold estate in real property securing a Mortgage Note, including all required riders, addenda or amendments thereto. "Mortgage Loan Package" Each pool of Mortgage Loans sold on any Closing Date and listed on a Mortgage Loan Schedule attached to this Agreement on the Closing Date. "Mortgage Loan Schedule": With respect to each Mortgage Loan Package, the schedule of Mortgage Loans annexed hereto as Exhibit 1 for the initial Closing Date or a supplement thereto for subsequent Closing Dates (as revised to reflect the Mortgage Loans accepted by the Purchaser pursuant to the terms of Section 5 hereof), which shall set forth the following information with respect to each Mortgage Loan in such Mortgage Loan Package: I. the loan number and first and last name of the primary Mortgagor; (i) the street address, city, state and zip code of the Mortgaged Property; (ii) (A) if such Mortgage Loan is a Fixed Rate Mortgage Loan, the monthly payment and the Mortgage Rate set forth in the related Mortgage Note, (B) if such Mortgage Loan is an Adjustable Rate Mortgage Loan, the monthly payment and Mortgage Rate at origination; (iii) the maturity date; (iv) the original principal balance; (v) the first payment date; 7 -4- (vi) if such Mortgage Loan is an Adjustable Rate Mortgage Loan, the Index and the Gross Margin; (vii) if such Mortgage Loan is an Adjustable Rate Mortgage Loan, the first Interest Rate Adjustment Date, and if such Adjustable Rate Mortgage Loan is a Negative Amortization Mortgage Loan, the first Payment Adjustment Date; (viii) if such Mortgage Loan is an Adjustable Rate Mortgage Loan, the Periodic Rate Cap and if such Adjustable Rate Mortgage Loan is a Negative Amortization Mortgage Loan, the Payment Adjustment Cap and the initial payment date, if any, as to which the Payment Adjustment Cap shall no longer be applicable; (ix) if such Mortgage Loan is an Adjustable Rate Mortgage Loan, the Interest Rate Adjustment Date frequency, and if such Adjustable Rate Mortgage Loan is a Negative Amortization Mortgage Loan, the Payment Adjustment Date frequency; (x) if such Mortgage Loan is an Adjustable Rate Mortgage Loan, the Minimum Rate and the Maximum Rate, and if such Adjustable Rate Mortgage Loan is a Negative Amortization Mortgage Loan, the Maximum Principal Amount; (xi) the unpaid principal balance as of the Cut-off Date; (xii) if such Mortgage Loan is an Adjustable Rate Mortgage Loan, the Mortgage Rate as of the Cut-off Date; (xiii) the occupancy status (primary, secondary or investor); (xiv) the purpose of the Mortgage Loan; (xv) the Collateral Value of the Mortgaged Property; (xvi) the original term to maturity; (xvii) whether or not the Mortgage Loan provides for a principal prepayment penalty; (xviii) the credit grade of the Mortgagor; (xix) the related Cut-off Date and Closing Date; 8 -5- (xx) a code indicating whether the Mortgaged Property is a one-family residence, a two- to four-family residence, a condominium unit or a unit in a planned unit development; (xxi) the paid-through date as of the related Closing Date; (xxii) if the Mortgaged Property is a two- to four-family residence, the number of dwelling units in the Mortgaged Property; (xxiii) whether the Mortgagor has a leasehold interest or a fee simple interest in the Mortgaged Property; (xxiv) with respect to each Graduated Payment Mortgage Loan, the date on which the graduated payment periods terminate; (xxv) with respect to each Graduated Payment Mortgage Loan, the Mortgage Rates that are applicable to the initial payments under the Mortgage Loan; (xxvi) (A) whether the Mortgage Loan is a Fixed Rate Mortgage Loan or an Adjustable Rate Mortgage Loan, (B) if such Mortgage Loan is an Adjustable Rate Mortgage Loan, whether such Mortgage Loan is a Negative Amortization Mortgage Loan, and (C) if such Adjustable Rate Mortgage Loan is a Graduated Payment Mortgage Loan; (xxvii) A code indicating whether the related Mortgaged Property was subject at origination to financing that was subordinate to the lien of the Mortgage Loan; and (xxviii) A code indicating the underwriting category pursuant to which the Mortgage Loan was originated. Exhibit 1 shall be supplemented as of each Closing Date to reflect the addition of the Mortgage Loan Schedule for each related Mortgage Loan Package (as such schedule may be amended to reflect the Mortgage Loans accepted by the Purchaser pursuant to the terms of Section 5 hereof). "Mortgage Note": The note or other evidence of the indebtedness of a Mortgagor under a Mortgage Loan. "Mortgage Rate": With respect to each Mortgage Loan, the annual rate at which interest accrues on such Mortgage Loan, as adjusted from time to time in accordance with the provisions of the related Mortgage Note in the case of an Adjustable Rate Mortgage Loan. 9 -6- "Mortgaged Property": The real property, including all buildings, structures, improvements or fixtures thereon and all appurtenances, water rights, privileges and benefits appertaining thereto, that is conveyed, pledged or mortgaged, or in which a security interest is granted, pursuant to a Mortgage, to secure the payment and performance of a Mortgage Loan. "Mortgagor": The obligor or obligors on a Mortgage Note. "Officers' Certificate": A certificate signed by the Chairman of the Board or the Vice Chairman of the Board or a President or a Vice President and by the Treasurer or the Secretary or one of the Assistant Treasurers or Assistant Secretaries of the person on behalf of whom such certificate is being delivered. "Pass-Through Transfer": The sale or transfer of some or all of the Mortgage Loans on one or more dates by the Purchaser or an affiliate of the Purchaser to a trust or trusts to be formed as part of a public offering or private placement of mortgage-backed securities. "Payment Adjustment Cap": With respect to each Negative Amortization Mortgage Loan and each Payment Adjustment Date occurring prior to the initial payment date on which such cap is no longer applicable, the amount (expressed as a percentage) by which the monthly payment on such Negative Amortization Mortgage Loan due in the month preceding such Payment Adjustment Date is multiplied for purposes of calculating the maximum amount to which the monthly payment may be adjusted. "Payment Adjustment Date": With respect to each Negative Amortization Mortgage Loan, the date set forth in the related Mortgage Note on which the amount of the monthly payment thereon is scheduled to change. The first Payment Adjustment Date as to each Negative Amortization Mortgage Loan is set forth in the Mortgage Loan Schedule. "Periodic Rate Cap": With respect to each Adjustable Rate Mortgage Loan and each Interest Rate Adjustment Date therefor, the maximum amount by which the related Mortgage Rate may increase (without regard to the Maximum Rate) or decrease (without regard to the Minimum Rate) from the Mortgage Rate in effect immediately prior to such Interest Rate Adjustment Date. "REO Property": A Mortgaged Property acquired through foreclosure or deed-in-lieu of foreclosure in connection with a defaulted Mortgage Loan. "Whole Loan Transfer": Any sale or assignment of legal or beneficial ownership interest in one or more of the Mortgage Loans by the Purchaser or an affiliate of the Purchaser to any person other than as part of a Pass-Through Transfer. SECTION 2. Agreement to Purchase. The Seller agrees to sell, and the Purchaser agrees to purchase, Mortgage Loans from time to time. The Mortgage Loans to be included in 10 -7- any Mortgage Loan Package shall be identified on the related Mortgage Loan Schedule, as such schedule may be amended to reflect the Mortgage Loans accepted by the Purchaser on the related Closing Date pursuant to the terms of Section 5 hereof. Each Mortgage Loan Schedule shall be delivered to the Seller by the Purchaser not less than five (5) Business Days prior to the related Closing Date. The Purchaser shall notify the Seller and Servicer (as defined in Section 14) as to whether the Purchaser shall purchase the balances under the Mortgage Loans on an actual or scheduled basis. The Mortgage Loans to be included in any Mortgage Loan Package shall have an aggregate outstanding principal balance as of the close of business on the Cut-off Date of an amount specified in such Confirmation Letter (plus or minus 5% of such amount), or such other amount acceptable to the Purchaser as evidenced by the actual aggregate outstanding principal balance of such Mortgage Loans accepted by the Purchaser on such Closing Date. With respect to each Mortgage Loan that is purchased on a scheduled principal balance basis, the principal balance of such Mortgage Loan shall be determined after giving effect to any payments due on or before the Cut-off Date, whether or not received, and all principal prepayments received on or before the Cut-off Date (the "Scheduled Principal Balance"). With respect to each Mortgage Loan that is purchased on an actual principal balance basis, the principal balance of such Mortgage Loan shall be determined after giving effect to all payments of principal actually received on or before the Cut-off Date (the "Actual Principal Balance"). The sale of the Mortgage Loans to be included in any Mortgage Loan Package shall take place on the Closing Date. The purchase price for the Mortgage Loans included in any Mortgage Loan Package shall be equal to the purchase price percentage specified in the related Confirmation Letter multiplied by the aggregate outstanding Scheduled Principal Balance or Actual Principal Balance, as the case may be, thereof as of the close of business on the related Cut-off Date, together with interest accrued on such principal balance from the related Cut-off Date (in the case of any Mortgage Loan purchased on a scheduled basis) or the paid-through date of the Mortgage Loan (in the case of a Mortgage Loan purchased on an actual basis) to but not including the related Closing Date at the per annum rate specified in such Confirmation Letter. The purchase price shall be paid to the Seller by wire transfer in immediately available funds on the related Closing Date by or on behalf of the Purchaser, or as otherwise agreed by the Purchaser (or an affiliate thereof) and the Seller. In addition to the related purchase price, as additional consideration for the sale of the Mortgage Loans in any Mortgage Loan Package, DLJ Mortgage Capital, Inc. or an affiliated successor or assignee thereof, (the "Initial Purchaser") shall deliver to the Seller on the closing date of any related Pass-Through Transfer effected by the Initial Purchaser (i) a 100% percentage interest in the most subordinate class of Certificates issued in connection with such Pass-Through Transfer and (ii) a 99.99% percentage interest in the residual class of such Certificates if such residual class constitutes the most subordinate class, unless the Purchaser and the Seller agree that such ownership interests shall not be delivered to the Seller. With respect to each Mortgage Loan sold on a scheduled basis, the Purchaser shall be entitled to all scheduled principal payments due after the related Cut-off Date, all other payments of principal due and collected after such Cut-off Date, and all payments of interest on such Mortgage Loan, minus that portion of any such interest payment which is allocable to the 11 -8- period prior to such Cut-off Date. All scheduled payments of principal due on or before such Cutoff Date and collected after such Cut-off Date shall belong to the Purchaser (in the event actual balances are purchased) or the Seller (in the event scheduled balances are purchased), subject to the terms of the Whole Loan Financing Facility between the Seller and the Purchaser, dated as of March 16, 1998 (the "Finance Facility"), together with the Pledge Agreement, Tri-Party Custodial Agreement and Interim Servicing Agreement related thereto. With respect to each Mortgage Loan sold on an actual basis, the Purchaser shall be entitled to all principal payments received after the related Cut-off Date and all payments of interest on such Mortgage Loan. All payments of principal received on or before such Cut-off Date shall belong to the Seller. The Purchaser shall have the right to transfer to any person all or a portion of its right, title and interest in and to each Mortgage Loan on or subsequent to the related Closing Date, and other rights and obligations under this Agreement with respect to such Mortgage Loan (except, in the case of any such transfer by the Initial Purchaser to an unaffiliated party, its rights under Section II and its right to indemnification and notice) as part of one or more Whole Loan Transfers or Pass-Through Transfers, as applicable, and the transferee thereof shall succeed to such right, title and interest and rights and obligations hereunder of the Purchaser with respect to such Mortgage Loan. With respect to any Mortgage Loan or related interest that has been so transferred, all references herein to the Purchaser shall be deemed to refer to the related transferee. SECTION 3. Conveyance of Mortgage Loans. With respect to the Mortgage Loans included in any Mortgage Loan Package, the Seller hereby agrees to transfer, assign, set over and otherwise convey to the Purchaser, without recourse but subject to the terms of this Agreement, on the related Closing Date, all the right, title and interest of the Seller in and to the Mortgage Loans identified on the related Mortgage Loan Schedule as of such Closing Date. Each Mortgage Loan Schedule shall conform to the requirements of the Purchaser as set forth in this Agreement. Each Mortgage Loan Schedule shall be amended on the related Closing Date, if necessary, to reflect the Mortgage Loans accepted by the Purchaser on such Closing Date in accordance with Section 5 hereof. In connection with any such transfer and assignment, the Seller shall execute and deliver to the Purchaser an Assignment and Conveyance, substantially in the form of Exhibit 8 annexed hereto, with respect to the related Mortgage Loans and shall deliver, or cause to be delivered, to the Custodian or its designee, the documents or instruments specified below with respect to each such Mortgage Loan (each a "Mortgage File"). On or before the Closing Date for any such transfer and assignment, each of the related Mortgage Files shall have been delivered by the Seller to the Custodian and shall be held by the Custodian pursuant to the Tri-Party Custodial Agreement dated September 25, 1995 (as amended, supplemented or otherwise modified from time to time, the "Custody Agreement"), among the Purchaser, the Seller and the Custodian, until the Custody Agreement is terminated as to the related Mortgage Loan. 12 -9- All Mortgage Files so delivered shall be held by the Custodian in escrow at all times prior to the related Closing Dates for the benefit of the Purchaser under the Custody Agreement. Each Mortgage File shall contain the following documents: (a) the original mortgage note, naming the Seller as the holder/payee thereof (or, if the Seller is not the original holder/payee thereof, bearing all endorsements necessary to evidence a complete and unbroken chain of endorsements from the original holder/payee to the Seller) and endorsed by the Seller "Pay to the order of ____, without recourse"; (b) the original mortgage, security deed, deed of trust or other security instrument ("Mortgage"), naming the Seller as the "mortgagee" or "beneficiary" thereof (or, if the Seller is not the original mortgagee/beneficiary thereof, such Mortgage together with all assignments necessary to evidence a complete and unbroken chain of intervening assignments from the original mortgagee/beneficiary to the Seller) and bearing evidence that such instrument has been recorded in the appropriate jurisdiction where the Mortgaged Property is located (or, in lieu of the original of the recorded Mortgage, a duplicate or conformed copy of the Mortgage, together with a certificate of an officer of either (l) the Seller or (ii) a representative of the escrow company, title insurer or other closing agent certifying that such copy represents a true and correct copy of the original and that such original has been submitted for recordation in the appropriate governmental recording office of the Jurisdiction where the Mortgaged Property is located, or a certificate of receipt from the recording office, certifying that such copy represents a true and correct copy of the original and that such original has been submitted for recordation in the appropriate governmental recording office of the jurisdiction where the Mortgaged Property is located); (c) an original assignment of the Mortgage executed at the direction of the Purchaser by the Seller, without recourse, to either (i) "Bankers Trust Company, as trustee, " (ii) "Bankers Trust Company, as trustee for the holders of DLJ Mortgage Acceptance Corp. Mortgage Pass-Through Certificates," or (iii) in blank, with evidence of recording thereon (except with respect to any assignments of Mortgage that are delivered in blank) and the original of any intervening assignment or assignments of the Mortgage, including any warehousing assignment, necessary to evidence a complete and unbroken chain of assignments from the original mortgagee/beneficiary to the Seller and bearing evidence that each such instrument has been recorded in the appropriate jurisdiction where the Mortgaged Property is located (or, in lieu of any such original recorded assignment of Mortgage or any such original recorded intervening assignment of Mortgage, a duplicate or conformed copy of such assignment of Mortgage, together with a certificate of an officer of the Seller certifying that such copy represents a true and correct copy of the original and that such original has been submitted for recordation in the appropriate governmental recording office of the jurisdiction where the Mortgaged Property is located, or a certificate of receipt from the recording office, certifying that 13 -10- such copy represents a true and correct copy of the original and that such original has been submitted for recordation in the appropriate governmental recording office of the jurisdiction where the Mortgaged Property is located); (d) the original lender's title insurance policy, or, if such policy has not been issued and if the Mortgage Loan was funded through a title insurance company or other comparable closing agent pursuant to closing instructions precluding the title insurance company or other comparable closing agent from funding until it is prepared to issue the required title insurance coverage, a copy of such closing instructions; (e) the original of any assumption, modification, extension or guaranty agreement; (f) the original or a copy of the preliminary title report (or equivalent thereof) on the Mortgaged Property; and (g) if the mortgage note, the Mortgage, any assignment of Mortgage or any other related document has been signed by a person on behalf of the mortgagor, the original power of attorney or other instrument that authorized and empowered such person to sign, or a duplicate or conformed copy of the power of attorney or other instrument, together with a certification of an officer of the Seller or of the applicable title insurance company, escrow company or other comparable closing agent certifying that such copy represents a true and correct copy of the original. The Seller shall, promptly upon receipt thereof, deliver to the Purchaser, or its designee, the original Mortgage or assignment, as the case may be, with evidence of recording indicated thereon, in each instance where a copy thereof certified by the Seller, escrow company, title insurer, other closing agent or the appropriate governmental recording office was delivered to the Purchaser or its designee. In the event the Seller cannot deliver any recorded Mortgage or assignment of Mortgage to the Purchaser or its assignee for any reason, the Seller shall deliver or cause to be delivered to the Purchaser or its assignee a photocopy of such Mortgage or assignment, as the case may be, certified by the appropriate county recorder's office to be a true and complete copy of the original thereof. If a copy of the closing instructions has been delivered by the Seller in lieu of a title insurance policy, the Seller shall use its best reasonable efforts to deliver to the Purchaser, or its designee, the related title insurance policy within 120 days of the Closing Date. In the event that any document specified in paragraphs (a) through (e) and (g) above for any Mortgage Loan is not delivered to the Purchaser within 120 days following the related Closing Date, upon written request of the Purchaser the Seller shall repurchase such Mortgage Loan at a price equal to the sum of (i) 100% of the outstanding principal balance thereof, (ii) unpaid accrued interest thereon from the due date as to which interest was last paid by the Mortgagor to the first day of the month following the month of repurchase at a rate equal to the related Mortgage Rate, and (iii) all amounts advanced by the Servicer or any other person on the Mortgage Loan and not reimbursed together with unpaid Servicing Fees (as defined in the 14 -11- related Servicing Agreement). Notwithstanding the foregoing, (i) the obligation of the Seller to deliver any document specified in (g) above shall be deemed to have been satisfied upon the delivery to the Purchaser of a duplicate or conformed copy of the power of attorney or other instrument that authorized and empowered any person to sign a mortgage note, Mortgage, assignment of Mortgage or any other related document, together with a certification of an officer of the Seller or of the applicable title insurance company, escrow company or other comparable closing agent certifying that such copy represents a true and correct copy of the original; and (ii) in the event that any original recorded document required to be delivered pursuant to paragraphs (b) or (c) above has not been delivered to the Purchaser within 120 days following the Closing Date due to circumstances that are not within the control of the Seller, the Seller shall deliver to the Purchaser, prior to the expiration of such 120 day period, an officer's certificate of the Seller which shall (A) identify the undelivered document, (B) state that the recorded document has not been delivered to the Purchaser due solely to circumstances that are not within the control of the Seller and identify such circumstances, and (C) state the date the document was delivered to the public recording office. In the event the Seller is unable to deliver such recorded document or a photocopy of such document certified by the appropriate county recorder's office to be a true and complete copy of the original thereof within 365 days following the Closing Date, upon written request of the Purchaser the Seller shall repurchase such Mortgage Loan at the repurchase price specified above. In the event that any assignment is lost or returned unrecorded because of a defect therein, the Seller shall prepare a substitute assignment or cure such defect and record such cured or substituted assignment, at the expense of the Seller, in accordance with this Section 3. The Seller shall also pay the fees of the Custodian (or its designee) incurred in connection with the removal and replacement of any assignment of Mortgage delivered for recording, as well as the fees of the Custodian (or its designee) incurred in connection with the addition of any title insurance policy or recorded Mortgage to the related Mortgage File. With respect to any Whole Loan Transfer by the Initial Purchaser, the Seller shall, promptly upon the request of the Initial Purchaser, deliver to the Custodian or its designee original assignments of the Mortgages for the related Mortgage Loans, without recourse and in blank, to be executed by either "Bankers Trust Company, as trustee," or "Bankers Trust Company, as trustee for the holders of DLJ Mortgage Acceptance Corp. Mortgage Pass-Through Certificates," as applicable, in recordable form and sufficient under the laws of the jurisdictions wherein the related Mortgaged Properties are located to reflect of record the sale of such Mortgages upon the completion of such assignments. The Seller shall use its best efforts to cause the Custodian or its designee to execute such assignments as provided in the preceding sentence and to deliver them in accordance with the Initial Purchaser's instructions. The Seller shall not be liable for the Custodian's or its designee's failure to timely execute and deliver any assignment as provided in this paragraph. Subsequent to a Whole Loan Transfer or Pass-Through Transfer by the Initial Purchaser, the Seller shall deliver to the Purchaser or its designee all original documents relating 15 -12- to the Mortgage Loans that have not previously been delivered to the Purchaser, an affiliate thereof or the Custodian in trust for the benefit of the Purchaser or any assignee, transferee or designee of the Purchaser, other than original documents required to be held by the Seller pursuant to applicable mortgage lending laws and rules and regulations of the jurisdiction in which the related Mortgaged Property is located (in lieu of which the Seller shall deliver photocopies), and any person's possession of any such documents on behalf of the Purchaser shall be at the will of the Purchaser and any documents held by the Servicer shall be for the sole purpose of servicing the related Mortgage Loan and such possession by such person shall be in a custodial capacity only. Upon sale of any Mortgage Loan by the Seller to the Purchaser hereunder, the ownership of the related Mortgage Note, the related Mortgage and the contents of the related Mortgage File shall be vested in the Purchaser and the ownership of all records and documents with respect to such Mortgage Loan prepared by or that come into the possession of the Seller shall immediately vest in the Purchaser and shall be retained and maintained, in trust, by the Seller at the will of the Purchaser in such custodial capacity only. The Seller's records shall accurately reflect the sale of each Mortgage Loan to the Purchaser. In the event that any original document held by the Seller is required pursuant to the terms of this Section 3 to be a part of a Mortgage File, such document shall be delivered promptly to the Purchaser or its designee. SECTION 4. Late Payment Charges and Prepayment Charges; Seller's Repurchase Right. Any late payment charges or prepayment charges collected in connection with any Mortgage Loan shall be retained by or paid to the Seller during any period that the Initial Purchaser is the owner of such Mortgage Loan. The Seller's right to late payment and prepayment charges on any Mortgage Loan shall terminate in the event of a Whole Loan Transfer thereof on a servicing released basis without payment of any additional consideration to the Seller. The Initial Purchaser shall have the right to purchase the Seller's right to the late payment and prepayment charges on the Mortgage Loans at a price mutually agreed upon by the Initial Purchaser and the Seller, and the payment for such right shall be included in the purchase price and paid on the related Closing Date. In addition, during the period the Initial Purchaser is the owner of any Mortgage Loan, the Seller shall have the option to purchase any related REO Property acquired or to be acquired for an amount equal to the unpaid principal balance of the related Mortgage Loan immediately prior to its conversion to an REO Property together with all accrued and unpaid interest thereon through the first day of the month following the month of repurchase and all unreimbursed expenses or advances in connection therewith, in each case as promptly as possible but in any event within thirty days following the later of (a) the date on which such Mortgage Loan becomes an REO Property and (b) the date on which the Servicer notifies the Seller that such Mortgage Loan has become an REO Property; provided that if the Seller does not purchase any two Mortgage Loans that become REO Properties as permitted above, the Seller shall thereafter have no right or option to purchase any additional REO Property as provided in this paragraph. Except to the extent otherwise agreed upon by the Seller, the agreement or agreements pursuant to which any Mortgage Loan is transferred as part of a Pass-Through Transfer by the Initial Purchaser shall provide that (i) any late payment charges or prepayment 16 -13- charges collected in connection with such Mortgage Loan shall be paid to the Seller and (ii) the Seller shall have the option to purchase any related REO Property acquired or to be acquired as provided in the preceding paragraph subject to the limitation that if the Seller does not purchase any two Mortgage Loans which are subject to such Pass-Through Transfer and that become REO Properties as permitted above, the Seller shall thereafter have no right or option to purchase any additional REO Property or Mortgage Loan that becomes an REO Property sold in connection with such Pass-Through Transfer. SECTION 5. Examination of Mortgage Files and Due Diligence Review. On or before the Closing Date related to each Mortgage Loan Package, the Seller shall (a) deliver or cause to be delivered to the Purchaser magnetic tapes acceptable to the Purchaser which contain such information about the Mortgage Loans in such Mortgage Loan Package as may be reasonably requested by the Purchaser, and (b) as directed by the Purchaser, either, deliver to the Purchaser or its designee, in escrow, or make available, or cause to be made available, for examination during normal business hours, all credit files, underwriting documentation and Mortgage Files relating to such Mortgage Loans. The Purchaser may reject any Non-Program Loan (as that term is defined in the Commitment Letter between the Purchaser and the Seller dated March 16, 1998) offered for sale hereunder in its sole discretion. The fact that the Purchaser has conducted or has failed to conduct any partial or complete examination of the credit file, underwriting documentation or Mortgage File relating to any Mortgage Loan shall not affect the Purchaser's right to demand repurchase of such Mortgage Loan or other relief as provided under this Agreement. In addition to the foregoing examination of the Mortgage Files and related documents, the Seller agrees to allow the Initial Purchaser, or its designee, or any representative of any nationally recognized statistical rating agency rating the Certificates issued as part of any Pass-Through Transfer by the Initial Purchaser (a "Rating Agency"), to examine and audit all books, records and files pertaining to the Mortgage Loans, the Seller's underwriting procedures and the Seller's ability to perform or observe all of the terms, covenants and conditions of this Agreement. Such examinations and audits shall take place at one or more offices of the Seller during normal business hours and in the course of such examinations and audits, the Seller shall make available to the Initial Purchaser, or its designee, adequate facilities, as well as the assistance of a sufficient number of knowledgeable and responsible individuals who are familiar with the Mortgage Loans and the terms of this Agreement, and the Seller shall cooperate fully with any such review in all respects. The Seller agrees to provide the Initial Purchaser, its designee and any representative of a Rating Agency with all material information regarding the Seller (including its financial condition), and to provide access to knowledgeable financial or accounting officers for the purpose of answering questions with respect to the Seller's financial condition, financial statements or other developments affecting the Seller. The Initial Purchaser shall, upon reasonable prior notice, also have the right to perform such examinations and audits or to obtain such material information regarding the Seller's financial condition and access to the officers described above following any Closing Date. 17 -14- The Seller understands and agrees that any information, including but not limited to financial information, regarding the status of the Seller with respect to any regulatory body or entity and information as to the loss and delinquency experience of loans originated or acquired by the Seller, obtained in the examination and review described in the foregoing paragraph may be disclosed in an Offering Circular (as defined herein); provided, however, that neither the Initial Purchaser nor any affiliate thereof assumes any responsibility with respect to such information. SECTION 6. Representations. Warranties and Covenants of the Seller. In order to induce the Purchaser to enter into this Agreement, the Seller hereby represents, warrants and covenants to the Purchaser that as of the date hereof and as of each Closing Date (or such other date specifically provided herein): (i) The Seller is a corporation, duly organized, validly existing and in good standing under the laws of the State of California with full power and authority to carry on its business as presently conducted by it. The Seller had the full power and authority and legal right to originate or acquire the Mortgage Loans sold on such Closing Date. The Seller has the full power and authority and legal right to own the Mortgage Loans sold on such Closing Date and to transfer and convey such Mortgage Loans to the Purchaser and has the full power and authority and legal right to execute and deliver, engage in the transactions contemplated by, and perform and observe the terms and conditions of, this Agreement, each Servicing Agreement and the Custody Agreement. (ii) This Agreement, each Servicing Agreement and the Custody Agreement have been duly and validly authorized, executed and delivered by the Seller, all requisite corporate action has been or will have been taken, and (assuming the due authorization, execution and delivery hereof and thereof by the other parties hereto and thereto) each constitutes or will constitute the valid, legal and binding agreement of the Seller, enforceable in accordance with its terms, except as such enforcement may be limited by (i) laws relating to bankruptcy, insolvency, reorganization, receivership or moratorium, (ii) other laws relating to or affecting the rights of creditors generally and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law) or (iii) public policy considerations underlying the securities laws, to the extent that such public policy considerations limit the enforceability of the provisions of this Agreement which purport to provide indemnification from liabilities under applicable securities laws. (iii) Either (a) no consent, approval, authorization or order of, registration or filing with, or notice to, any governmental authority or court is required, under federal or state laws, for the execution, delivery and performance of or compliance by the Seller with this Agreement, each Servicing Agreement or the Custody Agreement, or the consummation by the Seller of any other transaction contemplated hereby or (b) such consent, approval, authorization or order has been obtained, or such registration, filing or notice has been made. 18 -15- (iv) Neither the transfer of the Mortgage Loans sold on such Closing Date to the Purchaser, nor the execution, delivery or performance of this Agreement, each Servicing Agreement or the Custody Agreement by the Seller, conflicts or will conflict with, or results or will result in a breach of, or constitutes or will constitute a default under (a) any term or provision of the documents governing the Seller's organization, or (b) any term or provision of any material agreement, contract, instrument or indenture, to which the Seller is a party or is bound, or (c) any law, rule, regulation, order, judgment, writ, injunction or decree of any court or governmental authority having jurisdiction over the Seller, or results or will result in the creation or imposition of any lien, charge or encumbrance which, in any of the foregoing cases, would have a material adverse effect upon such Mortgage Loans or any documents or instruments evidencing or securing such Mortgage Loans. (v) The Seller has delivered to the Initial Purchaser audited consolidated financial statements as to its last complete fiscal year (if applicable) and its unaudited financial statements as of any later quarter ended more than ninety (90) days prior to the date hereof or such Closing Date, as applicable. All such financial statements fairly present the pertinent results of operations and changes in financial position for each of such periods and the financial position at the end of each such period of the Seller, and have been prepared in accordance with generally accepted accounting principles consistently applied throughout the periods involved, except as set forth in the notes thereto. (vi) Except as have been previously disclosed in writing by the Seller, there are no actions or proceedings against, or investigations of, the Seller pending or, to the Seller's knowledge, threatened against the Seller before any court, administrative agency or other tribunal, which would reasonably be expected to adversely affect the transfer of the Mortgage Loans, the issuance of Certificates as part of any Pass-Through Transfer by the Initial Purchaser, the execution, delivery or enforceability of this Agreement, the Servicing Agreement or the Custody Agreement, or have a material adverse effect on the financial condition of the Seller. (vii) The information set forth on the Mortgage Loan Schedule related to each Mortgage Loan sold on such Closing Date is true and correct in all material respects. (viii) The Seller represents and warrants that each of the representations and warranties contained in Exhibit 6 annexed hereto and in the Assignment and Conveyance related to each Mortgage Loan sold, on such Closing Date is true and correct and the Seller shall restate such representations on the closing date of any related Whole Loan Transfer or Pass-Through Transfer by the Initial Purchaser in accordance with Section 11 hereof. (ix) The Seller covenants to (a) provide in a timely manner all of the information regarding itself and the Mortgage Loans sold on such Closing Date as the Initial Purchaser may reasonably request in connection with the preparation of any related Offering Circular, (b) fully cooperate with, and supply all information requested by a Rating Agency to the 19 -16- extent practicable, and (c) dedicate adequate personnel and resources as may be required to comply with all of the terms and conditions of this Agreement. (x) The Seller covenants with the Initial Purchaser that as of the date of any Offering Circular and as of the closing date for the related Whole Loan Transfer or Pass-Through Transfer, the information contained in such Offering Circular with respect to the Seller's Information (as defined in Section 12(a)) shall be true and accurate and shall not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they are made, not misleading. (xi) Other than in connection with solicitations or promotions directed at the general public, the Seller agrees that it shall not solicit the Mortgagor with respect to any Mortgage Loan for the purpose of refinancing such Mortgage Loan after the execution of the Confirmation Letter with respect to the Mortgage Loan. (xii) The Seller is, and at all times during the term of this Agreement shall remain a mortgagee approved by the Secretary of Department of Housing and Urban Development pursuant to Sections 203 and 211 of the National Housing Act, as amended. SECTION 7. Cure, Repurchase and Indemnity Obligations of the Seller. Each of the representations, warranties and covenants contained in or required to be made pursuant to Section 6 or Section 11 of this Agreement shall survive the sale of the related Mortgage Loans and shall continue in full force and effect, notwithstanding any restrictive or qualified endorsement on the related Mortgage Notes and notwithstanding subsequent termination of this Agreement. The representations, warranties and covenants contained in or required to be made pursuant to Section 6 or Section 11 of this Agreement shall not be impaired by any review or examination of the Mortgage Files or other documents evidencing or relating to the related Mortgage Loans or any failure on the part of the Purchaser to review or examine such documents and shall inure to the benefit of any transferee of such Mortgage Loans from the Purchaser or any affiliate thereof, including, without limitation, any transferee related to a Whole Loan Transfer or Pass-Through Transfer. Upon discovery of any defective document in a Mortgage File relating to a Mortgage Loan which materially and adversely affects the interests of the Purchaser, any affiliate thereof, any holder of the Mortgage Loan or any holders of Certificates representing an interest in the Mortgage Loan, the Purchaser or its assignee shall notify the Seller of such defect and request that the Seller cure such defect within 60 days from the date the Seller was notified of such defect. The Seller hereby covenants and agrees that if any such defect cannot be corrected or cured within such 60-day period, the Seller shall, not later than 90 days after its receipt of notice of such defect, repurchase the related Mortgage Loan at a price equal to the sum of (i) 100% of the outstanding principal balance thereof, (ii) unpaid accrued interest thereon from the due date as to which interest was last paid by the Mortgagor to the first day of the month following the 20 -17- month of repurchase at a rate equal to the related Mortgage Rate, (iii) all amounts advanced by the Servicer or any other person on the Mortgage Loan and not reimbursed together with unpaid Servicing Fees (as defined in the related Servicing Agreement) and (iv) all expenses reasonably incurred or to be incurred by or on behalf of the Purchaser in respect of the breach or defect giving rise to the repurchase obligation, including any expenses arising out of the enforcement of the repurchase obligation (the sum of the amounts in clauses (i) through (iv), the "Repurchase Price"). Within 90 days of the earlier of discovery by the Seller or receipt of notice by the Seller of a breach of any of the representations, warranties or covenants of the Seller set forth in or required to be made pursuant to Section 6 or Section 11 of this Agreement which materially and adversely affects the interests of the Purchaser, any affiliate thereof, any holder of the Mortgage Loan or the holders of the Certificates representing an interest in the Mortgage Loan, or to the extent that the Seller cannot restate as of the closing date of any related Whole Loan Transfer or Pass-Through Transfer by the Initial Purchaser any of the representations or warranties for any Mortgage Loan as set forth in Section 6 hereof or required by Section 11 hereof, the Seller shall either (i) cure such breach in all material respects or (ii) repurchase the related Mortgage Loan from the Purchaser at the Repurchase Price. In addition to such cure and repurchase obligation, the Seller shall indemnify the Purchaser and hold it harmless against any losses, damages, penalties, fines, forfeitures, reasonable and necessary legal fees and related costs, judgments, and other costs and expenses resulting from any claim, demand, defense or assertion based on or grounded upon, or resulting from, a breach of the Seller's representations and warranties contained in Section 6 or Section 11 hereof. It is understood and agreed that solely with respect to a defective document or a breach of the Seller's representations and warranties with respect to a Mortgage Loan which materially and adversely affects the interests of the Purchaser, any affiliate thereof, any holder of the Mortgage Loan or the holders of the Certificates representing an interest in the Mortgage Loan, the obligations of the Seller set forth in this Section 7 to cure or repurchase a defective Mortgage Loan and to indemnify the Initial Purchaser as provided in this Section 7 and in Section 12 hereof constitute the sole remedies of the Purchaser or its assignee; provided that this limitation shall not in any way limit the Purchaser's rights or remedies upon breach of any other representation or warranty herein. The Repurchase Price for any repurchased Mortgage Loan shall be payable to the Purchaser or its assignee by wire transfer of immediately available funds to the account designated by the Purchaser, and the Purchaser or its assignee, upon receipt of such funds, shall release or cause to be released to the Seller the related Mortgage File and shall execute and deliver such instruments of transfer or assignment, in each case without recourse, as shall be necessary to vest in the Seller title to any Mortgage Loan released pursuant hereto. 21 -18- SECTION 8. Representations and Warranties of the Purchaser. In order to induce the Seller to enter into this Agreement, the Purchaser hereby represents and warrants to the Seller that as of the date hereof and as of each Closing Date: (i) The Purchaser is a corporation, duly organized, validly existing and in good standing under the laws of the State of Delaware with full power and authority to carry on its business as presently conducted by it. The Purchaser has the full power and authority and legal right to execute and deliver, engage in the transactions contemplated by, and perform and observe the terms and conditions of, this Agreement. (ii) This Agreement has been duly and validly authorized, executed and delivered by the Purchaser, all requisite corporate action has been or will have been taken, and (assuming the due authorization, execution and delivery hereof by the other parties hereto) constitutes or will constitute a valid, legal and binding agreement of the Purchaser, enforceable in accordance with its terms, except as such enforcement may be limited by (i) laws relating to bankruptcy, insolvency, reorganization, receivership or moratorium, (ii) other laws relating to or affecting the rights of creditors generally and by general equity principles (regardless of whether such enforcement is considered in a proceeding in equity or at law) or (iii) public policy considerations underlying the securities laws, to the extent that such public policy considerations limit the enforceability of the provisions of this Agreement which purport to provide indemnification from liabilities under applicable securities laws. (iii) Either (a) no consent, approval, authorization or order of, registration or filing with, or notice to, any governmental authority or court is required, under federal or state laws, for the execution, delivery and performance of or compliance by the Purchaser with this Agreement, or the consummation by the Purchaser of any other transaction contemplated hereby or (b) such consent, approval, authorization or order has been obtained, or such registration, filing or notice has been made. (iv) The execution, delivery or performance of this Agreement by the Purchaser does not conflict or will not conflict with, or does not result or will not result in a breach of, or does not constitute or will not constitute a default under (a) any term or provision of the documents governing the Purchaser's organization, or (b) any term or provision of any material agreement, contract, instrument or indenture. to which the Purchaser is a party or is bound, or (c) any law, rule, regulation, order, judgment, writ, injunction or decree of any court or governmental authority having jurisdiction over the Purchaser. (v) There are no actions or proceedings against, or investigations of, the Purchaser pending or, to the Purchaser's knowledge, threatened against the Purchaser before any court, administrative agency or other tribunal, which would reasonably be expected to adversely affect the transfer of the Mortgage Loans sold on such Closing Date, the execution, delivery or enforceability of this Agreement or have a material adverse effect on the financial condition of the Purchaser. 22 -19- SECTION 9. Closing. The closing of the sale of the Mortgage Loans to be purchased on each Closing Date shall be held at the offices of Thacher Proffitt & Wood, located at Two World Trade Center, New York, New York, at 10:00 A.M., New York time (or such other place and time as the Purchaser and the Seller shall agree), on such Closing Date, and such closing shall be subject to each of the following conditions: (a) All of the representations and warranties of the Seller and the Purchaser shall be true and correct in all material respects as of such Closing Date; (b) All Closing Documents specified in Section 10 of this Agreement, in such forms as are agreed upon and acceptable to the Purchaser and the Seller, shall be duly executed and delivered by all signatories as required pursuant to the respective terms thereof (c) The Seller shall have delivered and released to the Purchaser or its designee all documents required to be delivered pursuant to Section 3 of this Agreement; (d) The result of the examination and audit performed by the Purchaser pursuant to Section 5 hereof shall be satisfactory to the Purchaser in its sole determination; (e) All other terms and conditions of this Agreement required to be complied with on or before such Closing Date shall have been complied with and the Seller and the Purchaser shall have the ability to comply with all terms and conditions and perform all duties and obligations required to be complied with or performed after such Closing Date; and (f) The Purchaser shall have received from the Custodian a Trust Receipt (as defined in the Custody Agreement) for the Mortgage File related to each Mortgage Loan to be sold on such Closing Date. SECTION 10 Closing Documents. The "Closing Documents" for the Mortgage Loans to be sold on any Closing Date shall consist of the following: (a) If such Closing Date is the initial Closing Date, this Agreement duly executed by the Purchaser and the Seller; (b) With respect to each Mortgage Loan Package sold on such Closing Date, an Assignment and Conveyance from the Seller to the Purchaser or its designee, substantially in the form of Exhibit 8 annexed hereto, dated such Closing Date, with a copy of the related Mortgage Loan Schedule attached thereto; (c) An Officers' Certificate of the Seller in the form of Exhibit 2 annexed hereto, dated such Closing Date, and attached thereto resolutions of the board of directors 23 -20- of the Seller, in a form substantially similar to Exhibit 3 annexed hereto, together with copies of the documents governing the Seller's organization and a certificate of good standing of the Seller; (d) On the initial Closing Date and on each subsequent Closing Date on which the Purchaser requests such opinion due to the Purchaser's reasonable determination that the Seller's condition may have changed prior to the initial Closing Date, a written opinion of counsel for the Seller reasonably satisfactory to the Purchaser, substantially in the form of Exhibit 4 annexed hereto, dated such Closing Date; (e) With respect to each Mortgage Loan Package sold on such Closing Date, a cross-receipt dated such Closing Date, substantially in the form of Exhibit 7 annexed hereto, duly executed by the Seller and the Purchaser; and (f) Such other documents as the Purchaser may reasonably request. SECTION 11. Information to be Provided by the Seller. As an inducement to the Purchaser to purchase the Mortgage Loans to be included in any Mortgage Loan Package, the Seller agrees to cooperate and use its best efforts to (i) take such actions as are reasonably required by the Initial Purchaser in connection with each Whole Loan Transfer and Pass-Through Transfer by the Initial Purchaser and (ii) assist in the preparation by the Initial Purchaser of any related prospectus, private placement memorandum or other document containing information with respect to the Seller or one or more of such Mortgage Loans (each such document, an "Offering Circular"), including any document used in connection with the sale of a Mortgage Loan as part of any Whole Loan Transfer by the Initial Purchaser and any document pursuant to which the Certificates that are issued as part of any Pass-Through Transfer by the Initial Purchaser will be offered to investors. The Seller agrees to provide the Initial Purchaser with any and all information and appropriate verification of information, whether through letters of its auditors and counsel or otherwise, and shall provide to the Initial Purchaser such additional representations, warranties, covenants, opinions of counsel, including, without limitation, true sale and perfection opinions of counsel, letters from auditors, and certificates of public officials or officers of the Seller as may reasonably be believed to be necessary by the Initial Purchaser and reasonably acceptable to the Initial Purchaser in order to effect (i) the issuance of the Certificates related to any Pass-Through Transfer by the Initial Purchaser, the class of senior Certificates of which shall bear a rating no lower than in the highest rating category of one or more nationally recognized statistical rating agencies, or (ii) any Whole Loan Transfer by the Initial Purchaser. Without limiting the generality of the Seller's agreements in the foregoing sentence, such additional representations and warranties shall be made as of the "cut-off date", as such term is defined in the agreement or agreements pursuant to which the Mortgage Loans related to any Whole Loan Transfer or Pass-Through Transfer by the Initial Purchaser are transferred, except for those representations and warranties which shall be made as of the closing date relating to any Whole Loan Transfer 24 -21- or Pass-Through Transfer by the Initial Purchaser or as of any other date between such "cut-off date" and such closing date, and shall include for each such Mortgage Loan a restatement of all representations and warranties made in Section 6 of this Agreement as of the related "cut-off date" or closing date of the Whole Loan Transfer or Pass-Through Transfer or any date between such dates, as applicable, and the Initial Purchaser shall have the right to direct the Seller to make statistical pool representations and warranties with respect to the information listed on the Mortgage Loan Schedule, except that the representations and warranties with respect to mortgage pool statistics (including those on the Mortgage Loan Schedule) may be modified to accurately reflect the actual mortgage pool statistics of such Mortgage Loans as of such "cut-off date", closing date or intervening date to the extent such mortgage pool statistics change as a result of payments or defaults on such Mortgage Loans or a repurchase of any such Mortgage Loan by the Seller. As to each Whole Loan Transfer by the Initial Purchaser, the information to be supplied shall be that which is customary for similar transactions, and as to each Pass-Through Transfer by the Initial Purchaser, the information to be supplied shall be that which is customary for public or private, rated transactions for the issuance of mortgage pass-through certificates and that which is substantially similar to information previously provided by the Seller with respect to other issuances of mortgage pass-through certificates. The Purchaser and Seller acknowledge that the assignment related to any Whole Loan Transfer by the Initial Purchaser may, and the issue and sale of the Certificates related to any Pass-Through Transfer by the Initial Purchaser will, require the disclosure of the Seller's underwriting criteria, loss and delinquency experience and the characteristics of the related Mortgage Loans as all or a portion of a pool of such Mortgage Loans by the Seller as part of one or more Offering Circulars or similar disclosure documents. The Purchaser and the Seller each agree to execute and deliver to the other such additional documents, instruments or agreements as may be necessary or appropriate to effectuate the purposes of this Agreement and in connection with any Whole Loan Transfer or Pass-Through Transfer by the Initial Purchaser. SECTION 12. Indemnification. (a) The Seller agrees to indemnify and hold harmless the Initial Purchaser, DLJ Mortgage Acceptance Corp. (the "Depositor") and Donaldson, Lufkin & Jenrette Securities Corporation ("DLJSC"), their respective officers and directors, and each person, if any, who controls the Initial Purchaser, the Depositor or DLJSC within the meaning of either Section 15 of the Securities Act of 1933, as amended (the "1933 Act"), or Section 20 of the Securities Exchange Act of 1934, as amended (the " 1934 Act"), against any and all losses, claims, damages or liabilities, joint or several, to which they or any of them may become subject under the 1933 Act, the 1934 Act or other federal or state statutory law or regulation, at common law or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based in whole or in part upon any untrue statement or alleged untrue statement of a material fact contained in any Offering Circular, or any omission or alleged omission to state in any Offering Circular a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading, or any such untrue statement or omission or alleged untrue statement or alleged omission made in any amendment of or supplement to any Offering Circular, or elsewhere 25 -22- in reliance upon any information furnished to the Initial Purchaser by the Seller or approved by the Seller, or upon a defective document or a breach or alleged breach of the representations, warranties, covenants or agreements of the Seller as set forth in this Agreement, in any exhibit hereto or in any Assignment and Conveyance or as set forth in any documents, instruments or agreements of the Seller required to be delivered in connection with any Whole Loan Transfer or Pass-Through Transfer by the Initial Purchaser as described in Section II of this Agreement (collectively, the "Seller's Information"), it being acknowledged that all statements set forth in any Offering Circular under the captions "Description of the Mortgage Pool" and "The Seller" or elsewhere in such Offering Circular with respect to the subjects discussed under such captions will be made in reliance upon information furnished or approved by the Seller and it being further acknowledged that the "Seller's Information" shall not include the information set forth in any Offering Circular under the captions "The Seller-Loan Delinquency, Forbearance, Foreclosure, Bankruptcy and REO Property Status" and "REO Property Liquidation Experience" (or, if any such captions do not appear in an Offering Circular, under captions containing information of like character to information contained under similar captions in other offering circulars relating to mortgage loans originated or acquired by the Seller) or elsewhere in such Offering Circular with respect to the subjects discussed under such captions. Coincident with the printing of any Offering Circular, the Seller shall deliver to the Initial Purchaser or an affiliate thereof a letter signed by an authorized officer of the Seller stating that the Seller has approved such Seller's Information. The Seller acknowledges that the Initial Purchaser, the Depositor and DLJSC will enter into one or more mortgage loan purchase agreements, underwriting agreements or placement agreements in reliance upon this indemnity agreement of the Seller. This indemnity agreement shall be in addition to any liability which the Seller may otherwise have. (b) In case any proceeding (including any governmental investigation) shall be instituted involving any person in respect of which indemnity may be sought pursuant to Section 12(a) above, such person (the "indemnified party") shall promptly notify the person against whom such indemnity may be sought (the "indemnifying party") in writing and the indemnifying party, upon request of the indemnified party, shall retain counsel reasonably satisfactory to the indemnified party to represent the indemnified party and any others the indemnifying party may designate in such proceeding and shall pay the reasonable fees and disbursements of such counsel related to such proceeding. In any such proceeding, any indemnified party shall have the right to retain its own counsel, but the reasonable fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the indemnifying party and the indemnified party shall have mutually agreed to the retention of such counsel or (ii) the named parties to any such proceeding (including any impleaded parties) include both the indemnifying party and the indemnified party and representation of both parties by the same counsel would be inappropriate due to actual or potential differing interests between them. It is understood that the indemnifying party shall not, in connection with any proceeding or related proceedings in the same jurisdiction, be liable for the reasonable fees and expenses of more than one separate firm for all such indemnified parties. The indemnifying party may, at its option, at any time upon written notice to the indemnified party, assume the defense of any proceeding and may designate counsel satisfactory to the indemnified party in connection therewith provided that 26 -23- the counsel so designated would have no actual or potential conflict of interest in connection with such representation. Unless it shall assume the defense of any proceeding, the indemnifying party shall not be liable for any settlement of any proceeding effected without its written consent, but if settled with such consent or if there be a final judgment for the plaintiff, the indemnifying party agrees to indemnify the indemnified party from and against any loss or liability by reason of such settlement or judgment. If the indemnifying party assumes the defense of any proceeding, it shall be entitled to settle such proceeding with the consent of the indemnified party or, if such settlement provides for release of the indemnified party in connection with all matters relating to the proceeding which have been asserted against the indemnified party in such proceeding by the other parties to such settlement, without the consent of the indemnified party. (c) If the indemnification provided for in this Section 12 is unavailable to an indemnified party under Section 12(a) hereof or insufficient in respect of any losses, claims, damages or liabilities referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities, in such proportion as is appropriate to reflect the relative fault of the 'Indemnified and indemnifying parties in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The relative fault of the indemnified and indemnifying parties shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by such parties. (d) The Purchaser and the Seller agree that it would not be just and equitable if contribution pursuant to Section 12(c) were determined by pro rata allocation or by any other method of allocation which does not take account of the considerations referred to in Section 12(c) above. The amount paid or payable by an indemnified party as a result of the losses, claims, damages and liabilities referred to in this Section 12 shall be deemed to include, subject to the limitations set forth above, any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim, except where the indemnified party is required to bear such expenses pursuant to this Section 12, which expenses the indemnifying party shall pay as and when incurred, at the request of the indemnified party, to the extent that the indemnifying party will be ultimately obligated to pay such expenses. In the event that any expenses so paid by the indemnifying party are subsequently determined to not be required to be borne by the indemnifying party hereunder, the party which received such payment shall promptly refund the amount so paid to the party which made such payment. No person guilty of fraudulent misrepresentation (within the meaning of Section 11 (f) of the 1933 Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. (e) The indemnity and contribution agreements contained in this Section 12 shall remain operative and in full force and effect regardless of (i) any termination of this Agreement, (ii) any investigation made by the Initial Purchaser, the Depositor or DLJSC or any 27 -24- person controlling the Initial Purchaser, the Depositor or DLJSC or by or on behalf of the Seller and their respective directors or officers or any person controlling the Seller, and (iii) acceptance of and payment for any of the Mortgage Loans or the Certificates as part of or in connection with any Whole Loan Transfer or Pass-Through Transfer by the Initial Purchaser. SECTION 13. Costs. The Seller shall pay directly all of its own expenses, including out-of-pocket expenses, the expenses of the preparation and recording of assignments of Mortgage pursuant to Section 3 hereof and the delivery of documents required pursuant to Section 3 hereof to the Custodian or its designee, fees for title policy endorsements and continuations, and its attorney fees. SECTION 14. Servicing. Each of the Mortgage Loans included in any Mortgage Loan Package shall be serviced by a servicer acceptable to the Purchaser (the "Servicer") pursuant to a Servicing Agreement identified in the related Assignment and Conveyance, the "Servicing Agreement"), among the related Servicer, the Purchaser, the Seller and the Custodian thereunder, if applicable, until the Servicing Agreement is terminated as to such Mortgage Loan. The Seller hereby represents to the Purchaser as of each Closing Date that the Mortgage Loans sold on such Closing Date are serviced by the related Servicer pursuant to the related Servicing Agreement and are not subject to servicing agreements with third parties, and it is understood and agreed between the Seller and the Purchaser that such Mortgage Loans are to be delivered free and clear of any servicing agreements with third party servicers. SECTION 15. Notices. All demands, notices and communications hereunder shall be in writing and shall be deemed to have been duly given if personally delivered or mailed by registered mail, postage prepaid, return receipt requested, to the following addresses: if to the Purchaser, addressed to the Purchaser at 277 Park Avenue, New York, New York 10172, Attention: Paul Najarian, or to such other address as the Purchaser may designate in writing to the Seller; or if to the Seller, addressed to the Seller at 1063 McGaw Avenue, Irvine, California 92614-5532, Attention: President, or to such other addresses as the Seller may designate in writing to the Purchaser. SECTION 16. Severability of Provisions. Any part, provision, representation, warranty or covenant of this Agreement that is prohibited or that is held to be void or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. Any part, provision, representation or warranty of this Agreement that is prohibited or unenforceable or is held to be void or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction as to any Mortgage Loan shall not invalidate or render unenforceable such provision in any other jurisdiction. To the extent permitted by applicable law, the parties hereto waive any provision of law which prohibits or renders void or unenforceable any provision hereof. 28 -25- SECTION 17. Survival; Third Party Beneficiary. The Seller and the Purchaser agree that the representations, warranties and agreements made herein and in any certificate or other instrument delivered pursuant hereto shall be deemed to be relied upon by the other party, notwithstanding any investigation heretofore or hereafter made by such party or on such party's behalf, and that the representations, warranties and agreements made by the Seller and the Purchaser herein or in any such certificate or other instrument shall survive the delivery of and payment for the Mortgage Loans. The parties hereto agree that the Depositor and DLJSC are intended third party beneficiaries of Section 12 hereof, and that the Depositor and DLJSC may enforce such provision to the same extent as if the Depositor and DLJSC were parties to this Agreement. SECTION 18. Governing Law. This Agreement is to be governed by, and construed in accordance with, the laws of the State of California. SECTION 19. Successors and Assigns. The rights and obligations of the Seller under this Agreement shall not be assigned by the Seller without the prior written consent of the Purchaser. The Purchaser has the right to assign its interest under this Agreement (except, in the case of any such transfer by the Initial Purchaser to an unaffiliated party, its rights under Section 11 and its rights to indemnification and notice) with respect to any Mortgage Loan, in whole or in part, to any person as may be required to effect any Whole Loan Transfer or Pass-Through Transfer, by written notice to the Seller, without the consent of Seller, and the related assignee shall thereupon succeed to the rights and obligations hereunder of the Purchaser. Subject to the foregoing, this Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors and assigns. This Agreement supersedes all prior agreements and understandings relating to the subject matter hereof. SECTION 20. Waivers. Neither this Agreement nor any term hereof may be changed, waived, discharged or terminated orally, but only by an instrument in writing signed by the party against whom enforcement of the change, waiver, discharge or termination is sought. SECTION 21. Headings. The headings in this Agreement are for purposes of reference only and shall not limit or otherwise affect the meaning hereof. SECTION 22. Intention of the Parties. It is the express intent of the parties hereto that the conveyance of the Mortgage Loans sold by the Seller to the Purchaser as provided in Section 3 hereof be, and be construed as, a sale of such Mortgage Loans by the Seller to the Purchaser and not as a pledge of such Mortgage Loans by the Seller to the Purchaser to secure a debt or other obligation of the Seller. However, in the event that, notwithstanding the aforementioned intent of the parties, any such Mortgage Loans are held to be property of the Seller, then (a) it is the express intent of the parties that such conveyance be deemed a pledge of such Mortgage Loans by the Seller to the Purchaser to secure a debt or other obligation of the Seller and (b) (1) this Agreement shall also be deemed to be a security agreement within the 29 -26- meaning of Articles 8 and 9 of the applicable Uniform Commercial Code; (2) the conveyance provided for in Section 3 of this Agreement shall be deemed to be a grant by the Seller to the Purchaser of a security interest in or lien on all of the Seller's right, title and interest in and to such Mortgage Loans and all amounts payable to the holders of such Mortgage Loans in accordance with the terms thereof and all proceeds of the conversion, voluntary or involuntary, of the foregoing into cash, instruments, securities or other property; (3) the possession by the Purchaser or its agent of mortgage notes, the related mortgages and such other items of property as constitute instruments, money, negotiable documents or chattel paper shall be deemed to be "possession by the secured party" for purposes of perfecting the security interest pursuant to Section 9-305 of the applicable Uniform Commercial Code; and (4) notifications to persons holding such property, and acknowledgments, receipts or confirmations from persons holding such property, shall be deemed notifications to, or acknowledgment, receipts or confirmations from, financial intermediaries, bailees or agents (as applicable) of the Purchaser for the purpose of perfecting such security interest or lien under applicable law. Any assignment of the interest of the Purchaser pursuant to Section 2 hereof shall also be deemed to be an assignment of any security interest created hereby. The Seller and the Purchaser shall, to the extent consistent with this Agreement, take such actions as may be necessary to ensure that, if this Agreement were deemed to create a security interest in or lien on any of the Mortgage Loans sold to the Purchaser, such security interest or lien would be deemed to be a perfected security interest or lien of first priority under applicable law and will be maintained as such throughout the term of the Agreement. SECTION 23. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall constitute an original but all of which, when taken together, shall constitute but one legal instrument. It shall not be necessary in making proof of this Agreement to produce or account for more than one such counterpart. SECTION 24. Further Assurances. The Seller and the Purchaser each agree to execute and deliver such instruments and take such actions as the other may, from time to time, reasonably request in order to effectuate the purpose and to carry out the terms of this Agreement. 30 IN WITNESS WHEREOF, the Seller and the Purchaser have caused their names to be signed by their respective officers thereunto duly authorized as of the date first above written. DLJ MORTGAGE CAPITAL, INC. By: /s/ N. DANTE LAROCCA ------------------------------- Name: N. Dante Larocca Title: BNC MORTGAGE, INC. By: /s/ KELLY MONAHAN ------------------------------- Name: Kelly Monahan Title: President 31 EXHIBIT I MORTGAGE LOAN SCHEDULE 32 EXHIBIT 2 OFFICERS' CERTIFICATE I,_________, hereby certify that I am a duly elected ____________ of BNC Mortgage, Inc. (the "Seller"), a corporation organized under the laws of the State of _________, that I have made such reasonable investigation as I have deemed necessary to deliver this Officers' Certificate, including discussions with responsible officers of the Seller and further certify to the best of my knowledge as follows: 1. Attached hereto is a true and correct copy of the Articles of Incorporation and By-laws of the Seller, all of which are in full force and effect on the date hereof. Attached hereto is a Certificate of Good Standing, dated__________, 199_. No event has occurred since_________ 199_ which has affected the good standing of the Seller under the laws of the State of ____________________. 2. Except as have been previously discussed in writing by the Seller, there are no actions, suits or proceedings pending or threatened against or affecting the Seller which if adversely determined, individually or in the aggregate, would materially adversely affect the Seller's obligations under (a) the Master Mortgage Loan Purchase Agreement (the "Master Mortgage Loan Purchase Agreement") dated as of March__________, 1998 between the Seller and DLJ Mortgage Capital, Inc. ("DLJMC"), (b) the Confirmation Letter[s] dated, __________, 199_ (the "Confirmation Letter[s]") between the Seller and DLJMC, (c) the Servicing Agreement dated as of______ ____________________ (as amended, the "Servicing Agreement") among the Seller, DLJMC,__________________ and Bankers Trust Company (the "Custodian"), (d) the Custody Agreement dated as of ________ ____,199_ (as amended, the "Custody Agreement") among the Seller, DLJMC and the Custodian, and (e) the Assignment and Conveyance, dated_______________, 199_. The Master Mortgage Loan Purchase Agreement, the Confirmation Letter[s], the Servicing Agreement, the Custody Agreement and the Assignment and Conveyance are collectively referred to herein as the "Agreements." 3. Each person who, as an officer or representative of the Seller, signed any of the Agreements or any other document delivered prior hereto or on the date hereof in connection with the transactions described in the Agreements was, at the respective times of such signing and delivery, and is now, duly elected or appointed, qualified and acting as such officer or representative, and the signatures of such persons appearing on such documents are their genuine signatures. 4. Each of the Mortgage Loans to be sold on the date hereof was originated or acquired (1) by the Seller either directly or indirectly through loan brokers or a correspondent lender specifically approved by the Seller and DLJMC, such that (a) the Mortgage Loan was originated in conformity with the Seller's underwriting guidelines, (b) DLJMC approved the Mortgage Loan either prior to or after the funding thereof, and (c) the Seller funded the Mortgage Loan on the date of origination thereof with its own funds or with funds obtained by it or, in the case of a Mortgage Loan originated by a 33 -2- correspondent lender approved by the Seller and DLJMC, the Mortgage Loan was approved by the Seller prior to origination and was purchased by the Seller from such correspondent lender within 30 days of the date of origination pursuant to a mandatory purchase commitment in effect at origination, (2) by a savings and loan association, savings bank, commercial bank, credit union, insurance company or similar institution that is supervised and examined by a federal or state authority or (3) by a mortgagee approved by the Secretary of the Department of Housing and Urban Development pursuant to Sections 203 and 211 of the National Housing Act, as amended. 5. All of the Seller's representations and warranties contained in the Agreements are true and correct in all material respects as of the respective dates thereof and are true and correct in all material respects as of the date hereof (except with respect to the representations and warranties in the Master Mortgage Loan Purchase Agreement related to the Mortgage Loans sold on any Closing Date prior to the date hereof, as to which no representation or warranty is made as of the date hereof), and no event of default in the performance of any of the Seller's covenants or agreements under the Agreements has occurred and is continuing, nor has an event occurred which with the passage of time or notice or both would become such event of default. 6. With respect to its transfer of the Mortgage Loans to be sold on the date hereof and the transactions contemplated by the Agreements, the Seller has complied in all material respects with all the agreements by which it is bound and has satisfied in all material respects all the conditions on its part to be performed or satisfied prior to the date hereof other than those which have been waived pursuant to the terms of the Agreements. 7. Attached hereto is a certified true copy of the resolutions of the Board of Directors of the Seller which authorize the sale of the Mortgage Loans to be sold on the date hereof, and the same are in full force and effect and have not been revoked, repealed or amended. 8. The representations and warranties contained in Exhibit 6 to the Master Mortgage Loan Purchase Agreement and in each Assignment and Conveyance dated the date hereof are true and correct with respect to the Mortgage Loans to be sold on the date hereof. 9. Any necessary consents, approvals, authorizations or orders of any court or governmental agency or body, which are required for the execution, delivery and performance by the Seller of or compliance by the Seller with the Agreements, the sale of the Mortgage Loans to be sold on the date hereof as evidenced by the Agreements, or the consummation of the transactions contemplated by the Agreements, have been obtained. The Agreements and all related agreements have been authorized by the Board of Directors of the Seller, such authorization being reflected in the minutes of that Board and shall be maintained from the date of their execution as records of the Seller. The Agreements and 34 -3- all related agreements are and shall be from the time of their execution official records of the Seller. Capitalized terms used herein and not otherwise defined herein shall have the meanings specified in the Master Mortgage Loan Purchase Agreement. 35 IN WITNESS WHEREOF, I have hereunto signed my name and affixed the seal of the Seller. Dated:_______________, 199_ BNC MORTGAGE, INC. I, ___________________, [Assistant] Secretary of BNC Mortgage, Inc., hereby certify that ___________ is a duly elected, qualified and acting _________ of the Seller and that the signature appearing above is such person's genuine signature. IN WITNESS WHEREOF, I have hereunto signed my name. Dated: ____________, 199_ ------------------------------- BNC MORTGAGE, INC. 36 EXHIBIT 3 FORM OF RESOLUTIONS [To be supplied by ___________________________] 37 EXHIBIT 4 FORM OF OPINION LETTER OF COUNSEL TO THE SELLER [To be supplied by _____________ ] 38 EXHIBIT 5 FORM OF CONFIRMATION LETTER [Letterhead of the Purchaser] _________, 199_ ___________________ ___________________ ___________________ Re: Master Mortgage Loan Purchase Agreement between DLJ Mortgage Capital, Inc. and BNC Mortgage, Inc. Ladies and Gentlemen: Reference is made to the Master Mortgage Loan Purchase Agreement dated as of March __, 1998 (the "Agreement") between DLJ Mortgage Capital, Inc. (the "Purchaser") and BNC Mortgage, Inc. (the "Seller"). Capitalized terms used herein and not otherwise defined herein shall have the meanings specified in the Agreement. The Purchaser hereby confirms its agreement to purchase, and the Seller hereby acknowledges its agreement to sell, pursuant to the Agreement, [Fixed Rate Mortgage Loans having an original term to maturity from the due date of the first monthly payment of [15/30] years] [Adjustable Rate Mortgage Loans that have ______ as the Index, that have a fixed initial interest rate period equal to approximately [____year[s]/six months]] and that are [not] subject to negative amortization. The Mortgage Loans shall be sold on an [actual/actual][scheduled/scheduled/scheduled] basis. The [Seller][Purchaser] shall be entitled to retain any late payment charges and prepayment charges on the Mortgage Loans. The Cut-off Date for such Mortgage Loans shall be _______________ ,199_ and the Closing Date for such Mortgage Loans shall be ____________ , 199_. The aggregate outstanding principal balance of such Mortgage Loans, as of the close of business on the related Cut-off Date, shall be $ ____. The purchase price for such Mortgage Loans shall be equal to ___% of such principal balance, together with interest accrued on such principal balance at a per annum rate equal to ___% from the related [Cut-off Date] [paid through date] to but not including the related Closing Date[; provided that, the Purchaser shall not pay more than 60 days accrued interest with respect to any Mortgage Loan]. 39 -2- If the foregoing accurately reflects our agreement with respect to the matters specified above, please have a copy of this letter signed by an authorized representative and return such copy to the Purchaser at the address for notices provided in the Agreement. DLJ MORTGAGE CAPITAL, INC. By:.__________________________________ Name: Title: Acknowledged and agreed: BNC MORTGAGE, INC. By:_____________________________ Name: Title: 40 EXHIBIT 6 SELLER REPRESENTATIONS AND WARRANTIES Representations and Warranties. Pursuant to Section 6 and Section 11 of the Master Mortgage Loan Purchase Agreement, the Seller has made or will make certain representations and warranties to the Purchaser. The Seller shall confirm such representations and warranties and in connection therewith shall deliver an Officers' Certificate on each Closing Date and, pursuant to Section 11 of the Master Mortgage Loan Purchase Agreement, on the closing date of each Whole Loan Transfer and Pass-Through Transfer by the Initial Purchaser, reaffirming such representations and warranties as of such dates. The following representations and the representations required pursuant to Section 11 of the Master Mortgage Loan Purchase Agreement also may be, as part of any Whole Loan Transfer or Pass-Through Transfer, assigned by the Purchaser, together with the related repurchase rights specified in the Master Mortgage Loan Purchase Agreement. All capitalized terms used herein and not otherwise defined in the Master Mortgage Loan Purchase Agreement shall have the meanings assigned in the Finance Facility. The Seller hereby represents and warrants to the Purchaser, as to each Mortgage Loan, that as of the related Closing Date or as of such other date specifically provided herein: (i) The information set forth on the related Mortgage Loan Schedule with respect to each Mortgage Loan is true and correct in all material respects as of the related Closing Date, and each of the representations and warranties contained in the Assignment and Conveyance related to such Mortgage Loan Schedule is true and correct in all material respects with respect to the Mortgage Loans identified therein; (ii) Each Mortgage is a valid and enforceable first lien on the Mortgaged Property subject only to (1) the lien of nondelinquent current real property taxes and assessments, (2) covenants, conditions and restrictions, rights of way, easements and other matters of public record as of the date of recording of such Mortgage, such exceptions appearing of record being acceptable to mortgage lending institutions generally or specifically reflected in the appraisal made in connection with the origination of the related Mortgage Loan, and (3) other matters to which like properties are commonly subject that do not materially interfere with the benefits of the security intended to be provided by such Mortgage; (iii) Immediately prior to the delivery of the Mortgage Loan to the Purchaser, the Seller had good title to, and was the sole owner of, such Mortgage Loan free and clear of any mortgage, pledge, lien, security interest, charge or other encumbrance (other than any junior lien on the Mortgaged Property encumbered by the related Mortgage) and has full right and authority, subject to no interest or participation of, or agreement with, any other party, to sell and assign the Mortgage Loan pursuant to this Agreement; (iv) There was no delinquent tax or assessment lien against any Mortgaged Property at the time of the origination of the related Mortgage Loan; 41 -2- (v) There is no valid offset, defense or counterclaim to any Mortgage Note or Mortgage, including the obligation of the Mortgagor to pay the unpaid principal of or interest on such Mortgage Note, and any applicable right of rescission has expired as of the related Closing Date; (vi) There are no mechanics' liens or claims for work, labor or material affecting any Mortgaged Property that are or may be a lien prior to, or equal with, the lien of such Mortgage, except those that are insured against by the title insurance policy referred to in clause (x) below; (vii) Each Mortgaged Property is free of material damage and is in at least adequate repair; (viii) Each Mortgage Loan at origination complied in all respects with applicable state and federal laws, including, without limitation, usury, equal credit opportunity, real estate settlement procedures, truth-in-lending and disclosure laws, and consummation of the transactions contemplated hereby will not involve the violation of any such laws; (ix) At the related Closing Date, neither the Seller nor any prior holder of any Mortgage has, except as the Mortgage File may reflect, (1) modified the Mortgage in any material respect, (2) satisfied, canceled or subordinated such Mortgage in whole or in part, (3) released the related Mortgaged Property in whole or in part from the lien of such Mortgage or (4) executed any instrument of release, cancellation, modification or satisfaction with respect thereto; (x) A lender's policy of title insurance or a commitment (binder) to issue the same was effective on the date of the origination of each Mortgage Loan, each such policy is valid and remains in full force and effect and each such policy was issued by a title insurer acceptable to the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC") and in a form acceptable to FNMA or FHLMC; (xi) Each Mortgage Loan was originated or acquired (1) by the Seller either directly or indirectly through loan brokers or a correspondent lender specifically approved by the Seller and the Purchaser, such that (a) the Mortgage Loan was originated in conformity with the Seller's underwriting guidelines, (b) the Purchaser approved the Mortgage Loan either prior to or after the funding thereof and (c) the Seller funded the Mortgage Loan on the date of origination thereof with its own funds or with funds obtained by it or, in the case of a Mortgage Loan originated by a correspondent lender approved by the Seller and the Purchaser, the Mortgage Loan was approved by the Seller prior to origination and was purchased by the Seller from such correspondent lender within 30 days of the date of origination pursuant to a mandatory purchase commitment in effect at origination, (2) by a savings and loan association, savings bank, commercial bank, credit union, insurance company or similar institution that is supervised and examined by a federal or state authority or (3) by a mortgagee approved by the Secretary of 42 -3- Department of Housing and Urban Development pursuant to Sections 203 and 211 of the National Housing Act, as amended; (xii) All of the improvements that were included for the purpose of determining the appraised value of the Mortgaged Property are insured to lie wholly within the boundaries and building restriction lines of such property, and no improvements on adjoining properties encroach upon the Mortgaged Property, unless, in either case, an agreement permitting such encroachment is recorded in the applicable real property records and such agreement was taken into account in conducting the appraisal of the Mortgaged Property; (xiii) No portion of any improvement considered in determining the related appraised value located on or being part of the Mortgaged Property is in violation of any applicable zoning law or regulation. All inspections, licenses and certificates required to be made or issued with respect to the use and occupancy of the Mortgaged Property, including but not limited to certificates of occupancy and fire underwriting certificates, have been made or obtained from the appropriate authorities and the Mortgaged Property is lawfully occupied under applicable law; (xiv) All parties that have had any interest in the Mortgage, whether as mortgagee, assignee, pledgee or otherwise, are, or, during the period in which they held and disposed of such interest, were (1) in compliance with any and all applicable licensing requirements of the laws of the state wherein the Mortgaged Property is located, and (2)(a) organized under the laws of such state, (b) qualified to do business in such state, (c) federal savings associations or national banks having principal offices in such state or (d) not doing business in such state; (xv) The Mortgage Note and the related Mortgage are genuine, and each is the legal, valid and binding obligation of the maker thereof, enforceable in accordance with its terms. All parties to the Mortgage Note and the Mortgage had legal capacity to execute the Mortgage Note and the Mortgage and each Mortgage Note and Mortgage has been duly and properly executed and delivered by such parties; (xvi) The proceeds of the Mortgage Loan have been fully disbursed by the Seller, there is no requirement for future advances thereunder and any and all requirements as to completion of any on-site or off-site improvements and as to disbursements of any escrow funds therefor (including any escrow funds held to make monthly payments pending completion of such improvements) have been complied with. All costs, fees and expenses incurred in making, closing or recording the Mortgage Loans were paid; (xvii) The related Mortgage contains customary and enforceable provisions that render the rights and remedies of the holder thereof adequate for the realization against the Mortgaged Property of the benefits of the security, including (1) in the case of a Mortgage designated as a deed of trust, by trustee's sale, and (2) otherwise by judicial foreclosure. There 43 -4- is no homestead or other exemption available to the Mortgagor that would interfere with the right to sell the Mortgaged Property at a trustee's sale or the right to foreclose the Mortgage; (xviii) With respect to each Mortgage constituting a deed of trust, a trustee, duly qualified under applicable law to serve as such, has been properly designated and currently so serves and is named in such Mortgage, and no fees or expenses are or will become payable by the holder of the Mortgage Loan to the trustee under the deed of trust, except in connection with a trustee's sale after default by the Mortgagor; (xix) Each Mortgaged Property is suitable for year-round occupancy; (xx) There exist no deficiencies with respect to escrow deposits and payments, if such are required, for which customary arrangements for repayment thereof have not been made, and no escrow deposits or payments of other charges or payments due with respect to the Mortgage Loan (other than origination points and fees) have been capitalized under the Mortgage or the related Mortgage Note; (xxi) The origination practices used by the Seller with respect to each Mortgage Loan have been in all respects legal, proper, prudent and customary in the mortgage origination business; (xxii) There is no pledged account or other security other than real estate securing the Mortgagor's obligations; (xxiii) No Mortgage Loan has a shared appreciation feature or other contingent interest feature; (xxiv) No Mortgage Loan is subject to any temporary buydown provisions; (xxv) With respect to each Mortgage Loan in which the Mortgagor has a leasehold interest in the related Mortgaged Property: (a) The leasehold was created by direct lease of the freehold estate, and the ground lease or memorandum thereof has been recorded and by its terms permits the leasehold estate to be mortgaged. The ground lease grants any leasehold mortgagee standard protection necessary to protect the security of a leasehold mortgagee, including the right of the leasehold mortgagee to receive notice of the lessee's default under the ground lease, the right of the leasehold mortgagee, with adequate time, to cure such default, and, in the case of incurable defaults of the lessee, the right of the leasehold mortgagee to enter into a new ground lease with the lessor on terms financially identical and otherwise substantially identical to the existing ground lease; 44 -5- (b) The ground lease was at the origination of the Mortgage Loan and, to the best of the Seller's knowledge is, in full force and effect without any outstanding defaults, and was at the origination of the Mortgage Loan and, to the best of Seller's knowledge is, not subject to liens and encumbrances; (c) The ground lease shall be automatically renewable for at least thirty (30) years or at least ten (10) years beyond the scheduled date for the final payment on the Mortgage Loan; and (d) The fee estate of the lessor under the ground lease is encumbered by the ground lease, and any lien of any present or future fee mortgagee is and will be subject to and subordinate to the ground lease. The foreclosure of the fee mortgage will not terminate the leasehold estate or the rights of the sub-tenants, and the fee mortgage is subject to the ground lease; (xxvi) Pursuant to the terms of the related Mortgage, all buildings or other improvements upon the Mortgaged Property are insured by a generally acceptable insurer against loss by fire, hazards of extended coverage and such other hazards as are customary in the area where the Mortgaged Property is located pursuant to insurance policies conforming to the requirements of FNMA and FHLMC. If the Mortgaged Property is in an area identified in the Federal Register by the Federal Emergency Management Agency as having special flood hazards (and such flood insurance has been made available) a flood insurance policy is in effect which policy conforms to the requirements of FNMA and FHLMC; (xxvii) An appraisal of each Mortgaged Property is on a form approved by FNMA or FHLMC with such riders as have been approved by FNMA or FHLMC, as the case may be, and each appraiser meets the minimum qualifications of FNMA or FHLMC for appraisers; (xxviii) Each Mortgage Loan contains a customary "due-on-sale" clause; (xxix) Except for the criteria for eligible Mortgagors set forth in the Seller's underwriting guidelines, the Seller knows of nothing involving any Mortgage File, Mortgaged Property or Mortgagor's credit standing that could reasonably be expected (1) to cause private institutional investors to regard the Mortgage Loan as an unacceptable investment, (2) to cause the Mortgage Loan to become delinquent or (3) to affect adversely the value or marketability of the Mortgage Loan; (xxx) There are no condemnation proceedings pending with respect to any Mortgaged Property, and. no Mortgaged Property has been condemned either in whole or in part; 45 -6- (xxxi) Except as identified on the Assignment and Conveyance, none of such Mortgage Loans will have been thirty or more days delinquent more than once during the twelve months preceding the date hereof; (xxxii) All of the Mortgage Loans were originated or acquired under the Seller's "regular lending program"; and (xxxiii) The Mortgage Loans identified on the Mortgage Loan Schedule attached hereto were not selected for inclusion therein from the Seller's portfolio of mortgage loans originated under its "regular lending program" on any basis which would have a material adverse affect on the Purchaser. 46 EXHIBIT 7 FORM OF CROSS-RECEIPT _____,199_ Reference is made to the Master Mortgage Loan Purchase Agreement dated _____, 199_ (the "Master Mortgage Loan Purchase Agreement") between DLJ Mortgage Capital, Inc. (the "Company") and BNC Mortgage, Inc. (the "Seller") and the Confirmation Letter dated _________, 199_ (the "Confirmation Letter") between the Seller and the Company, relating to the purchase and sale of the Mortgage Loans identified on the related Mortgage Loan Schedule. Capitalized terms used herein and not otherwise defined herein shall have the meanings specified in the Master Mortgage Loan Purchase Agreement. (i) The Company hereby acknowledges receipt of the Mortgage Loans identified on such Mortgage Loan Schedule. DLJ MORTGAGE CAPITAL, INC. By:______________________________ Name: Title: (ii) BNC Mortgage, Inc. hereby acknowledges receipt from the Company of funds in the amount specified in the Confirmation Letter. BNC MORTGAGE, INC. By:______________________________ Name: Title: 47 EXHIBIT 8 FORM OF ASSIGNMENT AND CONVEYANCE 199_, BNC Mortgage, Inc. (the "Seller"), as the seller On this _ day of _________, 199_, BNC Mortgage, Inc. (the "Seller"), as the seller under that certain Master Mortgage Loan Purchase Agreement dated _________, 199_ (the "Agreement"), between the Seller and DLJ Mortgage Capital, Inc. (the "Purchaser"), does hereby sell, transfer, assign, set over and convey to Purchaser, as the purchaser under the Agreement, without recourse, but subject to the terms of the Agreement, all the right, title and interest of the Seller in and to the Mortgage Loans identified on the Mortgage Loan Schedule attached hereto, together with the related Mortgage Files and all rights and obligations arising under the documents contained therein. The Seller has delivered the documents for each such Mortgage Loan in accordance with Section 3 of the Agreement. The ownership of the Mortgage Note and Mortgage related to each such Mortgage Loan, and the contents of the related Mortgage File, shall be vested in the Purchaser and the ownership of all records and documents with respect to each such Mortgage Loan prepared by or which come into the possession of the Seller shall immediately vest in the Purchaser and, to the extent retained by the Seller, shall be retained and maintained, in trust, by the Seller at the will of the Purchaser in a custodial capacity only. The Seller confirms to the Purchaser that the representations and warranties set forth in Section 6 and Section 11 of the Agreement and in Exhibit 6 to the Agreement are true and correct in all respects as of the date hereof with respect to the Seller and the Mortgage Loans identified on the Mortgage Loan Schedule attached hereto, and that all statements made in the Officers' Certificate of the Seller dated the date hereof and all attachments thereto are true and correct in all respects as of the date hereof, and the Seller makes the following additional representations and warranties to the Purchaser: (a) The Mortgage Loans are serviced by ________ and ________, pursuant to Servicing Agreement, dated as of ________ (as amended, the "Servicing Agreement"), among the Seller, the Initial Purchaser, ________ and ________. (b) [Identify loan characteristics regarding fixed vs. adjustable rate loans, graduated payment and negative amortization characteristics, index and margin for adjustable rate loans, amortization schedule for mortgage loans]. (c) The Mortgage Loans shall be sold on an [actual/actual] [scheduled/scheduled] basis. (d) The [Seller][Purchaser] shall be entitled to retain any late payment charges and prepayment charges on the Mortgage Loans. [(e) When measured by unpaid principal balance, no more than __% of the Mortgage Loans [, which are [specify Mortgage Loan type and underwriting program if different from balance of Mortgage Loan Package]] have been thirty or more days delinquent more than once during the preceding twelve months.] 48 -2- (f) No more than approximately _% of the Mortgage Loans identified on the Mortgage Loan Schedule attached hereto, by outstanding principal balance as of the related Cut-off Date, have Mortgaged Properties that are located in any one zip code area, and no more than approximately _% of such Mortgage Loans, by outstanding principal balance as of such Cut-off Date, have Mortgaged Properties that are located in any one zip code area in the State of California. (g) No Mortgage Loan had a Loan-to-Value Ratio at origination in excess of __%. No Mortgage Loan had a combined Loan-to-Value Ratio at origination, including any second deed of trust subordinated to the lien of the Mortgage, in excess of 90%. The Seller shall confirm the foregoing representations and warranties, pursuant to Section 11 of the Agreement, on the closing date of each Whole Loan Transfer and Pass-Through Transfer of any of the related Mortgage Loans by the Initial Purchaser and, in connection therewith, shall deliver an Officers' Certificate on such date, reaffirming the foregoing representations and warranties as of such date with respect to such Mortgage Loans (with such modifications as are permitted by such section) and providing the repurchase rights specified in the Agreement in respect of the representations and warranties made as of such date. The foregoing representations and warranties and the representations and warranties required pursuant to Section 11 of the Agreement may be, as part of any Whole Loan Transfer or Pass-Through Transfer, assigned by the Purchaser together with the related repurchase rights specified in the Agreement and such Officers' Certificate. Capitalized terms used herein and not otherwise defined shall have the meanings set forth in the Agreement. 49 IN WITNESS WHEREOF, the Seller has caused this instrument to be signed by its officer thereunto duly authorized as of the date first above written. BNC MORTGAGE, INC. By:______________________________ Name: Title: EX-10.7 6 WARRANT TO PURCHASE 285,587 SHARES 1 EXHIBIT 10.7 THE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY NOT BE OFFERED FOR SALE, SOLD OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT FILED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT. VOID AFTER 5:00 P.M., NEW YORK TIME, ON MARCH 10, 2003 OR IF NOT A BUSINESS DAY, AS DEFINED HEREIN, AT 5:00 P.M., NEW YORK TIME, ON THE NEXT FOLLOWING BUSINESS DAY. WARRANT TO PURCHASE 285,587 SHARES OF COMMON STOCK NO. 1 WARRANT TO PURCHASE COMMON STOCK OF BNC MORTGAGE, INC. TRANSFER RESTRICTED -- SEE SECTION 5.02 This certifies that, for good and valuable consideration, CIBC Oppenheimer Corp., and its registered, permitted assigns (collectively, the "Warrantholder"), is entitled to purchase from BNC Mortgage, Inc., a Delaware corporation (the "Company"), subject to the terms and conditions hereof, at any time on or after 9:00 A.M., New York time, on March 10, 1999, and before 5:00 P.M., New York time, on March 10, 2003 (or, if such day is not a Business Day, at or before 5:00 P.M., New York time, on the next following Business Day), the number of fully paid and non-assessable shares of Common Stock stated above at the Exercise Price. The Exercise Price and the number of shares purchasable hereunder are subject to adjustment from time to time as provided in Article III hereof. ARTICLE I SECTION 1.01: DEFINITION OF TERMS. As used in this Warrant, the following capitalized terms shall have the following respective meanings: (a) Business Day: A day other than a Saturday, Sunday or other day on which banks in the State of New York are authorized by law to remain closed. (b) Common Stock: Common Stock, $.001 par value per share, of the Company. (c) Common Stock Equivalents: Securities that are convertible into or exercisable for shares of Common Stock. 1 2 (d) Demand Registration: See Section 6.02. (e) Exchange Act: The Securities Exchange Act of 1934, as amended from time to time. (f) Exercise Price: $10.45 per Warrant Share, as such price may be adjusted from time to time pursuant to Article III hereof. (g) Expiration Date: 5:00 P.M., New York time, on March 10, 2003 or if such day is not a Business Day, the next succeeding day which is a Business Day. (h) 25% Holders: At any time as to which a Demand Registration is requested, the Holder and/or the holders of any other Warrants and/or the holders of Warrant Shares who have the right to acquire or hold, as the case may be, not less than 25% of the combined total of Warrant Shares issuable and Warrant Shares outstanding at the time such Demand Registration is requested. (i) Holder: A Holder of Registrable Securities. (j) NASD: National Association of Securities Dealers, Inc.; and NASDAQ: NASD Automatic Quotation System. (k) Person: An individual, partnership, joint venture, corporation, trust, unincorporated organization or government or any department or agency thereof. (l) Piggyback Registration: See Section 6.01. (m) Prospectus: Any prospectus included in any Registration Statement, as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities covered by such Registration Statement and all other amendments and supplements to the Prospectus, including post-effective amendments and all material incorporated by reference in such Prospectus. (n) Public Offerings: A public offering of any of the Company's equity or debt securities pursuant to a registration statement under the Securities Act. (o) Registration Expenses: Any and all expenses incurred in connection with any registration or action incident to performance of or compliance by the Company with Article VI, including, without limitation, (i) all SEC, national securities exchange and NASD registration and filing fees; all listing fees and all transfer agent fees; (ii) all fees and expenses of complying with state securities or blue sky laws (including the fees and disbursements of counsel for the underwriters in connection with blue sky qualifications of the Registrable Securities; (iii) all printing, mailing, messenger and delivery expenses and (iv) all fees and disbursements of counsel for the Company and of its accountants, including the expenses of any special audits and/or "cold comfort" letters required by or incident to such performance and compliance, but excluding underwriting discounts and commissions, 2 3 brokerage fees and transfer taxes, if any, and fees of counsel or accountants retained by the holders of Registrable Securities to advise them in their capacity as Holders of Registrable Securities. (p) Registrable Securities: Any Warrant Shares issued to CIBC Oppenheimer Corp. and Piper Jaffray Inc. and/or their designees or transferees as permitted under Section 5.02 and/or other securities that may be or are issued by the Company upon exercise of this Warrant, including those which may thereafter be issued by the Company in respect of any such securities by means of any stock splits, stock dividends, recapitalizations, reclassifications or the like, and as adjusted pursuant to Article III hereof. (q) Registration Statement: Any registration statement of the Company filed or to be filed with the SEC which covers any of the Registrable Securities pursuant to the provisions of this Agreement, including all amendments (including post-effective amendments) and supplements thereto, all exhibits thereto and all material incorporated therein by reference. (r) SEC: The Securities and Exchange Commission or any other federal agency at the time administering the Securities Act or the Exchange Act. (s) Securities Act: The Securities Act of 1933, as amended from time to time. (t) Transfer: See Section 5.02. (u) Warrants: This Warrant, all other warrants issued on the date hereof and all other warrants that may be issued in its or their place (together evidencing the right to purchase an aggregate of 317,319 shares of Common Stock), originally issued as set forth in the definition of Registrable Securities. (v) Warrantholder: The person(s) or entity(ies) to whom this Warrant is originally issued, or any successor in interest thereto, or any assignee or transferee thereof, in whose name this Warrant is registered upon the books to be maintained by the Company for that purpose. (w) Warrant Shares: Common Stock, Common Stock Equivalents and other securities purchased or purchasable upon exercise of the Warrants. ARTICLE II DURATION AND EXERCISE OF WARRANT SECTION 2.01: DURATION OF WARRANT. Subject to the limitations specified in Section 2.02.(a)(ii) regarding a Cashless Exercise, the Warrantholder may exercise this Warrant at any time and from time to time after 9:00 A.M., New York time, on March 10, 1999, and before 5:00 P.M., New York time, on the Expiration Date. If this Warrant is not exercised on or prior to the Expiration Date, it shall become void, and all rights hereunder shall thereupon cease. 3 4 SECTION 2.02: EXERCISE OF WARRANT. (a) The Warrantholder may exercise this Warrant, in whole or in part, as follows: (i) By presentation and surrender of this Warrant to the Company at its principal executive offices or at the office of its stock transfer agent, if any, with the Subscription Form annexed hereto duly executed and accompanied by payment of the full Exercise Price for each Warrant Share to be purchased; or (ii) By presentation and surrender of this Warrant to the Company at its principal executive offices with a Cashless Exercise Form annexed hereto duly executed (a "Cashless Exercise"). In the event of a Cashless Exercise, the Warrantholder shall exchange its warrant for that number of shares of Common Stock determined by multiplying the number of Warrant Shares by a fraction, the numerator of which shall be the amount by which the then current market price per share of Common Stock exceeds the Exercise Price, and the denominator of which shall be the then current market price per share of Common Stock. For purposes of any computation under this Section 2.02(a)(ii), the then current market price per share of Common Stock at any date shall be deemed to be the average of the daily closing prices for 20 consecutive trading days commencing 30 trading days before such date. The closing price for each day shall be the last sale price regular way or, in case no such reported sales take place on such day, the average of the last reported bid and asked prices regular way, in either case on the principal national securities exchange on which the Common Stock is admitted to trading or listed, or if not listed or admitted to trading on any such exchange, the representative closing bid price as reported by NASDAQ, or other similar organization if NASDAQ is no longer reporting such information, or if not so available, the fair market price as determined by the Board of Directors of the Company. (b) Upon receipt of this Warrant, in the case of Section 2.02 (a) (i), with the Subscription Form duly executed and accompanied by payment of the aggregate Exercise Price for the Warrant Shares for which this Warrant is then being exercised, or, in the case of Section 2.02 (a) (ii), with the Cashless Exercise Form duly executed, the Company shall cause to be issued certificates for the total number of whole shares of Common Stock for which this Warrant is being exercised (adjusted to reflect the effect of the anti-dilution provisions contained in Article III hereof, if any, and as provided in Section 2.04 hereof) in such denominations as are requested for delivery to the Warrantholder, and the Company shall thereupon deliver such certificates to the Warrantholder. The Warrantholder shall be deemed to be the holder of record of the shares of Common Stock issuable upon such exercise, notwithstanding that the stock transfer books of the Company shall then be closed or that certificates representing such shares of Common Stock shall not then be actually delivered to the Warrantholder. If at the time this Warrant is exercised, a Registration Statement is not in effect to register under the Securities Act the issuance of the Warrant Shares upon exercise of this Warrant, the Company may require the Warrantholder to make such representations, and may place such legends on certificates representing the Warrant 4 5 Shares, as may be reasonably required in the opinion of counsel to the Company to permit the Warrant Shares to be issued without such registration. (c) In case the Warrantholder shall exercise this Warrant with respect to less than all of the Warrant Shares that may be purchased under this Warrant, the Company shall execute a new warrant in the form of this Warrant for the balance of such Warrant Shares and deliver such new warrant to the Warrantholder. (d) The Company shall pay any and all stock transfer and similar taxes which may be payable in respect of the issue of this Warrant or in respect of the issue of any Warrant Shares; provided, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer of this Warrant, or the Warrant Shares, by any Warrantholder. SECTION 2.03: RESERVATION OF SHARES. The Company hereby agrees that at all times there shall be reserved for issuance and delivery upon exercise of this Warrant such number of shares of Common Stock or other shares of capital stock of the Company from time to time issuable upon exercise of this Warrant. All such shares shall be duly authorized, and when issued upon such exercise, shall be validly issued, fully paid and nonassessable, free and clear of all liens, security interests, charges and other encumbrances or restrictions on sale and free and clear of all preemptive rights (except the restrictions imposed by the legend appearing at the top of Page 1 of this Warrant). SECTION 2.04: FRACTIONAL SHARES. The Company shall not be required to issue any fraction of a share of its capital stock in connection with the exercise of this Warrant, and in any case where the Warrantholder would, except for the provisions of this Section 2.04, be entitled under the terms of this Warrant to receive a fraction of a share upon the exercise of this Warrant, the Company shall, upon the exercise of this Warrant and tender of the Exercise Price (as adjusted to cover the balance of the share), issue the larger number of whole shares purchasable upon exercise of this Warrant. The Company shall not be required to make any cash or other adjustment in respect of such fraction of a share to which the Warrantholder would otherwise be entitled. SECTION 2.05: LISTING. Prior to the issuance of any shares of Common Stock upon exercise of this Warrant, the Company shall secure the listing of such shares of Common Stock upon each national securities exchange or automated quotation system, if any, upon which shares of Common Stock are then listed (subject to official notice of issuance upon exercise of this Warrant) and shall maintain, so long as any other shares of Common Stock shall so be listed, such listing of all shares of Common Stock from time to time issuable upon the exercise of this Warrant; and the Company shall so list on each national securities exchange or automated quotation system, and shall maintain such listing of, any other shares of capital stock of the Company issuable upon the exercise of this Warrant if and so long as any shares of the same class shall be listed on such national securities exchange or automated quotation system. 5 6 ARTICLE III ADJUSTMENT OF SHARES OF COMMON STOCK PURCHASABLE AND OF EXERCISE PRICE The Exercise Price and the number and kind of Warrant Shares shall be subject to adjustment from time to time upon the happening of certain events as provided in this Article III. SECTION 3.01: MECHANICAL ADJUSTMENTS. (a) If at any time prior to the exercise of this Warrant in full, the Company shall (i) declare a dividend or make a distribution on the Common Stock payable in shares of its capital stock (whether shares of Common Stock or of capital stock of any other class); (ii) subdivide, reclassify or recapitalize outstanding Common Stock into a greater number of shares; (iii) combine, reclassify or recapitalize its outstanding Common Stock into a smaller number of shares; or (iv) issue any shares of its capital stock by reclassification of its Common Stock (including any such reclassification in connection with a consolidation or a merger in which the Company is the continuing corporation), the Exercise Price in effect at the time of the record date of such dividend, distribution, subdivision, combination, reclassification or recapitalization shall be adjusted so that the Warrantholder shall be entitled to receive the aggregate number and kind of shares which, if this Warrant had been exercised in full immediately prior to such event, it would have owned upon such exercise and been entitled to receive by virtue of such dividend, distribution, subdivision, combination, reclassification or recapitalization. Any adjustment required by this paragraph 3.01(a) shall be made successively immediately after the record date, in the case of a dividend or distribution, or the effective date, in the case of a subdivision, combination, reclassification or recapitalization, to allow the purchase of such aggregate number and kind of shares. (b) If at any time prior to the exercise of this Warrant in full, the Company shall fix a record date for the issuance or making a distribution to all holders of Common Stock (including any such distribution to be made in connection with a consolidation or merger in which the Company is to be the continuing corporation) of evidences of its indebtedness, any other securities of the Company or any cash, property or other assets (excluding a combination, reclassification or recapitalization referred to in Section 3.01(a), regular cash dividends or cash distributions paid out of net profits legally available therefor and in the ordinary course of business and subscription rights, options or warrants for Common Stock or Common Stock Equivalents (any such nonexcluded event being herein called a "Special Dividend"), (i) the Exercise Price shall be decreased immediately after the record date for such Special Dividend to a price determined by multiplying the Exercise Price then in effect by a fraction, the numerator of which shall be the then current market price of the Common Stock (as defined in Section 3.01(e)) on such record date less the fair market value (as determined by the Company's Board of Directors) of the evidences of indebtedness, securities or property, or other assets issued or distributed in such Special Dividend applicable to one share of Common Stock or of such subscription rights, options or warrants applicable to one share of Common Stock and the denominator of which shall be such then 6 7 current market price per share of Common Stock (as so determined) and (ii) the number of shares of Common Stock subject to purchase upon exercise of this Warrant shall be increased to a number determined by multiplying the number of shares of Common Stock subject to purchase immediately before such Special Dividend by a fraction, the numerator of which shall be the Exercise Price in effect immediately before such Special Dividend and the denominator of which shall be the Exercise Price in effect immediately after such Special Dividend. Any adjustment required by this paragraph 3.01(b) shall be made successively whenever such a record date is fixed and in the event that such distribution is not so made, the Exercise Price shall again be adjusted to be the Exercise Price that was in effect immediately prior to such record date. (c) If at any time prior to the exercise of this Warrant in full, the Company shall make a distribution to all holders of the Common Stock of stock of a subsidiary or securities convertible into or exercisable for such stock, then in lieu of an adjustment in the Exercise Price or the number of Warrant Shares purchasable upon the exercise of this warrant, each Warrantholder, upon the exercise hereof at any time after such distribution, shall be entitled to receive from the Company, such subsidiary or both, as the Company shall determine, the stock or other securities to which such Warrantholder would have been entitled if such Warrantholder had exercised this Warrant immediately prior thereto, all subject to further adjustment as provided in this Article III, and the Company shall reserve, for the life of the Warrant, such securities of such subsidiary or other corporation; provided, however, that no adjustment in respect of dividends or interest on such stock or other securities shall be made during the term of this Warrant or upon its exercise. (d) Whenever the Exercise Price payable upon exercise of each Warrant is adjusted pursuant to one or more of paragraphs (a) and (b) of this Section 3.01, the Warrant Shares shall simultaneously be adjusted by multiplying the number of Warrant Shares initially issuable upon exercise of each Warrant by the Exercise Price in effect on the date of such adjustment and dividing the product so obtained by the Exercise Price, as adjusted. (e) For the purpose of any computation under this Section 3.01, the current market price per share of Common Stock at any date shall be deemed to be the average of the daily closing prices for 20 consecutive trading days commencing 30 trading days before such date. The closing price for each day shall be the last sale price regular way or, in case no such reported sales take place on such day, the average of the last reported bid and asked prices regular way, in either case on the principal national securities exchange on which the Common Stock is admitted to trading or listed, or if not listed or admitted to trading on any such exchange, the representative closing bid price as reported by NASDAQ, or other similar organization if NASDAQ is no longer reporting such information, or if not so available, the fair market price as determined by the Board of Directors of the Company. (f) No adjustment in the Exercise Price shall be required unless such adjustment would require an increase or decrease of at least ten cents ($.10) in such price; provided, however, that any adjustments which by reason of this paragraph (f) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 3.01 shall be made to the nearest cent or to the nearest one- 7 8 hundredth of a share, as the case may be. Notwithstanding anything in this Section 3.01 to the contrary, the Exercise Price shall not be reduced to less than the then existing par value of the Common Stock as a result of any adjustment made hereunder. (h) In the event that at any time, as a result of any adjustment made pursuant to Section 3.01(a), the Warrantholder thereafter shall become entitled to receive any shares of the Company other than Common Stock, thereafter the number of such other shares so receivable upon exercise of any Warrant shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Common Stock contained in Section 3.01(a). SECTION 3.02: NOTICE OF ADJUSTMENT. Whenever the number of Warrant Shares or the Exercise Price is adjusted as herein provided, the Company shall prepare and deliver forthwith to the Warrantholder a certificate signed by its President, and by any Vice President, Treasurer or Secretary, setting forth the adjusted number of shares purchasable upon the exercise of this Warrant and the Exercise Price of such shares after such adjustment, a brief statement of the facts requiring such adjustment and the computation by which adjustment was made. SECTION 3.03: NO ADJUSTMENT FOR DIVIDENDS. Except as provided in Section 3.01 of this Agreement, no adjustment in respect of any cash dividends paid by the Company shall be made during the term of this Warrant or upon the exercise of this Warrant. SECTION 3.04: PRESERVATION OF PURCHASE RIGHTS IN CERTAIN TRANSACTIONS. In case of any reclassification, capital reorganization or other change of outstanding shares of Common Stock (other than a subdivision or a combination of the outstanding Common Stock and other than a change in the par value of the Common Stock or in case of any consolidation or merger of the Company with or into another corporation (other than a merger with a subsidiary in which the Company is the continuing corporation and said merger does not result in any reclassification, capital reorganization or other change of outstanding shares of Common Stock of the class issuable upon exercise of this Warrant)) or in case of any sale, lease, transfer or conveyance to another corporation of the property and assets of the Company as an entirety or substantially as an entirety, the Company shall, as a condition precedent to such transaction, cause such successor or purchasing corporation, as the case may be, to execute with the Warrantholder an agreement granting the Warrantholder the right thereafter, upon payment of the Exercise Price in effect immediately prior to such action, to receive upon exercise of this Warrant the kind and amount of shares and other securities and property which he would have owned or have been entitled to receive after the happening of such reclassification, change, consolidation, merger, sale or conveyance had this Warrant been exercised immediately prior to such action. Such agreement shall provide for adjustments in respect of such shares of stock and other securities and property, which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Article III. In the event that in connection with any such reclassification, capital reorganization, change, consolidation, merger, sale or conveyance, additional shares of Common Stock shall be issued in exchange, conversion, substitution or payment, in whole or in part, for, or of, a security of the Company other than Common Stock, any such issue shall be treated as an issue of Common Stock covered by the provisions of Article III. The provisions of this Section 3.04 shall similarly apply to successive reclassification, capital reorganizations, consolidations, mergers, sales or conveyances. 8 9 SECTION 3.05: FORM OF WARRANT AFTER ADJUSTMENTS. The form of this Warrant need not be changed because of any adjustments in the Exercise Price or the number or kind of the Warrant Shares, and Warrants theretofore or thereafter issued may continue to express the same price and number and kind of shares as are stated in this Warrant, as initially issued. SECTION 3.06: TREATMENT OF WARRANTHOLDER. Prior to due presentment for registration of transfer of this Warrant, the Company may deem and treat the Warrantholder as the absolute owner of this Warrant (notwithstanding any notation of ownership or other writing hereon) for all purposes and shall not be affected by any notice to the contrary. ARTICLE IV OTHER PROVISIONS RELATING TO RIGHTS OF WARRANTHOLDER SECTION 4.01: NO RIGHTS AS SHAREHOLDERS; NOTICE TO WARRANTHOLDERS. Nothing contained in this Warrant shall be construed as conferring upon the Warrantholder or his or its transferees the right to vote or to receive dividends or to consent to or receive notice as a shareholder in respect of any meeting of shareholders for the election of directors of the Company or any other matter, or any other rights whatsoever as shareholders of the Company. The Company shall give notice to the Warrantholder by registered mail if at any time prior to the expiration or exercise in full of the Warrants, any of the following events shall occur: (a) the Company shall authorize the payment of any dividend upon shares of Common Stock payable in any securities or authorize the making of any distribution (other than a cash dividend subject to the parenthetical set forth in Section 3.01(b)) to all holders of Common Stock; (b) the Company shall authorize the issuance to all holders of Common Stock of any additional shares of Common Stock or Common Stock Equivalents or of rights, options or warrants to subscribe for or purchase Common Stock or Common Stock Equivalents or of any other subscription rights, options or warrants; (c) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger, or sale or conveyance of the property of the Company as an entirety or substantially as an entirety); or (d) a capital reorganization or reclassification of the Common Stock (other than a subdivision or combination of the outstanding Common Stock and other than a change in the par value of the Common Stock) or any consolidation or merger of the Company with or into another corporation (other than a consolidation or merger in which the Company is the continuing corporation and that does not result in any reclassification or change of Common Stock outstanding) or in the case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety. Such giving of notice shall be initiated (i) at least 10 Business Days prior to the date fixed as a record date or effective date or the date of closing of the Company's stock transfer books for the 9 10 determination of the shareholders entitled to such dividend, distribution or subscription rights, or for the determination of the shareholders entitled to vote on such proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing the stock transfer books, as the case may be. Failure to provide such notice shall not affect the validity of any action taken in connection with such dividend, distribution or subscription rights, or proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up. SECTION 4.02: LOST, STOLEN, MUTILATED OR DESTROYED WARRANTS. If this Warrant is lost, stolen, mutilated or destroyed, the Company may, on such terms as to indemnity or otherwise as it may in its discretion impose (which shall, in the case of a mutilated Warrant, include the surrender thereof), issue a new Warrant of like denomination and tenor as and in substitution for this Warrant. ARTICLE V SPLIT-UP, COMBINATION EXCHANGE AND TRANSFER OF WARRANTS SECTION 5.01: SPLIT-UP, COMBINATION, EXCHANGE AND TRANSFER OF WARRANTS. Subject to the provisions of Section 5.02 hereof, this Warrant may be split up, combined or exchanged for another Warrant or Warrants containing the same terms to purchase a like aggregate number of Warrant Shares. If the Warrantholder desires to split up, combine or exchange Warrants, he or it shall make such request in writing delivered to the Company and shall surrender to the Company any Warrants to be so split up, combined or exchanged. Upon any such surrender for a split up, combination or exchange, the Company shall execute and deliver to the person entitled thereto a Warrant or Warrants, as the case may be, as so requested. The Company shall not be required to effect any split up, combination or exchange which will result in the issuance of a Warrant entitling the Warrantholder to purchase upon exercise a fraction of a share of Common Stock or a fractional Warrant. The Company may require such Warrantholder to pay a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any split up, combination or exchange of Warrants. SECTION 5.02: RESTRICTIONS ON TRANSFER. Neither this Warrant nor the Warrant Shares may be disposed of or encumbered (any such action, a "Transfer"), except (i) to CIBC Oppenheimer Corp., any successor to the business of such company, or any officer of such company, or (ii) to any underwriter in connection with a Public Offering of the Common Stock, provided (as to (ii)) that this Warrant is exercised upon such Transfer and the shares of Common Stock issued upon such exercise are sold by such underwriter as part of such Public Offering and, as to both (i) and (ii), only in accordance with and subject to the provisions of the Securities Act and the rules and regulations promulgated thereunder. If at the time of a Transfer, a Registration Statement is not in effect to register this Warrant or the Warrant Shares, the Company may require the Warrantholder to make such representations, and may place such legends on certificates representing this Warrant, as may be reasonably required in the opinion of counsel to the Company to permit a Transfer without such registration. 10 11 ARTICLE VI REGISTRATION UNDER THE SECURITIES ACT OF 1933 SECTION 6.01: PIGGYBACK REGISTRATION. (a) Right to Include Registrable Securities. If at any time or from time to time after March 10, 1999 and prior to the Expiration Date, the Company proposes to register any of its securities under the Securities Act on any form for the registration of securities under such Act, whether or not for its own account (other than by a registration statement on Form S-8 or other form which does not include substantially the same information as would be required in a form for the general registration of securities or would not be available for the Registrable Securities) (a "Piggyback Registration"), it shall as expeditiously as possible give written notice to all Holders of its intention to do so and of such Holders' rights under this Section 6.01. Such rights are referred to hereinafter as "Piggyback Registration Rights." Upon the written request of any such Holder made within 20 days after receipt of any such notice (which request shall specify the Registrable Securities intended to be disposed of by such Holder), the Company shall include in the Registration Statement the Registrable Securities which the Company has been so requested to register by the Holders thereof and the Company shall keep such registration statement in effect and maintain compliance with each Federal and state law or regulation for the period necessary for such Holder to effect the proposed sale or other disposition (but in no event for a period greater than 120 days). (b) Withdrawal of Piggyback Registration by Company. If, at any time after giving written notice of its intention to register any securities in a Piggyback Registration but prior to the effective date of the related Registration Statement, the Company shall determine for any reason not to register such securities, the Company shall give written notice of such determination to each Holder and, thereupon, shall be relieved of its obligation to register any Registrable Securities in connection with such Piggyback Registration. All best efforts obligations of the Company pursuant to Section 6.04 shall cease if the Company determines to terminate prior to such effective date any registration where Registrable Securities are being registered pursuant to this Section 6.01. (c) Piggyback Registration of Underwritten Public Offerings. If a Piggyback Registration involves an offering by or through underwriters, then, (i) all Holders requesting to have their Registrable Securities included in the Company's Registration Statement must sell their Registrable Securities to the underwriters selected by the Company on the same terms and conditions as apply to other selling shareholders and (ii) any Holder requesting to have his or its Registrable Securities included in such Registration Statement may elect in writing, not later than three Business Days prior to the effectiveness of the Registration Statement filed in connection with such registration, not to have his or its Registrable Securities so included in connection with such registration. (d) Payment of Registration Expenses for Piggyback Registration. The Company shall pay all Registration Expenses in connection with each registration of Registrable 11 12 Securities requested pursuant to a Piggyback Registration Right contained in this Section 6.01. (e) Priority in Piggyback Registration. If a Piggyback Registration involves an offering by or through underwriters, the Company shall not be required to include Registrable Shares therein if and to the extent the underwriter managing the offering reasonably believes in good faith and advises each Holder requesting to have Registrable Securities included in the Company's Registration Statement that such inclusion would materially adversely affect such offering; provided that (i) any such reduction or elimination shall be pro rata to all other holders of the securities of the Company exercising "piggyback registration rights" similar to those set forth herein and to any selling shareholders who are employees, officers, directors or other affiliates of the Company, in each case in proportion to the respective number of shares they have requested to be registered, and (ii) in such event, such Holders may delay any offering by them of all Registrable Shares requested to be included (or that portion of such Registrable Shares eliminated for such period, not to exceed 90 days, as the managing underwriter shall request) and the Company shall file such supplements and post-effective amendments and take such other action necessary under Federal and state law or regulation as may be necessary to permit such Holders to make their proposed offering for a period of 90 days following such period of delay. SECTION 6.02: DEMAND REGISTRATION. (a) Request for Registration. If, at any time subsequent to March 10, 1999 and prior to the Expiration Date, any 25% Holders request that the Company file a registration statement under the Securities Act, the Company as soon as practicable shall use its best efforts to file a registration statement with respect to all Warrant Shares that it has been so requested to include and obtain the effectiveness thereof, and to take all other action necessary under any Federal or state law or regulation to permit the Warrant Shares that are then held and/or that may be acquired upon the exercise of the Warrants specified in the notices of the Holders or holders thereof to be sold or otherwise disposed of, and the Company shall maintain such compliance with each such Federal and state law and regulation for the period necessary for such Holders or holders to effect the proposed sale or other disposition (but in no event for more than 120 days); provided, however, the Company shall be entitled, no more than once during such period, to defer such registration for a period of up to 60 days if and to the extent that its Board of Directors shall determine that such registration would interfere with a pending corporate transaction or would require the disclosure, pursuant to such registration, of material information, which disclosure has been determined, by the Board of Directors of the Company in good faith, to be not in the best interests of the Company (any cash request being a "Demand Registration"). The Company shall also promptly give written notice to the Holder and the holders of any other Warrants and/or the holders of any Warrant Shares who or that have not made a request to the Company pursuant to the provisions of this subsection (a) of its intention to effect any required registration or qualification and shall use its best efforts to effect as expeditiously as possible such registration or qualification of all other such Warrant Shares that are then held and/or that may be acquired upon the exercise of the Warrants, the Holder or holders 12 13 of which have requested such registration or qualification, within 15 days after such notice has been given by the Company, as provided in the preceding sentence. The Company shall be required to effect a registration or qualification pursuant to this subsection (a) on one occasion only. (b) Payment of Registration Expenses for Demand Registration. The Company shall pay all Registration Expenses in connection with the Demand Registration. SECTION 6.03: BUY-OUTS OF REGISTRATION DEMAND. In lieu of carrying out its obligations to effect a Piggyback Registration or Demand Registration of any Registrable Securities pursuant to this Article VI, the Company may carry out such obligation by offering to purchase and purchasing such Registrable Securities requested to be registered at an amount in cash equal to the difference between (a) the last sale price of the Common Stock on the day the request for registration is made and (b) the Exercise Price in effect on such day. SECTION 6.04: REGISTRATION PROCEDURES. If and whenever the Company is required to use its best efforts to take action pursuant to any Federal or state law or regulation to permit the sale or other disposition of any Warrant Shares that are then held or that may be acquired upon exercise of the Warrants, in order to effect or cause the registration of any Registrable Securities under the Securities Act as provided in this Article VI, the Company shall, as expeditiously as practicable: (a) furnish to each selling Holder of Registrable Securities and the underwriters, if any, without charge, as many copies of the Registration Statement, the Prospectus or the Prospectuses (including each preliminary prospectus) and any amendment or supplement thereto as they may reasonably request; (b) enter into such agreements (including an underwriting agreement) and take all such other actions reasonably required in connection therewith in order to expedite or facilitate the disposition of such Registrable Securities and in such connection, if the registration is in connection with an underwritten offering (i) make such representations and warranties to the underwriters in such form, substance and scope as are customarily made by issuers to underwriters in underwritten offerings and confirm the same if and when requested; (ii) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions in form, scope and substance shall be reasonably satisfactory to the underwriters) addressed to the underwriters and the Holders covering the matters customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by such underwriters; (iii) obtain "cold comfort" letters and updates thereof from the Company's accountants addressed to the underwriters such letters to be in customary form and to cover matters of the type customarily covered in "cold comfort" letters to underwriters and the Holders in connection with underwritten offerings; (iv) set forth in full, in any underwriting agreement entered into, the indemnification provisions and procedures of Section 6.05 hereof with respect to all parties to be indemnified pursuant to said Section; and (v) deliver such documents and certificates as may be reasonably requested by the underwriters to evidence compliance with clause (i) above and with any customary conditions contained in the underwriting agreement or other agreement entered into by the 13 14 Company; the above shall be done at each closing under such underwriting or similar agreement or as and to the extent required thereunder; (c) make available for inspection by one or more representatives of the Holders of Registrable Securities being sold, any underwriter participating in any disposition pursuant to such registration, and any attorney or accountant retained by such Holders or underwriter, all financial and other records, pertinent corporate documents and properties of the Company, and cause the Company's officers, directors and employees to supply all information reasonably requested by any such representatives in connection with such; (d) otherwise use its best efforts to comply with all applicable Federal and state regulations; and take such other action as may be reasonably necessary or advisable to enable each such Holder and each such underwriter to consummate the sale or disposition in such jurisdiction or jurisdiction, in which any such Holder or underwriter shall have requested that the Registrable Securities be sold; provided, however, that the Company shall not be required in connection therewith to qualify to do business as a foreign corporation or take any action that would subject it to taxation or general service of process in any jurisdiction where it is not then so qualified or subject. Except as otherwise provided in this Agreement, the Company shall have sole control in connection with the preparation, filing, withdrawal, amendment or supplementing of each Registration Statement, the selection of underwriters, and the distribution of any preliminary prospectus included in the Registration Statement, and may include within the coverage thereof additional shares of Common Stock or other securities for its own account or for the account of one or more of its other security holders; Each seller of Registrable Securities as to which any registration is being effected shall furnish to the Company such information regarding the distribution of such securities and such other information as may otherwise be required by the Securities Act to be included in such Registration Statement. SECTION 6.05: WITHDRAWAL OF REGISTRATION RIGHTS. The Company shall not be required by this Article VI to file any Registration Statement if, in the opinion of counsel for the Warrantholders and the Company (or, should they not agree, in the opinion of another counsel experienced in securities law matters acceptable to counsel for such holders and the Company), the proposed public offering or other transfer as to which such Registration Statement is requested is exempt from applicable federal and state securities laws and would result in all purchasers or transferees obtaining securities which are not "restricted securities," as defined in Rule 144 under the Act. This Article VI shall terminate and be of no further force or effect as of the first date upon which all of the Warrant Shares then issuable upon exercise of the Warrants may be sold publicly pursuant to Rule 144(k). SECTION 6.06: INDEMNIFICATION. (a) Indemnification by Company. In connection with each Registration Statement relating to disposition of Registrable Securities, the Company shall indemnify and hold harmless each Holder and each underwriter of Registrable Securities and each Person, 14 15 if any, who controls such Holder or underwriter (within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) against any and all losses, claims, damages and liabilities, joint or several (including any reasonable investigation, legal and other expenses incurred in connection with, and any amount paid in settlement of any action, suit or proceeding or any claim asserted), to which they, or any of them, may become subject under the Securities Act, the Exchange Act or other Federal or state law or regulation, at common law or otherwise, insofar as such losses, claims, damages or liabilities arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement, Prospectus or preliminary prospectus or any amendment thereof or supplement thereto, or arise out of or are based upon any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that such indemnity shall not inure to the benefit of any Holder or underwriter (or any Person controlling such Holder or underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) on account of any losses, claims, damages or liabilities arising from the sale of Registrable Securities if such untrue statement or omission or alleged untrue statement or omission was made in such Registration Statement, Prospectus or preliminary prospectus, or such amendment or supplement, in reliance upon and in conformity with information furnished in writing to the Company by the Holder or underwriter specifically for use therein and provided, further, that with respect to any preliminary prospectus, the foregoing indemnification shall not inure to the benefit of any Holder from whom the person asserting any loss, claim, damage, liability or expense purchased Warrant Shares, or to any person controlling such Holder, if copies of the Prospectus were timely delivered to such Holder and a copy of the Prospectus (as then amended or supplemented if the Company shall have timely furnished any amendments or supplements thereto) was not sent or given by or on behalf of such Holder to such person, if required by law to have been so delivered, at or prior to the written confirmation of the sale of the Warrant Shares to such person, and if such Prospectus (as so amended or supplemented) would have cured the defect giving rise to such loss, claim, damage, liability or expense. This indemnity agreement shall be in addition to any liability which the Company may otherwise have. (b) Indemnification by Holder. In connection with each Registration Statement, each Holder shall indemnify, to the same extent as the indemnification provided by the Company in Section 6.06(a), the Company, its directors and each officer who signs the Registration Statement and each Person who controls the Company (within the meaning of Section 15 of the Securities Act and Section 20 of the Exchange Act) but only insofar as such losses, claims, damages and liabilities arise out of or are based upon any untrue statement or omission or alleged untrue statement or omission which was made in the Registration Statement, the Prospectus or preliminary prospectus or any amendment thereof or supplement thereto, in reliance upon and in conformity with information furnished in writing by such Holder to the Company specifically for use therein. In no event shall the liability of any selling Holder of Registrable Securities hereunder be greater in amount than the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. The Company shall be entitled to receive indemnities from underwriters, selling brokers, dealer managers and similar 15 16 securities industry professionals participating in the distribution, to the same extent as provided above, with respect to information so furnished in writing by such Persons specifically for inclusion in any Prospectus, Registration Statement or preliminary prospectus or any amendment thereof or supplement thereto. (c) Conduct of Indemnification Procedure. Any party that proposes to assert the right to be indemnified hereunder will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim is to be made against an indemnifying party or parties under this Section, notify each such indemnifying party of the commencement of such action, suit or proceeding, enclosing a copy of all papers served. No indemnification provided for in Section 6.06(a) or 6.06(b) shall be available to any party who shall fail to give notice as provided in this Section 6.06(c) if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was prejudiced by the failure to give such notice, but the omission so to notify such indemnifying party of any such action, suit or proceeding shall not relieve it from any liability that it may have to any indemnified party for contribution or otherwise than under this Section. In case any such action, suit or proceeding shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate in, and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party, and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof and the approval by the indemnifying party to such indemnified party of its election so to assume the defense thereof and the approval by the indemnified party of such counsel, the indemnifying party shall not be liable to such indemnified party for any legal or other expenses, except as provided below and except for the reasonable costs of investigation subsequently incurred by such indemnified party in connection with the defense thereof. The indemnified party shall have the right to employ its counsel in any such action, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the employment of counsel by such indemnified party has been authorized in writing by the indemnifying parties, (ii) the indemnified party shall have reasonably concluded, based on the advice of its counsel, that there may be a conflict of interest between the indemnifying parties and the indemnified party in the conduct of the defense of such action (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party) or (iii) the indemnifying parties shall not have employed counsel to assume the defense of such action within a reasonable time after notice of the commencement thereof, in each of which cases the fees and expenses of counsel shall be at the expense of the indemnifying parties , it being understood, however, that the indemnifying parties shall not be liable for the expenses of more than one separate counsel, which counsel shall be reasonably approved by the indemnifying parties. An indemnifying party shall not be liable for any settlement of any action, suit, proceeding or claim effected without its written consent. (d) Contribution. In order to provide for just and equitable contribution in circumstances in which the indemnification provided for in Section 6.06(a) and 6.06(b) is 16 17 due in accordance with its terms but for any reason is held to be unavailable from the Company or any Holder, the Company and the Holders shall contribute to the aggregate losses, claims, damages and liabilities (including any investigation, legal and other expenses reasonably incurred in connection with, and any amount paid in settlement of, any action, suit or proceeding or any claims asserted, but after deducting any contribution received by the Company from persons other than the Holders, such as persons who control the Company within the meaning of the Securities Act, officers of the Company who signed any Registration Statement and directors of the Company, who may also be liable for contribution) to which the Company and one or more of the Holders may be subject in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and each such Holder on the other from the offering of the Warrant Shares or, if such allocation is not permitted by applicable law or indemnification is not available as a result of the indemnifying party not having received notice as provided in Section 6.06(c) hereof, in such proportion as is appropriate to reflect not only the relative benefits referred to above but also the relative fault of the Company on the one hand and each such Holder on the other in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The relative benefits received by the Company and each such Holder shall be deemed to be in the same proportion as (x) the total proceeds from the offering (net of underwriting discounts but before deducting expenses) received by the Company, bear to (y) the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. The relative fault of the Company or any such Holder shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact related to information supplied by the Company or any such Holder and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Holders agree that it would not be just and equitable if contribution pursuant to this Section 6.06(d) were determined by pro rata allocation (even if the Holders were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above. Notwithstanding the provisions of this Section 6.06(d), (i) in no case shall any Holder be liable or responsible for any amount in excess of the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation, and (ii) the Company shall be liable and responsible for any amount in excess of such dollar amount; provided, however, that no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 6.06, each person, if any, who controls a Holder within the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act shall have the same rights to contribution as such Holder, and each person, if any, who controls the Company within the meaning of the Section 15 of the Securities Act or Section 20(a) of the Exchange Act, each officer of the Company who shall have signed any Registration Statement and each director of the Company shall have the same rights to contribution as the Company, subject in each case to clauses (i) and (ii) in the immediately preceding sentence of this Section 6.06(d). Any party entitled to contribution will, promptly after receipt of notice of commencement 17 18 of any action, suit or proceeding against such party in respect of which a claim for contribution may be made against another party or parties under this Section, notify such party or parties from whom contribution may be sought, but the omission so to notify such party or parties from whom contribution may be sought shall not relieve the party or parties from whom contribution may be sought from any other obligation it or they may have hereunder or otherwise than under this Section 6.06. No party shall be liable for contribution with respect to any action, suit, proceeding or claim settled without its written consent. Each Holder's obligations to contribute pursuant to this Section 6.06(d) are several in proportion to their respective underwriting commitments and not joint. (e) Specific Performance. The Company and the Holder acknowledge that remedies at law for the enforcement of this Section 6.06 may be inadequate and intend that this Section 6.06 shall be specifically enforceable. ARTICLE VII OTHER MATTERS SECTION 7.01: AMENDMENTS AND WAIVERS. The provisions of this Warrant, including the provisions of this sentence, may not be amended, modified or supplemented, and waiver or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of holders of at least a majority of the outstanding Registrable Securities. Holders shall be bound by any consent authorized by this Section whether or not certificates representing such Registrable Securities have been marked to indicate such consent. SECTION 7.02: COUNTERPARTS. This Warrant may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. SECTION 7.03: GOVERNING LAW. This Warrant shall be governed by and construed in accordance with the laws of the State of New York. SECTION 7.04: SEVERABILITY. In the event that any one or more of the provisions contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provisions in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. SECTION 7.05: ATTORNEYS' FEES. In any action or proceeding brought to enforce any provisions of this Warrant, or where any provisions hereof or thereof is validly asserted as a defense, the successful party shall be entitled to recover reasonable attorneys' fees and disbursements in addition to its costs and expenses and any other available remedy. SECTION 7.06: NOTICE. Any notices or certificates by the Company to the Holder and by the Holder to the Company shall be deemed delivered if in writing and delivered in person or by registered mail (return receipt requested) to the Holder addressed to him in care of CIBC Oppenheimer Corp., Oppenheimer Tower, World Financial Center, New York, New York 10281 or, 18 19 if the Holder has designated, by notice in writing to the Company, any other address, to such other address, and if to the Company, addressed to it at BNC Mortgage, Inc., 1063 McGaw Avenue, Irvine, California 92614, Attn: President. The Company may change its address by written notice to the Holder and the Holder may change his or its address by written notice to the Company. 19 20 IN WITNESS WHEREOF, this Warrant has been duly executed by the Company under its corporate seal as of the 16 day of March, 1998. BNC MORTGAGE, INC. By: /s/ Kelly W. Monahan ------------------------------------- Name: Kelly W. Monahan Title: President Attest: /s/ Evan R. Buckley ------------------------- Secretary 20 21 ASSIGNMENT (TO BE EXECUTED ONLY UPON ASSIGNMENT OF WARRANT CERTIFICATE) For value received, ____________________ hereby sells, assigns and transfers unto _________________________ the within Warrant Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint ___________________ attorney, to transfer said Warrant Certificate on the books of the within-named Company with respect to the number of Warrants set forth below, with full power of substitution in the premises: Name(s) of Assignees(s) Address No. of Warrants ------------- ------- --------------- And if said number of Warrants shall not be all the Warrants represented by the Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the Warrants represented by said Warrant Certificate. Dated: ------------------ ----------------------------------------- Note: The above signature should correspond exactly with the name on the face of this Warrant Certificate. 21 22 SUBSCRIPTION FORM (TO BE EXECUTED UPON EXERCISE OF WARRANT PURSUANT TO SECTION 2.02(a)(i)) The undersigned hereby irrevocably elects to exercise the right of purchase represented by the within Warrant Certificate for, and to purchase thereunder ____________ shares of Common Stock, as provided for therein, and tenders herewith payment of the purchase price in full in the form of cash or a certified or official bank check in the amount of $ ____________. Please issue a certificate or certificates for such Common Stock in the name of: Name: ---------------------------------- --------------------------------------- --------------------------------------- --------------------------------------- (Please Print Name, Address and Social Security Number) Signature ----------------------------- NOTE: The above signature should respond exactly with the name on the first page of this Warrant Certificate or with the name of the assignee appearing in the assignment form below. And if said number of shares shall not be all the shares purchasable under the within Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the shares purchasable thereunder rounded up to the next higher number of shares. 22 23 CASHLESS EXERCISE FORM (TO BE EXECUTED UPON EXERCISE OF WARRANT PURSUANT TO SECTION 2.02(a)(ii)) The undersigned hereby irrevocably elects to Exchange its Warrant for such shares of Common Stock pursuant to the Cashless Exercise provisions of the within Warrant Certificate, as provided for in Section 2.02(a)(ii) of such Warrant Certificate. Please issue a certificate or certificates for such Common Stock in the name of: Name: ---------------------------------- --------------------------------------- --------------------------------------- --------------------------------------- (Please Print Name, Address and Social Security Number) Signature ----------------------------- NOTE: The above signature should correspond exactly with the name on the first page of this Warrant Certificate or with the name of the assignee appearing in the assignment form below. And if said number of shares shall not be all the shares exchangeable or purchasable under the within Warrant Certificate, a new Warrant Certificate is to be issued in the name of the undersigned for the balance remaining of the shares purchasable rounded up to the next higher number of shares. 23 EX-10.8 7 WARRANT TO PURCHASE 31,732 SHARES 1 EXHIBIT 10.8 THE SECURITIES REPRESENTED BY THIS CERTIFICATE MAY NOT BE OFFERED FOR SALE, SOLD OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT FILED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT. VOID AFTER 5:00 P.M., NEW YORK TIME, ON MARCH 10, 2003 OR IF NOT A BUSINESS DAY, AS DEFINED HEREIN, AT 5:00 P.M., NEW YORK TIME, ON THE NEXT FOLLOWING BUSINESS DAY. WARRANT TO PURCHASE 31,732 SHARES OF COMMON STOCK NO. 2 WARRANT TO PURCHASE COMMON STOCK OF BNC MORTGAGE, INC. TRANSFER RESTRICTED -- SEE SECTION 5.02 This certifies that, for good and valuable consideration, Piper Jaffray Inc., and its registered, permitted assigns (collectively, the "Warrantholder"), is entitled to purchase from BNC Mortgage, Inc., a Delaware corporation (the "Company"), subject to the terms and conditions hereof, at any time on or after 9:00 A.M., New York time, on March 10, 1999, and before 5:00 P.M., New York time, on March 10, 2003 (or, if such day is not a Business Day, at or before 5:00 P.M., New York time, on the next following Business Day), the number of fully paid and non-assessable shares of Common Stock stated above at the Exercise Price. The Exercise Price and the number of shares purchasable hereunder are subject to adjustment from time to time as provided in Article III hereof. ARTICLE I SECTION 1.01: DEFINITION OF TERMS. As used in this Warrant, the following capitalized terms shall have the following respective meanings: (a) Business Day: A day other than a Saturday, Sunday or other day on which banks in the State of New York are authorized by law to remain closed. (b) Common Stock: Common Stock, $.001 par value per share, of the Company. (c) Common Stock Equivalents: Securities that are convertible into or exercisable for shares of Common Stock. 1 2 (d) Demand Registration: See Section 6.02. (e) Exchange Act: The Securities Exchange Act of 1934, as amended from time to time. (f) Exercise Price: $10.45 per Warrant Share, as such price may be adjusted from time to time pursuant to Article III hereof. (g) Expiration Date: 5:00 P.M., New York time, on March 10, 2003 or if such day is not a Business Day, the next succeeding day which is a Business Day. (h) 25% Holders: At any time as to which a Demand Registration is requested, the Holder and/or the holders of any other Warrants and/or the holders of Warrant Shares who have the right to acquire or hold, as the case may be, not less than 25% of the combined total of Warrant Shares issuable and Warrant Shares outstanding at the time such Demand Registration is requested. (i) Holder: A Holder of Registrable Securities. (j) NASD: National Association of Securities Dealers, Inc.; and NASDAQ: NASD Automatic Quotation System. (k) Person: An individual, partnership, joint venture, corporation, trust, unincorporated organization or government or any department or agency thereof. (l) Piggyback Registration: See Section 6.01. (m) Prospectus: Any prospectus included in any Registration Statement, as amended or supplemented by any prospectus supplement, with respect to the terms of the offering of any portion of the Registrable Securities covered by such Registration Statement and all other amendments and supplements to the Prospectus, including post-effective amendments and all material incorporated by reference in such Prospectus. (n) Public Offerings: A public offering of any of the Company's equity or debt securities pursuant to a registration statement under the Securities Act. (o) Registration Expenses: Any and all expenses incurred in connection with any registration or action incident to performance of or compliance by the Company with Article VI, including, without limitation, (i) all SEC, national securities exchange and NASD registration and filing fees; all listing fees and all transfer agent fees; (ii) all fees and expenses of complying with state securities or blue sky laws (including the fees and disbursements of counsel for the underwriters in connection with blue sky qualifications of the Registrable Securities; (iii) all printing, mailing, messenger and delivery expenses and (iv) all fees and disbursements of counsel for the Company and of its accountants, including the expenses of any special audits and/or "cold comfort" letters required by or incident to such performance and compliance, but excluding underwriting discounts and commissions, 2 3 brokerage fees and transfer taxes, if any, and fees of counsel or accountants retained by the holders of Registrable Securities to advise them in their capacity as Holders of Registrable Securities. (p) Registrable Securities: Any Warrant Shares issued to Piper Jaffray Inc and CIBC Oppenheimer Corp. and/or their designees or transferees as permitted under Section 5.02 and/or other securities that may be or are issued by the Company upon exercise of this Warrant, including those which may thereafter be issued by the Company in respect of any such securities by means of any stock splits, stock dividends, recapitalizations, reclassifications or the like, and as adjusted pursuant to Article III hereof. (q) Registration Statement: Any registration statement of the Company filed or to be filed with the SEC which covers any of the Registrable Securities pursuant to the provisions of this Agreement, including all amendments (including post-effective amendments) and supplements thereto, all exhibits thereto and all material incorporated therein by reference. (r) SEC: The Securities and Exchange Commission or any other federal agency at the time administering the Securities Act or the Exchange Act. (s) Securities Act: The Securities Act of 1933, as amended from time to time. (t) Transfer: See Section 5.02. (u) Warrants: This Warrant, all other warrants issued on the date hereof and all other warrants that may be issued in its or their place (together evidencing the right to purchase an aggregate of 317,319 shares of Common Stock), originally issued as set forth in the definition of Registrable Securities. (v) Warrantholder: The person(s) or entity(ies) to whom this Warrant is originally issued, or any successor in interest thereto, or any assignee or transferee thereof, in whose name this Warrant is registered upon the books to be maintained by the Company for that purpose. (w) Warrant Shares: Common Stock, Common Stock Equivalents and other securities purchased or purchasable upon exercise of the Warrants. ARTICLE II DURATION AND EXERCISE OF WARRANT SECTION 2.01: DURATION OF WARRANT. Subject to the limitations specified in Section 2.02.(a)(ii) regarding a Cashless Exercise, the Warrantholder may exercise this Warrant at any time and from time to time after 9:00 A.M., New York time, on March 10, 1999, and before 5:00 P.M., New York time, on the Expiration Date. If this Warrant is not exercised on or prior to the Expiration Date, it shall become void, and all rights hereunder shall thereupon cease. 3 4 SECTION 2.02: EXERCISE OF WARRANT. (a) The Warrantholder may exercise this Warrant, in whole or in part, as follows: (i) By presentation and surrender of this Warrant to the Company at its principal executive offices or at the office of its stock transfer agent, if any, with the Subscription Form annexed hereto duly executed and accompanied by payment of the full Exercise Price for each Warrant Share to be purchased; or (ii) By presentation and surrender of this Warrant to the Company at its principal executive offices with a Cashless Exercise Form annexed hereto duly executed (a "Cashless Exercise"). In the event of a Cashless Exercise, the Warrantholder shall exchange its warrant for that number of shares of Common Stock determined by multiplying the number of Warrant Shares by a fraction, the numerator of which shall be the amount by which the then current market price per share of Common Stock exceeds the Exercise Price, and the denominator of which shall be the then current market price per share of Common Stock. For purposes of any computation under this Section 2.02(a)(ii), the then current market price per share of Common Stock at any date shall be deemed to be the average of the daily closing prices for 20 consecutive trading days commencing 30 trading days before such date. The closing price for each day shall be the last sale price regular way or, in case no such reported sales take place on such day, the average of the last reported bid and asked prices regular way, in either case on the principal national securities exchange on which the Common Stock is admitted to trading or listed, or if not listed or admitted to trading on any such exchange, the representative closing bid price as reported by NASDAQ, or other similar organization if NASDAQ is no longer reporting such information, or if not so available, the fair market price as determined by the Board of Directors of the Company. (b) Upon receipt of this Warrant, in the case of Section 2.02 (a)(i), with the Subscription Form duly executed and accompanied by payment of the aggregate Exercise Price for the Warrant Shares for which this Warrant is then being exercised, or, in the case of Section 2.02 (a)(ii), with the Cashless Exercise Form duly executed, the Company shall cause to be issued certificates for the total number of whole shares of Common Stock for which this Warrant is being exercised (adjusted to reflect the effect of the anti-dilution provisions contained in Article III hereof, if any, and as provided in Section 2.04 hereof) in such denominations as are requested for delivery to the Warrantholder, and the Company shall thereupon deliver such certificates to the Warrantholder. The Warrantholder shall be deemed to be the holder of record of the shares of Common Stock issuable upon such exercise, notwithstanding that the stock transfer books of the Company shall then be closed or that certificates representing such shares of Common Stock shall not then be actually delivered to the Warrantholder. If at the time this Warrant is exercised, a Registration Statement is not in effect to register under the Securities Act the issuance of the Warrant Shares upon exercise of this Warrant, the Company may require the Warrantholder to make such representations, and may place such legends on certificates representing the Warrant 4 5 Shares, as may be reasonably required in the opinion of counsel to the Company to permit the Warrant Shares to be issued without such registration. (c) In case the Warrantholder shall exercise this Warrant with respect to less than all of the Warrant Shares that may be purchased under this Warrant, the Company shall execute a new warrant in the form of this Warrant for the balance of such Warrant Shares and deliver such new warrant to the Warrantholder. (d) The Company shall pay any and all stock transfer and similar taxes which may be payable in respect of the issue of this Warrant or in respect of the issue of any Warrant Shares; provided, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer of this Warrant, or the Warrant Shares, by any Warrantholder. SECTION 2.03: RESERVATION OF SHARES. The Company hereby agrees that at all times there shall be reserved for issuance and delivery upon exercise of this Warrant such number of shares of Common Stock or other shares of capital stock of the Company from time to time issuable upon exercise of this Warrant. All such shares shall be duly authorized, and when issued upon such exercise, shall be validly issued, fully paid and nonassessable, free and clear of all liens, security interests, charges and other encumbrances or restrictions on sale and free and clear of all preemptive rights (except the restrictions imposed by the legend appearing at the top of Page 1 of this Warrant). SECTION 2.04: FRACTIONAL SHARES. The Company shall not be required to issue any fraction of a share of its capital stock in connection with the exercise of this Warrant, and in any case where the Warrantholder would, except for the provisions of this Section 2.04, be entitled under the terms of this Warrant to receive a fraction of a share upon the exercise of this Warrant, the Company shall, upon the exercise of this Warrant and tender of the Exercise Price (as adjusted to cover the balance of the share), issue the larger number of whole shares purchasable upon exercise of this Warrant. The Company shall not be required to make any cash or other adjustment in respect of such fraction of a share to which the Warrantholder would otherwise be entitled. SECTION 2.05: LISTING. Prior to the issuance of any shares of Common Stock upon exercise of this Warrant, the Company shall secure the listing of such shares of Common Stock upon each national securities exchange or automated quotation system, if any, upon which shares of Common Stock are then listed (subject to official notice of issuance upon exercise of this Warrant) and shall maintain, so long as any other shares of Common Stock shall so be listed, such listing of all shares of Common Stock from time to time issuable upon the exercise of this Warrant; and the Company shall so list on each national securities exchange or automated quotation system, and shall maintain such listing of, any other shares of capital stock of the Company issuable upon the exercise of this Warrant if and so long as any shares of the same class shall be listed on such national securities exchange or automated quotation system. 5 6 ARTICLE III ADJUSTMENT OF SHARES OF COMMON STOCK PURCHASABLE AND OF EXERCISE PRICE The Exercise Price and the number and kind of Warrant Shares shall be subject to adjustment from time to time upon the happening of certain events as provided in this Article III. SECTION 3.01: MECHANICAL ADJUSTMENTS. (a) If at any time prior to the exercise of this Warrant in full, the Company shall (i) declare a dividend or make a distribution on the Common Stock payable in shares of its capital stock (whether shares of Common Stock or of capital stock of any other class); (ii) subdivide, reclassify or recapitalize outstanding Common Stock into a greater number of shares; (iii) combine, reclassify or recapitalize its outstanding Common Stock into a smaller number of shares; or (iv) issue any shares of its capital stock by reclassification of its Common Stock (including any such reclassification in connection with a consolidation or a merger in which the Company is the continuing corporation), the Exercise Price in effect at the time of the record date of such dividend, distribution, subdivision, combination, reclassification or recapitalization shall be adjusted so that the Warrantholder shall be entitled to receive the aggregate number and kind of shares which, if this Warrant had been exercised in full immediately prior to such event, it would have owned upon such exercise and been entitled to receive by virtue of such dividend, distribution, subdivision, combination, reclassification or recapitalization. Any adjustment required by this paragraph 3.01(a) shall be made successively immediately after the record date, in the case of a dividend or distribution, or the effective date, in the case of a subdivision, combination, reclassification or recapitalization, to allow the purchase of such aggregate number and kind of shares. (b) If at any time prior to the exercise of this Warrant in full, the Company shall fix a record date for the issuance or making a distribution to all holders of Common Stock (including any such distribution to be made in connection with a consolidation or merger in which the Company is to be the continuing corporation) of evidences of its indebtedness, any other securities of the Company or any cash, property or other assets (excluding a combination, reclassification or recapitalization referred to in Section 3.01(a), regular cash dividends or cash distributions paid out of net profits legally available therefor and in the ordinary course of business and subscription rights, options or warrants for Common Stock or Common Stock Equivalents (any such nonexcluded event being herein called a "Special Dividend"), (i) the Exercise Price shall be decreased immediately after the record date for such Special Dividend to a price determined by multiplying the Exercise Price then in effect by a fraction, the numerator of which shall be the then current market price of the Common Stock (as defined in Section 3.01(e)) on such record date less the fair market value (as determined by the Company's Board of Directors) of the evidences of indebtedness, securities or property, or other assets issued or distributed in such Special Dividend applicable to one share of Common Stock or of such subscription rights, options or warrants applicable to one share of Common Stock and the denominator of which shall be such then 6 7 current market price per share of Common Stock (as so determined) and (ii) the number of shares of Common Stock subject to purchase upon exercise of this Warrant shall be increased to a number determined by multiplying the number of shares of Common Stock subject to purchase immediately before such Special Dividend by a fraction, the numerator of which shall be the Exercise Price in effect immediately before such Special Dividend and the denominator of which shall be the Exercise Price in effect immediately after such Special Dividend. Any adjustment required by this paragraph 3.01(b) shall be made successively whenever such a record date is fixed and in the event that such distribution is not so made, the Exercise Price shall again be adjusted to be the Exercise Price that was in effect immediately prior to such record date. (c) If at any time prior to the exercise of this Warrant in full, the Company shall make a distribution to all holders of the Common Stock of stock of a subsidiary or securities convertible into or exercisable for such stock, then in lieu of an adjustment in the Exercise Price or the number of Warrant Shares purchasable upon the exercise of this warrant, each Warrantholder, upon the exercise hereof at any time after such distribution, shall be entitled to receive from the Company, such subsidiary or both, as the Company shall determine, the stock or other securities to which such Warrantholder would have been entitled if such Warrantholder had exercised this Warrant immediately prior thereto, all subject to further adjustment as provided in this Article III, and the Company shall reserve, for the life of the Warrant, such securities of such subsidiary or other corporation; provided, however, that no adjustment in respect of dividends or interest on such stock or other securities shall be made during the term of this Warrant or upon its exercise. (d) Whenever the Exercise Price payable upon exercise of each Warrant is adjusted pursuant to one or more of paragraphs (a) and (b) of this Section 3.01, the Warrant Shares shall simultaneously be adjusted by multiplying the number of Warrant Shares initially issuable upon exercise of each Warrant by the Exercise Price in effect on the date of such adjustment and dividing the product so obtained by the Exercise Price, as adjusted. (e) For the purpose of any computation under this Section 3.01, the current market price per share of Common Stock at any date shall be deemed to be the average of the daily closing prices for 20 consecutive trading days commencing 30 trading days before such date. The closing price for each day shall be the last sale price regular way or, in case no such reported sales take place on such day, the average of the last reported bid and asked prices regular way, in either case on the principal national securities exchange on which the Common Stock is admitted to trading or listed, or if not listed or admitted to trading on any such exchange, the representative closing bid price as reported by NASDAQ, or other similar organization if NASDAQ is no longer reporting such information, or if not so available, the fair market price as determined by the Board of Directors of the Company. (f) No adjustment in the Exercise Price shall be required unless such adjustment would require an increase or decrease of at least ten cents ($.10) in such price; provided, however, that any adjustments which by reason of this paragraph (f) are not required to be made shall be carried forward and taken into account in any subsequent adjustment. All calculations under this Section 3.01 shall be made to the nearest cent or to the nearest one- 7 8 hundredth of a share, as the case may be. Notwithstanding anything in this Section 3.01 to the contrary, the Exercise Price shall not be reduced to less than the then existing par value of the Common Stock as a result of any adjustment made hereunder. (h) In the event that at any time, as a result of any adjustment made pursuant to Section 3.01(a), the Warrantholder thereafter shall become entitled to receive any shares of the Company other than Common Stock, thereafter the number of such other shares so receivable upon exercise of any Warrant shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Common Stock contained in Section 3.01(a). SECTION 3.02: NOTICE OF ADJUSTMENT. Whenever the number of Warrant Shares or the Exercise Price is adjusted as herein provided, the Company shall prepare and deliver forthwith to the Warrantholder a certificate signed by its President, and by any Vice President, Treasurer or Secretary, setting forth the adjusted number of shares purchasable upon the exercise of this Warrant and the Exercise Price of such shares after such adjustment, a brief statement of the facts requiring such adjustment and the computation by which adjustment was made. SECTION 3.03: NO ADJUSTMENT FOR DIVIDENDS. Except as provided in Section 3.01 of this Agreement, no adjustment in respect of any cash dividends paid by the Company shall be made during the term of this Warrant or upon the exercise of this Warrant. SECTION 3.04: PRESERVATION OF PURCHASE RIGHTS IN CERTAIN TRANSACTIONS. In case of any reclassification, capital reorganization or other change of outstanding shares of Common Stock (other than a subdivision or a combination of the outstanding Common Stock and other than a change in the par value of the Common Stock or in case of any consolidation or merger of the Company with or into another corporation (other than a merger with a subsidiary in which the Company is the continuing corporation and said merger does not result in any reclassification, capital reorganization or other change of outstanding shares of Common Stock of the class issuable upon exercise of this Warrant)) or in case of any sale, lease, transfer or conveyance to another corporation of the property and assets of the Company as an entirety or substantially as an entirety, the Company shall, as a condition precedent to such transaction, cause such successor or purchasing corporation, as the case may be, to execute with the Warrantholder an agreement granting the Warrantholder the right thereafter, upon payment of the Exercise Price in effect immediately prior to such action, to receive upon exercise of this Warrant the kind and amount of shares and other securities and property which he would have owned or have been entitled to receive after the happening of such reclassification, change, consolidation, merger, sale or conveyance had this Warrant been exercised immediately prior to such action. Such agreement shall provide for adjustments in respect of such shares of stock and other securities and property, which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Article III. In the event that in connection with any such reclassification, capital reorganization, change, consolidation, merger, sale or conveyance, additional shares of Common Stock shall be issued in exchange, conversion, substitution or payment, in whole or in part, for, or of, a security of the Company other than Common Stock, any such issue shall be treated as an issue of Common Stock covered by the provisions of Article III. The provisions of this Section 3.04 shall similarly apply to successive reclassification, capital reorganizations, consolidations, mergers, sales or conveyances. 8 9 SECTION 3.05: FORM OF WARRANT AFTER ADJUSTMENTS. The form of this Warrant need not be changed because of any adjustments in the Exercise Price or the number or kind of the Warrant Shares, and Warrants theretofore or thereafter issued may continue to express the same price and number and kind of shares as are stated in this Warrant, as initially issued. SECTION 3.06: TREATMENT OF WARRANTHOLDER. Prior to due presentment for registration of transfer of this Warrant, the Company may deem and treat the Warrantholder as the absolute owner of this Warrant (notwithstanding any notation of ownership or other writing hereon) for all purposes and shall not be affected by any notice to the contrary. ARTICLE IV OTHER PROVISIONS RELATING TO RIGHTS OF WARRANTHOLDER SECTION 4.01: NO RIGHTS AS SHAREHOLDERS; NOTICE TO WARRANTHOLDERS. Nothing contained in this Warrant shall be construed as conferring upon the Warrantholder or his or its transferees the right to vote or to receive dividends or to consent to or receive notice as a shareholder in respect of any meeting of shareholders for the election of directors of the Company or any other matter, or any other rights whatsoever as shareholders of the Company. The Company shall give notice to the Warrantholder by registered mail if at any time prior to the expiration or exercise in full of the Warrants, any of the following events shall occur: (a) the Company shall authorize the payment of any dividend upon shares of Common Stock payable in any securities or authorize the making of any distribution (other than a cash dividend subject to the parenthetical set forth in Section 3.01(b)) to all holders of Common Stock; (b) the Company shall authorize the issuance to all holders of Common Stock of any additional shares of Common Stock or Common Stock Equivalents or of rights, options or warrants to subscribe for or purchase Common Stock or Common Stock Equivalents or of any other subscription rights, options or warrants; (c) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation, merger, or sale or conveyance of the property of the Company as an entirety or substantially as an entirety); or (d) a capital reorganization or reclassification of the Common Stock (other than a subdivision or combination of the outstanding Common Stock and other than a change in the par value of the Common Stock) or any consolidation or merger of the Company with or into another corporation (other than a consolidation or merger in which the Company is the continuing corporation and that does not result in any reclassification or change of Common Stock outstanding) or in the case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety. Such giving of notice shall be initiated (i) at least 10 Business Days prior to the date fixed as a record date or effective date or the date of closing of the Company's stock transfer books for the 9 10 determination of the shareholders entitled to such dividend, distribution or subscription rights, or for the determination of the shareholders entitled to vote on such proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up. Such notice shall specify such record date or the date of closing the stock transfer books, as the case may be. Failure to provide such notice shall not affect the validity of any action taken in connection with such dividend, distribution or subscription rights, or proposed merger, consolidation, sale, conveyance, dissolution, liquidation or winding up. SECTION 4.02: LOST, STOLEN, MUTILATED OR DESTROYED WARRANTS. If this Warrant is lost, stolen, mutilated or destroyed, the Company may, on such terms as to indemnity or otherwise as it may in its discretion impose (which shall, in the case of a mutilated Warrant, include the surrender thereof), issue a new Warrant of like denomination and tenor as and in substitution for this Warrant. ARTICLE V SPLIT-UP, COMBINATION EXCHANGE AND TRANSFER OF WARRANTS SECTION 5.01: SPLIT-UP, COMBINATION, EXCHANGE AND TRANSFER OF WARRANTS. Subject to the provisions of Section 5.02 hereof, this Warrant may be split up, combined or exchanged for another Warrant or Warrants containing the same terms to purchase a like aggregate number of Warrant Shares. If the Warrantholder desires to split up, combine or exchange Warrants, he or it shall make such request in writing delivered to the Company and shall surrender to the Company any Warrants to be so split up, combined or exchanged. Upon any such surrender for a split up, combination or exchange, the Company shall execute and deliver to the person entitled thereto a Warrant or Warrants, as the case may be, as so requested. The Company shall not be required to effect any split up, combination or exchange which will result in the issuance of a Warrant entitling the Warrantholder to purchase upon exercise a fraction of a share of Common Stock or a fractional Warrant. The Company may require such Warrantholder to pay a sum sufficient to cover any tax or governmental charge that may be imposed in connection with any split up, combination or exchange of Warrants. SECTION 5.02: RESTRICTIONS ON TRANSFER. Neither this Warrant nor the Warrant Shares may be disposed of or encumbered (any such action, a "Transfer"), except (i) to Piper Jaffray Inc., any successor to the business of such company, or any officer of such company, or (ii) to any underwriter in connection with a Public Offering of the Common Stock, provided (as to (ii)) that this Warrant is exercised upon such Transfer and the shares of Common Stock issued upon such exercise are sold by such underwriter as part of such Public Offering and, as to both (i) and (ii), only in accordance with and subject to the provisions of the Securities Act and the rules and regulations promulgated thereunder. If at the time of a Transfer, a Registration Statement is not in effect to register this Warrant or the Warrant Shares, the Company may require the Warrantholder to make such representations, and may place such legends on certificates representing this Warrant, as may be reasonably required in the opinion of counsel to the Company to permit a Transfer without such registration. 10 11 ARTICLE VI REGISTRATION UNDER THE SECURITIES ACT OF 1933 SECTION 6.01: PIGGYBACK REGISTRATION. (a) Right to Include Registrable Securities. If at any time or from time to time after March 10, 1999 and prior to the Expiration Date, the Company proposes to register any of its securities under the Securities Act on any form for the registration of securities under such Act, whether or not for its own account (other than by a registration statement on Form S-8 or other form which does not include substantially the same information as would be required in a form for the general registration of securities or would not be available for the Registrable Securities) (a "Piggyback Registration"), it shall as expeditiously as possible give written notice to all Holders of its intention to do so and of such Holders' rights under this Section 6.01. Such rights are referred to hereinafter as "Piggyback Registration Rights." Upon the written request of any such Holder made within 20 days after receipt of any such notice (which request shall specify the Registrable Securities intended to be disposed of by such Holder), the Company shall include in the Registration Statement the Registrable Securities which the Company has been so requested to register by the Holders thereof and the Company shall keep such registration statement in effect and maintain compliance with each Federal and state law or regulation for the period necessary for such Holder to effect the proposed sale or other disposition (but in no event for a period greater than 120 days). (b) Withdrawal of Piggyback Registration by Company. If, at any time after giving written notice of its intention to register any securities in a Piggyback Registration but prior to the effective date of the related Registration Statement, the Company shall determine for any reason not to register such securities, the Company shall give written notice of such determination to each Holder and, thereupon, shall be relieved of its obligation to register any Registrable Securities in connection with such Piggyback Registration. All best efforts obligations of the Company pursuant to Section 6.04 shall cease if the Company determines to terminate prior to such effective date any registration where Registrable Securities are being registered pursuant to this Section 6.01. (c) Piggyback Registration of Underwritten Public Offerings. If a Piggyback Registration involves an offering by or through underwriters, then, (i) all Holders requesting to have their Registrable Securities included in the Company's Registration Statement must sell their Registrable Securities to the underwriters selected by the Company on the same terms and conditions as apply to other selling shareholders and (ii) any Holder requesting to have his or its Registrable Securities included in such Registration Statement may elect in writing, not later than three Business Days prior to the effectiveness of the Registration Statement filed in connection with such registration, not to have his or its Registrable Securities so included in connection with such registration. (d) Payment of Registration Expenses for Piggyback Registration. The Company shall pay all Registration Expenses in connection with each registration of Registrable 11 12 Securities requested pursuant to a Piggyback Registration Right contained in this Section 6.01. (e) Priority in Piggyback Registration. If a Piggyback Registration involves an offering by or through underwriters, the Company shall not be required to include Registrable Shares therein if and to the extent the underwriter managing the offering reasonably believes in good faith and advises each Holder requesting to have Registrable Securities included in the Company's Registration Statement that such inclusion would materially adversely affect such offering; provided that (i) any such reduction or elimination shall be pro rata to all other holders of the securities of the Company exercising "piggyback registration rights" similar to those set forth herein and to any selling shareholders who are employees, officers, directors or other affiliates of the Company, in each case in proportion to the respective number of shares they have requested to be registered, and (ii) in such event, such Holders may delay any offering by them of all Registrable Shares requested to be included (or that portion of such Registrable Shares eliminated for such period, not to exceed 90 days, as the managing underwriter shall request) and the Company shall file such supplements and post-effective amendments and take such other action necessary under Federal and state law or regulation as may be necessary to permit such Holders to make their proposed offering for a period of 90 days following such period of delay. SECTION 6.02: DEMAND REGISTRATION. (a) Request for Registration. If, at any time subsequent to March 10, 1999 and prior to the Expiration Date, any 25% Holders request that the Company file a registration statement under the Securities Act, the Company as soon as practicable shall use its best efforts to file a registration statement with respect to all Warrant Shares that it has been so requested to include and obtain the effectiveness thereof, and to take all other action necessary under any Federal or state law or regulation to permit the Warrant Shares that are then held and/or that may be acquired upon the exercise of the Warrants specified in the notices of the Holders or holders thereof to be sold or otherwise disposed of, and the Company shall maintain such compliance with each such Federal and state law and regulation for the period necessary for such Holders or holders to effect the proposed sale or other disposition (but in no event for more than 120 days); provided, however, the Company shall be entitled, no more than once during such period, to defer such registration for a period of up to 60 days if and to the extent that its Board of Directors shall determine that such registration would interfere with a pending corporate transaction or would require the disclosure, pursuant to such registration, of material information, which disclosure has been determined, by the Board of Directors of the Company in good faith, to be not in the best interests of the Company (any cash request being a "Demand Registration"). The Company shall also promptly give written notice to the Holder and the holders of any other Warrants and/or the holders of any Warrant Shares who or that have not made a request to the Company pursuant to the provisions of this subsection (a) of its intention to effect any required registration or qualification and shall use its best efforts to effect as expeditiously as possible such registration or qualification of all other such Warrant Shares that are then held and/or that may be acquired upon the exercise of the Warrants, the Holder or holders 12 13 of which have requested such registration or qualification, within 15 days after such notice has been given by the Company, as provided in the preceding sentence. The Company shall be required to effect a registration or qualification pursuant to this subsection (a) on one occasion only. (b) Payment of Registration Expenses for Demand Registration. The Company shall pay all Registration Expenses in connection with the Demand Registration. SECTION 6.03: BUY-OUTS OF REGISTRATION DEMAND. In lieu of carrying out its obligations to effect a Piggyback Registration or Demand Registration of any Registrable Securities pursuant to this Article VI, the Company may carry out such obligation by offering to purchase and purchasing such Registrable Securities requested to be registered at an amount in cash equal to the difference between (a) the last sale price of the Common Stock on the day the request for registration is made and (b) the Exercise Price in effect on such day. SECTION 6.04: REGISTRATION PROCEDURES. If and whenever the Company is required to use its best efforts to take action pursuant to any Federal or state law or regulation to permit the sale or other disposition of any Warrant Shares that are then held or that may be acquired upon exercise of the Warrants, in order to effect or cause the registration of any Registrable Securities under the Securities Act as provided in this Article VI, the Company shall, as expeditiously as practicable: (a) furnish to each selling Holder of Registrable Securities and the underwriters, if any, without charge, as many copies of the Registration Statement, the Prospectus or the Prospectuses (including each preliminary prospectus) and any amendment or supplement thereto as they may reasonably request; (b) enter into such agreements (including an underwriting agreement) and take all such other actions reasonably required in connection therewith in order to expedite or facilitate the disposition of such Registrable Securities and in such connection, if the registration is in connection with an underwritten offering (i) make such representations and warranties to the underwriters in such form, substance and scope as are customarily made by issuers to underwriters in underwritten offerings and confirm the same if and when requested; (ii) obtain opinions of counsel to the Company and updates thereof (which counsel and opinions in form, scope and substance shall be reasonably satisfactory to the underwriters) addressed to the underwriters and the Holders covering the matters customarily covered in opinions requested in underwritten offerings and such other matters as may be reasonably requested by such underwriters; (iii) obtain "cold comfort" letters and updates thereof from the Company's accountants addressed to the underwriters such letters to be in customary form and to cover matters of the type customarily covered in "cold comfort" letters to underwriters and the Holders in connection with underwritten offerings; (iv) set forth in full, in any underwriting agreement entered into, the indemnification provisions and procedures of Section 6.05 hereof with respect to all parties to be indemnified pursuant to said Section; and (v) deliver such documents and certificates as may be reasonably requested by the underwriters to evidence compliance with clause (i) above and with any customary conditions contained in the underwriting agreement or other agreement entered into by the 13 14 Company; the above shall be done at each closing under such underwriting or similar agreement or as and to the extent required thereunder; (c) make available for inspection by one or more representatives of the Holders of Registrable Securities being sold, any underwriter participating in any disposition pursuant to such registration, and any attorney or accountant retained by such Holders or underwriter, all financial and other records, pertinent corporate documents and properties of the Company, and cause the Company's officers, directors and employees to supply all information reasonably requested by any such representatives in connection with such; (d) otherwise use its best efforts to comply with all applicable Federal and state regulations; and take such other action as may be reasonably necessary or advisable to enable each such Holder and each such underwriter to consummate the sale or disposition in such jurisdiction or jurisdiction, in which any such Holder or underwriter shall have requested that the Registrable Securities be sold; provided, however, that the Company shall not be required in connection therewith to qualify to do business as a foreign corporation or take any action that would subject it to taxation or general service of process in any jurisdiction where it is not then so qualified or subject. Except as otherwise provided in this Agreement, the Company shall have sole control in connection with the preparation, filing, withdrawal, amendment or supplementing of each Registration Statement, the selection of underwriters, and the distribution of any preliminary prospectus included in the Registration Statement, and may include within the coverage thereof additional shares of Common Stock or other securities for its own account or for the account of one or more of its other security holders; Each seller of Registrable Securities as to which any registration is being effected shall furnish to the Company such information regarding the distribution of such securities and such other information as may otherwise be required by the Securities Act to be included in such Registration Statement. SECTION 6.05: WITHDRAWAL OF REGISTRATION RIGHTS. The Company shall not be required by this Article VI to file any Registration Statement if, in the opinion of counsel for the Warrantholders and the Company (or, should they not agree, in the opinion of another counsel experienced in securities law matters acceptable to counsel for such holders and the Company), the proposed public offering or other transfer as to which such Registration Statement is requested is exempt from applicable federal and state securities laws and would result in all purchasers or transferees obtaining securities which are not "restricted securities," as defined in Rule 144 under the Act. This Article VI shall terminate and be of no further force or effect as of the first date upon which all of the Warrant Shares then issuable upon exercise of the Warrants may be sold publicly pursuant to Rule 144(k). 14 15 SECTION 6.06: INDEMNIFICATION. (a) Indemnification by Company. In connection with each Registration Statement relating to disposition of Registrable Securities, the Company shall indemnify and hold harmless each Holder and each underwriter of Registrable Securities and each Person, if any, who controls such Holder or underwriter (within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) against any and all losses, claims, damages and liabilities, joint or several (including any reasonable investigation, legal and other expenses incurred in connection with, and any amount paid in settlement of any action, suit or proceeding or any claim asserted), to which they, or any of them, may become subject under the Securities Act, the Exchange Act or other Federal or state law or regulation, at common law or otherwise, insofar as such losses, claims, damages or liabilities arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in any Registration Statement, Prospectus or preliminary prospectus or any amendment thereof or supplement thereto, or arise out of or are based upon any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that such indemnity shall not inure to the benefit of any Holder or underwriter (or any Person controlling such Holder or underwriter within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act) on account of any losses, claims, damages or liabilities arising from the sale of Registrable Securities if such untrue statement or omission or alleged untrue statement or omission was made in such Registration Statement, Prospectus or preliminary prospectus, or such amendment or supplement, in reliance upon and in conformity with information furnished in writing to the Company by the Holder or underwriter specifically for use therein and provided, further, that with respect to any preliminary prospectus, the foregoing indemnification shall not inure to the benefit of any Holder from whom the person asserting any loss, claim, damage, liability or expense purchased Warrant Shares, or to any person controlling such Holder, if copies of the Prospectus were timely delivered to such Holder and a copy of the Prospectus (as then amended or supplemented if the Company shall have timely furnished any amendments or supplements thereto) was not sent or given by or on behalf of such Holder to such person, if required by law to have been so delivered, at or prior to the written confirmation of the sale of the Warrant Shares to such person, and if such Prospectus (as so amended or supplemented) would have cured the defect giving rise to such loss, claim, damage, liability or expense. This indemnity agreement shall be in addition to any liability which the Company may otherwise have. (b) Indemnification by Holder. In connection with each Registration Statement, each Holder shall indemnify, to the same extent as the indemnification provided by the Company in Section 6.06(a), the Company, its directors and each officer who signs the Registration Statement and each Person who controls the Company (within the meaning of Section 15 of the Securities Act and Section 20 of the Exchange Act) but only insofar as such losses, claims, damages and liabilities arise out of or are based upon any untrue statement or omission or alleged untrue statement or omission which was made in the Registration Statement, the Prospectus or preliminary prospectus or any amendment thereof or 15 16 supplement thereto, in reliance upon and in conformity with information furnished in writing by such Holder to the Company specifically for use therein. In no event shall the liability of any selling Holder of Registrable Securities hereunder be greater in amount than the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. The Company shall be entitled to receive indemnities from underwriters, selling brokers, dealer managers and similar securities industry professionals participating in the distribution, to the same extent as provided above, with respect to information so furnished in writing by such Persons specifically for inclusion in any Prospectus, Registration Statement or preliminary prospectus or any amendment thereof or supplement thereto. (c) Conduct of Indemnification Procedure. Any party that proposes to assert the right to be indemnified hereunder will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim is to be made against an indemnifying party or parties under this Section, notify each such indemnifying party of the commencement of such action, suit or proceeding, enclosing a copy of all papers served. No indemnification provided for in Section 6.06(a) or 6.06(b) shall be available to any party who shall fail to give notice as provided in this Section 6.06(c) if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was prejudiced by the failure to give such notice, but the omission so to notify such indemnifying party of any such action, suit or proceeding shall not relieve it from any liability that it may have to any indemnified party for contribution or otherwise than under this Section. In case any such action, suit or proceeding shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate in, and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party, and after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof and the approval by the indemnifying party to such indemnified party of its election so to assume the defense thereof and the approval by the indemnified party of such counsel, the indemnifying party shall not be liable to such indemnified party for any legal or other expenses, except as provided below and except for the reasonable costs of investigation subsequently incurred by such indemnified party in connection with the defense thereof. The indemnified party shall have the right to employ its counsel in any such action, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the employment of counsel by such indemnified party has been authorized in writing by the indemnifying parties, (ii) the indemnified party shall have reasonably concluded, based on the advice of its counsel, that there may be a conflict of interest between the indemnifying parties and the indemnified party in the conduct of the defense of such action (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party) or (iii) the indemnifying parties shall not have employed counsel to assume the defense of such action within a reasonable time after notice of the commencement thereof, in each of which cases the fees and expenses of counsel shall be at the expense of the indemnifying parties , it being understood, however, that the indemnifying parties shall not be liable for the expenses of more than one separate counsel, which counsel 16 17 shall be reasonably approved by the indemnifying parties. An indemnifying party shall not be liable for any settlement of any action, suit, proceeding or claim effected without its written consent. (d) Contribution. In order to provide for just and equitable contribution in circumstances in which the indemnification provided for in Section 6.06(a) and 6.06(b) is due in accordance with its terms but for any reason is held to be unavailable from the Company or any Holder, the Company and the Holders shall contribute to the aggregate losses, claims, damages and liabilities (including any investigation, legal and other expenses reasonably incurred in connection with, and any amount paid in settlement of, any action, suit or proceeding or any claims asserted, but after deducting any contribution received by the Company from persons other than the Holders, such as persons who control the Company within the meaning of the Securities Act, officers of the Company who signed any Registration Statement and directors of the Company, who may also be liable for contribution) to which the Company and one or more of the Holders may be subject in such proportion as is appropriate to reflect the relative benefits received by the Company on the one hand and each such Holder on the other from the offering of the Warrant Shares or, if such allocation is not permitted by applicable law or indemnification is not available as a result of the indemnifying party not having received notice as provided in Section 6.06(c) hereof, in such proportion as is appropriate to reflect not only the relative benefits referred to above but also the relative fault of the Company on the one hand and each such Holder on the other in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The relative benefits received by the Company and each such Holder shall be deemed to be in the same proportion as (x) the total proceeds from the offering (net of underwriting discounts but before deducting expenses) received by the Company, bear to (y) the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation. The relative fault of the Company or any such Holder shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact related to information supplied by the Company or any such Holder and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company and the Holders agree that it would not be just and equitable if contribution pursuant to this Section 6.06(d) were determined by pro rata allocation (even if the Holders were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above. Notwithstanding the provisions of this Section 6.06(d), (i) in no case shall any Holder be liable or responsible for any amount in excess of the dollar amount of the net proceeds received by such Holder upon the sale of the Registrable Securities giving rise to such indemnification obligation, and (ii) the Company shall be liable and responsible for any amount in excess of such dollar amount; provided, however, that no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 6.06, each person, if any, who controls a Holder within the meaning of Section 15 of the Securities Act or Section 20(a) of the Exchange Act shall have the same rights to 17 18 contribution as such Holder, and each person, if any, who controls the Company within the meaning of the Section 15 of the Securities Act or Section 20(a) of the Exchange Act, each officer of the Company who shall have signed any Registration Statement and each director of the Company shall have the same rights to contribution as the Company, subject in each case to clauses (i) and (ii) in the immediately preceding sentence of this Section 6.06(d). Any party entitled to contribution will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim for contribution may be made against another party or parties under this Section, notify such party or parties from whom contribution may be sought, but the omission so to notify such party or parties from whom contribution may be sought shall not relieve the party or parties from whom contribution may be sought from any other obligation it or they may have hereunder or otherwise than under this Section 6.06. No party shall be liable for contribution with respect to any action, suit, proceeding or claim settled without its written consent. Each Holder's obligations to contribute pursuant to this Section 6.06(d) are several in proportion to their respective underwriting commitments and not joint. (e) Specific Performance. The Company and the Holder acknowledge that remedies at law for the enforcement of this Section 6.06 may be inadequate and intend that this Section 6.06 shall be specifically enforceable. ARTICLE VII OTHER MATTERS SECTION 7.01: AMENDMENTS AND WAIVERS. The provisions of this Warrant, including the provisions of this sentence, may not be amended, modified or supplemented, and waiver or consents to departures from the provisions hereof may not be given unless the Company has obtained the written consent of holders of at least a majority of the outstanding Registrable Securities. Holders shall be bound by any consent authorized by this Section whether or not certificates representing such Registrable Securities have been marked to indicate such consent. SECTION 7.02: COUNTERPARTS. This Warrant may be executed in any number of counterparts and by the parties hereto in separate counterparts, each of which so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. SECTION 7.03: GOVERNING LAW. This Warrant shall be governed by and construed in accordance with the laws of the State of New York. SECTION 7.04: SEVERABILITY. In the event that any one or more of the provisions contained herein, or the application thereof in any circumstances, is held invalid, illegal or unenforceable, the validity, legality and enforceability of any such provisions in every other respect and of the remaining provisions contained herein shall not be affected or impaired thereby. SECTION 7.05: ATTORNEYS' FEES. In any action or proceeding brought to enforce any provisions of this Warrant, or where any provisions hereof or thereof is validly asserted as a defense, 18 19 the successful party shall be entitled to recover reasonable attorneys' fees and disbursements in addition to its costs and expenses and any other available remedy. SECTION 7.06: NOTICE. Any notices or certificates by the Company to the Holder and by the Holder to the Company shall be deemed delivered if in writing and delivered in person or by registered mail (return receipt requested) to the Holder addressed to him in care of Piper Jaffray Inc., 222 South Ninth Street, Minneapolis, Minnesota 55402, Attention: Stuart Harvey or, if the Holder has designated, by notice in writing to the Company, any other address, to such other address, and if to the Company, addressed to it at BNC Mortgage, Inc., 1063 McGaw Avenue, Irvine, California 92614, Attn: President. The Company may change its address by written notice to the Holder and the Holder may change his or its address by written notice to the Company. IN WITNESS WHEREOF, this Warrant has been duly executed by the Company under its corporate seal as of the 16 day of March, 1998. BNC MORTGAGE, INC. By: /s/ Kelly W. Monahan ------------------------------------- Name: Kelly W. Monahan Title: President Attest: /s/ Evan R. Buckley ----------------------------- Secretary 19 20 ASSIGNMENT (TO BE EXECUTED ONLY UPON ASSIGNMENT OF WARRANT CERTIFICATE) For value received, ____________________ hereby sells, assigns and transfers unto _________________________ the within Warrant Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint ___________________ attorney, to transfer said Warrant Certificate on the books of the within-named Company with respect to the number of Warrants set forth below, with full power of substitution in the premises: Name(s) of Assignees(s) Address No. of Warrants ------------ ------- --------------- And if said number of Warrants shall not be all the Warrants represented by the Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the Warrants represented by said Warrant Certificate. Dated: ------------------ ----------------------------------------- Note: The above signature should correspond exactly with the name on the face of this Warrant Certificate. 20 21 SUBSCRIPTION FORM (TO BE EXECUTED UPON EXERCISE OF WARRANT PURSUANT TO SECTION 2.02(a)(i)) The undersigned hereby irrevocably elects to exercise the right of purchase represented by the within Warrant Certificate for, and to purchase thereunder ____________ shares of Common Stock, as provided for therein, and tenders herewith payment of the purchase price in full in the form of cash or a certified or official bank check in the amount of $ ____________. Please issue a certificate or certificates for such Common Stock in the name of: Name: ---------------------------------- --------------------------------------- --------------------------------------- --------------------------------------- (Please Print Name, Address and Social Security Number) Signature ------------------------------ NOTE: The above signature should respond exactly with the name on the first page of this Warrant Certificate or with the name of the assignee appearing in the assignment form below. And if said number of shares shall not be all the shares purchasable under the within Warrant Certificate, a new Warrant Certificate is to be issued in the name of said undersigned for the balance remaining of the shares purchasable thereunder rounded up to the next higher number of shares. 21 22 CASHLESS EXERCISE FORM (TO BE EXECUTED UPON EXERCISE OF WARRANT PURSUANT TO SECTION 2.02(a)(ii)) The undersigned hereby irrevocably elects to Exchange its Warrant for such shares of Common Stock pursuant to the Cashless Exercise provisions of the within Warrant Certificate, as provided for in Section 2.02(a)(ii) of such Warrant Certificate. Please issue a certificate or certificates for such Common Stock in the name of: Name: ---------------------------------- --------------------------------------- --------------------------------------- --------------------------------------- (Please Print Name, Address and Social Security Number) Signature ------------------------------ NOTE: The above signature should correspond exactly with the name on the first page of this Warrant Certificate or with the name of the assignee appearing in the assignment form below. And if said number of shares shall not be all the shares exchangeable or purchasable under the within Warrant Certificate, a new Warrant Certificate is to be issued in the name of the undersigned for the balance remaining of the shares purchasable rounded up to the next higher number of shares. 22 EX-11.1 8 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS 1 Exhibit 11. 1 - Computation of Per Share Earnings
For the Year Ended June 30, -------------------------------------------------- 1998 1997 1996 Basic earnings per common share Net income for calculating basic earnings per common share ........................ $7,236,000 $7,542,000 $ 417,000 ========== ========== ========== Average common shares outstanding ....... 4,654,000 4,187,000 2,892,000 ---------- ---------- ---------- Basic earnings per common share ......... $ 1.55 $ 1.80 $ 0.14 ========== ========== ========== Diluted earnings per common share Net income for calculating basic earnings per common share ........................ $7,236,000 $7,542,000 $ 417,000 ========== ========== ========== Average common shares outstanding ....... 4,654,000 4,187,000 2,892,000 Add exercise of options and warrants .... 142,000 -- -- ---------- ---------- ---------- Diluted common shares outstanding ....... 4,796,000 4,187,000 2,892,000 ========== ========== ========== Diluted earnings per common share ...... $ 1.51 $ 1.80 $ 0.14 ========== ========== ==========
EX-21.1 9 SUBSIDIARIES 1 EXHIBIT 21.1 SUBSIDIARIES
Name of Subsidiary State of Incorporation - ------------------ ---------------------- BNC Trustee Services, Inc. Missouri Equity Credit Corporation California Simple Mortgage USA, Inc. California
EX-27 10 FINANCIAL DATA SCHEDULE
5 12-MOS JUN-30-1998 JUL-01-1997 JUN-30-1998 25,890,000 638,000 3,777,000 0 98,717,000 129,022,000 2,346,000 813,000 130,555,000 99,704,000 0 0 0 6,000 30,845,000 130,555,000 44,393,000 44,393,000 0 0 26,856,000 0 5,486,000 12,051,000 4,815,000 0 0 0 0 7,236,000 1.55 1.51
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