-----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, DUalZHAEu+A/W/bdNnKJ8pqEaYsN8uHSu1zGPenfdSewFuFSSSNd9nXcmqcOPnLQ VCmfWeFZi1kPOaA83cDmUw== 0000950131-97-004025.txt : 19970619 0000950131-97-004025.hdr.sgml : 19970619 ACCESSION NUMBER: 0000950131-97-004025 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 19970618 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NEW CENTURY FINANCIAL CORP CENTRAL INDEX KEY: 0001036075 STANDARD INDUSTRIAL CLASSIFICATION: MORTGAGE BANKERS & LOAN CORRESPONDENTS [6162] IRS NUMBER: 330683629 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-25483 FILM NUMBER: 97625640 BUSINESS ADDRESS: STREET 1: 4910 BIRCH STREET STREET 2: SUITE 100 CITY: NEWPORT BEACH STATE: CA ZIP: 92660 BUSINESS PHONE: 7144407030 MAIL ADDRESS: STREET 1: 4910 BIRCH STREET STREET 2: SUITE 100 CITY: NEWPORT BEACH STATE: CA ZIP: 92660 S-1/A 1 FORM S-1/A AMENDMENT #2 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 18, 1997 REGISTRATION NO. 333-25483 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- AMENDMENT NO. 2 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- NEW CENTURY FINANCIAL CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 6162 33-0683629 (STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER OF INCORPORATION OR CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER) ORGANIZATION)
4910 BIRCH STREET, SUITE 100 NEWPORT BEACH, CALIFORNIA 92660 (714) 440-7030 (ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) --------------- BRAD MORRICE NEW CENTURY FINANCIAL CORPORATION 4910 BIRCH STREET, SUITE 100 NEWPORT BEACH, CALIFORNIA 92660 (714) 440-7030 (NAME, ADDRESS, INCLUDING ZIP CODE AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) --------------- COPIES TO: ROGER M. COHEN DAVID A. KRINSKY BRUCE R. HALLETT KAREN K. DREYFUS JAMES S. BRENNAN O'MELVENY & MYERS LLP BROBECK, PHLEGER & HARRISON LLP 610 NEWPORT CENTER DRIVE, SUITE 1700 4675 MACARTHUR COURT, SUITE 1000 NEWPORT BEACH, CALIFORNIA 92660 NEWPORT BEACH, CALIFORNIA 92660 (714) 760-9600 (714) 752-7535
--------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box: [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------
PROPOSED PROPOSED AMOUNT MAXIMUM MAXIMUM TITLE OF EACH CLASS OF TO BE OFFERING PRICE AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED REGISTERED PER UNIT OFFERING PRICE (1) REGISTRATION FEE - ------------------------------------------------------------------------------------------------ Common Stock, $0.01 par value... 4,025,000 $10.50 $42,262,500 $12,806 - ------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457 under the Securities Act of 1933. --------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A + +REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE + +SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY + +OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT + +BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR + +THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE + +SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE + +UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF + +ANY SUCH STATE. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION, DATED JUNE 18, 1997 3,500,000 SHARES [LOGO OF NEW CENTURY FINANCIAL CORPORATION] COMMON STOCK Of the 3,500,000 shares of Common Stock offered hereby (the "Offering"), 2,900,000 are being sold by New Century Financial Corporation ("New Century" or the "Company") and 600,000 are being sold by Cornerstone Fund I, L.L.C. (individually, a "Selling Stockholder"). The Company will not receive any proceeds from the sale of shares by the Selling Stockholder. Prior to the Offering, there has been no public market for the Common Stock. It is currently anticipated that the initial public offering price will be between $8.50 and $10.50 per share. See "Underwriting" for a discussion of factors to be considered in determining the initial public offering price. Application has been made to have the Common Stock approved for quotation on the Nasdaq National Market under the trading symbol "NCEN." SEE "RISK FACTORS" COMMENCING ON PAGE 10 FOR A DISCUSSION OF MATERIAL RISKS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF COMMON STOCK OFFERED HEREBY. ----------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Price to Underwriting Proceeds to Proceeds to Selling Public Discount (1) Company (2) Stockholder - ------------------------------------------------------------------------------- Per Share............. $ $ $ $ Total (3)............. $ $ $ $
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (1) See "Underwriting" for information relating to indemnification of the Underwriters and other matters. (2) Before deducting expenses payable by the Company estimated at $800,000. (3) The Company has granted the Underwriters a 30-day option to purchase up to 232,500 additional shares of Common Stock, and the Selling Stockholder and Cornerstone Equity Partners, L.L.C. (collectively, the "Selling Stockholders") have granted the Underwriters a 30-day option to purchase up to 292,500 additional shares of Common Stock, on the same terms and conditions as set forth above, solely to cover over-allotments, if any. If such options are exercised in full, the total Price to Public will be $ , Underwriting Discount will be $ , Proceeds to Company will be $ and Proceeds to Selling Stockholders will be $ . The shares of Common Stock are offered by the Underwriters named herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. It is expected that delivery of the certificates representing such shares will be made against payment therefore at the offices of Montgomery Securities on or about , 1997. ----------- Montgomery Securities Piper Jaffray Inc. , 1997 [ARTWORK MAP OF THE UNITED STATES, INDICATING, AS OF MAY 31, 1997, (I) THE RETAIL SALES OFFICES OF THE COMPANY LOCATED IN ARIZONA (3), CALIFORNIA (15), COLORADO, HAWAII (2), ILLINOIS (2), KANSAS, MINNESOTA (2), MISSOURI (3), NEVADA, NEW MEXICO, OHIO (3), OREGON, PENNSYLVANIA (2), UTAH, WASHINGTON AND WISCONSIN; (II) THE WHOLESALE SALES OFFICES OF THE COMPANY LOCATED IN ARIZONA, CALIFORNIA (3), COLORADO, FLORIDA, GEORGIA, HAWAII, INDIANA, MINNESOTA, MISSOURI (3), NEVADA, NEW MEXICO, OHIO (3), PENNSYLVANIA (2), TEXAS (2) AND WASHINGTON; (III) THE REGIONAL OPERATING CENTERS OF THE COMPANY LOCATED IN SOUTHERN CALIFORNIA, NORTHERN CALIFORNIA AND CHICAGO; (IV) THE SEVENTEEN (17) STATES IN WHICH THE COMPANY ORIGINATES LOANS BUT NO OFFICES ARE LOCATED (ALABAMA, ARKANSAS, IDAHO, IOWA, KENTUCKY, LOUISIANA, MASSACHUSETTS, MICHIGAN, MONTANA, NORTH CAROLINA, NORTH DAKOTA, OKLAHOMA, SOUTH CAROLINA, TENNESSEE, VIRGINIA, WEST VIRGINIA AND WYOMING); AND (V) THE LOCATION OF THE COMPANY'S HEADQUARTERS IN ORANGE COUNTY, CALIFORNIA.] ---------------- The Company intends to furnish its stockholders annual reports containing financial statements audited by an independent accounting firm, and quarterly reports containing unaudited financial information for the first three quarters of each fiscal year. ---------------- CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK, INCLUDING PURCHASES OF THE COMMON STOCK TO STABILIZE ITS MARKET PRICE, PURCHASES OF THE COMMON STOCK TO COVER SOME OR ALL OF A SHORT POSITION IN THE COMMON STOCK MAINTAINED BY THE UNDERWRITERS AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING." 2 PROSPECTUS SUMMARY The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and Financial Statements, including the Notes thereto, appearing elsewhere in this Prospectus. Except as otherwise specified, all information in this Prospectus assumes no exercise of the Underwriters' over-allotment option (see "Underwriting") and does not include (i) 2,000,000 shares reserved for issuance under the Company's 1995 Stock Option Plan (the "Stock Option Plan") as of the closing of the Offering, (ii) 127,500 shares subject to options granted or to be granted to two executive officers and one non-employee director of the Company outside the Stock Option Plan and (iii) 333,333 shares reserved for issuance pursuant to warrants granted or to be granted to Comerica Incorporated. Unless otherwise indicated, all references in this Prospectus to the "Company" or "New Century" are to New Century Financial Corporation and its subsidiary, New Century Mortgage Corporation. THE COMPANY New Century is a specialty finance company engaged in the business of originating, purchasing, selling and servicing subprime mortgage loans secured primarily by first mortgages on single family residences. See "Risk Factors-- Subprime Mortgage Banking Industry." The Company originates loans through independent loan brokers (the "Wholesale Division") and through direct solicitation of borrowers (the "Retail Division"). From the commencement of lending operations in February 1996 through March 31, 1997, the Company originated and purchased $607.5 million in mortgage loans. The Company's loan originations and purchases have grown from $4.3 million for the first quarter of 1996 to $250.6 million for the first quarter of 1997. The Company's principal strategy is to continue to increase loan originations through geographic expansion, high levels of service to brokers through its Wholesale Division and increased consumer marketing through its Retail Division. New Century has also implemented a loan sales strategy that includes both securitizations and whole loan sales in order to advance the Company's goal of enhancing profitability while managing cash flows. See "Business--General." The Company's borrowers generally have substantial equity in the property securing the loan, but are considered "subprime" borrowers because they have impaired or limited credit profiles or higher debt-to-income ratios than traditional mortgage lenders allow. See "Business--Underwriting." The Company's borrowers also include individuals who, due to self-employment or other circumstances, have difficulty verifying their income, and individuals who prefer the prompt and personalized service provided by the Company. These types of borrowers are generally willing to pay higher loan origination fees and interest rates than those charged by conventional lending sources. Because these borrowers typically use the proceeds of the Company's loans to consolidate and refinance debt and to finance home improvements, education and other consumer needs, the Company believes that its loan volume will be less dependent on general levels of interest rates or home sales and therefore less cyclical than conventional mortgage lending. Although the Company's underwriting guidelines include five levels of risk classification, approximately 54.1% of the principal balance of the loans originated and purchased by the Company in 1996 were to borrowers within the Company's two highest credit grades. See "Business--Loan Production by Borrower Risk Classification." One important consideration in underwriting subprime loans is the nature and value of the collateral securing the loans. The Company believes that the amount of equity present in the real estate securing its loans, together with the fact that approximately 88.2% of its loans originated and purchased in the first quarter of 1997 were secured by borrowers' primary residences, mitigates the risks inherent in subprime lending. The maximum loan- to-value ratio allowed for first mortgage borrowers in the Company's highest credit grade is 90% and second mortgages offered through the Company's recently formed alternative mortgage products division (the "Alternative Mortgage Products Division") include loans with loan-to-value ratios of up to 125% for borrowers with good credit histories. However, the average loan-to-value ratio on loans originated and purchased by the Company in 1996 was approximately 71.5%. Approximately 97.3% and 98.4% of the loans originated and purchased by the Company during 1996 and the first quarter of 1997, respectively, were secured by first mortgages, and the remainder of the loans the Company originated and purchased in such periods were secured by second mortgages. See "Business--General." 3 The Wholesale Division originates loans through independent loan brokers and accounted for $159.1 million, or 63.5%, of the Company's loan production during the first quarter of 1997. As of May 31, 1997, the Wholesale Division originated loans through its three regional operating centers located in Southern California, Northern California and Chicago and through 23 additional sales offices located in 15 states. Because brokers conduct their own marketing and employ their own personnel to complete loan applications and maintain contact with borrowers, originating loans through the Wholesale Division allows the Company to increase its loan volume without incurring the higher marketing, labor and other overhead costs associated with increased retail originations. See "Business--Loan Originations and Purchases, --Geographic Distribution." The Company also purchases loans through its correspondent program (the "Correspondent Program") which operates as part of its Wholesale Division. Loans purchased through the Correspondent Program accounted for $17.1 million, or 6.8%, of the Company's loan production during the first quarter of 1997. See "Business--Correspondent Program." The Retail Division originates loans through the direct solicitation of borrowers and accounted for $74.4 million, or 29.7%, of the Company's loan production during the first quarter of 1997. As of May 31, 1997, the Retail Division originated loans through a network of 15 sales offices located in California and 25 sales offices located in 15 other states. By creating a direct relationship with the borrower, retail lending creates a more sustainable loan origination franchise and provides the Company with greater control over the lending process. The Company also receives the origination fees paid by the borrower on loans originated through the Retail Division, which offsets the higher costs of retail lending and may contribute to increased profitability and cash flow. See "Business--Loan Originations and Purchases, --Geographic Distribution." The Company's retail marketing includes high-volume targeted direct mail and more traditional marketing activities conducted by retail loan officers, who seek to identify potential borrowers through referral sources as well as individual sales efforts. See "Business-- Marketing." The Company's seven senior executives have substantial mortgage banking experience and have previously directed the national expansion of several conventional and subprime mortgage companies, and the Company's current underwriters have an average of 10 years of subprime mortgage lending experience. 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 in conjunction with the Company's underwriting guidelines. Furthermore, all loan originations presently require two underwriting approvals. See "Business--Underwriting Standards." In addition to its thorough underwriting process, the Company maintains strong controls throughout the lending process, including subjecting all loans to a series of pre-funding and post-funding audits to verify the accuracy of the loan application data and to assure compliance with the Company's underwriting policies, procedures and guidelines. The Company believes that its underwriting and review processes provide the necessary support to continue the Company's rapid loan origination growth while maintaining loan quality. New Century sells its mortgage loans through securitizations as well as through bulk sales of whole loans to institutional purchasers. During 1996, the Company sold $298.7 million of loans through whole loan sales transactions at a weighted average sales price equal to 105.0% of the original principal balance of the loans sold. As of May 31, 1997, the Company has securitized $228.4 million of its mortgage loans through two securitization transactions. Each of these securitizations has been credit enhanced by an insurance policy provided through a monoline insurance company allowing the senior certificates in the related trusts to receive ratings of "AAA" from Standard & Poor's Ratings Services and "Aaa" from Moody's Investors Service, Inc. The Company intends to securitize a majority of its loans while continuing to sell a substantial portion of its loans through whole loan sale transactions. See "Business--Loan Sales and Securitizations." Until February 1997, the Company sold all of its loan production on a servicing-released basis. In connection with its first securitization in February 1997, the Company retained the servicing rights on the loans sold through the securitization. While retaining servicing rights as the master servicer on the securitized loans, 4 the Company currently outsources its servicing operations to Advanta Mortgage Corp. USA ("Advanta"). As of March 31, 1997, the Company's servicing portfolio consisted of 3,110 loans with an aggregate principal balance of approximately $346.4 million, of which 2,255 loans with an aggregate principal balance of approximately $248.6 million were being serviced on an interim basis. The Company intends to develop its own servicing capability in the future in order to manage the servicing relationship with its borrowers and oversee the performance of its loans more directly. See "--Recent Developments" and "Business--Loan Servicing and Delinquencies." GROWTH AND OPERATING STRATEGIES Increasing Growth of Retail Production. The Company will emphasize the growth of retail loan production during 1997 through geographic expansion and increased consumer marketing efforts. The Company has opened 20 retail sales offices during the first five months of 1997 and intends to open 10 or more additional retail sales offices during the remainder of 1997. See "Business-- Geographic Distribution." The Company targets markets for expansion based on demographics and its ability to recruit sales office managers and other qualified personnel in that market. The Company's geographic expansion plans require additional capital and human resources and there can be no assurance the Company will successfully implement its expansion plans. See "Risk Factors--Ability to Sustain Growth and Rapid Geographic Expansion." The Company also intends to increase its consumer marketing, which includes the use of direct mail, a loans-by-mail program and more traditional marketing methods, such as referrals and individual loan officer sales efforts. The Company has increased the number of targeted direct mail pieces sent to retail borrowers from approximately 750,000 mailers in January 1997 to approximately 1.4 million mailers in May 1997 and intends to increase the number of targeted direct mail pieces to over 2 million per month by the end of 1997. See "Business--Growth and Operating Strategies." Continuing Growth of Wholesale Production. The Company will continue the growth of its Wholesale Division, primarily through geographic expansion and greater penetration in existing markets. The Company intends to continue its geographic expansion through the development of lending operations in the Southeast and Northeast regions of the country where the Company has had limited activity. See "Business--Geographic Distribution." In connection with its expansion, the Company plans to open 5 or more additional wholesale sales offices in markets surrounding the Company's existing and planned regional operations centers and to increase the total number of account executives from 42 as of May 31, 1997 to approximately 80 by the end of 1997. The Company's geographic expansion plans require additional capital and human resources and there can be no assurance the Company will successfully implement its expansion plans. See "Risk Factors--Ability to Sustain Growth and Rapid Geographic Expansion, --Growth and Operating Strategies." Enhancing Profitability while Managing Cash Flow. New Century has implemented a loan sales strategy that includes both securitizations and whole loan sales in order to advance the Company's goal of enhancing profits while managing cash flows. Loan sales through securitizations permit the Company to enhance operating profits and to benefit from future cash flows generated by the residual interests retained by the Company (the "residual interests"). Whole loan sale transactions enable the Company to generate current cash flow, protect against the potential volatility of the securitization market and reduce the risks inherent in retaining residual interests in securitizations. The Company continually evaluates different securitization and financing strategies which may improve its profitability and/or cash flow position. See "Business--Growth and Operating Strategies." Regionalizing Operations and Incentivizing Performance. New Century is implementing a strategy of regionalizing operations support, which will place Company decision makers closer to local brokers, enable the Company to refine its procedures to reflect local market practices and conditions and enable the Company to provide a higher level of service to brokers. The Company's compensation structure, which includes stock options and cash incentives based on both loan volume and loan quality for a large number of key employees, incentivizes its employees to achieve the Company's performance goals. The Company believes its compensation structure also enables it to attract and retain key employees. See "Business--Growth and Operating Strategies." 5 Expanding Product Offerings. The Company frequently reviews its products and pricing for competitiveness and introduces new products to meet the needs of its borrowers, brokers and correspondents. The Company recently commenced loan originations through its Alternative Mortgage Products Division which offers loans to borrowers meeting conventional mortgage lending standards and offers a broad selection of second mortgage products, including loans with loan-to-value ratios of up to 125% for borrowers with good credit histories. The Company believes that these mortgage products will enable the Company to increase loan production from brokers and correspondents who have customers seeking such products and from borrowers identified through the Company's retail marketing whose needs are not satisfied by the mortgage products offered by the Retail Division. The Alternative Mortgage Products Division maintains separate underwriting and loan processing staffs and the Company expects that the mortgage loans originated through its Alternative Mortgage Products Division will be sold by the Company on a broker or correspondent basis, rather than through securitizations or servicing-retained sales. See "Business--Growth and Operating Strategies." The Company's headquarters are located at 18400 Von Karman, Suite 1000, Irvine, California 92612 and its telephone number is (714) 440-7030. RECENT DEVELOPMENTS Comerica Investment and Strategic Relationship. On May 30, 1997, the Company sold 545,000 shares of Common Stock of the Company to Comerica Incorporated ("Comerica") for $4,087,500. Comerica is a bank holding company which had assets of $34.9 billion at March 31, 1997 and the parent of Comerica Bank. In connection with the sale of stock to Comerica, the Company and Comerica have agreed to enter into certain arrangements concerning servicing and other strategic relationships. In order to increase the likelihood of success of such strategic relationships, the Company has issued warrants to purchase 100,000 shares of Common Stock to Comerica and has agreed to issue Comerica warrants to purchase an additional 233,333 shares of Common Stock. The issuance of the additional warrants is subject to the completion by Comerica of certain performance events related to the strategic relationships. All of the warrants are exercisable over five years at an exercise price equal to the initial public offering price of the Company's Common Stock, subject to vesting in equal installments on December 31, 1997, 1998 and 1999. Accelerated vesting will occur upon (i) certain changes in control of the Company, or (ii) the inclusion of the shares underlying the warrants in a registration statement, subject to certain limitations, upon exercise of Comerica's registration rights. Pursuant to one of the strategic relationships, Comerica has agreed to act as a sub-servicer for the Company, providing certain servicing functions with respect to the Company's mortgage loans. The functions to be performed by Comerica include payment processing, customer service, tax, insurance and investor reporting. Comerica is a FNMA and FHLMC approved servicer and as of March 31, 1997 serviced residential mortgage loans with a principal balance of $4.1 billion and also serviced consumer loans with a principal balance of $4.4 billion. In connection with these arrangements, the Company will pay Comerica one time set-up and removal fees for loans boarded on and removed from the Comerica servicing system and a fixed monthly fee for each loan with respect to which Comerica performs the specified subservicing functions. The Company will continue to act as master servicer with respect to its mortgage loans and intends to develop an in-house default management process, including collections, delinquency management, foreclosure and REO disposition services. The Company's senior management has substantial experience in building and overseeing servicing operations, including subprime mortgage loan default management, and plans to recruit additional personnel and install appropriate systems before commencing servicing operations under the Comerica agreement. This arrangement will allow the Company to utilize Comerica's existing servicing expertise with respect to certain standardized servicing functions, while allowing the Company to benefit from controlling the collections and default management process. The Company will obtain approval of any appropriate third parties, including rating agencies and monoline insurance companies, before utilizing the new servicing platform for any 6 existing or future securitizations. It is anticipated that servicing operations under the Comerica agreement will begin by the end of 1997. Comerica and the Company have also agreed to create a process to develop leads for the Company's loan products through Comerica's existing bank and mortgage company branch network. In consideration for the services to be performed by Comerica with respect to such loans, the Company will pay Comerica a fee based on the principal balance of the loans funded by the Company. Comerica and the Company have also agreed to develop a process to identify prospective Company borrowers within Comerica's existing consumer loan portfolio and to develop a targeted list of such borrowers for the Company to direct mail or telemarket. In connection with this arrangement, the Company will pay Comerica a fee for the services performed by Comerica with respect to each loan funded by the Company which was identified through Comerica's consumer loan portfolio. May 1997 Securitization. In May 1997, the Company completed its second public securitization, involving approximately $129.3 million of loans. The May 1997 securitization was credit enhanced by an insurance policy provided through a monoline insurance company allowing the senior certificates in the related trust to receive ratings of "AAA" from Standard & Poor's Ratings Services and "Aaa" from Moody's Investors Service, Inc. Recent Loan Origination Volume. The Company originated and purchased $125.5 million in mortgage loans in the month of April 1997, including $34.2 million through the Retail Division, $79.3 million through the Wholesale Division and $12.0 million through the Correspondent Program. Total loan origination and purchase volume in April represented an increase of approximately 50% over average monthly volume during the first quarter of 1997. THE OFFERING Common Stock offered by the Company............. 2,900,000 shares Common Stock offered by the Selling Stockholder. 600,000 shares Common Stock outstanding after the Offering(1).. 13,892,373 shares Use of Proceeds................................. To fund future loan originations and purchases, to fund securitization transaction costs and for general corporate purposes. See "Use of Proceeds." Nasdaq Symbol................................... "NCEN" Risk Factors.................................... See "Risk Factors" for a description of material risks which should be considered carefully in evaluating an investment in the Common Stock offered by this Prospectus.
- -------- (1) Excludes (i) 2,000,000 shares reserved for issuance under the Stock Option Plan as of the closing of the Offering, including options to acquire 1,267,520 shares which have been granted under the Stock Option Plan, and 441,500 shares which will be granted upon the closing of the Offering, (ii) options to acquire 127,500 shares which have been granted or will be granted to two executive officers and one non-employee director of the Company outside the Stock Option Plan and (iii) 333,333 shares reserved for issuance pursuant to warrants granted or to be granted to Comerica. 7 SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE PERIOD FROM INCEPTION (NOVEMBER 17, 1995) FOR THE QUARTER ENDED THROUGH FOR THE YEAR ENDED ----------------------------- DECEMBER 31, 1995 DECEMBER 31, 1996 MARCH 31, 1996 MARCH 31, 1997 ------------------- ------------------ -------------- -------------- STATEMENT OF OPERATIONS DATA: Revenues: Gain on sale of loans.. $ -- $11,630 $ -- $10,012 Servicing income....... -- 29 -- 302 Interest income........ 14 2,846 39 2,271 ----- ------- ------ ------- Total revenues......... 14 14,505 39 12,585 Operating expenses...... 95 12,200 899 8,539 ----- ------- ------ ------- Earnings (loss) before income taxes (benefit).............. (81) 2,305 (860) 4,046 Income taxes (benefit).. 1 970 (362) 1,699 ===== ======= ====== ======= Net earnings (loss)..... $ (82) $ 1,335 $(498) $ 2,347 ===== ======= ====== ======= Pro forma primary earnings (loss) per share(4)............... $ 0.10 $(0.05) $ 0.19 Pro forma fully diluted earnings (loss) per share(4)............... $ 0.10 $(0.05) $ 0.19
DECEMBER 31, MARCH 31, 1997 -------------- ----------------------- PRO FORMA 1995 1996 ACTUAL AS ADJUSTED(1) ------ ------- -------- -------------- BALANCE SHEET DATA: Loans receivable held for sale, net..... $ -- $57,990 $113,162 $113,162 Residual interests in securitization.... -- -- 13,243 13,243 Total assets............................ 3,151 64,638 133,582 133,582 Borrowings under warehouse lines of credit................................. -- 41,702 65,803 37,178 Borrowings under aggregation lines of credit................................. -- 13,957 44,731 44,731 Residual financing ..................... -- -- 7,248 7,248 Other borrowings........................ -- 1,326 3,119 1,869 Total stockholders' equity.............. 3,068 4,403 6,750 36,625
AS OF OR FOR THE PERIOD FROM INCEPTION AS OF OR FOR THE (NOVEMBER 17, 1995) AS OF OR QUARTER ENDED THROUGH FOR THE YEAR ENDED ----------------------------- DECEMBER 31, 1995 DECEMBER 31, 1996 MARCH 31, 1996 MARCH 31, 1997 ----------------------- ------------------ -------------- -------------- OPERATING STATISTICS: Loan origination and purchase activities: Wholesale originations.......... $ -- $287,992 $2,292 $159,075 Retail originations.... -- 66,487 2,001 74,384(2) Correspondent purchases............. -- 2,460 -- 17,111 ----- -------- ------ -------- Total loan originations and purchases(3)...... $ -- $356,939 $4,293 $250,570 Average principal balance per loan....... $ -- $ 106 $ 110 $ 108 Percent of loans secured by first mortgages..... -- 97.3% 96.5% 98.4% Weighted average initial loan-to-value ratio.... -- 71.5% 72.5% 70.9% Originations by product type(3): Adjustable-rate mortgages ("ARMs").... $ -- $264,510 $2,090 $187,987 Fixed rate mortgages... -- 92,429 2,203 62,583 Weighted average interest rates: Fixed-rate............. -- 10.4% 9.8% 9.9% ARMs................... -- 9.3% 9.0% 9.2% Margin-ARMs............ -- 7.0% 5.7% 7.0% Loan sales: Loans sold through whole loan transactions(3)....... $ -- $298,713 $ -- $ 95,716 Loans sold through securitizations....... -- -- -- 99,132
8
AS OF OR FOR THE QUARTER ENDED -------------------------------------------------------------------------------- MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996 MARCH 31, 1997 -------------- ------------- ------------------ ----------------- -------------- STATEMENT OF OPERATIONS DATA: Revenues: Gain on sale of loans.. $ -- $ 830 $ 2,658 $ 8,142 $ 10,012 Servicing income....... -- -- 10 19 302 Interest income........ 39 248 560 1,999 2,271 ------ ------- -------- -------- -------- Total revenues......... 39 1,078 3,228 10,160 12,585 Operating expenses...... 899 1,620 2,721 6,960 8,539 ------ ------- -------- -------- -------- Earnings (loss) before income taxes (benefit).............. (860) (542) 507 3,200 4,046 Income taxes (benefit).. (362) (225) 213 1,344 1,699 ------ ------- -------- -------- -------- Net earnings (loss)..... $ (498) $ (317) $ 294 $ 1,856 $ 2,347 ====== ======= ======== ======== ======== Pro forma primary earnings (loss) per share(4)............... $(0.05) $ (0.03) $ 0.02 $ 0.16 $ 0.19 Pro forma fully diluted earnings (loss) per share(4)............... $(0.05) $ (0.03) $ 0.02 $ 0.16 $ 0.19 OPERATING STATISTICS: Loan origination and purchase activities: Wholesale originations.......... $2,292 $45,412 $104,392 $135,896 $159,075 Retail originations.... 2,001 7,120 18,956 38,410 74,384(2) Correspondent purchases............. -- -- -- 2,460 17,111 ------ ------- -------- -------- -------- Total loan originations and purchases(3)...... $4,293 $52,532 $123,348 $176,766 $250,570 Average principal balance per loan....... $ 110 $ 115 $ 103 $ 105 $ 108 Percent of loans secured by first mortgages..... 96.5% 97.4% 96.8% 97.7% 98.4% Weighted average initial loan-to-value ratio.... 72.5% 71.5% 71.9% 71.1% 70.9% Originations by product type(3): ARMs................... $2,090 $35,340 $ 93,473 $133,607 $187,987 Fixed-rate mortgages... $2,203 $17,192 $ 29,875 $ 43,159 62,583 Weighted average interest rates: Fixed-rate............. 9.8% 10.3% 10.6% 10.3% 9.9% ARMs................... 9.0% 9.4% 9.2% 9.4% 9.2% Margin-ARMs............ 5.7% 6.9% 6.9% 7.1% 7.0% Loan sales: Loans sold through whole loan transactions.......... $ -- $28,822 $ 79,419 $190,472 $ 95,716(5) Loans sold through securitizations....... $ -- $ -- $ -- $ -- $ 99,132 Staffing and offices: Total employees........ 53 105 178 333 462 Total wholesale account executives............ 4 16 25 34 46 Total retail loan officers.............. 6 20 24 58 105 Total regional operating centers..... 2 3 3 3 3 Total wholesale sales offices............... 1 1 5 12 18 Total retail sales offices............... 2 5 8 20 30
- -------- (1) Adjusted to reflect (i) the exercise of 304,501 warrants at an average price of $3.50 per share, (ii) the sale of 545,000 shares of Common Stock to Comerica at a price of $7.50 per share, less estimated expenses payable by the Company, and (iii) the sale of 2,900,000 shares of Common Stock offered hereby at an assumed initial public offering price of $9.50 per share (after deducting the underwriting discount and estimated expenses payable by the Company), and the application of the estimated net proceeds therefrom to reduce outstanding balances under the Company's warehouse facilities and repay approximately $1.25 million outstanding under the Company's revolving line of credit. Adjustments have not been made to reflect the impact should the Underwriters' over-allotment option be exercised. (2) Includes $634,000 of loans originated through the Alternative Mortgage Products Division. (3) Excludes non-refundable fees and direct costs associated with the origination or purchase of mortgage loans. (4) Pro forma earnings (loss) per share has been computed by dividing pro forma net earnings by the pro forma weighted average number of shares outstanding. The pro forma weighted average number of shares includes all options and warrants issued below the estimated initial public offering price within one year prior to the filing of the Registration Statement for the initial public offering and is calculated using the treasury stock method. Historical earnings per share is not presented because it is not indicative of the ongoing entity. (5) Includes $2.5 million of loans repurchased and resold by the Company in the first quarter of 1997. 9 RISK FACTORS Prospective purchasers of the Common Stock offered hereby should consider carefully the following factors, as well as the other information appearing elsewhere in this Prospectus, in evaluating an investment in the Company. This Prospectus may contain forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the following risk factors and elsewhere in this Prospectus. LIMITED HISTORY OF OPERATIONS AND RAPID GROWTH The Company commenced lending operations in February 1996 and has a limited operating history. Although the Company has experienced rapid and substantial growth in mortgage loan originations and total revenues since it commenced operations, there can be no assurance that the Company can sustain these rates of growth or that it will be able to create an infrastructure or recruit and retain sufficient personnel to keep pace with a prolonged period of growth. The inability of the Company to sustain or keep pace with its rate of growth would have a material adverse effect on the Company's results of operations, financial condition and business prospects. Unlike companies with longer and more established operating histories, the historical financial and operating performance of the Company may be of limited relevance in predicting future performance. Since its incorporation in November 1995, the Company has generated earnings for a limited period and there can be no assurance the Company will generate earnings in the future. Further, the Company has completed only two securitizations of its loans to date. There can be no assurance that the Company will complete additional securitizations and the failure to complete securitizations would have a material adverse effect on the Company's results of operations, financial condition and business prospects. See "Risk Factors--Ability to Sustain Growth." LACK OF LOAN PERFORMANCE DATA Prior to commencing its securitization program in February 1997, the Company sold all of the loans it originated or purchased on a servicing-released basis. The Company is unable to track the delinquency, loss and prepayment experience of such loans in any meaningful fashion. Consequently, the Company does not have representative historical delinquency, bankruptcy, foreclosure, default or prepayment experience that may be referred to for purposes of estimating the future delinquency, loss and prepayment experience of its originated or purchased loans. Likewise, the Company does not have meaningful delinquency, loss and prepayment data with respect to the loans included in the Company's first and second securitizations, as these loans have been outstanding for only a short period of time. In view of the Company's lack of loan performance data, it is extremely difficult to validate the Company's loss or prepayment assumptions used to calculate its gain on sale in connection with its first and second securitizations or with future securitizations. Any material difference between these assumptions and actual performance could have a material adverse impact on the timing and/or receipt of the Company's future revenues, the value of the residual interests held on the Company's balance sheet and the Company's cash flow. RAPID GEOGRAPHIC EXPANSION AND ABILITY TO SUSTAIN GROWTH The Company has grown significantly since the commencement of lending operations in February 1996 and no assurances can be given that the Company can maintain this growth rate, successfully manage its infrastructure or recruit and retain sufficient personnel. The Company intends to continue to pursue a growth strategy for the foreseeable future, primarily through the expansion of its Wholesale Division, Retail Division and Correspondent Program. The growth strategy includes the planned geographic expansion of the Wholesale and Retail Divisions through the opening of a substantial number of new wholesale and retail sales offices in 1997 and the hiring of additional personnel. Each of these expansion plans requires additional capital and human resources and there can be no assurance that the Company will continue to manage effectively its funding sources and information and operating systems, that it will be able to successfully expand and operate such divisions and programs profitably, that it will be able to identify and hire adequate numbers of qualified employees to support its expansion plans or that management will be able to manage the planned expansion effectively. In addition, 10 there can be no assurance that the Company will achieve its planned expansion in a timely and cost-effective manner or, if achieved, that the expansion will result in profitable operations. The failure of the Company to implement its planned geographic expansion would have a material adverse effect on the Company's results of operations, financial condition and business prospects. The Company also plans to broaden its product offerings to include alternative types of mortgage loans and other consumer loans. There can be no assurance the Company can successfully broaden its product offerings and such failure to broaden its product offerings could have a material adverse effect on the Company's results of operations, financial condition and business prospects. SUBPRIME MORTGAGE BANKING INDUSTRY Lenders in the subprime mortgage banking industry make loans to borrowers who have impaired or limited credit histories, limited documentation of income and higher debt-to-income ratios than traditional mortgage lenders allow. The subprime mortgage banking industry is subject to certain risks, including, but not limited to, risks related to (i) making loans to lower credit grade borrowers, (ii) increasing competition and (iii) the negative impact of economic slowdowns or recessions. The failure of the Company to adequately address the risks of subprime lending would have a material adverse impact on the Company's results of operations, financial condition and business prospects. See "Risk Factors--Risks Related to Lower Credit Grade Borrowers, - --Economic Slowdown or Recession, --Competition." RISKS RELATED TO LOWER CREDIT GRADE BORROWERS Loans made to lower credit grade borrowers, including credit-impaired borrowers, may entail a higher risk of delinquency and higher losses than loans made to borrowers with better credit. Lower credit grade borrowers include individuals who have impaired or limited credit profiles, including open bankruptcies, limited documentation of income and/or higher debt-to- income ratios than traditional mortgage lenders allow. Virtually all of the Company's loans are made to borrowers who do not qualify for loans from conventional mortgage lenders and approximately 20.5% of the loans originated or purchased by the Company during the first quarter of 1997 were made to borrowers in the Company's two lowest credit grade classifications. No assurance can be given that the Company's underwriting criteria or methods will afford adequate protection against the higher risks associated with loans made to lower credit grade borrowers. In the event that loans sold by the Company through securitizations or whole loan sales experience higher losses than anticipated, the Company's results of operations, financial condition and business prospects could be adversely affected. See "Business--Underwriting Standards." ACCESS TO FUNDING SOURCES The Company requires access to short-term warehouse and aggregation credit facilities in order to fund loan originations and purchases pending the pooling and sale of such loans. The Company currently has an $85 million warehouse line of credit led by First Bank National Association ("First Bank"), which expires in May 1998, and has received a commitment letter from First Bank proposing an increase in the Company's warehouse line limit to $150 million subject to the completion of the Offering. The Company intends to agree to such proposal upon the closing of the Offering. The Company also has a $175 million aggregation facility with Salomon Brothers ("Salomon"), which may be terminated by Salomon on 28 days prior notice and a residual financing agreement with Salomon pursuant to which Salomon will provide the Company with financing upon the Company's retention of residual interests in securitizations on which Salomon is the lead underwriter. The amount of residual financing provided by Salomon upon each securitization is determined pursuant to a formula set forth in the agreement and, in the event of a change in the variables utilized by Salomon in determining such financing amount, the Company may be required to repay some or all of any residual financing balance outstanding. Any such repayment could have a material adverse effect on the Company's results of operations, financial condition and business prospects. The Company will need to add new credit facilities, as well as renew and expand its existing credit facilities, in order to finance growing levels of loan production and future securitization transactions. Although the Company expects to be able to maintain and expand its existing warehouse line of credit and aggregation facility, as well as its existing residual financing arrangement, or to obtain replacement or additional financing as the current arrangements expire or become fully utilized, there can be no assurance that such 11 financing will be available on favorable terms, if at all. In addition, there can be no assurances that the Company will be able to continue to sell or securitize its loans on favorable terms, if at all. To the extent that the Company is unable to access adequate capital to fund its loan production or to the extent that the Company is unable to access adequate capital to complete the desired level of securitizations, the Company may have to curtail its loan origination, purchase and securitization activities, which would have a material adverse impact on the Company's ability to execute its growth and operating strategies. The Company's results of operations, financial condition and business prospects could suffer as a result. See "Management's Discussion and Analysis of Results of Operations and Financial Condition--Liquidity and Capital Resources." LIQUIDITY; NEGATIVE CASH FLOW The Company's business requires substantial cash to support its operating activities and growth plans. The Company's growing negative operating cash flow position is primarily a function of its securitization strategy and rapid growth. The Company records a residual interest in securitization and recognizes a gain on sale when it effects a securitization, but only receives the cash representing such gain over the life of the loans securitized. As a result of its strategy to significantly grow its loan origination, purchase and securitization programs, the Company expects that its operating uses of cash will substantially exceed its operating sources of cash. This gap will continue to increase to the extent that the Company's securitization volumes increase, whether due to increased volumes of loan production or as a result of a continued shift towards securitization in its loan sales mix. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." The Company intends to rely on secured and unsecured credit facilities ("credit facilities") and undertake public or private capital markets equity or debt financings ("capital markets financings") in order to obtain funds to finance the negative cash flow generated by its operations, securitization strategy and expansion. There can be no assurances that the Company will be able to renew, replace or add to its existing credit facilities, or that it will be able to undertake capital markets financings on favorable terms, if at all. If the Company is unable to obtain adequate financing, it may have to curtail its growth plans or its securitization program. This may have a significant adverse impact on the Company's results of operations, financial condition and business prospects. In addition, to the extent that the Company is unable to renew or expand its access to credit facilities, the Company may have to undertake larger and/or more frequent capital markets financings than anticipated. Capital markets financings may result in greater than anticipated interest expense and shares outstanding, which may have a dilutive impact on operating earnings or have a negative effect on the Company's financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." DEPENDENCE ON SECURITIZATIONS FOR FUTURE EARNINGS The Company has completed only two securitizations to date and there can be no assurance that the Company will complete additional securitizations. The Company plans to pool and sell through securitizations a majority of the loans it originates or purchases and expects that the gain on sale from such securitizations will represent a significant portion of the Company's future revenues and net earnings. The Company's ability to complete securitizations of its loans will depend on a number of factors, including conditions in the securities markets generally, conditions in the asset-backed securities market specifically, the performance of the Company's portfolio of securitized loans and the Company's ability to obtain credit enhancement. If the Company were unable to securitize profitably a sufficient number of its loans in a particular quarter, then the Company's revenues for such quarter would decline, which could result in lower earnings or a loss reported for such quarter. In addition, because the Company expects to use the proceeds generated by securitizations to repay amounts outstanding under its warehouse credit facility and aggregation facility, delays in closing a securitization could adversely affect the Company's ability to access additional cash under its credit facilities in order to fund additional loan origination and purchases and could increase the Company's interest rate risk by increasing the warehousing period for its loans. 12 The Company relies on credit enhancements provided by monoline insurance companies to guarantee senior certificates in the securitization trusts. Such credit enhancements enable the Company to obtain an "AAA/Aaa" rating for such senior certificates. If such insurance companies were unwilling to guarantee the senior certificates in the Company's loan pools, the Company might be unable to continue to sell its loans through securitizations, which could have a material adverse effect on the Company's results of operations, financial condition and business prospects. Although alternative structures to securitization trusts may be available, there can be no assurances that the Company can access these structures or that these structures will be economically viable for the Company. The willingness of insurance companies to credit enhance securitizations may also be adversely affected by any future poor performance of the Company's securitization trusts or the securitization trusts of others. The inability of the Company to complete future securitizations for any reason would have a material adverse effect on the Company's results of operations, financial condition and business prospects. DEPENDENCE ON WHOLE LOAN SALES FOR FUTURE EARNINGS The gain on sale generated by whole loan sales also represents a source of the Company's future earnings. In 1996, the Company sold all of its loan originations and purchases in the secondary market to a limited number of institutional purchasers and plans to sell a significant number of loans it originates or purchases through whole loan sales in the future. There can be no assurance that such purchasers will continue to purchase the Company's loans and to the extent that the Company could not successfully replace such loan purchasers, the Company's results of operations, financial condition and business prospects could be materially and adversely affected. Further, adverse conditions in the asset-backed securitization market could negatively impact the ability of the Company to complete whole loan sales, as many of the Company's whole loan purchasers securitize the loans they purchase from the Company. RESIDUAL INTERESTS IN SECURITIZATIONS The Company plans to derive a substantial portion of its revenue and earnings by recognizing gain on sale of loans through securitizations. In a securitization, the Company sells loans that it has originated or purchased to a trust for a cash purchase price and an interest in the loans securitized called residual interests. Management believes that it has made reasonable estimates of the present value of the residual interests on its balance sheet. The Company projects the expected cash flows over the life of the residual interests, using prepayment and default assumptions that market participants would use for similar financial instruments that are subject to prepayment, credit and interest rate risks. The Company then determines the present value of these cash flows using an interest rate commensurate with the risks involved. If the Company's actual experience differs materially from the assumptions used in the determination of the present value of the residual interests, future cash flows and earnings could be negatively impacted. The Company could also be required to reduce the fair value of its residual interests on its balance sheet, which could decrease the residual financing available to the Company under the Salomon residual financing facility. Furthermore, because the Company does not have meaningful loan performance data, the Company's assumptions are not based on the actual performance of its loans but on available historical loss data for comparable portfolios of loans and the specific characteristics of the loans included in the Company's securitizations. To the Company's knowledge, there is currently no active market for the sale of these residual interests. No assurance can be given that the residual interests could be sold at their stated value, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Loan Sales and Securitizations." The documents governing the Company's February and May 1997 securitizations require the trustee to obtain certain over-collateralization levels through initial funding or retention of residual interest distributions, which reduces the principal balances of the senior certificates issued by the related trust while diverting cash that would otherwise flow to the Company. The Company continues to be subject to the risks of default and foreclosure following the sale of loans through securitization to the extent such losses reduce the residual interest distributions. If losses exceed the current period residual interest distributions, an insurance policy will fund the losses and the insurer will be reimbursed from future residual interest distributions. Over- collateralization levels could change throughout the life of the securitization based upon the loss and delinquency experience and other 13 loan performance variables with respect to the securitized pool of loans, which could negatively impact cash flows to the Company. Any such change in the Company's cash flows could have a material adverse effect on the Company's results of operations, financial condition and business prospects. See "Management's Discussion and Analysis of Financial Condition and Results of Operation--Loan Sales and Securitizations." DEPENDENCE ON WHOLESALE BROKERS The Company depends primarily on independent mortgage brokers and, to a lesser extent, on correspondent lenders, for the origination and purchase of its wholesale mortgage loans, which constitute a significant portion of the Company's loan production. These independent mortgage brokers deal with multiple lenders for each prospective borrower. The Company competes with these lenders for the independent brokers' business on pricing, service, loan fees, costs and other factors. The Company's competitors also seek to establish relationships with such brokers, who are not obligated by contract or otherwise to do business with the Company. The Company's future results of operations and financial condition may be vulnerable to changes in the volume and cost of its wholesale loans resulting from, among other things, competition from other lenders and purchasers of such loans. ELIMINATION OF LENDER PAYMENTS TO BROKERS Class-action lawsuits have been filed against a number of mortgage lenders alleging that such lenders have violated the Federal Real Estate Settlement Procedures Act ("RESPA") by making certain payments to independent mortgage brokers. These lawsuits have generally been filed on behalf of a purported nationwide class of borrowers and allege 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. Future regulatory interpretations or judicial decisions may require the Company to change its broker compensation programs or subject it to material monetary judgments or other penalties. Any such changes or penalties may have a material adverse effect on the Company's results of operations, financial condition and business prospects. See "Business-- Regulation." ECONOMIC SLOWDOWN OR RECESSION The risks associated with the Company's business are more acute during periods of economic slowdown or recession because these periods may be accompanied by decreased demand for consumer credit and declining real estate values. Declining real estate values reduce the ability of borrowers to use home equity to support borrowings by negatively affecting loan-to-value ratios of the home equity collateral. In addition, because the Company makes a substantial number of loans to credit-impaired borrowers, the actual rates of delinquencies, foreclosures and losses on such loans could be higher during economic slowdowns. Any sustained period of increased delinquencies, foreclosures or losses could adversely affect the Company's ability to sell loans or the prices the Company receives for its loans. CHANGES IN INTEREST RATES The Company's profitability may be directly affected by changes in interest rates, which affect the Company's ability to earn a spread between the interest received on its loans and its funding costs. The revenues of the Company may be adversely affected during any period of unexpected or rapid change in interest rates. For example, a substantial and sustained increase in interest rates could adversely affect the demand for the Company's products. In addition, the Company's adjustable-rate mortgage loans have a life rate cap above which the interest rate on the loan may not rise. In the event of general interest rate increases, the rate of interest on these mortgage loans could be limited, while the rate payable on the senior certificates representing interests in a securitization trust into which such loans are sold may be uncapped, which would reduce the amount of cash the Company receives over the life of its residual interests, thereby requiring the Company to reduce the fair value of such residual interests. Furthermore, a significant decrease in interest rates could increase the rate at which 14 loans are prepaid, which would also reduce the amount of cash the Company receives over the life of its residual interests. Either of these events could require the Company to reduce the fair value of its residual interests, which would have a material adverse effect on the Company's results of operations, financial condition and business prospects. Adjustable-rate mortgage loans ("ARMs") (which include loans that have initial fixed-rate terms of up to three years) originated or purchased by the Company totaled $188.0 million in principal during the first quarter of 1997. Substantially all such ARMs included an initial interest rate, or "teaser" rate, significantly below the fully indexed interest rate at origination. Borrowers may encounter financial difficulties as a result of increases in the interest rate over the life of these loans or may prepay such loans earlier than expected, which would reduce the amount of cash the Company receives over the life of its residual interests and could require the Company to reduce the fair value thereof, which would have a material adverse effect on the Company's results of operations, financial condition and business prospects. During periods of rising interest rates, the value and profitability of the Company's loans may be negatively impacted, from the date of origination or purchase until the date the Company sells or securitizes such loans. The market values of fixed-rate mortgage loans are more sensitive to changes in market interest rates than are the market values of ARMs. The Company from time to time may use various hedging strategies to provide a level of protection against such interest rate risks on its fixed-rate mortgage loans. While the Company believes its hedging strategies are cost-effective and provide some protection against interest rate risks, no hedging strategy can completely protect the Company from such risks. 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. Further, the Company does not believe that hedging against the interest rate risks associated with ARMs is cost effective and the Company does not utilize the hedging strategies described above with respect to these loans, which constitute the majority of the Company's loan production. See "Business--Interest Rate Risk Management." QUARTERLY FLUCTUATIONS IN EARNINGS The Company's revenues and net earnings have fluctuated in the past and are expected to fluctuate in the future as a result of a number of factors, including the size and timing of securitizations and whole loan sales, expansion costs incurred by the Company and the volume of loan originations and purchases. If the Company were unable to securitize profitably a sufficient number of its loans in a particular quarter, or were unable to complete a sufficient number of whole loan sales, then the Company's revenues for such quarter would decline, which could result in lower earnings or a loss reported for such quarter and have a material adverse effect on the Company's results of operations, financial condition and business prospects. COMPETITION The Company faces intense competition in the business of originating, purchasing and selling mortgage loans. 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. Many of the Company's competitors are substantially larger and have considerably greater financial, technical and marketing resources than the Company. 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 companies. In the future, the Company may also face competition from government-sponsored entities, such as the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. These government- sponsored entities may enter the subprime mortgage market and target potential customers in the Company's highest credit grades, who constitute a significant portion of the Company's customer base. The current level of gains realized by the Company and its competitors on the sale of subprime mortgage loans could attract additional competitors into this market. Certain large finance companies and conforming mortgage originators have announced their intention to originate non-conforming mortgage loans, and some of 15 these large mortgage companies, thrifts and commercial banks have begun offering non-conforming loan products to customers similar to the borrowers targeted by the Company. In addition, establishing a broker-sourced loan business requires a substantially smaller commitment of capital and human resources than a direct-sourced loan business. This relatively low barrier to entry permits new competitors to enter this market quickly and compete with the Company's wholesale lending business. Additional competition may lower the rates the Company can charge borrowers, thereby potentially lowering the gain on future loan sales. Increased competition may also reduce the volume of the Company's loan origination and loan sales and increase the demand for the Company's experienced personnel and the potential that such personnel will leave the Company for the Company's competitors. Fluctuations in interest rates and general and localized economic conditions may also affect the competition the Company faces. Competitors with lower costs of capital have a competitive advantage over the Company. During periods of declining rates, competitors may solicit the Company's customers to refinance their loans. In addition, during periods of economic slowdown or recession, the Company's borrowers may face financial difficulties and be more receptive to the offers of the Company's competitors to refinance their loans. The Company plans to expand into new geographic markets, where it will face additional competition from lenders already established in these markets. There can be no assurance that the Company will be able to successfully compete with these lenders. CONTINGENT RISKS Although the Company sells substantially all of the mortgage loans it originates or purchases, the Company retains some degree of credit risk on substantially all of the loans it sells. During the period of time that the loans are held for sale, the Company is subject to the various business risks associated with the lending business, including borrower default, foreclosure and the risk that a rapid increase in interest rates would result in a decline of the value of loans held for sale to potential purchasers. In connection with its securitizations, the Company is required to repurchase or substitute loans in the event of a breach of a representation or warranty made by the Company. While the Company may have recourse to the sellers of loans it purchased, there can be no assurance of the sellers' abilities to honor their respective obligations to the Company. Likewise, in connection with its whole loan sales, the Company enters agreements which 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 early default on such mortgage loans. The remedies available to a purchaser of mortgage loans from the Company are generally broader than those available to the Company against the sellers of such loans, and if a purchaser enforces its remedies against the Company, the Company may not be able to enforce whatever remedies the Company may have against such sellers. In addition, borrowers, purchasers of the Company's loans, monoline insurance carriers and trustees in the Company's securitization may make claims against the Company arising from alleged breaches of fiduciary obligations, misrepresentations, errors and omissions of employees, officers and agents of the Company, including appraisers, incomplete documentation and failure by the Company to comply with various laws and regulations applicable to its business. Any claims asserted in the future may result in liabilities or legal expenses that could have a material adverse effect on the Company's results of operations, financial condition and business prospects. RISKS ASSOCIATED WITH SERVICING The Company currently contracts for the servicing of all loans it originates, purchases and holds for sale with Advanta pursuant to an interim servicing agreement (the "Advanta Interim Agreement"). In addition, Advanta subservices each public securitization of the Company's loans pursuant to the related pooling and 16 servicing agreement and a corresponding subservicing agreement between the Company and Advanta (the "Advanta Securitization Agreement"). As with any external service provider, the Company is subject to risks associated with insufficient or untimely services. Many of the Company's borrowers require notices and reminders to keep their loans current and to prevent delinquencies and foreclosures. Any failure of the servicer to adequately service the Company's loans could cause a substantial increase in the Company's delinquency or foreclosure rate, which could adversely affect the Company's ability to access equity or debt capital resources, and which could therefore have a material adverse effect on the Company's results of operations, financial condition and business prospects. Under the Advanta Interim Agreement and the Advanta Securitization Agreement, if the Company terminates either of such agreements without cause or transfers the servicing of any amount of the mortgage loans serviced by Advanta to another servicer, the Company must pay Advanta certain penalties, fees and costs. Depending on the size of the Company's loan portfolio serviced by Advanta at any point in time, the termination or transfer penalties that the Company would be obligated to pay Advanta may be substantial. With respect to mortgage loans securitized by the Company, the Company will not be able to terminate the servicer without the approval of the trustee for such securitization. On March 17, 1997, Advanta Corp., the parent of Advanta, announced that it was considering strategic alternatives, including the possibility of selling all or part of its businesses, as a result of increased losses from credit card loans. Although the management of Advanta Corp. stated that its mortgage business was performing well, there can be no assurance that a sale by Advanta Corp. of all or some of its businesses, including its Advanta servicing operations, would not have an adverse effect upon the servicing of the Company's loans. The Company intends to establish in-house servicing operations to service the loans it originates and purchases and to engage Comerica to perform specified servicing functions. See "Prospectus Summary--Recent Developments-- Comerica Investment and Strategic Relationship." There can be no assurance that the Company will anticipate and respond effectively to all of the demands that servicing its loans will have on the Company's management, infrastructure and personnel. The failure of the Company to meet the challenges of servicing its loans could have a material adverse effect on the Company's results of operations, financial condition and business prospects. The Company will also remain subject to risks associated with insufficient or untimely services from Comerica as an external service provider. In addition, any change in servicing operations may result in greater delinquencies and losses on related loans, which would adversely impact the value of the residual interests held by the Company in connection with its securitizations. RISKS ASSOCIATED WITH HIGH LOAN-TO-VALUE LOAN PRODUCTS The Company recently commenced loan originations through its Alternative Mortgage Products Division which offers loans to borrowers meeting conventional mortgage lending standards and offers a broad selection of second mortgage products, including loans with loan-to-value ratios of up to 125%. Although the Company acts as a broker or correspondent in the sale of all of its high loan-to-value loan products, rather than selling such loans through securitizations or servicing-retained sales, the Company is subject to the risk of borrower default and foreclosure on these loans during the period of time that the loans are held for sale or if the Company is required to repurchase any such loans. To the extent that borrowers with high loan-to- value ratios default on their loan obligations while the loans are held by the Company, the Company would be unable to rely on equity in the collateral property to reduce the Company's loss exposure. Under these circumstances, the Company might be required to absorb any losses and such absorption, if the losses exceed the Company's reserves for such losses, could have a material adverse effect on the Company's financial condition, results of operations and business prospects. DEPENDENCE ON A LIMITED NUMBER OF KEY PERSONNEL The Company is dependent upon the continued services of Robert K. Cole, Brad A. Morrice, Edward F. Gotschall and Steven G. Holder, the Chief Executive Officer, President, Chief Operating Officer--Finance/Administration and Chief Operating Officer--Production/Operations of the Company, respectively. The loss of their services could have a material adverse effect on the Company's results of operations, financial 17 condition and business prospects. The Company currently has a $1 million key- man life insurance policy for each of these executive officers. In addition, the Company has entered into employment agreements with Messrs. Cole, Morrice, Gotschall and Holder. See "Management--Executive Compensation." CONCENTRATION OF OPERATIONS IN CALIFORNIA Approximately 49.8% of the dollar volume of loans originated or purchased by the Company during the first quarter of 1997 were secured by properties located in California. Although the Company has expanded its office network outside California and plans further expansion outside California in the future, the Company's sales loan originations and purchases may remain concentrated in California for the foreseeable future. Consequently, the Company's results of operations, financial condition and business prospects are dependent on the California economy and its residential real estate market. Over the last several years, the California economy experienced an economic slowdown or recession and a sustained decline in the California real estate market. Residential real estate market declines may adversely affect the values of the properties securing mortgage loans. A decline in the value of the mortgaged properties may result in the principal balances of such loans, together with any primary financing on the mortgaged properties, to equal or exceed the value of the mortgaged properties. In addition, California is vulnerable to certain natural disaster risks, such as earthquakes and mudslides. These disasters are not typically covered by the standard hazard insurance policies maintained by borrowers and may adversely impact borrowers' ability to repay loans made by the Company. 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, financial condition and business prospects. See "Business--Geographic Distribution." ENVIRONMENTAL LIABILITIES The Company may acquire real property securing loans that are in default and there is a risk that hazardous substances or waste, contaminants or pollutants could be discovered on such properties after the Company acquires them. The Company might be required to remove such substances from the affected properties at its sole cost and expense, and the cost of such removal may substantially exceed the value of the affected properties or the loans secured by such properties. Furthermore, the Company may not have adequate remedies against the prior owners or other responsible parties to recover its costs. Finally, the Company may find it difficult or impossible to sell the affected real properties either prior to or following any such removal. LEGISLATIVE OR REGULATORY RISKS 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 and regulations impose obligations and restrictions on the Company's loan originations, 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. 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, the 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. Failure to comply with any of 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. Because the Company's business is highly regulated, the laws, rules and regulations applicable to the Company are subject to regular modification and change. In addition, various laws, rules and regulations currently are proposed, which, if adopted, could impact the Company. There can be no assurance that these 18 proposed laws, rules and regulations, or other such laws, rules or regulations, will not be adopted in the future. Such adoption 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 results of operations, financial condition and business prospects of the Company. Government officials, including members of Congress, have from time to time suggested the elimination of the mortgage interest deduction for federal income tax purposes. 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 advantages of tax deductible interest, when compared with alternative sources of consumer 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. ANTI-TAKEOVER PROVISIONS The Company's Certificate of Incorporation (the "Certificate of Incorporation") and its Bylaws (the "Bylaws") include provisions that could delay, defer or prevent a takeover attempt that may be in the best interest of stockholders. These provisions include the ability of the Board of Directors to issue up to 7,500,000 shares of preferred stock (the "Preferred Stock") without any further stockholder approval, a classified Board of Directors and requirements that (i) stockholders give advance notice with respect to certain proposals they may wish to present for a stockholder vote, (ii) stockholders act only at annual or special meetings and (iii) two-thirds of all directors approve a change in the number of directors of the Company. Issuance of Preferred Stock could also discourage bids for the Common Stock at a premium as well as create a depressive effect on the market price of the Common Stock. In addition, under certain conditions, Section 203 of the Delaware General Corporation Law (the "DGCL") would prohibit the Company from engaging in a "business combination" with an "interested stockholder" (in general, a stockholder owning 15% or more of the Company's outstanding voting stock) for a period of three years unless the business combination is approved in a prescribed manner. See "Description of Capital Stock." CONTROL BY CERTAIN STOCKHOLDERS Upon completion of the Offering, the existing stockholders of the Company will beneficially own an aggregate of approximately 74.8% of the outstanding shares of Common Stock (approximately 71.5% following the completion of the Offering assuming the exercise of the Underwriters' over-allotment option in full). Accordingly, such persons, if they were to act in concert, would have majority control of the Company, with the ability to approve certain fundamental corporate transactions (including mergers, consolidations and sales of assets) and to elect all members of the Board of Directors. See "Beneficial Ownership of Securities and Selling Stockholders" and "Management--Board of Directors." POSSIBLE VOLATILITY OF STOCK PRICE; EFFECT OF FUTURE OFFERINGS ON MARKET PRICE OF COMMON STOCK The market price of the Common Stock may experience fluctuations that are unrelated to the operating performance of the Company. In particular, the price of the Common Stock may be affected by general market price movements as well as developments specifically related to the consumer finance industry and the financial services sector such as, among other things, interest rate movements, quarterly variations or changes in financial estimates by securities analysts and a significant reduction in the price of the stock of another participant in the consumer finance industry. In addition, the Company's operating income on a quarterly basis is significantly dependent upon the successful completion of the Company's loan sales and securitizations in the market, and the Company's inability to complete these transactions in a particular quarter may have a material adverse impact on the Company's results of operations for that quarter and could, therefore, negatively impact the price of the Common Stock. The Company may increase its capital by making additional private or public offerings of its Common Stock, securities convertible into its Common Stock, preferred stock or debt securities. The actual or perceived 19 effect of such offerings 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. ABSENCE OF PUBLIC MARKET There is currently no trading market for the Common Stock and there can be no assurance that an active trading market for the Common Stock will develop. Although an application has been made to have the Common Stock approved for quotation on Nasdaq, there can be no assurance that an active public trading market for the Common Stock will develop after the Offering or that, if developed, it will be sustained. The public offering price of the Common Stock offered hereby was determined by negotiations among the Company and representatives of the Underwriters and may not be indicative of the price at which the Common Stock will trade after the Offering. See "Underwriting." Consequently, there can be no assurance that the market price for the Common Stock will not fall below the public offering price. SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offering, the Company will have outstanding 13,892,373 shares of Common Stock. The 3,500,000 shares of Common Stock offered in the Offering (4,025,000 shares if the Underwriters' over-allotment option in the Offering is exercised in full) will be immediately eligible for sale in the public market without restriction beginning on the date of this Prospectus. Future sales of substantial amounts of Common Stock after the Offering, or the perception that such sales could occur, could adversely affect the market price of the Common Stock. No prediction can be made as to the effect, if any, that future sales of shares, or the availability of shares for further sale, will have on the market price of the Common Stock. Additionally, 2,000,000 shares of Common Stock will be reserved for issuance under the Stock Option Plan as of the closing of the Offering, including outstanding options to acquire 1,267,520 shares which have been granted and options to acquire 441,500 shares which will be granted upon the closing of the Offering. In addition, options to acquire 127,500 shares of Common Stock were granted or will be granted to two executive officers and one non-employee director of the Company outside the Stock Option Plan and 333,333 shares of Common Stock will be reserved for issuance under the Comerica warrants, of which warrants to purchase 100,000 shares have been issued. The Company intends to file a registration statement under the Securities Act to register such shares of Common Stock reserved for issuance under its Stock Option Plan, thus permitting the resales of such shares by non-affiliates in the public market without restriction under the Securities Act of 1933, as amended (the "Securities Act"). Such registration statement is expected to be filed shortly after the date of this Prospectus. The remaining 10,392,373 shares (10,099,873 shares if the Underwriters' over-allotment option in the Offering is exercised in full) of Common Stock held by the existing stockholders of the Company are "restricted securities" as that term is defined in Rule 144 promulgated under the Securities Act and are eligible for sale subject to the holding period, volume and other limitations imposed thereby. In addition, certain existing stockholders have registration rights with respect to shares of Common Stock which they own or have a right to acquire. The Company, certain existing stockholders of the Company and the executive officers and directors of the Company have agreed with the Underwriters that, subject to certain conditions, for a period of 180 days following the commencement of this Offering, they will not sell, contract to sell or otherwise dispose of any shares of Common Stock or rights to acquire such shares (other than pursuant to employee plans) without the prior written consent of Montgomery Securities on behalf of the Underwriters. See "Underwriting." SUBSTANTIAL AND IMMEDIATE DILUTION The initial public offering price is substantially higher than the net tangible book value per share of Common Stock. Investors purchasing shares of Common Stock in the Offering will be subject to immediate dilution of $6.87 per share in net tangible book value. See "Dilution." 20 ABSENCE OF DIVIDENDS The Company does not anticipate declaring or paying any cash dividends on the Common Stock following the Offering. Future dividend policy will depend on the Company's earnings, capital requirements, financial condition and other factors considered relevant by the Board of Directors. In addition, the Company is prohibited under the terms of its current warehouse facility from paying dividends without the prior approval of First Bank. See "Dividend Policy" and "Management's Discussion and Analysis of Financial Condition and Results of Operation--Liquidity and Capital Resources." FORWARD-LOOKING STATEMENTS This Prospectus may contain forward-looking statements that may be identified by the use of forward-looking terminology such as "may," "will," "should," "expect," "anticipate," "estimate" or "continue" or the negative thereof or other variations thereon or comparable terminology. The matters set forth under "Risk Factors" constitute cautionary statements identifying important factors with respect to any forward-looking statements, including certain risks and uncertainties, that could cause actual results to differ materially from those in such forward-looking statements. 21 USE OF PROCEEDS The net proceeds to be received by the Company from the sale of the Common Stock offered hereby (assuming an initial public offering price of $9.50 per share and after deducting the estimated underwriting discount and expenses payable by the Company), are estimated to be approximately $24.8 million. The Company intends to apply the net proceeds from the Offering in the following manner: (i) to fund loan originations and purchases; (ii) to fund securitization transaction costs; and (iii) for general corporate purposes, including costs related to expansion of the Retail and Wholesale Divisions. Until the time that such proceeds are utilized, the net proceeds will be invested in high quality, short-term investment instruments such as short-term corporate investment grade or United States Government interest-bearing securities. DIVIDEND POLICY The Company has never declared or paid any cash dividends on its Common Stock. The Company currently intends to retain any earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. In addition, the Company is prohibited from paying dividends under its current warehouse facility without the prior approval of First Bank. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." DILUTION As of March 31, 1997, the Company had a net tangible book value of $11.8 million, or $1.07 per share of Common Stock, after adjusting the net tangible book value and number of shares outstanding to reflect the exercise of warrants to purchase 304,501 shares of Common Stock and the sale of 545,000 shares of Common Stock of the Company to Comerica. Net tangible book value per share is determined by dividing the net tangible book value of the Company (total tangible assets less total liabilities) by the number of shares of Common Stock outstanding as of March 31, 1997. After giving effect to the sale by the Company of the shares of Common Stock offered by the Company hereby at an assumed initial public offering price per share of $9.50 (after deducting the estimated underwriting discount and offering expenses), the Company's net tangible book value as of March 31, 1997 would have been $36.6 million or $2.63 per share of Common Stock. This represents an immediate increase in net tangible book value of $1.56 per share to existing stockholders and an immediate dilution of $6.87 per share to new investors purchasing shares in the Offering. The following table illustrates this per share dilution: Assumed initial public offering price per share................ $9.50 Pro forma net tangible book value per share before the Offer- ing......................................................... $1.07 Increase per share attributable to new investors............. 1.56 ----- Pro forma net tangible book value per share after the Offer- ing........................................................... 2.63 2.63 ----- ----- Dilution per share to new investors............................ $6.87 =====
22 The following table sets forth on a pro forma basis, as of March 31, 1997, the relative investments of all existing stockholders and new investors purchasing shares of Common Stock from the Company in the Offering. The calculations are based on an assumed initial public offering price of $9.50 per share.
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE ------------------ ------------------- PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- ------- ----------- ------- --------- Existing stockholders (1)...... 10,992,373 79.1% $ 8,303,254 23.2% $0.76 New investors.................. 2,900,000 20.9 27,550,000 76.8 9.50 ---------- ----- ----------- ----- ----- Total...................... 13,892,373 100.0% $35,853,254 100.0% $2.58 ========== ===== =========== ===== =====
- -------- (1) Sales by the Selling Stockholder in the Offering will reduce the number of shares held by existing stockholders to 10,392,373 shares, or 74.8% of the total shares of Common Stock outstanding (10,099,873 shares, or 71.5% of the total shares of Common Stock if the Underwriters' over-allotment option is exercised in full), and will increase the number of shares held by new investors to 3,500,000 shares, or 25.2% of the total shares of Common Stock outstanding (4,025,,000 shares, or 28.5% of the total shares of Common Stock if the Underwriters' over-allotment option is exercised in full) after the Offering. The foregoing table excludes (i) 2,000,000 shares reserved for issuance under the Stock Option Plan as of the closing of the Offering, including outstanding options to acquire 1,267,520 shares at a weighted average exercise price of $5.17 per share which have been granted under the Stock Option Plan and options to acquire 441,500 shares which will be granted upon the closing of the Offering, (ii) options to acquire 120,000 shares at a weighted average exercise price of $3.50 per share which have been granted to two executive officers of the Company outside the Stock Option Plan, (iii) options to acquire 7,500 shares at the initial public offering price which will be granted to two non-employee directors of the Company outside the Stock Option Plan, and (iv) 333,333 shares of Common Stock that will be reserved for issuance pursuant to the Comerica warrants at the initial public offering price, of which warrants to purchase 100,000 shares have been issued. To the extent that any options of the Company are exercised, there will be further dilution to new investors. See "Management--Stock Option Plan." 23 CAPITALIZATION The following table sets forth the pro forma capitalization of the Company at March 31, 1997, after giving effect to the exercise of 304,501 warrants, the sale of 545,000 shares of Common Stock to Comerica, the issuance of the Common Stock offered hereby at an assumed public offering price of $9.50 per share (after deducting the estimated underwriting discount and offering expenses) and the application of the net proceeds to reduce borrowings under warehouse and aggregation lines of credit and to repay approximately $1.25 million outstanding under the Company's revolving line of credit. This table should be read in conjunction with the Company's Financial Statements and the Notes thereto.
AS OF MARCH 31, 1997 -------------------- PRO FORMA ACTUAL AS ADJUSTED -------- ----------- (IN THOUSANDS) DEBT: Borrowings under warehouse and aggregation lines of credit................................................. $110,534 $ 81,909 Residual financing...................................... 7,248 7,248 Other borrowings........................................ 3,119 1,869 -------- -------- Total debt............................................ 120,901 91,026 -------- -------- STOCKHOLDERS EQUITY: Preferred stock, $0.01 par value; 7,320,000 shares authorized and 7,500,000 shares authorized pro forma as adjusted; 5,820,000 shares issued and outstanding and none issued and outstanding pro forma as adjusted...... $ 58 $ -- Common Stock, $0.01 par value per share; 12,963,778 shares authorized and 45,000,000 shares authorized pro forma as adjusted; 528,618 shares issued and outstanding and 13,892,373 shares issued and outstanding pro forma as adjusted(1)................... 6 139 Additional paid-in capital.............................. 3,086 32,886 Retained earnings, restricted........................... 3,600 3,600 -------- -------- Total stockholders' equity............................ 6,750 36,625 -------- -------- Total capitalization.................................. $127,651 $127,651 ======== ========
- -------- (1) Excludes (i) 2,000,000 shares reserved for issuance under the Stock Option Plan as of the closing of the Offering, including outstanding options to acquire 1,267,520 shares at a weighted average exercise price of $5.17 per share which have been granted and options to acquire 441,500 shares which will be granted upon the closing of the Offering, (ii) options to acquire 120,000 shares at a weighted average exercise price of $3.50 per share which have been granted to two executive officers of the Company outside the Stock Option Plan, (iii) options to acquire 7,500 shares at the initial public offering price which will be granted to two non-employee directors of the Company outside the Stock Option Plan, and (iv) 333,333 shares of Common Stock that will be reserved for issuance pursuant to the Comerica warrants at the initial public offering price, of which warrants to purchase 100,000 shares have been issued. 24 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) The following selected consolidated statements of operations and balance sheet data as of December 31, 1996 and 1995 and for the year ended December 31, 1996 and for the period from November 17, 1995 (inception) to December 31, 1995 have been derived from the Company's financial statements audited by KPMG Peat Marwick LLP, independent auditors, whose report with respect thereto appears elsewhere herein. The following selected statements of operations and balance sheet data as of March 31, 1996, June 30, 1996, and September 30, 1996 and March 31, 1997 and for the quarters ended March 31, 1996, June 30, 1996, September 30, 1996, December 31, 1996 and March 31, 1997 have been derived from the unaudited financial statements of the Company and include all adjustments, consisting only of normal recurring accruals, which management considers necessary for a fair presentation of such financial information for those periods. Such selected financial data should be read in conjunction with those financial statements and the notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" also included elsewhere herein.
FOR THE PERIOD FROM INCEPTION (NOVEMBER 17, 1995) FOR THE FOR THE QUARTER ENDED THROUGH YEAR ENDED ----------------------------- DECEMBER 31, 1995 DECEMBER 31, 1996 MARCH 31, 1996 MARCH 31, 1997 --------------------- ----------------- -------------- -------------- STATEMENT OF OPERATIONS DATA: Revenues: Gain on sale of loans.. $ -- $11,630 $ -- $10,012 Servicing income....... -- 29 -- 302 Interest income........ 14 2,846 39 2,271 ----- ------- ------ ------- Total revenues........ 14 14,505 39 12,585 Operating Expenses...... 95 12,200 899 8,539 ----- ------- ------ ------- Earnings (loss) before income taxes (benefit). (81) 2,305 (860) 4,046 Income taxes (benefit).. 1 970 (362) 1,699 ----- ------- ------ ------- Net earnings (loss)..... $ (82) $ 1,335 $ (498) $ 2,347 ===== ======= ====== ======= Pro forma primary earnings (loss) per share(4)............... $ 0.10 $(0.05) $ 0.19 Pro forma fully diluted earnings (loss) per share(4)............... $ 0.10 $(0.05) $ 0.19
DECEMBER 31, MARCH 31, 1997 -------------- ----------------------- PRO FORMA 1995 1996 ACTUAL AS ADJUSTED(1) ------ ------- -------- -------------- BALANCE SHEET DATA: Loans receivable held for sale, net..... $ -- $57,990 $113,162 $113,162 Residual interests in securitization.... -- -- 13,243 13,243 Total assets............................ 3,151 64,638 133,582 133,582 Borrowings under warehouse lines of credit................................. -- 41,702 65,803 37,178 Borrowings under aggregation lines of credit................................. -- 13,957 44,731 44,731 Residual financing...................... -- -- 7,248 7,248 Other borrowings........................ -- 1,326 3,119 1,869 Total stockholders' equity.............. 3,068 4,403 6,750 36,625
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AS OF OR FOR THE PERIOD FROM INCEPTION AS OF OR FOR THE (NOVEMBER 17, 1995) QUARTER ENDED THROUGH AS OF OR FOR THE YEAR ENDED ----------------------------- DECEMBER 31, 1995 DECEMBER 31, 1996 MARCH 31, 1996 MARCH 31, 1997 --------------------- --------------------------- -------------- -------------- OPERATING STATISTICS: Loan origination and purchase activities: Wholesale originations. $ -- $287,992 $2,292 $159,075 Retail originations.... -- 66,487 2,001 74,384(2) Correspondent purchases............. -- 2,460 -- 17,111 -------- -------- ------ -------- Total loan originations and purchases(3)..... $ -- $356,939 $4,293 $250,570 Average principal balance per loan....... $ -- $ 106 $ 110 $ 108 Percent of loans secured by first mortgages..... -- 97.3% 96.5% 98.4% Weighted average initial loan-to-value ratio.... -- 71.5% 72.5% 70.9% Originations by product type(3): ARMs................... $ -- $264,510 $2,090 $187,987 Fixed-rate mortgages... -- 92,429 2,203 62,583 Weighted average interest rates: Fixed-rate mortgages... -- 10.4% 9.8% 9.9% ARMs................... -- 9.3% 9.0% 9.2% Margin-ARMs............ -- 7.0% 5.7% 7.0% Loan sales: Loans sold through whole loan transactions(4)....... $ -- $298,713 $ -- $ 95,716 Loans sold through securitizations....... -- -- -- 99,132
26
AS OF OR FOR THE QUARTER ENDED -------------------------------------------------------------------------------- MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996 MARCH 31, 1997 -------------- ------------- ------------------ ----------------- -------------- STATEMENT OF OPERATIONS DATA: Revenues: Gain on sale of loans.. $ -- $ 830 $ 2,658 $ 8,142 $ 10,012 Servicing income....... -- -- 10 19 302 Interest income........ 39 248 560 1,999 2,271 ------ ------- -------- -------- -------- Total revenues......... 39 1,078 3,228 10,160 12,585 Operating Expenses...... 899 1,620 2,721 6,960 8,539 ------ ------- -------- -------- -------- Earnings (loss) before income taxes (benefit). (860) (542) 507 3,200 4,046 Income taxes (benefit).. (362) (225) 213 1,344 1,699 ------ ------- -------- -------- -------- Net earnings (loss)..... $ (498) $ (317) $ 294 $ 1,856 $ 2,347 ====== ======= ======== ======== ======== Pro forma primary earnings (loss) per share(4)............... $(0.05) $ (0.03) $ 0.02 $ 0.16 $ 0.19 Pro forma fully diluted earnings (loss) per share(4)............... $(0.05) $ (0.03) $ 0.02 $ 0.16 $ 0.19 OPERATING STATISTICS: Loan origination activities: Wholesale originations. $2,292 $45,412 $104,392 $135,896 $159,075 Retail originations.... 2,001 7,120 18,956 38,410 74,384(2) Correspondent purchases............. -- -- -- 2,460 17,111 ------ ------- -------- -------- -------- Total loan originations and purchases(3)...... $4,293 $52,532 $123,348 $176,766 $250,570 Average principal balance per loan....... $ 110 $ 115 $ 103 $ 105 $ 108 Percent of loans secured by first mortgages..... 96.5% 97.4% 96.8% 97.7% 98.4% Weighted average initial loan-to-value ratio.... 72.5% 71.5% 71.9% 71.1% 70.9% Originations by product type(3): ARMs................... $2,090 $35,340 $ 93,473 $133,607 $187,987 Fixed-rate mortgages... $2,203 $17,192 $ 29,875 $ 43,159 $ 62,583 Weighted average interest rates: Fixed-rate mortgages... 9.8% 10.3% 10.6% 10.3% 9.9% ARMs................... 9.0% 9.4% 9.2% 9.4% 9.2% Margin-ARMs............ 5.7% 6.9% 6.9% 7.1% 7.0% Loan sales: Loans sold through whole loan transactions.......... $ -- $28,822 $ 79,419 $190,472 $ 95,716(5) Loans sold through securitizations....... $ -- $ -- $ -- $ -- $ 99,132 Staffing and offices: Total employees........ 53 105 178 333 462 Total wholesale account executives............ 4 16 25 34 46 Total retail loan officers.............. 6 20 24 58 105 Total regional operating centers..... 2 3 3 3 3 Total wholesale sales offices............... 1 1 5 12 18 Total retail sales offices............... 2 5 8 20 30
- ------- (1) Adjusted to reflect (i) the exercise of 304,501 warrants at an average price of $3.50 per share, (ii) the sale of 545,000 shares of Common Stock to Comerica at a price of $7.50 per share, less estimated expenses payable by the Company, and (iii) the sale of 2,900,000 shares of Common Stock offered hereby at an assumed initial public offering price of $9.50 per share (after deducting the underwriting discount and estimated expenses payable by the Company), and the application of the estimated net proceeds therefrom to reduce outstanding balances under the Company's warehouse facilities and repay approximately $1.25 million outstanding under the Company's revolving line of credit. Adjustments have not been made to reflect the impact should the Underwriters' over-allotment option be exercised. (2) Includes $634,000 of loans originated through the Alternative Mortgage Products Division. (3) Excludes non-refundable fees and direct costs associated with the origination or purchase of mortgage loans. (4) Pro forma earnings (loss) per share has been computed by dividing pro forma net earnings by the pro forma weighted average number of shares outstanding. The pro forma weighted average number of shares includes all options and warrants issued below the estimated initial public offering price within one year prior to the filing of the Registration Statement for the initial public offering and is calculated using the treasury stock method. Historical earnings per share is not presented because it is not indicative of the ongoing entity. (5) Includes the $2.5 million of loans repurchased and resold by the Company in the first quarter of 1997. 27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the preceding Selected Consolidated Financial and Other Data and the Company's Financial Statements and the Notes thereto and the other financial data included elsewhere in this Prospectus. GENERAL New Century is a specialty finance company engaged in the business of originating, purchasing, selling and servicing subprime mortgage loans secured primarily by first mortgages on single family residences. See "Risk Factors-- Subprime Mortgage Banking Industry." The Company originates and purchases loans through its Wholesale and Retail Divisions. From the commencement of lending operations in February 1996 through March 31, 1997, the Company originated and purchased $607.5 million in mortgage loans. The Company's loan originations and purchases have grown from $4.3 million for the first quarter of 1996 to $250.6 million for the first quarter of 1997. New Century's borrowers generally have substantial equity in the property securing the loan, but have impaired or limited credit profiles or higher debt-to-income ratios than traditional mortgage lenders allow. The Company's borrowers also include individuals who, due to self-employment or other circumstances, have difficulty verifying their income, as well as individuals who prefer the prompt and personalized service provided by the Company. Because these borrowers typically use the proceeds of the Company's loans to consolidate and refinance debt, and to finance home improvements, education and other consumer needs, the Company believes that its loan volume will be less dependent on general levels of interest rates or home sales and therefore less cyclical than conventional mortgage lending. LOAN ORIGINATIONS AND PURCHASES As of March 31, 1997, the Company's Wholesale Division was operating through three regional operating centers located in Southern California, Northern California and Chicago, and through 18 additional sales offices located in 13 states. The Wholesale Division funded $159.1 million in loans, or 63.5%, of the Company's total loan production during the first quarter of 1997. As of March 31, 1997, the Retail Division was operating through 13 retail sales offices in California, and 17 retail sales offices in 13 other states. The Retail Division funded $74.4 million in loans, or 29.7%, of total loan production during the first quarter of 1997. The Company expects to increase the percentage of loans originated within the Retail Division in the future. See "Risk Factors--Ability to Sustain Growth and Rapid Geographic Expansion." Under the Correspondent Program, established in December 1996, the Company purchases closed loans from other mortgage bankers and financial institutions. This program is designed to complement wholesale production efforts and accounted for $17.1 million, or 6.8%, of the Company's total loan production during the first quarter of 1997. 28 The following table summarizes the Company's loan originations and purchases for the periods shown.
FOR THE YEAR ENDED DECEMBER 31, 1996 FOR THE QUARTER ENDED MARCH 31, 1997 ------------------------------------------ ------------------------------------------- WHOLESALE RETAIL CORRESPONDENT TOTAL WHOLESALE RETAIL(1) CORRESPONDENT TOTAL --------- ------- ------------- -------- --------- --------- ------------- -------- Principal balance (in thousands)............. $287,992 $66,487 $2,460 $356,939 $159,075 $74,384 $17,111 $250,570 Number of loans......... 2,611 745 22 3,378 1,486 687 154 2,327 Average principal balance (in thousands). $ 110 $ 89 $ 112 $ 106 $ 107 $ 108 $ 111 $ 108 Weighted average interest rates: Fixed-rate............. 10.5% 10.1% 10.2% 10.4% 10.0% 9.7% 10.5% 9.9% ARMs................... 9.4% 9.1% 10.3% 9.3% 9.4% 8.4% 10.1% 9.2% Margin-ARMs............ 7.0% 6.9% 7.5% 7.0% 7.1% 7.0% 6.6% 7.0% Weighted average initial loan-to-value ratio(2). 71.4% 72.0% 67.8% 71.5% 70.5% 72.4% 68.7% 70.9% Percentage of loans: ARMs................... 79.2% 51.2% 94.5% 74.1% 81.8% 58.5% 84.5% 75.0% Fixed-rate............. 20.8% 48.8% 5.5% 25.9% 18.2% 41.5% 15.5% 25.0% Percentage of loans secured by first and second mortgages: Percentage of loans secured by first mortgages............. 98.1% 93.8% 99.0% 97.3% 99.4% 95.7% 100.0% 98.4% Percentage of loans secured by second mortgages............. 1.9% 6.2% 1.0% 2.7% 0.6% 4.3% -- 1.6%
- -------- (1) Includes $634,000 of loans originated through the Alternative Mortgage Products Division. (2) The weighted average initial loan-to-value ratio of a loan secured by a first mortgage is determined by dividing the amount of the loan by the appraised value of the mortgaged property at origination. The weighted average initial loan-to-value ratio of a loan secured by a second mortgage is determined by taking the sum of the first and second mortgages and dividing by the appraised value of the mortgaged property at origination. The Company has increased its loan origination volume on a quarterly basis in large part as a result of the significant expansion of the Wholesale and Retail Divisions. The following table sets forth the quarterly loan production results, the number of office locations and the number of sales professionals at the end of each quarter by division:
AS OF OR FOR THE QUARTER ENDED -------------------------------------------------------------------------------- MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996 MARCH 31, 1997 -------------- ------------- ------------------ ----------------- -------------- (DOLLARS IN THOUSANDS) WHOLESALE Volume................. $2,292 $45,412 $104,392 $135,896 $159,075 Offices (including regional operating centers).............. 3 4 8 15 21 Account Executives..... 4 16 25 34 46 RETAIL Volume................. $2,001 $ 7,120 $ 18,956 $ 38,410 $ 74,384(1) Offices................ 2 5 8 20 30 Loan Officers.......... 6 20 24 58 105 CORRESPONDENT Volume................. $ -- $ -- $ -- $ 2,460 $ 17,111 TOTAL Volume................. $4,293 $52,532 $123,348 $176,766 $250,570 Offices................ 5 9 16 35 51
- -------- (1) Includes $634,000 of loans originated through the Alternative Mortgage Products Division. 29 LOAN SALES AND SECURITIZATIONS The Company completed the sale of loans through securitization in February and May 1997 and anticipates that significant revenue will be generated from the sale of mortgage-backed securities created through securitization transactions in future periods. In a securitization, the Company sells loans that it has originated or purchased to a trust for a cash purchase price and an interest in the securitized loans called residual interests. The cash purchase price is raised through the sale of senior certificates by the trust. Following the securitization, purchasers of senior certificates receive the principal collected, including prepayments, and the investor pass-through interest rate on the principal balance, while the Company receives the cash flows from the residual interests, after payment of servicing fees, guarantor fees and other trust expenses, and provided that specified over- collateralization requirements are met. Residual interests in real estate mortgage investment conduits are recorded on the Company's balance sheet as a result of the sale of loans through securitization. At the closing of the securitization, the Company removes from its balance sheet the mortgage loans held for sale and adds to its balance sheet (i) the cash received and (ii) the estimated fair value of the residual interests, which consists of (a) an over-collateralization amount ("OC") and (b) a net interest receivable. ("NIR"). The excess of cash received and assets retained by the Company over the carrying value of the loans sold, less transaction costs, equals the gain on sale of loans recorded by the Company. The recorded values of these residual interests are amortized as distributions are received from the trust holding the respective loan pool. Each OC represents the portion of the loans which are held by the trust as over-collateralization for the senior certificates sold and, along with a certificate guarantor insurance policy provided by a monoline insurance company, serves as credit enhancement to the senior certificate holders. Each OC initially consists of the excess of the principal balance of the securitized loans less the principal balance of the senior certificates sold to investors, which was 3% in the February 1997 securitization and 3.25% in the May 1997 securitization. Each OC is required to be maintained at a specified target level of the principal balance of the senior certificates, which may be increased significantly in the event delinquencies and/or losses exceed certain specified levels. Cash flows received by the trust in excess of the obligations of the trust to the senior certificate holders and others are deposited into the over-collateralization account until the target OC is reached, at which point distributions of excess cash are made to the Company as the holder of the residual interests. The Company allocates the basis in the mortgage loans between the portion of the mortgage loans sold through mortgage-backed securities (i.e., the senior certificates) and the portion retained (i.e., the residual interests) based on the relative fair values of those assets on the date of the sale. The Company may recognize gains or losses attributable to the change in the fair value of the residual interests, which are recorded at estimated fair value and accounted for as "held-for-trading" securities. The Company is not aware of an active market for the purchase or sale of residual interests; accordingly, the Company estimates the fair value of the residual interests by calculating the present value of the estimated expected future cash flows using a discount rate commensurate with the risks involved. For its February and May 1997 securitizations, the Company utilized discount rates of approximately 16.0%. Each NIR is determined by using the amount of the excess of the weighted average coupon on the loans sold over the sum of: (i) the coupon on the senior certificates, (ii) a servicing fee paid to the servicer of the loans, (iii) estimated losses to be incurred on the portfolio of loans securitized over the estimated lives of the loans and (iv) other expenses and revenues, which includes anticipated prepayment penalties. The significant assumptions used by the Company to estimate NIR cash flows are anticipated prepayments and estimated credit losses. The Company estimates prepayments by evaluating historical prepayment performance of comparable loans and the impact of trends in the industry. The Company's prepayment estimates have resulted in estimated average lives of its mortgage loans of between four and five years. The Company estimates credit losses using available historical loss data for comparable portfolios of loans and the specific characteristics of the loans included in the Company's securitizations. For purposes of calculating the NIR for its February and May 1997 30 securitizations, the Company assumed that aggregate credit losses as a percentage of the original principal balances of the respective securitized loan portfolios will total approximately 3%. There are no assurances that actual performance of any of the Company's securitized loan portfolios will be consistent with the Company's estimates and assumptions. To the extent that actual prepayment speeds, losses or market discount rates materially differ from the Company's estimates, the estimated value of its residual interests may increase or decrease, which would have a material impact on the Company's results of operations, financial condition and liquidity. See "Risk Factors--Residual Interests in Securitizations." RESULTS OF OPERATIONS Quarter Ended March 31, 1997 Compared to Quarter Ended March 31, 1996 The Company began lending operations in February 1996. Accordingly, results for the first quarter of 1996 primarily reflect costs incurred in the startup of operations. In the first quarter of 1996, total loan origination volume was $4.3 million, total revenues were $39,000 and total expenses were $899,000. The Company did not sell any loans during the first quarter of 1996. For the first quarter of 1997, total loan origination volume was $250.6 million and total loan sales were $194.8 million, including the Company's initial securitization of $99.1 million. Total revenues for the first quarter of 1997 were $12.6 million, and consisted primarily of gain on sale of loans of $10.0 million and interest income on invested cash and loans held for sale of $2.3 million. Total expenses for the first quarter of 1997 were $8.5 million, and consisted of personnel expense of $3.5 million, general and administrative expenses of $2.0 million, interest expense of $1.8 million, advertising and promotion expense of $842,000, servicing expense of $234,000 and professional services expense of $156,000. Net earnings for the first quarter of 1997 were $2.3 million compared to a net loss for the first quarter of 1996 of $498,000. Year Ended December 31, 1996 Compared to Period from November 17, 1995 (inception) to December 31, 1995 From the date of incorporation, November 17, 1995, through December 31, 1995, the primary focus of the Company was on the development of policies and procedures and on the hiring of key employees. The Company did not generate significant revenue during this period except $14,000 in interest income on invested cash, and incurred operating expenses of $95,000. In addition, the Company deferred certain organizational expenses totaling $59,000 during this period. Total revenues for 1996 were $14.5 million and consisted primarily of gain on sale of loans of $11.6 million and interest income on invested cash and loans held for sale of $2.8 million. Gain on sale of loans was recorded on the sale of $298.7 million of mortgage loans, which represented 83.7% of total loan originations for the year. Interest income was recorded primarily on loans held for sale, which totaled $58.0 million as of December 31, 1996, and which averaged $32.4 million for the year based on quarterly average balances. Total expenses, excluding $4.3 million of origination costs deducted directly from the gain on sale of loans, were $12.2 million, and consisted of personnel expenses of $6.1 million, general and administrative expenses of $2.5 million, interest expense of $1.9 million, advertising and promotion expense of $1.2 million, servicing expense of $269,000 and professional services expense of $282,000. Expenses for 1996 increased as compared to 1995 due primarily to (i) the increase in staffing from eight employees as of December 31, 1995 to 333 employees as of December 31, 1996, (ii) the opening of three regional operating centers, (iii) the opening of 32 sales offices and (iv) costs incurred in connection with the growing volume of loan originations. Net earnings for 1996 were $1.3 million as compared to a net loss for 1995 of $82,000. 31 Comparison of Quarters Ended March 31, 1996, June 30, 1996, September 30, 1996, December 31, 1996, and March 31, 1997 Revenues. Total revenues consisted of gain on sale of loans, interest income on invested cash and loans held for sale and servicing revenues. Total revenues were $39,000, $1.1 million, $3.2 million, $10.2 million and $12.6 million for the first, second, third and fourth quarters of 1996 and the first quarter of 1997, respectively. The quarterly increase in total revenues reflected the Company's significant increase in loan originations and purchases since the commencement of lending operations in February 1996, and was due primarily to (i) quarterly increases in gain on sale of loans resulting from increases in total loans sold, (ii) quarterly increases in interest income resulting from the increasing balance of loans held for sale during each successive quarter, and (iii) increases in servicing revenue resulting from the retention of servicing rights on a portion of loans sold through whole loan transactions during the third quarter of 1996, and the retention of servicing rights on the Company's initial securitization of $99.1 million of loans in February 1997, including income derived from the Company's residual interest in securitization. The Company has implemented a loan sales strategy that includes both securitizations and whole loan sales to advance the Company's goal of enhancing profitability while managing cash flows. The timing of specific loan sales may not always correlate to the timing of loan originations due to market conditions or other factors which may impact the value of loans, such as the size of the loan pools to be sold. The amount of loans sold in the fourth quarter of 1996 exceeded 100% of loan originations during such quarter due to the accumulation of loans originated in prior quarters for final sale. The following table sets forth the amount of loans sold through whole loan sales transactions and securitizations, and the components of the gain on sale of loans for the periods indicated.
FOR THE QUARTER ENDED -------------------------------------------------------------------------------- MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996 MARCH 31, 1997 -------------- ------------- ------------------ ----------------- -------------- (IN THOUSANDS) Total loans sold through whole loan transactions and securitizations.... $-- $28,822 $79,419 $190,472 $194,848 Total loans sold as a percentage of loan originations........... -- 54.9% 64.4% 107.8% 77.8% Gain on sale of loans: Gain from whole loan sale transactions and securitizations, net.. $-- $ 1,034 $ 3,749 $ 10,269 $ 11,903 Unrealized gain on held-for-trading securities............ -- -- -- -- 1,267 Provision for repurchase losses..... -- (20) (80) (606) (495) Non-refundable loan fees.................. -- 559 1,106 1,883 3,311 Premiums paid.......... -- (76) (739) (1,158) (1,803) Origination costs...... -- (667) (1,378) (2,246) (4,171) ---- ------- ------- -------- -------- Gain on sale of loans.. $-- $ 830 $ 2,658 $ 8,142 $ 10,012 ==== ======= ======= ======== ========
Gains or losses from whole loan sales of mortgage loans are recognized at the date of settlement and are based on the difference between the selling price and the carrying value of the related loans sold including the value of servicing rights. Gains or losses from securitizations are recognized at the date of settlement and are equal to the excess of cash received and assets retained by the Company, over the carrying value of the loans sold, less transaction costs. Gain from whole loan sales transactions and securitizations increased quarterly as a result of increases in the amount of loans sold, and increased as a percentage of total loans sold through whole 32 loan sales transactions and securitizations as a result of increasing premiums received by the Company resulting from, among other things, increases in the size of loan pools sold, and the impact of the Company's initial securitization in February 1997. The Company maintains an allowance for estimated losses related to possible off-balance sheet recourse associated with the potential repurchase of loans which were previously sold through whole loan sales transactions. The Company's determination of the level of allowance for repurchase losses is based upon historical experience, level of repurchase requests from investors, the Company's evaluation of potential repurchase liability during the course of its own review and industry statistics for projected losses related to representations and warranties made to whole loan purchasers of similar loans. This provision is charged against gain on sale of loans and credited to the allowance for repurchase losses in other liabilities. The Company's primary repurchase risk arises when the borrower fails to make the early payments on their loans. The establishment of a provision for losses of $20,000, $80,000, $606,000 and $495,000 in the second, third and fourth quarters of 1996 and the first quarter of 1997, respectively, reflects the significant increase in whole loan sales activities during those quarters. The Company charged off, net of recoveries, $0, $0, $50,000, $556,000 and $375,000 for the first, second, third and fourth quarters of 1996 and the first quarter of 1997, respectively. Non-refundable loan fees are generated primarily from origination fees paid by retail borrowers, and, to a lesser extent, from fees paid by loan brokers within the Wholesale Division and are deferred and recognized as an adjustment to gain on sale of loans when the loans are sold. The quarterly increase in non-refundable loan fees was due to quarterly increases in loan origination volume primarily within the Retail Division. Purchase premiums represent payments made by the Company to independent loan brokers and loan correspondents in connection with the origination and purchase of loans and are deferred and recognized as an adjustment to gain on sale of loans when the loans are sold. The quarterly increase in purchase premiums is primarily due to quarterly increases in loan origination volume within the Wholesale Division. Direct costs associated with the origination of mortgage loans, which include commissions and certain other compensation costs, are deferred and recognized as an adjustment to gain on sale of loans when the loans are sold. The quarterly increase in direct origination costs is the result of increases in commission and staffing costs related to the quarterly increases in loan origination volume. Interest income reflects interest earned on invested cash and loans held for sale, and was $39,000, $248,000, $560,000, $2.0 million and $2.3 million for the first, second, third and fourth quarters of 1996 and the first quarter of 1997, respectively. The quarterly increase in interest income is the result of increases in the average amount of loans held for sale, which increased as a result of the Company's increasing loan origination volume. The average amount of loans held for sale, calculated based on beginning of quarter and end of quarter balances, was $2.1 million, $16.1 million, $49.9 million, $64.9 million and $85.6 million for the first, second, third and fourth quarters of 1996 and the first quarter of 1997, respectively. Servicing income reflects servicing fees received on loans sold or securitized by the Company on which the Company has retained ownership of the servicing rights. While the Company sold primarily all of its loans through whole loan sales transactions on a servicing-released basis during 1996, the Company retained ownership of the servicing rights on approximately $17.3 million in loans sold in September 1996 and $99.1 million in loans securitized in February 1997. Expenses. Total expenses, excluding origination costs deducted directly from the gain on sale of loans, were $899,000, $1.6 million, $2.7 million, $7.0 million and $8.5 million for the first, second, third and fourth quarters of 1996 and the first quarter of 1997, respectively. The quarterly increase in total expenses is the result of the significant expansion of the Company's operations since the commencement of lending operations in February 1996. Beginning in the fourth quarter of 1996, the Company accelerated its geographic expansion, adding 19 new retail and wholesale sales offices in the fourth quarter of 1996 and 16 new sales offices in the first quarter of 33 1997. The Company expenses the start-up costs associated with opening new sales offices, and, therefore during periods of significant expansion, the Company's operating expenses may increase more rapidly than the Company's revenues, the recognition of which are dependent on the timing and volume of loan sales and securitizations. To help achieve the Company's objective of break-even levels of operations within two to four months after opening a wholesale sales office and five to eight months after opening a retail sales office, the Company plans to (i) focus initial hiring efforts on experienced sales professionals, (ii) utilize existing regional and/or corporate operations personnel to support the sales office locations, (iii) provide direct mail and/or telemarketing support to accelerate sales activity and (iv) minimize initial operating costs through the use of short term leases of executive suites and equipment. The following table sets forth the components of the Company's expenses for the periods indicated.
AS OF AND FOR THE QUARTER ENDED -------------------------------------------------------------------------------- MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996 MARCH 31, 1997 -------------- ------------- ------------------ ----------------- -------------- (DOLLARS IN THOUSANDS) Personnel............... $584 $ 845 $1,350 $3,304 $ 3,545 General and administrative expense. 144 322 592 1,398 1,954 Interest expense........ 14 169 346 1,412 1,808 Advertising and promotion.............. 106 199 297 567 842 Servicing............... -- 24 57 188 234 Professional expenses... 51 61 79 91 156 ---- ------ ------ ------ ------- Total expenses........ $899 $1,620 $2,721 $6,960 $ 8,539 ==== ====== ====== ====== ======= Total end of quarter staffing............... 53 105 178 333 462 Total offices........... 5 9 16 35 51
Personnel expense includes employee base salaries and benefits costs plus incentive bonus awards paid and accrued, but excludes a portion of commissions and certain personnel costs directly related to originations, which are deferred and recognized as an adjustment to gain on sale of loans when the loans are sold. Personnel expense increased quarterly due to the significant increase in staffing required to process the quarterly growth in loan origination and purchase volume, which increased from $4.3 million for the first quarter of 1996 to $250.6 million for the first quarter of 1997, and to support the opening of new offices. General and administrative expense includes costs associated with facilities leases, furniture and equipment, depreciation, equipment leases, postage and couriers, stationery and supplies, telephone expense, travel expense and other general business expenses. General and administrative expense increased quarterly due to an increase in (i) lease expense related to the growth in the number of branch offices, (ii) postage and courier expense and stationery and supplies expense directly related to the growth in loan origination volume, and (iii) depreciation of furniture and equipment and equipment lease expense required to support the increased number of offices and personnel. Interest expense includes interest costs related to the Company's warehouse, aggregation and residual financing facilities and other short-term borrowings, and interest costs related to long-term borrowings secured by the Company's furniture and equipment. Interest expense has increased quarterly due to (i) increases in the average outstanding balance of the warehouse and aggregation facilities, (ii) increases in long-term borrowings, and (iii) residual financing obtained in connection with the Company's February 1997 securitization. Advertising and promotion expense primarily reflects the cost of the Company's direct-mail marketing and, to a lesser extent, other promotional costs associated with loan origination activities. Advertising and promotion expense increased quarterly primarily due to an increase in the number of mailings supporting the Company's growth in retail sales offices. Total mailings were approximately 250,000, 720,000, 1.6 million, 1.9 million and 2.8 million for the first, second, third and fourth quarters of 1996 and the first quarter of 1997, respectively. 34 Servicing expense reflects initial setup fees, monthly sub-servicing costs and other fees paid to Advanta. Servicing expense increased quarterly due primarily to the growth in loan origination volume. Professional expenses include legal expenses, accounting fees and other consulting costs. Professional expenses increased quarterly due to (i) increased legal fees required to support the increased lending activity, (ii) increased accounting fees resulting from the growth of the Company and relating to the Company's initial securitization, and (iii) consulting costs incurred to assist the Company's multi-state licensing efforts and the ongoing development of the Company's quality control and compliance programs. The Company incurred net losses of $498,000 and $317,000 for the first and second quarters of 1996, respectively, primarily as a result of the significant costs associated with the startup of operations. The Company recorded net earnings of $294,000, $1.9 million and $2.3 million for the third and fourth quarters of 1996 and the first quarter of 1997, respectively, as the growth in loan origination volume and related loan sales activities resulted in increasing levels of revenue from gain on sale of loans and interest income. LIQUIDITY AND CAPITAL RESOURCES The Company requires access to short-term warehouse and aggregation credit facilities in order to fund loan originations and purchases pending the pooling and sale of such loans. The Company currently has an $85 million warehouse line of credit led by First Bank which expires in May 1998 and has received a commitment letter from First Bank proposing an increase in the Company's warehouse line limit to $150 million subject to the completion of the Offering. The Company intends to agree to such proposal upon the closing of the Offering. The Company utilizes the First Bank warehouse line to finance the actual funding of its loan originations and purchases. The Company also has a $175 million aggregation facility with Salomon, which is subject to renewal by Salomon on a monthly basis. After loans are funded by the Company utilizing the First Bank warehouse line and all loan documentation is complete, the loans are transferred to the Salomon aggregation facility, generally within 15 days after funding, where they are held until a loan sale is completed. The First Bank warehouse line is generally paid down upon the transfer of loans to the Salomon aggregation facility. The Salomon aggregation facility, and in some cases the First Bank warehouse line, are paid down with the proceeds of loan sales and securitizations. The Company expects to add new credit facilities, as well as renew and expand its existing credit facilities, in order to finance its growing levels of loan production. The Company also has a residual financing agreement with Salomon pursuant to which Salomon will provide the Company with financing upon the Company's retention of residual interests in securitizations on which Salomon is the lead underwriter. The amount of residual financing provided by Salomon upon each securitization is determined pursuant to a formula set forth in the agreement and, in the event of a change in the variables utilized by Salomon in determining such financing amount, the Company may be required to repay some or all of any residual financing balance outstanding. The Company will need to add new credit facilities, as well as renew and expand this credit facility in order to finance future securitization transactions. The Company's business requires substantial cash to support its operating activities and growth plans. The Company's growing negative operating cash flow position is primarily a function of its securitization strategy and rapid growth. The Company records a residual interest in securitization and recognizes a gain on sale when it effects a securitization, but only receives the cash representing such gain over the life of the loans securitized. In order to support its loan origination, purchase and securitization programs, the Company is required to make significant cash investments that include the funding of: (i) fees paid to brokers and correspondents in connection with generating loans through wholesale and correspondent lending activities; (ii) fees and expenses incurred in connection with the securitization and sale of loans including over-collateralization requirements for securitization; (iii) commissions paid to sales employees to originate loans; (iv) the difference between the amount funded per loan and the amount advanced under its current warehouse facility; and (v) income tax payments arising from the recognition of gain on sale of loans. The Company also requires cash to fund ongoing operating and administrative expenses, including sub-servicing expenses incurred in the servicing of the Company's loans, capital expenditures and debt service. The Company's sources of operating cash flow include: 35 (i) the premium advance component of the Salomon aggregation facility; (ii) premiums obtained in whole loan sales; (iii) mortgage origination income and fees; (iv) interest income on loans held for sale; (v) excess cash flow from securitization trusts; and (vi) cash servicing income. As a result of its strategy to significantly grow its loan origination, purchase and securitization programs, the Company expects that its operating uses of cash will substantially exceed its operating sources of cash. This gap will continue to increase to the extent that the Company's securitization volumes increase, whether due to increased volumes of loan production or as a result of a continued shift towards securitization in its loan sales mix. However, the Company believes that its cash flow profile will improve over time as its rate of loan production growth moderates and the balance of its residual interests and the size of its servicing portfolio increases. The Company intends to rely on credit facilities and undertake capital markets financings in order to generate funds to finance the negative cash flow generated by its operations, securitization and growth plans. The Company's current credit facilities include: (i) the First Bank warehouse line; (ii) the Salomon aggregation facility; (iii) the Salomon residual financing facility; and (iv) $5.0 million of long-term secured and unsecured credit facilities with First Bank. First Bank has expanded participation in the $85 million warehouse line facility to include Guaranty Federal Bank, F.S.B. As of March 31, 1997, the Company's outstanding balance under the warehouse line was $65.8 million. The facility provides for an advance rate equal to the lesser of 97% of the principal balance of loans originated or purchased, or 97% of the acquisition price and a rate of interest equal to the one-month LIBOR plus 1.50%. The availability of funds under this facility is subject to the Company's continued compliance with certain operating and financial covenants, including (i) leverage covenants based on the ratio of outstanding borrowings to net worth, (ii) cash covenants requiring minimum liquidity at each month end equal to $1.5 million, (iii) restrictions on changes in the Company's business, (iv) restrictions on selling any asset other than in the ordinary course of business and (v) restrictions on additional financing or guaranteeing the debt obligation of any other entity without prior approval. The Salomon aggregation facility provides for the financing of up to $175 million in loans originated or purchased by the Company at an advance rate equal to the lesser of market value as determined by Salomon, or 105% of the principal balance of the loans and a rate of interest generally equal to the one-month LIBOR plus 1.25%. As of March 31, 1997, amounts payable by the Company under this aggregation facility were $44.7 million. The Salomon residual financing facility provides for the financing of an amount calculated pursuant to a formula set forth in the agreement based on the amount of residual interests retained by the Company in a covered securitization and a rate of interest equal to the one-month LIBOR plus 1.25%. No significant financial or operating covenants have been imposed by Salomon in connection with the aggregation or residual financing facilities. In November 1996, the Company commited to provide Salomon with a first right to purchase whole loans from the Company and/or to have Salomon lead underwrite loans sold through securitization by the Company in an aggregate amount of $500 million. In May 1997 the Company fulfilled all such volume commitments to Salomon. The Company has a discretionary, non-revolving $2.5 million line of credit with an affiliate of First Bank secured by the Company's furniture and equipment. Advances under this facility are made periodically at the discretion of the lender, and bear interest at a fixed rate established at the time of each advance for a term of three years. As of March 31, 1997, amounts payable under this facility were $1.9 million, and the weighted average interest rate was 9.0%. In March 1997, the Company established a $2.5 million unsecured line of credit with First Bank for working capital purposes and has received a commitment letter from First Bank proposing an increase in the Company's working capital line to $5.0 million upon the completion of the Offering. The Company intends to agree to such proposal upon the closing of the Offering. As of March 31, 1997, amounts payable under this facility were $1.25 million and the interest rate was 10.25%. Outstanding balances under this line of credit bear interest at a variable rate 1.75% above First Bank's "reference rate" plus 1.75%, which, at March 31, 1997, was 8.5%, and funds may be borrowed on a revolving basis. The working capital facility is subject to the same covenants as the 36 warehouse line and has the same expiration date. As a sublimit under the working capital line of credit, First Bank has provided the Company with a $1.2 million letter of credit required by the landlord under the lease on the Company's new executive and administrative offices. See "Business-- Properties." The Company anticipates that the net proceeds from the Offering, together with the funds available under its credit facilities, will be sufficient to fund its operations for the next 12 months, if the Company's future operations are consistent with management's expectations. If more favorable advance rates are arranged on warehouse facilities, aggregation facilities, or residual financing, or more funds are made available under the furniture and equipment financing facility or working capital line, or if the Company increases the percentage of sales through whole loan transactions, the timing of additional liquidity needs would be extended. In the event the Offering is not consummated, however, the Company would have to arrange alternative financing, and possibly increase the amount of loans sold through whole loan transactions to maintain adequate liquidity. INCOME TAXES The Company accounts for income taxes using the asset and liability method. Under the asset and liability method, 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. 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. ACCOUNTING CONSIDERATIONS In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 125 (FASB 125), "Accounting for Transfer and Servicing of Financial Assets and Extinguishment of Liabilities." FASB 125 addresses the accounting for all types of securitization transactions, securities lending and repurchase agreements, collateralized borrowing arrangements and other transactions involving the transfer of financial assets. FASB 125 distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. FASB 125 is generally effective for transactions that occur after December 31, 1996, and it is to be applied prospectively. FASB 125 will require the Company to allocate its basis in the mortgage loans between the portion of the mortgage loans sold through mortgage backed securities and the portion retained (the residual interests) based on the relative fair values of those portions on the date of sale. The pronouncement requires the Company to account for residual interests as "held-for-trading" securities which are to be recorded at fair value in accordance with SFAS No. 115. The Company adopted FASB 125 on January 1, 1997 and there was no material impact on the Company's financial position or results of operations. In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 128 (FASB No. 128), "Earnings Per Share." FASB No. 128 supersedes APB Opinion No. 15 (APB No. 15), "Earnings Per Share" and specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicy held common stock or potential common stock. FASB No. 128 was issued to simplify the computation of EPS and to make the U.S. standard more compatible with the EPS standards of other countries and that of the International Accounting Standards Committee (IASC). It replaces the presentation of primary EPS with a presentation of basic EPS and fully diluted EPS with diluted EPS. Basic EPS, unlike primary EPS, excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS under APB No. 15. 37 FASB No. 128 is effective for financial statements for both interim and annual periods ending after December 15, 1997. Earlier application is not permitted. After adoption, all prior-period EPS data presented shall be restated to conform with FASB No. 128. The Company has determined that this statement will increase the earnings per share computation under basic EPS as compared to primary EPS. FASB No. 129, "Disclosure of Information about Capital Structure," is effective for financial statements for periods ending after December 15, 1997. It is not expected that the issuance of FASB No. 129 will require significant revision of prior disclosures since the Statement lists required disclosures that had been included in a number of previously existing separate statements and opinions. 38 BUSINESS This Prospectus may contain forward-looking statements which involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those discussed in "Risk Factors." GENERAL New Century is a specialty finance company engaged in the business of originating, purchasing, selling and servicing subprime mortgage loans secured primarily by first mortgages on single family residences. The Company originates loans through its Wholesale and Retail Divisions. From the commencement of lending operations in February 1996 through March 31, 1997, the Company originated and purchased $607.5 million in mortgage loans. The Company's loan originations and purchases have grown from $4.3 million for the first quarter of 1996 to $250.6 million for the first quarter of 1997. The Company's principal strategy is to continue to increase loan originations through geographic expansion, high levels of service to brokers through its Wholesale Division and increased consumer marketing through its Retail Division. New Century has also implemented a loan sales strategy that includes both securitizations and whole loan sales in order to advance the Company's goal of enhancing profitability while managing cash flows. The Company's borrowers generally have substantial equity in the property securing the loan, but have impaired or limited credit profiles or higher debt-to-income ratios than traditional mortgage lenders allow. The Company's borrowers also include individuals who, due to self-employment or other circumstances, have difficulty verifying their income, and individuals who prefer the prompt and personalized service provided by the Company. These types of borrowers are generally willing to pay higher loan origination fees and interest rates than those charged by conventional lending sources. Because these borrowers typically use the proceeds of the Company's loans to consolidate and refinance debt and to finance home improvements, education and other consumer needs, the Company believes that its loan volume will be less dependent on general levels of interest rates or home sales and therefore less cyclical than conventional mortgage lending. Although the Company's underwriting guidelines include five levels of credit risk classification, approximately 54.1% of the principal balance of the loans originated and purchased by the Company in 1996 were to borrowers within the Company's two highest credit grades. One important consideration in underwriting subprime loans is the nature and value of the collateral securing the loans. The Company believes that the amount of equity present in the real estate securing its loans, together with the fact that approximately 88.2% of its loans originated or purchased in the first quarter of 1997 were secured by borrowers' primary residences, mitigates the risks inherent in subprime lending. The average loan-to-value ratio on loans originated and purchased by the Company in 1996 was approximately 71.5%. Approximately 97.3% and 98.4% of the loans originated and purchased by the Company during 1996 and the first quarter of 1997, respectively, were secured by first mortgages, and the remainder of the loans the Company originated and purchased for such periods were secured by second mortgages. The Wholesale Division originates loans through independent loan brokers and accounted for $159.1 million, or 63.5%, of the Company's loan production during the first quarter of 1997. As of May 31, 1997, the Wholesale Division originated loans through its three regional operating centers located in Southern California, Northern California and Chicago and through 23 additional sales offices located in 15 states. The Company believes that it has been successful in penetrating the broker market by providing prompt, consistent service, which includes (i) utilizing experienced subprime underwriting personnel to evaluate the specific characteristics of each loan application, (ii) issuing a conditional loan approval or denial promptly, generally within 24 hours after receipt of an application from a broker, (iii) utilizing teams of account executives in the field and account managers in the office to actively assist brokers in completing approved transactions, (iv) providing brokers with access to the Company's decision-making personnel, (v) locating Company personnel in geographic proximity to their broker customers, (vi) avoiding the imposition of unnecessary conditions on loan approvals, and (vii) consistently funding loans in accordance with the approved terms, generally within 15 to 20 days following conditional approval. 39 The Retail Division originates loans through the direct solicitation of borrowers and accounted for $74.4 million, or 29.7%, of the Company's loan production during the first quarter of 1997. As of May 31, 1997, the Retail Division originated loans through a network of 15 sales offices located in California and 25 sales offices located in 15 other states. The Company's retail marketing includes high-volume targeted direct mail and more traditional marketing activities conducted by retail loan officers, who seek to identify potential borrowers through referral sources as well as individual sales efforts. By creating a direct relationship with the borrower, retail lending creates a more sustainable loan origination franchise and provides the Company with greater control over the lending process. The Company also receives the origination fees paid by the borrower on loans originated through the Retail Division, which offsets the higher costs of retail lending and may contribute to increased profitability and cash flow. The Company began purchasing closed loans from other mortgage bankers and financial institutions ("correspondents") in late 1996. In early 1997, the Company expanded this program to include the purchase of small, bulk packages of loans from correspondents. Correspondent purchases totaled $17.1 million, or 6.8%, of the Company's total loan production during the first quarter of 1997. Purchasing closed loans through the Correspondent Program allows the Company to supplement its own loan production with limited overhead expenses. Loans purchased by the Company under the Correspondent Program must be originated in accordance with the Company's underwriting guidelines and currently all such loans are re-underwritten by the Company prior to purchase. By focusing on the purchase of individual loans on a flow basis and small bulk purchases, the Company believes that its Correspondent Program complements its existing marketing efforts to brokers and enables the Company to increase loan production on a cost-effective basis. The Company plans to expand its Correspondent Program through marketing efforts by its broker account executives and through targeted marketing to selected financial institutions and mortgage bankers. The Company's seven senior executives have substantial mortgage banking experience and have previously directed the national expansion of several conventional and subprime mortgage companies. The senior management team has broad and complementary skills, including expertise in subprime originations, subprime underwriting, loan administration, servicing and collections, secondary marketing, capital markets, finance, legal/regulatory affairs and public company management. Furthermore, the Company's current underwriters have an average of 10 years of subprime mortgage lending experience and all loans presently require two underwriting approvals. The experience of its underwriting personnel allows the Company to exercise flexibility within its underwriting process based on the specific characteristics of each loan application. In addition, all appraisals are reviewed by qualified Company personnel or a qualified appraiser retained by the Company. Along with its thorough underwriting process, the Company maintains strong corporate controls throughout the lending process, including subjecting all loans to a series of pre- and post-funding audits to verify the accuracy of the loan application data and to assure compliance with the Company's underwriting policies, procedures and guidelines. The Company believes that its underwriting and review processes provide the necessary support to continue the Company's rapid loan origination growth while maintaining loan quality. New Century sells its mortgage loans through securitizations as well as through bulk sales of whole loans to institutional purchasers. During 1996, the Company sold $298.7 million of loans through whole loan sales transactions at a weighted average sales price equal to 105.0% of the original principal balance of the loans sold. As of May 31, 1997, the Company has securitized $228.4 million of its mortgage loans through two securitization transactions. Each of these securitizations has been credit enhanced by an insurance policy provided through a monoline insurance company allowing the senior certificates in the related trusts to receive ratings of "AAA" from Standard & Poor's Ratings Services and "Aaa" from Moody's Investors Service, Inc. The Company intends to securitize a majority of its loans while continuing to sell a substantial portion of its loans through whole loan sale transactions. Until February 1997, the Company sold all of its loan production on a servicing-released basis. Starting with its first securitization in February 1997, the Company has retained the servicing rights on the loans sold through its securitizations. While retaining servicing rights as the master servicer on the securitized loans, the Company currently outsources its servicing to Advanta. This strategy has allowed the Company to focus its 40 own management efforts and capital investments on expanding loan production and developing related loan processing, secondary marketing and administrative operations. Advanta currently conducts all of the Company's servicing operations, including interim servicing on loans held for sale, interim servicing of loans sold to whole loan purchasers pending a servicing transfer and servicing on loans for which the servicing rights are retained by the Company through securitization. As of March 31, 1997, the Company's servicing portfolio consisted of 3,110 loans with an aggregate principal balance of approximately $346.4 million, of which 999 loans with an aggregate principal balance of $112.2 million were held for sale and serviced on an interim basis, 1,256 loans with an aggregate principal balance of $136.4 million were serviced on an interim basis for the whole loan purchasers thereof and 855 loans with an aggregate principal balance of $97.8 million had been securitized. The Company intends to develop its own servicing capability in the future in order to manage the servicing relationship with its borrowers and oversee the performance of its loans more directly. See "Recent Developments--Comerica Investment and Strategic Relationship." GROWTH AND OPERATING STRATEGIES Increasing Growth of Retail Production. The Company will emphasize the growth of retail loan production during 1997 through geographic expansion and increased consumer marketing efforts. The Company has opened 20 retail sales offices during the first five months of 1997 and intends to open 10 or more additional retail sales offices during the remainder of 1997. The Company targets markets for expansion based on demographics and its ability to recruit sales office managers and other qualified personnel in particular markets and has not yet identified the exact locations of its planned additional retail sales offices. The expansion costs for new sales offices are generally mitigated by leasing short-term executive suite space until revenues are generated by the office, at which time the Company leases permanent space. Controlling the costs of expansion permits the Company to enter and, if necessary, exit new geographic markets quickly with limited financial impact. The Company intends to coordinate the opening of each new retail sales office with direct mail advertising with the goals of generating revenues for each such office within 60 to 90 days after opening and achieving break-even operations within five to eight months. The Company's geographic expansion plans require additional capital and human resources and there can be no assurance the Company will successfully implement its expansion plans. See "Risk Factors--Ability to Sustain Growth and Rapid Geographic Expansion." The Company also intends to increase its consumer marketing, which includes the use of direct mail, a loans-by-mail program and more traditional marketing methods, such as referrals and individual loan officer sales efforts. The Company has increased the number of targeted direct mail pieces to retail borrowers from approximately 750,000 mailers in January 1997 to approximately 1.4 million mailers in May 1997 and intends to increase the number of targeted direct mail pieces to over 2 million per month by the end of 1997. See "Business--Marketing." Continuing Growth of Wholesale Production. The Company will continue the growth of its Wholesale Division, primarily through geographic expansion and greater penetration in existing markets by providing continued high levels of service to brokers. The Company intends to continue its geographic expansion through the development of lending operations in the Southeast and Northeast regions of the country. In connection with its expansion, the Company plans to open 5 or more additional wholesale sales offices in markets surrounding the Company's existing and planned regional operations centers and to increase the total number of account executives from 42 as of May 31, 1997 to approximately 80 by the end of 1997. The Company has developed its National Call Center, a centralized telemarketing group that contacts mortgage brokers in areas where New Century does not currently have a wholesale sales office, to expand into new markets. The Company intends to target markets where the National Call Center program is particularly successful for the opening of new wholesale sales offices. The Company's geographic expansion plans require additional capital and human resources and there can be no assurance the Company will successfully implement its expansion plans. See "Risk Factors--Ability to Sustain Growth and Rapid Geographic Expansion." The Company believes that providing prompt, consistent service is the reason for its success with wholesale brokers. As a result, management has created a customer service oriented culture at the Company. By providing a high level of service, the Company seeks to maximize the number of potential loans closed in the short term and establishes the basis for repeat business, referrals and other future lending opportunities. The Company 41 expects to improve service to brokers by (i) regionalizing certain wholesale operational support activities, (ii) continuing improvements in the Company's computer and other support systems, which are expected to improve the Company's speed, efficiency and consistency in processing loan applications, and (iii) expanding product offerings to provide brokers with a broader selection of borrowing alternatives for their customers. Enhancing Profitability while Managing Cash Flow. New Century has implemented a loan sales strategy that includes both securitizations and whole loan sales in order to advance the Company's goal of enhancing profits while managing cash flows. Loan sales through securitizations permit the Company to enhance operating profits and to benefit from future cash flows generated by the residual interests retained by the Company. Whole loan sale transactions enable the Company to generate current cash flow, protect against the potential volatility of the securitization market and reduce the risks inherent in retaining residual interests. The Company's strategy is to enhance earnings by securitizing loans with characteristics which the securitization market considers most favorable. At the same time, the Company seeks to enhance 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. The Company may in the future increase or decrease the percentage of loans sold through securitizations based on economic conditions, secondary market conditions and available financial resources. The Company manages its cash flows in several ways, including selling a significant portion of its loans through whole loan sales which result in the receipt of cash gains at the time of sale. The Company also manages its cash flow through the use of a variety of funding sources, including the receipt of advance rates in excess of par on its loan aggregation facility and borrowing against the value of the residual interests received in its securitization. The residual interests retained by the Company constitute an investment which the Company believes will provide attractive investment returns and future cash flow. Further, the Company believes that its cash flow profile will improve over time as its rate of loan production growth moderates and the balance of its residual interests and the size of its servicing portfolio increases. The Company continually evaluates different securitization and financing strategies which may improve its profitability and/or cash flow position. Regionalizing Operations and Incentivizing Performance. New Century is implementing a strategy of regionalizing operations support, which will place Company decision makers closer to local brokers, enable the Company to refine its procedures to reflect local market practices and conditions and enable the Company to provide a higher level of service to brokers. The Company's compensation structure, which includes stock options and cash incentives based on both loan volume and loan quality for a large number of key employees, incentivizes its personnel to achieve the Company's performance goals. The Company believes its compensation structure also enables it to attract and retain key employees. In addition, the Company believes that its operations support compensation structure and the experience of its senior management, underwriting personnel and many members of its support staff, together with their ability to recruit and retain additional qualified personnel, provide fundamental support for the Company's growth and operating strategies. Expanding Product Offerings. The Company frequently reviews its products and pricing for competitiveness and introduces new products to meet the needs of its borrowers, brokers and correspondents. The Company recently commenced loan originations through its Alternative Mortgage Products Division which offers loans to borrowers meeting conventional mortgage lending standards and offers a broad selection of second mortgage products, including loans with loan-to- value ratios of up to 125% for borrowers with good credit histories. The Company believes that offering these high loan-to-value products is beneficial to the Company because a number of its competitors are offering such products and they generate fee-based cash income for the Company. The Company also believes that these mortgage products will enable the Company to increase loan production from brokers and correspondents who have customers seeking such products and from borrowers identified through the Company's retail marketing whose needs are not satisfied by the mortgage products offered by the Retail Division. The Alternative Mortgage Products Division maintains separate underwriting and loan processing staffs and the Company expects that the mortgage loans originated through its Alternative Mortgage Products Division will be sold by the Company on a broker or correspondent basis, rather than through securitizations or servicing-retained sales. Finally, the Company is evaluating the introduction of other categories of consumer loans to its product offerings, thereby expanding its consumer base and diversifying its product mix. 42 MARKETING Retail Division. The Company emphasizes high-volume targeted direct mail but also uses a variety of other marketing activities to attract borrowers for the Retail Division. Using its database screening, the Company selects the potential customers to whom it sends direct mail. The Company's database screening involves a detailed marketing analysis intended to identify current homeowners who are likely to be qualified candidates for the Company's loan products. Factors considered by the Company in identifying homeowners for its mailing list include the length of time the homeowner has owned the home and the individual's credit profile. Longer periods of homeownership increase the likelihood that the homeowner has substantial equity in the home and will satisfy the Company's loan-to-value requirements. Aspects of an individual's credit profile, such as credit problems, limited credit history and prior borrowings from consumer finance companies, also indicate that the individual is a likely candidate for the Company's loan programs. The Company tracks the success of its marketing efforts and regularly assesses the accuracy of its database screening in identifying likely candidates for its products. By limiting the mailing of direct mail pieces to likely borrowers, the Company believes it more efficiently utilizes its marketing expenditures. The Company has increased the number of targeted direct mail pieces to retail borrowers from approximately 750,000 mailers in January 1997 to approximately 1.4 million mailers in May 1997 and intends to increase the number of targeted direct mail pieces to over 2 million per month by the end of 1997. Under the Company's recently initiated loans-by-mail program, the Company utilizes its direct marketing methodology in markets where the Company does not currently maintain a sales office. The Company will target markets where the loans-by-mail program is particularly successful for the opening of new retail sales offices. The Company also will continue to emphasize retail loan generation through more traditional marketing methods, such as referrals and individual loan officer sales efforts, and intends to provide each sales office with an increased promotional budget to support these activities. In addition, the Company has initiated an "outbound" telemarketing strategy to augment the lead generation capabilities of direct marketing and is evaluating television and radio advertising. Wholesale Division. The Company's wholesale marketing strategy is focused on the sales efforts of its account executives, supported by the Company's commitment to providing prompt, consistent service to brokers and their customers. The Company expects that its growth in wholesale originations will stem primarily from increasing the number of account executives, increasing the number of markets served by such account executives and continuing efforts to improve the service provided to brokers and their customers. The Company will utilize the resources of its National Call Center to contact and establish relationships with brokers with whom the Company is not currently doing business in areas New Century has targeted for expansion. To date, the Company has not engaged in mass distribution of loan program information to the broker community, advertised in broker-focused publications or undertaken other similar marketing techniques to reach new brokers, but the Company will utilize some or all of these and other marketing techniques in the future. LOAN ORIGINATIONS AND PURCHASES The Company originates loans primarily through its Wholesale and Retail Divisions and purchases loan through its Correspondent Program. The Wholesale Division originates loans through a network of independent mortgage brokers, the Retail Division solicits loans directly from prospective borrowers and the Correspondent Program purchases loans from mortgage banking and financial institution correspondents that originate, underwrite and fund the loans prior to their sale to the Company. All of the Company's loans are secured by first or second mortgages on one-to-four single family residences. Wholesale Division. The Wholesale Division funded $159.1 million in loans, or 63.5% of the Company's total loan production, during the first quarter of 1997. As of May 31, 1997, the Wholesale Division was operating through three regional operating centers located in Southern California, Northern California and Chicago and through 23 additional sales offices located in Arizona, California (3), Colorado, Florida, Georgia, Hawaii, Indiana, Minnesota, Missouri (3), Nevada, New Mexico, Ohio (3), Pennsylvania (2), Texas (2) and Washington, 43 employing a total of 42 account executives. As of March 31, 1997, the Company had approximately 950 approved mortgage brokers and in the first quarter of 1997 originated loans through approximately 500 brokers. During the first quarter of 1997, New Century's 10 largest producing brokers originated approximately 17% of the Company's loans, with the largest broker accounting for approximately 4%. In wholesale originations, the broker's role is to identify the applicant, assist in completing the loan application form, gather necessary information and documents and serve as 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 complete loan applications and maintain contact with borrowers, originating loans through the Wholesale Division allows the Company to increase its loan volume without incurring the higher marketing, labor and other overhead costs associated with increased retail originations. Loan applications generally are submitted by mortgage brokers to an account executive in one of the Company's sales offices. The application is then forwarded to the closest regional operating center where the loan is logged-in for 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. An account manager and the originating New Century account executive 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 15-20 days after approval of the loan application. The following table sets forth selected information relating to wholesale loan originations excluding loans purchased through the Company's Correspondent Program during the periods shown:
FOR THE QUARTER ENDED -------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, 1996 1996 1996 1996 1997 --------- -------- ------------- ------------ --------- Principal balance (in thousands)............. $2,292 $45,412 $104,392 $135,896 $159,075 Average principal balance per loan (in thousands)............. $ 115 $ 123 $ 109 $ 108 $ 107 Combined weighted average initial loan- to-value ratio......... 71.0% 71.8% 72.0% 70.8% 70.5% Percent of first mortgage loans......... 93.5% 98.0% 97.7% 98.5% 99.4% Property securing loans: Owner occupied......... 95.0% 88.3% 86.9% 88.7% 87.7% Non-owner occupied..... 5.0% 11.7% 13.1% 11.3% 12.3% Weighted average interest rate: Fixed-rate............. 9.8% 10.2% 10.8% 10.5% 10.0% ARMs................... 8.3% 9.4% 9.2% 9.4% 9.4% Margin--ARMs........... 5.7% 6.9% 7.0% 7.1% 7.1%
Retail Division. During the first quarter of 1997, the Company originated $74.4 million in loans, or 29.7% of its total loan production, through its Retail Division. As of May 31, 1997, the Retail Division employed 134 retail loan officers, located in 40 sales offices in Arizona (3), California (15), Colorado, Hawaii (2), Illinois (2), Kansas, Minnesota (2), Missouri (3), Nevada, New Mexico, Ohio (3), Oregon, Pennsylvania (2), Utah, Washington and Wisconsin. By creating a direct relationship with the borrower, retail lending provides a more sustainable loan origination franchise and greater control over the lending process while generating loan origination fees to offset the higher costs of retail lending, which contributes to profitability and cash flow. In connection with the Company's direct mail activities, the Company's database screening activities are directed by a centralized staff who create a targeted mailing list for each geographic market and oversee the completion of mailings by a third party mailing vendor. All calls or written inquiries from potential borrowers 44 which result from the mailings are received at a centralized location, where the Company's telemarketing staff interviews the borrower, makes a preliminary evaluation of the borrower's credit and the value of the collateral property and refers qualified leads to loan officers in the retail sales office closest to the borrower. Under the loans-by-mail program, the qualified leads are referred to a centralized staff of loan officers who utilize document and signing services to exchange documentation with the borrower. The following table sets forth selected information relating to retail loan originations during the periods shown:
FOR THE QUARTER ENDED ------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, 1996 1996 1996 1996 1997 --------- -------- ------------- ------------ --------- Principal balance (in thousands)............. $2,001 $7,120 $18,956 $38,410 $74,384 Average principal balance per loan (in thousands)............. $ 105 $ 82 $ 81 $ 95 $ 108 Combined weighted average initial loan- to-value ratio......... 74.2% 70.0% 71.8% 72.3% 72.4% Percent of first mortgage loans......... 100.0% 93.6% 91.9% 94.6% 95.7% Property securing loans: Owner occupied......... 100.0% 92.0% 92.7% 93.9% 90.0% Non-owner occupied..... -- 8.0% 7.3% 6.1% 10.0% Weighted average interest rates: Fixed-rate............. 9.7% 10.4% 10.3% 10.0% 9.7% ARMs................... 9.7% 9.2% 9.3% 8.9% 8.4% Margin--ARMs........... 5.6% 6.6% 6.8% 7.0% 7.0%
Correspondent Program. The Company began purchasing closed loans from other mortgage bankers and financial institutions through its Correspondent Program in late 1996. In early 1997, the Company expanded this program to include the purchase of small, bulk packages of loans from correspondents. Correspondent purchases totaled $17.1 million, or 6.8%, of the Company's total loan production during the first quarter of 1997. Purchasing closed loans through the Correspondent Program allows the Company to supplement its own loan production with limited overhead expenses. Loans purchased by the Company under the Correspondent Program must be originated in accordance with the Company's underwriting guidelines and all such loans are currently re- underwritten by the Company prior to purchase. By focusing on the purchase of individual loans on a flow basis and small bulk purchases, the Company believes that its Correspondent Program complements its existing marketing efforts to brokers and enables the Company to increase loan production on a cost-effective basis. The Company plans to expand its Correspondent Program through marketing efforts by its broker account executives and through targeted marketing to selected financial institutions and mortgage bankers. The Company reviews an application for approval from each lender seeking to participate in the Correspondent Program. The Company analyzes the mortgage banker's underwriting guidelines and financial condition, including its licenses and financial statements. New Century requires each mortgage banker to enter into a purchase and sale agreement with customary representations and warranties regarding the loans such mortgage banker will sell to the Company, thereby providing the Company with representations and warranties that are comparable to those given by the Company to its loan purchasers. PRODUCT TYPES General. The Company offers both fixed-rate and adjustable-rate loans, as well as loans with an interest rate that is initially fixed for a period of time and subsequently converts to an adjustable-rate. Most of the ARMs originated by the Company are offered at a low initial interest 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. There can be no assurance, however, that the interest rate on these loans will reach the fully indexed rate if the loans are pre-paid or in cases of foreclosure. The Company's borrowers fall into five subprime risk classifications and products are available at different interest rates and with different origination and application points and fees depending on the particular 45 borrower's risk classification (see "Business--Underwriting Standards"). Borrowers may choose to increase or decrease their interest rate through the payment of different levels of origination fees and many of the Company's fixed-rate borrowers, in particular, choose to "buy down" their interest rate through the payment of additional origination fees. The Company's maximum loan amounts are generally $500,000 with a loan-to-value ratio of up to 85%. The Company does, however, offer larger 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+." Loans originated or purchased by the Company in 1996 had an average loan amount of approximately $105,666 and an average loan-to-value ratio of approximately 71.5%. 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, the Company generally imposes a prepayment penalty on the borrower. Approximately 66.2% of the loans the Company originated or purchased during the first quarter of 1997 provided for the payment by the borrower of a prepayment charge in limited circumstances on certain full or partial prepayments. Alternative Mortgage Products Division. The Company frequently reviews its products and pricing for competitiveness and introduces new products to meet the needs of its borrowers, brokers and correspondents. The Company recently commenced loan originations through its Alternative Mortgage Products Division which offers loans to borrowers meeting conventional mortgage lending standards and also offers a broad selection of second mortgage products, including loans with loan-to-value ratios of up to 125% for borrowers with good credit histories. The Alternative Mortgage Products Division maintains separate underwriting and loan processing staffs and the Company expects that the mortgage loans originated through its Alternative Mortgage Products Division will be sold by the Company on a broker or correspondent basis, rather than through securitizations or servicing-retained sales. The Company is evaluating the introduction of certain other categories of consumer loans to its product offerings, thereby expanding its consumer base and diversifying its product mix. UNDERWRITING STANDARDS New Century originates or purchases its mortgage loans in accordance with the underwriting criteria (the "Underwriting Guidelines") described below. The loans the Company originates or purchases generally do not satisfy conventional underwriting standards, such as those utilized by the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"); therefore, the Company's 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 Underwriting Guidelines are intended to evaluate the credit history of the potential borrower, the capacity of the borrower to repay the proposed loan, the value of the security property and the adequacy of such property as collateral for the proposed loan. Based upon the underwriter's review of the 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 utilizes only experienced underwriters and the Company's chief credit officer (the "Chief Credit Officer") must approve the hiring of all underwriters, including those located in the regional operations centers. The Company's underwriters are required to have had either substantial subprime underwriting experience with a consumer finance company or other subprime lender or substantial experience with the Company in other aspects of the subprime mortgage finance industry before becoming part of the Company's underwriting department. As of March 31, 1997, the Company employed 17 underwriters with an average of 10 years of subprime 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. In addition, the Company believes that by effectively employing its training program, its underwriters efficiently review and evaluate loan packages while understanding and adhering to the Company's Underwriting Guidelines. 46 Underwriters are not given approval authority until their work has been reviewed by the Chief Credit Officer for a period of time and deemed satisfactory. Thereafter, the Chief Credit Officer re-evaluates the authority levels of all underwriting personnel on an ongoing basis. All approved loans currently require a second underwriting approval. The Company believes that these controls and procedures constitute an important part of the Company's infrastructure and commitment to loan quality. On a case-by-case basis, exceptions to the Underwriting Guidelines are made where compensating factors exist. For example, it may be determined that an applicant 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, among others: low loan-to-value; a maximum of one 30-day late payment on all mortgage loans during the last 12 months; stable employment or ownership of the current residence for five or more years; and above average physical condition of the property securing the loan. An upgrade or exception may also be allowed if the applicant places a down payment through escrow of at least 20% of the purchase price of the mortgaged property, or if the new loan reduces the applicant's monthly aggregate mortgage payment by 25% or more. Accordingly, certain mortgagors may qualify in a more favorable risk category than would apply in the absence of such compensating factors. In limited circumstances, the underwriters may exercise judgment to make exceptions to the Underwriting Guidelines where no compensating factors exist. Each loan applicant completes an application that includes information with respect to the applicant's liabilities, income, credit history, employment history and personal information. The Underwriting Guidelines require a credit report on each applicant from a credit reporting company. The report typically contains information relating to such matters as credit history with local and national merchants and lenders, installment debt payments and any record of defaults, bankruptcies, repossessions or judgments. All mortgaged properties are appraised by qualified independent appraisers prior to funding of the loan. Such appraisers inspect and appraise the subject property and verify that it is in acceptable condition. The Company requires that all mortgaged properties be in at least "average" condition. Following each appraisal, the appraiser prepares a report that includes a market value analysis based on recent sales of comparable homes in the area and, when deemed appropriate, replacement cost analysis based on the current cost of constructing a similar home. 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 are generally on forms acceptable to FNMA and FHLMC. The Underwriting Guidelines require a review of the appraisal by a qualified employee of the Company or by a qualified appraiser retained by the Company. The Underwriting Guidelines include three levels of applicant documentation requirements, referred to as the "Full Documentation," "Limited 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 loans, (ii) the initial interest rate on loans which provide for two or three years of fixed payments before the initial interest rate adjustment or (iii) one percent above the initial interest rate on other adjustable-rate loans. The Underwriting Guidelines require that 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 a review of the appraisal, currently supports the outstanding loan balance. In general, the maximum loan amount for mortgage loans originated under the programs is $500,000; however, larger loans may be approved on a case-by-case basis. The Underwriting Guidelines permit one-to- four-family residential property 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 47 history, repayment ability and debt service-to-income ratio, as well as the type and use of the property. With respect to mortgage loans secured by mortgaged properties acquired by a borrower under a "lease option purchase," the loan-to-value of the related mortgage loan is based on the lower of the appraised value at the time of origination of such mortgage loan or the sale price of the related mortgaged property if the "lease option purchase price" was set less than six months prior to origination. If the "lease option purchase price" was set six months or more prior to origination, the loan-to- value is based on the appraised value at the time of origination. Under the Full Documentation program, applicants generally are required to submit two written forms of verification of stable income for at least twelve months. Under the Limited Documentation program, one such form of verification is required for twelve months. Under the Stated Income Documentation program, an applicant may be qualified based upon monthly income as stated on the mortgage loan application if the applicant meets certain criteria. All 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 70%. No such verification is required under any of the programs where the loan-to-value ratio is less than 70%. 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 mortgage loan and, therefore, are subjected to more stringent underwriting criteria and more limited loan-to-value ratios and are charged higher interest rates and loan origination fees. 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 loans generally mitigates these risks. 48 UNDERWRITING GUIDELINES(1)
A+ RISK A- RISK B RISK C RISK C- RISK ------------ ------------ ------------ ------------ ------------ Existing mortgage history................ Maximum one Maximum Maximum four Unlimited Unlimited 30-day late three 30-day 30-day late number of 30- and 60- payment and late payments and 30- and 60- day late no 60-day payments and one 60-day day late payments and late no 60-day late payment payments and a maximum of payments late within last maximum of two 90-day within last payments 12 months if two 90-day late 12 months; within last LTV is 75% late payments and must be 12 months if or less; no payments one 120-day current at LTV is 75% 60-day late within last late payment application or less; two payments if 12 months if if LTV is time 30-day late LTV is over LTV is 70% more than payments in 75%; not or less; 65%; if LTV last 12 required to maximum two is 65% or months if be current 60-day late less, there LTV is over at payments or may be a 75%; not application one 90-day current required to time late payment notice of be current if LTV is default; not at over 70%; required to application not required be current time to be at current at application application time time Other credit............ No open Minor Prior Significant Significant collection derogatory defaults prior defaults accounts or items acceptable; defaults acceptable; charge-offs allowed; not not more acceptable; open charge- open after more than than $1,000 generally, offs or funding $500 in open in open not more collection collection collection than $2,500 amounts may accounts or accounts or in open remain open charge-offs charge-offs collection after open after open after accounts or funding funding funding charge-offs open after funding Bankruptcy filings...... Generally, Generally, Generally, Generally, Bankruptcy, no no no no notice of bankruptcy bankruptcy bankruptcy bankruptcy sale filing, or notice of or notice of or notice of or notice of notice of default default default default default filings in filings in filings in filings in filing or last 3 years last 3 years last 2 years last 18 foreclosure months permitted on a case by case basis Debt service to income 42-45% 55% or less 60% or less 60% or less 65% or less ratio.................. Maximum loan-to-value ratio:(2) Owner occupied: single family.......... 85-90% 75-85% 70-80% 70-75% 70% Owner occupied: condo/two-to-four unit. 80% 70-75% 65-70% 65-70% 65% Non-owner occupied..... 75% 70-75% 65-75% 65-70% 60-65%
- -------- (1) The letter grades applied to each risk classification reflect the Company's internal standards and do not necessarily correspond to the classifications used by other mortgage lenders. "LTV" means loan-to-value ratio. (2) The maximum LTV set forth in the table is for borrowers providing full documentation. The LTV is reduced 5% for limited documentation and 10% for stated income applications, if applicable. New Century 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. The Company recently introduced a "mortgage only" underwriting program for borrowers in the two highest credit grade categories. Underwriting under the mortgage only program focuses primarily on the borrower's mortgage payment history and places less emphasis on consumer credit and other aspects of the borrower's credit history. In addition, the Company adopts underwriting guidelines appropriate to new loan products, such as those offered by the Alternative Mortgage Products Division. The conventional mortgage loans and second mortgage loans, including 125% loan-to-value loans, offered by the Alternative Mortgage Products 49 Division are underwritten to the standards of the intended buyers thereof and utilize information not considered by the Company in its standard Underwriting Guidelines, including credit scores. In addition, the Alternative Mortgage Products Division maintains separate underwriting and loan processing staffs. New Century commenced receiving applications for mortgage loans under its regular lending program in February 1996 and during 1996 sold all of its loans on a whole loan, servicing-released basis. Accordingly, the Company (whether as an originator or purchaser of mortgage loans) does not currently have representative historical delinquency, bankruptcy, foreclosure or default experience that may be referred to for purposes of estimating the future delinquency and loss experience of its mortgage loans. However, the Company recently established reporting systems to track such data for the loans included in its February and May 1997 securitizations and expects to have this data in the future with respect to the loans the Company securitizes. LOAN PRODUCTION BY BORROWER RISK CLASSIFICATION The following table sets forth information concerning the Company's principal balance of fixed rate and adjustable rate loan production by borrower risk classification for the periods shown:
FOR THE QUARTER ENDED FOR THE FOR THE --------------------------------------------- YEAR ENDED QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1996 1996 1996 1996 1997 --------- -------- ------------- ------------ ------------ ------------- A+ Risk Grade: Percent of total purchases and origination........... 25.1% 20.2% 23.4% 19.3% 21.0% 20.2% Combined weighted average initial loan- to-value ratio........ 75.7 74.6 73.5 72.7 73.3 73.0 Weighted average interest rate: Fixed-rate............. 9.9 9.8 9.8 9.9 9.8 9.5 ARMs................... 8.5 8.7 8.2 8.6 8.4 8.7 Margin-- ARMs.......... 5.8 6.4 6.4 6.7 6.5 6.8 A- Risk Grade: Percent of total purchases and origination........... 39.8% 35.9% 32.4% 32.8% 33.2% 36.1% Combined weighted average initial loan- to-value ratio........ 74.3 72.9 73.6 73.2 73.3 72.4 Weighted average interest rate: Fixed-rate............. 9.5 10.1 10.4 9.9 10.1 9.6 ARMs................... 9.4 9.0 9.0 8.8 8.9 8.7 Margin--ARMs........... 5.9 6.7 6.8 6.9 6.8 6.8 B Risk Grade: Percent of total purchases and origination........... 26.7% 21.0% 22.0% 24.1% 22.9% 23.2% Combined weighted average initial loan- to-value ratio........ 65.3 69.7 73.4 71.9 72.0 71.2 Weighted average interest rate: Fixed-rate............. 10.1 10.4 10.7 10.5 10.5 10.3 ARMs................... 9.2 9.5 9.3 9.4 9.4 9.4 Margin--ARMs........... 5.3 7.0 7.0 7.2 7.1 7.2 C Risk Grade: Percent of total purchases and origination........... 4.1% 14.8% 13.9% 14.3% 14.1% 12.1% Combined weighted average initial loan- to-value ratio........ 80.0 70.1 69.0 68.1 68.8 68.6 Weighted average interest rate: Fixed-rate............. -- 11.5 12.4 11.0 11.6 10.8 ARMs................... 8.3 9.7 10.2 10.3 10.2 10.0 Margin--ARMs........... 6.0 7.1 7.5 7.5 7.4 7.4 C- Risk Grade: Percent of total purchases and origination........... 4.3% 8.1% 8.3% 9.5% 8.8% 8.4% Combined weighted average initial loan- to-value ratio........ 75.0 65.4 62.2 63.3 63.3 62.3 Weighted average interest rate: Fixed-rate............. -- 10.8 12.2 12.3 11.9 11.4 ARMs................... 9.4 11.5 11.1 11.1 11.1 10.6 Margin--ARMs........... 5.0 7.5 7.6 7.7 7.6 7.5
50 GEOGRAPHIC DISTRIBUTION The following table sets forth aggregate dollar amounts (in thousands) and the percentage of all loans originated or purchased by the Company by state for the periods shown:
FOR THE QUARTER ENDED FOR THE FOR THE ----------------------------------------------------------- YEAR ENDED QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, DECEMBER 31, MARCH 31, 1996 1996 1996 1996 1996 1997 ------------ ------------- -------------- -------------- -------------- -------------- $ % $ % $ % $ % $ % $ % ------ ----- ------- ----- -------- ----- -------- ----- -------- ----- -------- ----- California.............. $4,122 96.0% $44,205 84.1% $ 75,565 61.3% $ 98,952 56.0% $222,844 62.4% $124,698 49.8% Illinois................ -- -- -- -- 23,250 18.8% 32,671 18.5% 55,921 15.7% 44,674 17.8% Ohio.................... -- -- -- -- 2,990 2.4% 10,814 6.1% 13,804 3.9% 13,190 5.3% Arizona................. -- -- 1,717 3.3% 5,315 4.3% 11,120 6.3% 18,152 5.1% 15,451 6.2% Colorado................ 101 2.4% 3,970 7.6% 5,558 4.5% 6,790 3.8% 16,419 4.6% 12,980 5.2% Utah.................... 70 1.6% 1,726 3.3% 3,394 2.8% 6,176 3.5% 11,366 3.2% 9,316 3.7% Other................... -- -- 914 1.7% 7,276 5.9% 10,243 5.8% 18,433 5.1% 30,261 12.0% ------ ----- ------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total.................. $4,293 100.0% $52,532 100.0% $123,348 100.0% $176,766 100.0% $356,939 100.0% $250,570 100.0%
LOAN SALES AND SECURITIZATIONS The Company currently intends to securitize a majority of the loans originated or purchased by the Company and to sell a substantial portion of its loans in bulk sales to institutional purchasers of whole loans. Whole Loan Sales. Until February 1997, the Company followed a strategy of selling for cash all of its loan originations and purchases in the secondary market through loan sales in which the Company disposes of its entire economic interest in the loans (including servicing rights) for a cash price that represents a premium over the principal balance of the loans sold. During 1996, the Company sold $298.7 million of loans through whole loan sales transactions at a weighted average sales price equal to 105.0% of the original principal balance of the loans sold. The Company did not sell any loans through securitization during this period; however, substantially all of the loans sold during this period were ultimately securitized by the purchasers thereof. The Company seeks to maximize its premium on whole loan sale revenue by closely monitoring institutional purchasers' requirements and focusing on originating or purchasing the types of loans that meet those requirements and for which institutional purchasers tend to pay higher premiums. During 1996, the Company sold loans to seven institutional purchasers, two of which purchased approximately 83.6% of the loans sold by the Company. Whole loan sales are made on a non-recourse basis pursuant to a purchase agreement containing customary representations and warranties by the Company regarding the underwriting criteria applied by the Company and the origination process. The Company, therefore, may be required to 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, unless other arrangements are made between the Company and the purchaser. 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. See "Risk Factors--Dependence on Whole Loan Sales for Future Earnings." Securitizations. The Company completed the sale of loans through securitization in February and May 1997 and anticipates that significant revenue from gain on the sale of loans will be generated from the sale of mortgage backed securities created through securitization transactions in future periods. In a securitization, the Company sells loans that it has originated or purchased to a trust for a cash purchase price and an interest in the loans securitized called residual interests. The cash purchase price is raised through an offering of senior certificates by the trust. Following the securitization, purchasers of senior certificates receive the principal collected, including prepayments, and the investor pass-through interest rate on the principal balance, while the Company receives the cash flows from the residual interests, after payment of servicing fees, guarantor fees and 51 other trust expenses and provided the specified over-collateralization requirements are met. The Company recognizes gain on sale of the loans, which represents the excess of the estimated fair value of the residual interests, less closing and underwriting costs, over the carrying value of the loans sold, in the fiscal quarter in which such loans are sold. Concurrent with recognizing such gain on sale, the Company records the residual interests as assets on its balance sheet. The recorded values of these residual interests are amortized as distributions are received from the trust holding the respective loan pool. With respect to the aforementioned securitizations, the Company arranged for the related trusts to purchase credit enhancements for the senior certificates in the related trusts in the form of insurance policies provided by one AAA/Aaa rated monoline insurance company and, as a result, the senior certificates in each trust received a rating of "AAA" from Standard & Poor's Ratings Services and "Aaa" from Moody's Investors Service, Inc. There are no assurances that actual performance of any of the Company's securitized loan portfolios will be consistent with the Company's estimates and assumptions. To the extent that actual prepayment speeds, losses or market discount rates materially differ from the Company's estimates, the estimated value of its residuals may increase or decrease, which may have a material impact on the Company's results of operations, financial condition and liquidity. See "Risk Factors--Dependence on Securitizations for Future Earnings,--Residual Interests in Securitizations,--Liquidity; Negative Cash Flow." LOAN SERVICING AND DELINQUENCIES Servicing. The Company subcontracts with Advanta, a third party subservicer, to conduct its servicing operations, which has allowed the Company to increase the volume of its loan originations and purchases without incurring related overhead investments in servicing operations. During the period from the date the Company originates or purchases loans and the date the Company sells these loans, which generally ranges from thirty to ninety days (the "Interim Period"), the Company is responsible for servicing the loans it originates and purchases. In some cases, whole loan purchasers may request that the Company, through Advanta, continue to service the loans purchased for an interim period following the sale. In April 1996, the Company entered into the Advanta Interim Agreement to service loans during the Interim Period, including any interim period following the sale of the loans. In addition, Advanta currently services or subservices loans sold through each public securitization of the Company's loans pursuant to the Advanta Securitization Agreement. According to Advanta's Annual Report on Form 10-K for the year ended December 31, 1996, Advanta's servicing portfolio at December 31, 1996 was approximately $6.4 billion in loans. Servicing includes collecting and remitting loan payments, making required advances, accounting for principal and interest, holding escrow or impound funds for payment of taxes and insurance, and, if applicable, contacting delinquent borrowers and supervising foreclosures and property dispositions in the event of unremedied defaults in accordance with the Company's guidelines. Advanta Interim Agreement. Under the Advanta Interim Agreement, New Century is obligated to pay Advanta an annual servicing fee on the declining principal balance of each loan serviced and a set-up fee for each loan delivered to Advanta for servicing, and to reimburse Advanta for certain customary costs and expenses. Such expenses include costs for the preservation, restoration and protection of the mortgaged properties secured by the Company's loans, any enforcement or judicial proceedings, including foreclosures, related to such mortgaged properties, the management and liquidation of the mortgaged properties if they are acquired in satisfaction of a defaulted mortgage loan, the maintenance of hazard insurance and the payment of property taxes and mortgage insurance premiums. If claims are not made or paid under applicable insurance policies or if coverage thereunder has ceased, the Company will suffer a loss to the extent that proceeds from liquidation of the mortgaged property, after reimbursement of Advanta's expenses in the sale, are less than the principal balance of the related mortgage loan. The Company may terminate the Advanta Interim Agreement upon the occurrence of one or more of the events specified in the Advanta Interim Agreement generally relating to Advanta's proper and timely 52 performance of its duties and obligations under such agreement. Either the Company or Advanta may terminate the Advanta Interim Agreement without cause upon 90 days' prior written notice to the other party; provided, that if the Company terminates such agreement without cause, the Company must pay Advanta all reasonable costs associated with the transfer of the Company's loans to another servicer. In addition, if the Company transfers servicing of any amount of mortgage loans being serviced by Advanta to another servicer, the Company must pay Advanta up to $50 per mortgage loan transferred. As is customary in the mortgage loan servicing industry, Advanta is entitled to retain any late payment charges, penalties and assumption fees collected in connection with the mortgage loans. Advanta also receives any benefit derived from interest earned on collected principal and interest payments between the date of collection and the date of remittance to the Company and from interest earned on escrow funds. However, the Company retains the benefit of any prepayment penalties collected on the loans. Under the Advanta Interim Agreement, Advanta is required to remit to the Company no later than the 20th day of each month all principal and interest collected from borrowers during the prior monthly reporting period. Advanta Securitization Agreement. Under the Advanta Securitization Agreement, the Company is obligated to pay Advanta a monthly servicing fee on the declining principal balance of each loan serviced and a set-up fee for each loan delivered to Advanta for servicing. Advanta is required to pay all expenses related to the performance of its duties under the Advanta Securitization Agreement. Further, Advanta is required to make advances of taxes and required insurance premiums that are not collected from borrowers with respect to any mortgage loan, only if it determines that such advances are recoverable from the mortgagor, insurance proceeds or other sources with respect to such mortgage loan. If such advances are made, Advanta generally will be reimbursed prior to the Company receiving the remaining proceeds. Advanta also will be entitled to reimbursement by the Company for expenses incurred by it in connection with the liquidation of defaulted mortgage loans and in connection with the restoration of mortgaged property. If claims are not made or paid under applicable insurance policies or if coverage thereunder has ceased, the Company will suffer a loss to the extent that the proceeds from liquidation of the mortgaged property, after reimbursement of Advanta's expenses in the sale, are less than the principal balance of the related mortgage loan. Under the Advanta Securitization Agreement, if the Company terminates such agreement without cause or transfers the servicing of any amount of the mortgage loans serviced by Advanta to another servicer, the Company must pay Advanta certain penalties, fees and costs. Depending on the size of the Company's loan portfolio serviced by Advanta at any point in time, the termination or transfer penalties that the Company would be obligated to pay Advanta may be substantial. With respect to mortgage loans securitized by the Company, the Company will not be able to terminate the servicer without the approval of the trustee for such securitization. As is customary in the mortgage loan servicing industry, Advanta is entitled to retain any late payment charges, penalties and assumption fees collected in connection with the mortgage loans, net of pre-payment penalties, which accrue to the Company. Advanta receives any benefit derived from interest earned on collected principal and interest payments between the date of collection and the date of remittance to the Company and from interest earned on tax and insurance impound funds. Under the Advanta Securitization Agreement, Advanta is generally required to remit all principal and interest scheduled to be collected from borrowers during the prior monthly reporting period generally no later than the 18th day of each month. The Company currently outsources its servicing operations to Advanta because this arrangement has allowed the Company to increase the volume of its loan originations and purchases without incurring related overhead investments in servicing operations. The Company intends to develop its own servicing capability in order to manage the relationship with its borrowers and oversee the performance of its loans more directly. See "Recent Developments--Comerica Investment and Strategic Relationship." Delinquencies and Foreclosures. Loans originated or purchased by the Company are secured by mortgages, deeds of trust, security deeds or deeds to secure debt, depending upon the prevailing practice in the state in which the property securing the loan is located. Depending on local law, foreclosure is effected by 53 judicial action or nonjudicial sale, and is subject to various notice and filing requirements. In general, the borrower, or any person having a junior encumbrance on the real estate, may cure a monetary default by paying the entire amount in arrears plus other designated costs and expenses incurred in enforcing the obligation during a statutorily prescribed reinstatement period. Generally, state law controls the amount of foreclosure expenses and costs, including attorneys fees, which may be recovered by a lender. After the reinstatement period has expired without the default having been cured, the borrower or junior lienholder no longer has the right to reinstate the loan and may be required to pay the loan in full to prevent the scheduled foreclosure sale. Where a loan has not yet been sold or securitized, the Company will generally allow a borrower to reinstate the loan up to the date of foreclosure sale. Although foreclosure sales are typically public sales, third-party purchasers rarely bid in excess of the lender's lien because of the difficulty of determining the exact status of title to the property, the possible deterioration of the property during the foreclosure proceedings and a requirement that the purchaser pay for the property in cash or by cashier's check. Thus, the foreclosing lender often purchases the property from the trustee or referee for an amount equal to the sum of the principal amount outstanding under the loan, accrued and unpaid interest and the expenses of foreclosure. Depending on market conditions, the ultimate proceeds of the sale may not equal the lender's investment in the property. New Century commenced receiving applications for mortgage loans under its regular lending program in February 1996 and during 1996 sold all of its loans on a whole loan, servicing-released basis. Accordingly, the Company (whether as an originator or purchaser of mortgage loans) does not have representative historical delinquency, bankruptcy, foreclosure or default experience that may be referred to for purposes of estimating the future delinquency and loss experience of its mortgage loans. Likewise, the Company does not have meaningful delinquency, loss and prepayment data with respect to the loans included in the Company's first securitization, as these loans have been outstanding for only a short period of time. 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 Company under its warehouse financing facilities or for securities issued in its securitizations. The spread can be adversely affected because of interest rate increases during the period from the date the loans are originated or purchased until the closing of the sale or securitization of such loans. The Company from time to time may use various hedging strategies to provide a level of protection against interest rate risks on its fixed-rate mortgage loans. These strategies may include selling short and selling forward United States Treasury securities and prefunding loan originations in its securitizations, as well as 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 Company's management determines the nature and quantity of hedging transactions based on various factors, including market conditions and the expected volume of mortgage loan originations and purchases. While the Company believes its hedging strategies are cost- effective and provide some protection against interest rate risks, no hedging strategy can completely protect the Company from such risks. Further, the Company does not believe that hedging against the interest rate risks associated with adjustable-rate mortgages is cost effective, and the Company does not utilize the hedging strategies described above with respect to its adjustable-rate loans, which constitute the majority of the Company's loan production. COMPETITION The Company faces intense competition in the business of originating, purchasing 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 competitors are substantially larger and have considerably greater financial, technical and marketing resources than the Company. In addition, many financial services organizations that are much 54 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 subprime 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 securitizations. 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. The Company believes its competitive strengths include: (i) the experience of its senior executive team and underwriting personnel; (ii) providing a high level of service to brokers and their customers; (iii) offering competitive loan programs for borrowers whose needs are not met by conventional mortgage lenders; (iv) the Company's high-volume targeted direct mail marketing program and database screening methodology; and (v) its performance-based compensation structure which allows the Company to attract, retain and motivate qualified personnel. 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 and regulations 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 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 of the Company 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. As of May 31, 1997, the Company was licensed or exempt from licensing requirements by the relevant state banking or consumer credit agencies to originate first mortgages in 41 states and second mortgages in 36 states. 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. 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 55 $400, or (ii) an annual percentage rate of more than ten percentage 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 did not originate or purchase Covered Loans in 1996, but the Company commenced originating and purchasing Covered Loans during the first quarter of 1997. 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. The Real Estate Settlement Procedures Act 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 the Department of Housing and Urban Development pursuant to the Home Mortgage Disclosure Act, which requires the collection and reporting of statistical data concerning loan transactions. 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 April 30, 1997, the Company employed 491 full-time employees and 3 part- time employees. None of the Company's employees is subject to a collective bargaining agreement. The Company believes that its relations with its employees are satisfactory. PROPERTIES The Company's executive and administrative offices were located in Newport Beach, California until June 1997, and consisted of approximately 9,300 square feet. The leases on the premises expire December 10, 1998, subject to termination in December 1997. The current annual rent for these offices is approximately $140,000. The Company relocated its executive and administrative offices in June 1997 to Irvine, California. The expiration date for the lease on the new premises is June 2002 and the monthly rent is approximately $75,000 through November 1997 for 41,092 square feet and from $110,000 to $122,000 thereafter for 60,189 square feet. The Company's relocation of its executive and administrative offices may cause a temporary short-term disruption in its operations; however, the Company believes that any such disruption will not have a material adverse effect on its results of operations or financial condition. 56 The Company also leases space for its sales offices. As of March 31, 1997, these facilities had an annual aggregate base rental of approximately $990,000 and the sales offices ranged in size from 100 to 4,968 square feet with lease terms typically ranging from one to five years. As of March 31, 1997, annual base rents for the sales offices ranged from approximately $3,600 to $82,000. In general, the terms of these leases vary as to duration and rent escalation provisions and the leases expire between June 1997 and May 2002 and provide for rent escalations dependent upon either increases in the lessors' operating expenses or fluctuations in the consumer price index in the relevant geographical area. LEGAL PROCEEDINGS The Company occasionally becomes involved in litigation arising in the normal course of business. Management believes that any liability with respect to such legal actions, individually or in the aggregate, will not have a material adverse effect on the Company's financial position or results of operations. 57 MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES The Board of Directors is divided into three classes: Class I, Class II and Class III. After each director's initial term, each director serves for a term ending the third annual meeting after which such director is elected and until such director's successor is elected. The terms of office of directors in Class I, Class II and Class III end after the annual meetings of stockholders of the Company in 1998, 1999 and 2000, respectively. Messrs. Gotschall, Ryan and Smith are Class I directors, Messrs. Chu, Morrice and Sachs are Class II directors and Messrs. Bentley, Cole and Holder are Class III directors. The following table sets forth the name, age and position with the Company of each person who is an executive officer, director or key employee of the Company.
NAME AGE POSITION ---- --- -------- Directors and Executive - ----------------------- Officers: -------- Robert K. Cole........... 50 Chairman of the Board, Chief Executive Officer, Director Brad A. Morrice.......... 40 Vice Chairman, President, General Counsel, Secretary, Director Edward F. Gotschall...... 42 Vice Chairman, Chief Operating Officer-- Finance/Administration, Director Steven G. Holder......... 40 Vice Chairman, Chief Operating Officer--Loan Production/Operations, Director John C. Bentley(1)(2).... 37 Director Sherman I. Chu(2)........ 32 Director Harlan W. Smith(3)....... 63 Director Martin F. Ryan........... 59 Director Michael M. Sachs(1)(2)... 56 Director Future Director: - --------------- Fredric J. Forster(4).... 53 Future Director Key Employees: - ------------- Patrick J. Flanagan...... 32 Director, Executive Vice President and Chief Operating Officer, New Century Mortgage (5) Shahid S. Asghar......... 34 Director, Senior Vice President--Wholesale Lending, New Century Mortgage (5) Paul L. Rigdon........... 36 Director, Senior Vice President--Retail Lending, New Century Mortgage (5)
- -------- (1) Member of Compensation Committee. (2) Member of Audit Committee. (3) Upon the completion of the Offering, Mr. Smith shall resign from the Board. (4) Mr. Forster shall become a director of the Company and a member of the Compensation Committee upon the closing of the Offering and has agreed to be named as such in the Prospectus. (5) New Century Mortgage Corporation ("New Century Mortgage") is a wholly- owned subsidiary of the Company. ROBERT K. COLE has been the Chairman of the Board and Chief Executive Officer of the Company since December 1995 and a director of the Company since November 1995. Mr. Cole also serves on the Board of Directors of New Century Mortgage. From February 1994 to March 1995, he was the President and Chief Operating Officer--Finance of Plaza Home Mortgage Corporation ("Plaza Home Mortgage"), a publicly-traded savings and loan holding company specializing in the origination and servicing of residential mortgage loans. In addition, Mr. Cole served as a director of Option One Mortgage Corporation ("Option One"), a subsidiary of 58 Plaza Home Mortgage specializing in the origination, sale and servicing of subprime mortgage loans. From June 1990 to January 1994, Mr. Cole was the President of Triple Five, Inc., an international real estate development company. Previously, Mr. Cole was the President of operating subsidiaries of NBD Bancorp and Public Storage, Inc. Mr. Cole received a Masters of Business Administration degree from Wayne State University. BRAD A. MORRICE has been Vice Chairman of the Company since December 1996, General Counsel of the Company since December 1995 and President, Secretary and a director of the Company since November 1995. Mr. Morrice also serves as Co-Chairman of the Board and Chief Executive Officer of New Century Mortgage. From February 1994 to March 1995, he was the President and Chief Operating Officer--Administration of Plaza Home Mortgage, after serving as its Executive Vice President, Chief Administrative Officer since February 1993. In addition, Mr. Morrice served as General Counsel and a director of Option One. From August 1990 to January 1993, Mr. Morrice was a partner in the law firm of King, Purtich & Morrice, where he specialized in the legal representation of mortgage banking companies. Mr. Morrice previously practiced law at the firms of Fried, King, Holmes & August and Manatt, Phelps & Phillips. He received his law degree from the University of California, Berkeley (Boalt Hall) and a Masters of Business Administration degree from Stanford University. EDWARD F. GOTSCHALL has been Vice Chairman of the Company since December 1996, Chief Operating Officer--Finance/Administration of the Company since December 1995 and a director of the Company since November 1995. Mr. Gotschall also serves as Chief Financial Officer and a director of New Century Mortgage. From April 1994 to July 1995, he was the Executive Vice President/Chief Financial Officer of Plaza Home Mortgage and a director of Option One. In December 1992, Mr. Gotschall was one of the co-founders of Option One and served as its Executive Vice President/Chief Financial Officer until April 1994. From January 1991 to July 1992, he was the Executive Vice President/Chief Financial Officer of The Mortgage Network, Inc., a retail mortgage banking company. STEVEN G. HOLDER has been Vice Chairman of the Company since December 1996, Chief Operating Officer--Loan Production/Operations of the Company since December 1995 and a director of the Company since November 1995. Mr. Holder also serves as Co-Chairman of the Board and Chief Executive Officer of New Century Mortgage. From February 1993 to August 1995, he was the Executive Vice President of Long Beach Mortgage Company ("Long Beach Mortgage"). From July 1991 to February 1993, Mr. Holder was the Vice President for Business Development of Transamerica Financial Services. From 1985 to 1990, he was a Regional Vice President for Nova Financial Services, a startup consumer finance subsidiary of First Interstate Bank. Mr. Holder has over 20 years experience in the consumer finance and mortgage business. PATRICK J. FLANAGAN has been Executive Vice President and Chief Operating Officer of New Century Mortgage since January 1997 and a director of New Century Mortgage Corporation since May 1997. Mr. Flanagan initially joined New Century Mortgage in May 1996 as Regional Vice President of Midwest Wholesale and Retail operations. From August 1994 to April 1996, Mr. Flanagan was a Regional Manager with Long Beach Mortgage. From July 1992 to July 1994, he was an Assistant Vice President for First Chicago Bank, from February 1989 to February 1991, he was Assistant Vice President for Banc One in Chicago and from February 1991 to July 1992, he was a Business Development Manager for Transamerica Financial Services. SHAHID S. ASGHAR has been Senior Vice President--Wholesale Lending of New Century Mortgage since January 1997 and a director of New Century Mortgage Corporation since May 1997. Mr. Asghar initially joined New Century Mortgage as Vice President, Mortgage Banking Operations in December 1995. From June 1995 to November 1995, Mr. Asghar was the Southern California District Manager for Ford Consumer Finance. From September 1992 to March 1995, he was an Area Sales Manager for Long Beach Mortgage and from June 1988 to September 1992, he was a Business Development Manager for Transamerica Financial Services. PAUL L. RIGDON has been Senior Vice President--Retail Lending of New Century Mortgage since February 1997 and a director of New Century Mortgage Corporation since May 1997. Mr. Rigdon joined New Century Mortgage in September 1996 as the Regional Manager in charge of expansion in the Northwest Retail Region. From May 1995 to September 1996, he was a District Manager for Advanta Finance. From March 1990 to May 1995, he was an Area Manager for Long Beach Mortgage. 59 JOHN C. BENTLEY has been a director of the Company since November 1995. Since February 1995, Mr. Bentley has been a principal of Cornerstone Equity Partners, L.L.C., a private equity investment company of which he is a co- founder. From February 1989 to February 1995, he was employed by Banc One Capital Corporation, most recently as a Senior Vice President, where he worked in the merchant banking group. Mr. Bentley also served four years as Chief Financial Officer of R.J. Moran, Inc., a diversified holding company. SHERMAN I. CHU has been a director of the Company since November 1995. Since April 1995, Mr. Chu has been a principal of Cornerstone Equity Partners, L.L.C., of which he is a co-founder. From November 1991 to March 1995, he was employed by Banc One Capital Corporation, most recently as an Assistant Vice President, where he worked in the merchant banking group. Mr. Chu was also employed for two years by Banc One Corporation, where he worked in the credit and international lending departments. HARLAN W. SMITH has been a director of the Company since November 1995 and following the completion of the Offering, Mr. Smith will resign from the Board. Since December 1994, Mr. Smith has been the owner and manager of Copper State Capital, LLC, a private equity investment company, and the owner and manager of Kiva Corporation, a consulting firm. From July 1986 to November 1993, he was the Chairman of the Board of Dyneer Corporation, a privately-held provider of mobile power transmission equipment. MICHAEL M. SACHS has been a director of the Company since November 1995. Since 1990, Mr. Sachs has been the principal shareholder, Chairman of the Board and Chief Executive Officer of Westrec Financial, Inc., which operates marinas and related businesses. He also serves on the Board of Directors of Innoserv Technologies, a publicly-traded company. MARTIN F. RYAN has been a director of the Company since December 1996. Mr. Ryan has practiced as an attorney since 1963 and has been the President and a director of Martin F. Ryan, Ltd. since 1983. Mr. Ryan has served as a director of The Foundation Companies, Inc. since its inception in 1992, including two years as Chairman of the Board. In addition, Mr. Ryan served as a director of the Baptist Foundation of Arizona for seven years. The Baptist Foundation is the sole owner of The Foundation Companies, Inc. and the Foundation Companies, Inc. is the managing member of Cornerstone Fund I, L.L.C. ("Cornerstone"). FREDRIC J. FORSTER will become a director of the Company upon the closing of this Offering. Since January 1996, Mr. Forster has been a principal of Financial Institutional Partners, LLC, a newly formed investment banking and brokerage firm headquartered in Irvine, California. From March 1993 to April 1996, Mr. Forster was the President and Chief Operating Officer of H.F. Ahmanson and Company and its subsidiary Home Savings of America, and from 1979 to 1993, he was the President of ITT Federal Bank, formerly Newport Balboa Savings and Loan Association. In addition, from 1986 to 1995, Mr. Forster served on the board of directors, and in 1995 was the Vice Chairman, of the Federal Home Loan Bank of San Francisco. Pursuant to the shareholders agreement in effect prior to the Offering among the Company, Cornerstone and the other stockholders of the Company, Cornerstone previously designated five directors (Messrs. Bentley, Chu, Sachs, Smith and Ryan), and Messrs. Cole, Morrice, Gotschall and Holder collectively designated themselves to the Board. All rights to designate directors will terminate along with the termination of the shareholders agreement upon the closing of the Offering. The Company anticipates that upon the closing of the Offering Mr. Smith will resign and be replaced by Mr. Forster. The directors, officers and key employees listed above each owns shares of Common Stock of the Company in the amounts set forth in the section entitled "Beneficial Ownership of Securities and Selling Stockholders." BOARD COMMITTEES The Company's Board of Directors has an Audit Committee and a Compensation Committee. The Audit Committee is comprised of Messrs. Sachs, Chu and Bentley and is responsible for making recommendations concerning the engagement of independent certified public accountants, approving professional services provided by the independent certified public accountants and reviewing the adequacy of the Company's internal 60 accounting controls. The Compensation Committee is comprised of Messrs. Bentley and Sachs and Mr. Forster will become a member of such committee upon the closing of the Offering. The Compensation Committee has the exclusive responsibility for establishing the compensation and other benefits payable to executive officers and has the responsibility for administering the Company's incentive compensation and benefit plans, including the Stock Option Plan and the Founding Managers' Plan. DIRECTOR COMPENSATION The Company pays its non-employee directors an annual retainer of $10,000, and a fee of $2,500 for each board or committee meeting attended. The Company will also reimburse its non-employee directors for reasonable expenses incurred in attending meetings. In addition, the Company's Stock Option Plan provides that, upon their initial election or appointment to the Board, each non-employee director will be granted a non-qualified option to purchase 15,000 shares of Common Stock, subject to vesting in equal installments over three years from the date of grant (a "Non-Employee Director Option"). If any non-employee director's services as a member of the Board terminate, each of such director's option which is not then exercisable will terminate. The current non-employee directors other than Mr. Smith were each granted a Non- Employee Director Option in May 1997 at an exercise price of $7.50 per share. Upon Mr. Smith's resignation from the Board effective as of the closing of the Offering, Mr. Smith will receive an option to purchase 7,500 shares of Common Stock at an exercise price equal to the initial public offering price. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION No member of the Compensation Committee is or has been an employee of the Company. LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS The Company has adopted a provision in its Certificate of Incorporation that limits the liability of its directors for monetary damages arising from a breach of their fiduciary duties as directors. The Company's Bylaws provide that the Company must indemnify its directors and officers to the fullest extent permitted by the Delaware General Corporation Law. The Company also has entered into indemnification agreements with its executive officers and directors and has officer and director liability insurance with respect to certain liabilities. See "Description of Capital Stock--Limitation of Liability of Directors and Indemnification of Directors and Officers." 61 EXECUTIVE COMPENSATION Summary Compensation Table The following table sets forth certain information with respect to compensation earned by the Company's Chief Executive Officer and the named executive officers other than the Chief Executive Officer during fiscal 1996.
LONG TERM COMPENSATION ------------ AWARDS ANNUAL ------------ COMPENSATION SECURITIES ---------------- UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION SALARY BONUS OPTIONS COMPENSATION(1) --------------------------- -------- ------- ------------ --------------- Robert K. Cole................ $150,000 $96,969(2) -- $ 825 Chairman of the Board and Chief Executive Officer Brad A. Morrice............... 150,000 96,969(2) -- 1,200 Vice Chairman, President and General Counsel Edward F. Gotschall........... 143,750 96,969(2) 40,000 6,933(3) Vice Chairman and Chief Operating Officer-- Finance/Administration Steven G. Holder.............. 150,000 81,969(2) 80,000 563 Vice Chairman and Chief Operating Officer-- Loan Production/Operations
- -------- (1) The contribution made by the Company on behalf of the executive officer to a 401(k) profit sharing plan. (2) Includes signing bonuses and amounts earned pursuant to the Founding Managers' Incentive Compensation Plan in 1996 but paid in 1997. (3) Includes $5,789 paid by the Company to lease an automobile for Mr. Gotschall. Option Grants in Fiscal 1996 The following table sets forth certain information with respect to individual grants of stock options made during fiscal 1996 to the named executive officers.
INDIVIDUAL GRANTS ---------------------------------------------- POTENTIAL REALIZABLE NUMBER OF PERCENT OF VALUE AT ASSUMED SECURITIES TOTAL ANNUAL RATES OF STOCK UNDERLYING OPTIONS PRICE APPRECIATION FOR OPTIONS GRANTED TO EXERCISE OPTION TERM(2) GRANTED EMPLOYEES IN PRICE EXPIRATION ----------------------- NAME (1) FISCAL 1996 ($/SH) DATE 5% 10% ---- ---------- ------------ -------- ---------- ----------- ----------- Robert K. Cole.......... -- -- -- -- -- -- Brad A. Morrice......... -- -- -- -- -- -- Edward F. Gotschall..... 40,000(3) 8.9% $3.50(4) 12/4/06 $ 88,000 $ 223,200 Steven G. Holder........ 80,000(3) 17.7% 3.50(4) 12/4/06 176,000 446,400
- -------- (1) All options were granted "at market" on the date of grant. (2) This column shows the hypothetical gains or "option spreads" of the options granted based on the per-share market price of the Common Stock at the time of grant and assumed annual compound stock appreciation rates of 5% and 10% over the full 10-year term of the options. The 5% and 10% assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of future Common Stock prices. The gains shown are net of the option exercise price, but do not include deductions for taxes or other expenses associated with the exercise of the option or the sale of the underlying shares. The actual gains, if any, on the exercises of stock options will depend on the future performance of the Common Stock, the option holder's continued employment through the option period for options granted pursuant to the Stock Option Plan, and the date on which the options are exercised. 62 (3) The options are exercisable as to one third of the shares of Common Stock on the first anniversary of the grant date, with an additional one third of the underlying shares becoming exercisable on each successive anniversary date, and full vesting on the third anniversary date. The options were granted for a term of 10 years, subject to earlier termination in certain events related to termination of employment. In certain circumstances, including a recapitalization, stock split, reorganization, merger, combination, consolidation and a sale of substantially all of the assets of the Company, the Board of Directors will adjust, in such manner and to such extent as it deems appropriate, the number, amount and type of shares subject to the option and the exercise price of the option. (4) The exercise price and tax withholding obligations related to exercise may be paid by delivery of already owned shares of Common Stock, subject to certain conditions. Fiscal Year-end Option Values The following table sets forth certain information with respect to the value of the options at the end of fiscal 1996 held by the named executive officers.
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT DECEMBER 31, 1996 (#) DECEMBER 31, 1996 ($)(1) ------------------------- ------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---- ----------- ------------- ----------- ------------- Robert K. Cole.............. -- -- -- -- Brad A. Morrice............. -- -- -- -- Edward F. Gotschall......... -- 40,000 -- $20,000 Steven G. Holder............ -- 80,000 -- $40,000
- -------- (1) The amounts set forth represent the difference between the estimated fair market value of $4.00 per share as of December 31, 1996 and the exercise price of the options, multiplied by the applicable number of shares underlying the options. Employment Agreements The Company has entered into employment agreements with Messrs. Cole, Morrice, Gotschall and Holder (the "Founding Managers"). Each agreement continues in effect until December 31, 1999 but is extended automatically for successive one-year periods unless terminated by either the Company or the respective Founding Manager. Under the terms of the agreements, the Founding Managers each received a signing bonus of $15,000 and an annual base salary at the rate of $150,000 per year during 1996 and thereafter at a rate determined by the Company's Board of Directors. The Founding Managers initially received a salary of $180,000 for fiscal 1997. On May 30, 1997, the Board of Directors revised the Founding Managers' salary to $256,000 for fiscal 1997, plus a $500 per month automobile allowance. In the event of termination of employment of a Founding Manager without cause (as defined in the agreement) by the Company, the Company: (i) will pay such Founding Manager his base salary through the end of the month during which such termination occurs plus credit for any vacation earned but not taken, his base salary in effect at termination for a minimum of six months or, if longer, through the expiration of the term of employment then in effect, and an amount equal to the most recent annual profit-sharing and/or incentive bonus received by him or, if more, the amount which would be due under the profit sharing and/or incentive bonus plans applicable to him for the then current year calculated as of the effective date of termination; (ii) will maintain such Founding Manager's medical insurance and other programs in which he was entitled to participate until the expiration of the term of employment then in effect or his commencement of full time employment with a new employer; and (iii) will pay all costs up to $20,000 related to such Founding Manager's participation in a senior executive outplacement program. Each Founding Manager may be terminated for cause only by a vote of a majority of the Board of Directors of the Company. 63 Founding Managers' Incentive Compensation Plan General. In December 1996, the Company adopted the Founding Managers' Incentive Compensation Plan and the Company has amended the terms thereof effective for 1997 and subsequent plan years (as amended, the "Incentive Compensation Plan"). The Incentive Compensation Plan is intended to promote the success of the Company by providing a means to retain and motivate the Founding Managers by rewarding them with additional incentive compensation for high levels of individual annual performance and for significant efforts to enhance the financial performance of the Company. The Compensation Committee (the "Committee") of the Board of Directors administers the Incentive Compensation Plan. The Committee has full discretion to construe and interpret the terms and provisions of the Incentive Compensation Plan and related agreements. In addition, the Committee has the authority to make all determinations under the Incentive Compensation Plan, and to prescribe, amend and rescind rules relating to the administration of the Incentive Compensation Plan. Capitalized terms not otherwise expressly defined herein shall have the meaning specified in the Incentive Compensation Plan. Shares Reserved for Awards. The total number of shares of the Company's Common Stock set aside for awards under the Incentive Compensation Plan is 250,000 shares, subject to certain adjustments described below. The number and kind of shares available under the Incentive Compensation Plan are subject to adjustment in the event of certain extraordinary events, such as a reorganization, merger, consolidation, recapitalization, reclassification, stock-split or similar event. The number of shares covered by awards outstanding are also subject to adjustment in these events. Incentive Compensation Amounts. Each of the four Founding Managers is entitled to one quarter of amounts payable under the Incentive Compensation Plan. Subject to the limitations described below, the amount available for incentive awards (the "Incentive Pool") for each fiscal year, commencing in 1997, is an amount equal to a percentage of the Company's earnings ("Earnings") before income taxes and without deducting amounts payable under the Incentive Compensation Plan. The specific percentage of Earnings which is used to determine the Incentive Pool is based on the ratio (the "Ratio") of Earnings to Total Stockholders' Equity. If the Ratio is at least 25% but less than 50%, the Incentive Pool is an amount equal to 5% of Earnings in excess of 25% of Total Stockholders' Equity. If the Ratio is at least 50%, the Incentive Pool is an amount equal to the sum of (i) 5% of Earnings in excess of 25% of Total Stockholders' Equity, plus (ii) 2% of Earnings in excess of 50% of Total Stockholders' Equity. Total Stockholders' Equity for purposes of this calculation is equal to the amount of stockholders' equity as of January 1 of each fiscal year adjusted on a pro-rata basis for any equity offerings completed during the fiscal year. Limits on Incentive Compensation. The Incentive Compensation Plan limits the aggregate amount of cash payable thereunder for each fiscal year. The maximum cash award payable for fiscal 1997 is 100% of the Founding Manager's base salary in such year and thereafter is 200% of such base salary. In the event the Incentive Pool for any fiscal year exceeds such maximum amounts, the balance of the awards will be paid in shares of restricted stock valued at the fair market value of the Company's Common Stock at the time of the award. The restricted stock will vest in equal annual installments over a three year period. In the event that a Founding Manager's employment terminates with the Company for any reason other than death or total disability, shares of restricted stock which have not yet become vested shall be forfeited. Notwithstanding the preceding, upon the occurrence of certain Change of Control Events, unvested shares subject to a restricted stock award will become fully vested. A Founding Manager who receives shares of restricted stock will be entitled to cash dividends and voting rights for each share of restricted stock issued under the Incentive Compensation Plan. Restrictions. If the payment of a Founding Manager's benefits under the Incentive Compensation Plan would cause the Company to violate any covenant contained in any agreement entered into by the Company with a third party, the payment of benefits under the Incentive Compensation Plan are deferred until such time as the Company would remain in compliance with these covenants after such benefits are paid. In addition, if the Company is in violation of any third party financial covenant, the payment of benefits will be deferred until the Company is in compliance with its financial covenants after such benefits are paid. 64 Semi-Annual and Annual Payments. On July 31 and January 31 of each year, the Founding Managers are entitled to a cash advance equal to 80% of the amount payable as of June 30 and December 31 based on the Company's unaudited financial statements as of such dates. To the extent the Incentive Pool for any fiscal year exceeds the aggregate of the semi-annual cash awards, an additional award in cash and/or restricted stock will be payable to the Founding Managers in a lump sum within 10 days of the receipt of the Company's audited financial statements for such fiscal year. To the extent the Incentive Pool for any fiscal year is less than the aggregate of the semi-annual cash advances, the Founding Managers shall refund in a lump sum the excess cash advances within 10 days of the completion of the Company's audited financial statements for such fiscal year. Stock Option Plan The Company adopted the New Century Financial Corporation 1995 Stock Option Plan (the "Stock Option Plan") in December 1995. The Stock Option Plan is intended to provide a means to attract, motivate and retain key employees, consultants, advisors and knowledgeable directors of the Company and to promote the success of the Company. Under the Stock Option Plan, awards ("Awards") may consist of any combination of stock options (incentive or nonqualified), restricted stock, stock appreciation rights ("SARs") and performance share awards. The number of shares of Common Stock reserved for issuance that may be issued under the Stock Option Plan currently is 2,000,000. The maximum number of shares that may be covered by options and SARs granted to any participant during a calendar year is 500,000 shares. Each of the foregoing limits is subject to adjustment under certain circumstances as described more fully in Section 6.2 of the Stock Option Plan. Awards under the Stock Option Plan may be made to officers and key employees of the Company, to consultants of the Company and to directors who are not employees or officers of the Company ("Non-Employee Directors"). See "Management--Director Compensation." As of May 31, 1997, the Company had granted options to purchase a total of 1,267,520 shares of Common Stock under the Stock Option Plan (of which 1,267,520 options remained outstanding and 36,450 shares were vested) which include options to purchase an aggregate of 60,000 shares of Common Stock which have been granted to the non-employee directors. The Company will grant options to purchase 441,500 shares of Common Stock upon the closing of the Offering, including an option to purchase 62,500 shares subject to three year vesting in equal annual installments, to each of Messrs. Cole, Morrice, Gotschall and Holder. In addition to the above options, a restricted stock award covering 92,500 shares of Common Stock has been granted to each of Messrs. Cole, Morrice, Gotschall and Holder, of which 92,500, 61,667 and 30,833 shares will be subject to forfeiture until the first, second and third anniversaries of the date of grant, respectively. The Stock Option Plan provides that all Awards are non-transferable and will not become subject in any manner to sale, transfer, anticipation, alienation, assignment, pledge, encumbrance or charge. The Compensation Committee may, however, permit Awards to be exercised by certain persons or entities related to a participant for estate and/or tax planning purposes. Only the participant, subject to the above exceptions, may exercise an Award during the participant's lifetime. Participants in the Stock Option Plan are recommended by management and approved by the Compensation Committee. The Compensation Committee is appointed by the Board of Directors and has the authority to construe and interpret the Stock Option Plan and any agreements thereunder, prescribe, amend and rescind rules and regulations relating to the administration of the Stock Option Plan, accelerate or extend the vesting or exercisability or extend the term of any or all outstanding Awards (within the maximum 10 year limit on the term of Awards), and make all other determinations necessary or desirable for the administration of the Stock Option Plan. Nonqualified stock options and incentive stock options (those intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code")) may be granted under the Stock Option Plan. Incentive stock options may only be granted to employees of the Company. The Compensation Committee determines the exercise price, vesting provisions, and terms of Options. However, the exercise price of incentive stock options cannot be less than the fair market value of the Common Stock on the date of grant (110% if granted to an employee who owns 10% or more of the Common Stock). 65 The Stock Option Plan contains a Non-Employee Director program which provides for the grant of options to Non-Employee Directors. Under this program, each Non-Employee Director who was elected or appointed to the Board of Directors at the Company's 1997 annual meeting of stockholders was granted a nonqualified stock option to purchase 15,000 shares of Common Stock. In addition, upon any other individual's initial election to the Board of Directors as a Non-Employee Director (or initial appointment to the Board of Directors as a Non-Employee Director), such Non-Employee Director will be granted a nonqualified stock option to purchase 15,000 shares of Common Stock. The number of shares provided for each grant is subject to adjustment upon certain events as provided in Section 6.2 of the Stock Option Plan. The purchase price per share for options granted under this program will equal the fair market value of the Common Stock on the date of grant. Each option granted under this program becomes exercisable in installments according to the following schedule: (i) one-third of the total number of shares subject to the option become exercisable on the first anniversary of the grant date, (ii) an additional one-third of the total number of shares subject to the option become exercisable on the second anniversary of the grant date, and (iii) the remaining number of shares subject to the option become exercisable on the third anniversary of the grant date. These options are granted for 10 year terms, but will terminate earlier if the director ceases to be a member of the Board of Directors. Restricted stock awards may be granted on the basis of such factors as the Compensation Committee deems appropriate. Each restricted stock award agreement must specify the number of shares of Common Stock to be issued, the date of such issuance, the price, if any, to be paid for such shares by the participant, whether and to what extent the cash consideration paid for such shares shall be returned upon forfeiture and the restrictions imposed on such shares, which will not terminate earlier than six months after the date the restricted stock is awarded. Shares subject to restricted stock awards are nontransferable and held by the Company until such shares have vested and are subject to a risk of forfeiture unless certain conditions are satisfied. SARs may be granted in connection with stock options or separately. SARs granted in connection with stock options will provide for payments to the holder based upon increases in the price of the Common Stock over the exercise price of the related option on the exercise date. The Compensation Committee may elect to pay SARs in cash, Common Stock or in a combination of cash and Common Stock. Performance share awards may be granted on the basis of such factors as the Compensation Committee deems appropriate. Generally, these awards will be based upon specific agreements and will specify the number of shares of Common Stock subject to the award, the price, if any, to be paid for such shares by the participant and the conditions upon which the issuance to the participant will be based. Without limiting the generality of the foregoing, the Stock Option Plan will permit the Compensation Committee to grant certain other types of Awards ("Performance Based Awards") which are intended to qualify as "performance- based compensation" under Section 162(m) of the Code. Options and SARs that are granted at fair market value are intended to qualify as Performance-Based Awards. In addition, other share-based awards may be granted under the Stock Option Plan and are intended to qualify as Performance-Based Awards. The Stock Option Plan also provides for the grant of Performance-Based Awards that are not denominated nor payable in and do not have a value derived from the value of or a price related to shares of Common Stock and are payable only in cash ("Cash--Based Awards"). The eligible class of persons for Performance-Based Awards is all executive officers of the Company. The maximum number of shares of Common Stock which may be delivered pursuant to all Awards that are granted as Performance-Based Awards to any participant in any calendar year may not exceed 500,000 shares (subject to adjustment) and the annual aggregate amount of compensation that may be paid to any participant in respect of Cash-Based Awards may not exceed $1,000,000. The performance goals of Performance-Based Awards are any one or a combination of Cash Flow, Earnings Per Share, Gain on Sale of Loans, Loan Production Volume, Loan Quality, Return on Equity, and Total Stockholder Return (each as defined in Article VII of the Stock Option Plan). These goals will be applied over performance cycles as determined by the Compensation Committee. Specific cycles and target levels of performance, as well as the award levels, will be determined by the Compensation Committee not later than the 66 applicable deadline under Section 162(m) of the Code and in any event at a time when achievement of such targets is substantially uncertain. Appropriate adjustments to goals and targets may be made by the Compensation Committee based upon objective criteria in the case of certain events that were not anticipated at the time goals were established. The Company believes that specific performance targets (when established) are likely to constitute confidential business information, the disclosure of which may adversely affect the Company or mislead the public. The Compensation Committee must certify the achievement of the applicable performance goals and the actual amount payable to each participant under Performance-Based Awards prior to payment. The Compensation Committee may retain discretion to reduce, but not increase, the amount payable under a Performance-Based Award, notwithstanding the achievement of targeted performance goals. Performance-Based Awards may be fully accelerated or the Compensation Committee may provide for partial credit in the event of certain events circumstances that the Compensation Committee may determine. Options which have not yet become exercisable will lapse upon the date a participant is no longer employed by the Company for any reason. Options which have become exercisable must generally be exercised within 30 days after such date if the termination of employment was for any reason other than retirement, total disability, death or discharge for cause. In the event the participant is discharged for cause, all options will lapse immediately upon such termination of employment. If the termination of employment was due to retirement, total disability or death, the options, which are exercisable on the date of such termination, must be exercised within three months of the date of such termination or such shorter period provided in the award agreement. SARs granted concurrently with an option have the same termination provisions as the option to which they relate. The termination provisions of SARs granted independently of an option are governed by the applicable award agreement. In the event of a termination of services to or employment with the Company for any reason, shares of Common Stock subject to a participant's restricted stock award will be forfeited in accordance with the related award agreement to the extent such shares have not vested on the date of termination. Likewise, in the event of a termination of services to or employment with the Company for any reason, shares of Common Stock subject to a participant's performance share award will be forfeited in accordance with the related award agreement to the extent such shares have not been issued or become issuable on the date of termination. In the event the stockholders of the Company approve the dissolution or liquidation of the Company, certain mergers or consolidations or the sale of substantially all of the business assets of the Company, unless prior to such event the Board of Directors determines that there will be either no acceleration or limited acceleration of awards, each option and related SAR will become immediately exercisable, restricted stock will immediately vest and the number of shares or an amount of cash covered by each performance share award will be issued or paid to the participant. The authority to grant new Awards under the Stock Option Plan will terminate on the tenth anniversary of its adoption by the Board of Directors, unless the Stock Option Plan is terminated prior to that time by the Board of Directors. Such termination typically will not affect rights of participants which accrued prior to such termination. The Board of Directors and the Compensation Committee may make certain amendments to the Stock Option Plan and outstanding Awards. To the extent required by applicable law or deemed necessary by the Board of Directors, the Stock Option Plan may not be amended, without shareholder consent, to increase the maximum number of shares which may be delivered pursuant to Awards granted thereunder, materially increase the benefits accruing to participants thereunder or materially change the requirements as to the eligibility to participate therein. With respect to nonqualified stock options, the Company is generally entitled to deduct an amount equal to the difference between the option exercise price and the fair market value of the shares at the time of exercise. With respect to incentive stock options, the Company is generally not entitled to a similar deduction either upon grant of the option or at the time the option is exercised. The current federal income tax consequences of other awards authorized under the Stock Option Plan generally follow certain basic patterns: SARs are taxed and deductible in substantially the same manner as nonqualified stock options; nontransferable restricted stock subject 67 to a substantial risk of forfeiture results in income recognition equal to the excess of the fair market value of the stock over the purchase price only at the time the restrictions lapse (unless the recipient elects to accelerate recognition as of the date of grant); performance share awards generally are subject to tax at the time of payment; unconditional stock bonuses are generally subject to tax measured by the value of the payment received; and Cash-Based Awards generally are subject to tax at the time of payment; in each of the foregoing cases, the Company will generally have a corresponding deduction at the time the participant recognizes income. If an Award is accelerated under the Stock Option Plan, the Company may not be permitted to deduct the portion of the compensation attributable to the acceleration. Furthermore, if the compensation attributable to Awards is not "performance- based" within the meaning of Section 162(m) of the Code, the Company may not be permitted to deduct such compensation in certain circumstances. 401(k) Profit Sharing Plan The Company has a 401(k) profit sharing plan that covers substantially all employees who have been employed by the Company for over three months and have attained the age of 21. The 401(k) plan allows eligible employees to defer amounts of their compensation up to the statutory limit each year. The Company matches 25% of employee contributions up to a maximum contribution by the Company of 1.5% of each employee's compensation. The Company also has a discretionary matching program under the plan, through which the Company may make contributions to employees out of the Company's current or accumulated net profit. In 1996, the Company contributed $47,000 to its 401(k) profit sharing plan. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In December 1996, the Company issued warrants to purchase the following number of shares of Common Stock, exercisable at $3.50 per share, to the following directors, executive officers and 5% security holders (collectively, the "Warrantholders") in satisfaction of their preemptive rights as stockholders: Cornerstone (220,656 shares), Westrec Rollover PS Plan (11,032 shares), Michael M. Sachs (16,550 shares), Harlan W. Smith (11,032 shares), Harcol Limited Partnership (11,032 shares), Cornerstone Equity Partners, L.L.C. (11,032 shares), Martin F. Ryan, Ltd. Defined Benefit Pension Plan (8,274 shares), Robert K. Cole (55,556 shares), Brad A. Morrice (54,453 shares), Samantha H. Morrice Trust (1,103 shares), Edward F. Gotschall (50,040 shares), and Steven G. Holder (47,834 shares). The Warrantholders voluntarily exercised these warrants on May 30, 1997. John Bentley and Sherman Chu, directors of the Company, are principals of Cornerstone Equity Partners, L.L.C., which manages certain aspects of and has a 20% "back-end" ownership interest in Cornerstone Fund I, L.L.C. Michael Sachs, a director of the Company, is the trustee of Westrec Rollover PS Plan. Harlan W. Smith, a director of the Company, is a general partner in Harcol Limited Partnership. Martin F. Ryan, a director of the Company, is the trustee of Martin F. Ryan, Ltd. Defined Benefit Pension Plan. The sole beneficiary of the Samantha H. Morrice Trust is the daughter of Brad A. Morrice, a director and executive officer of the Company. In connection with a letter of intent regarding the possible purchase of a subsidiary of Westrec Financial, Inc. ("Westrec"), the Company paid an aggregate of approximately $68,000 through March 31, 1997 to Westrec for the payment of certain operating expenses of such subsidiary. In exchange for the payment of such expenses, the Company received an option to purchase all of the outstanding shares of the subsidiary. The letter of intent was terminated in April 1997. Michael Sachs, a director of the Company, is the Chief Executive Officer, Chairman and primary shareholder of Westrec. In connection with the sale of 545,000 shares of Common Stock to Comerica, the Company and Comerica have agreed to enter into certain arrangements concerning servicing and other strategic relationships. Under the arrangements, the Company will pay certain fees to Comerica and has issued warrants to purchase 100,000 shares of Common Stock. The Company has also reserved an additional 233,333 shares of Common Stock for issuance under warrants to be granted to Comerica if certain performance goals are met, such as (i) the commencement of servicing operations under the sub-servicing arrangements between the Company and Comerica, (ii) the completion of one year of servicing operations under such sub-servicing agreements, and (iii) the funding of $20 million in loans by the Company as a result of leads developed through Comerica's branch system and consumer loan portfolio. See "Prospectus Summary--Recent Developments--Comerica Investment and Strategic Relationship." 68 BENEFICIAL OWNERSHIP OF SECURITIES AND SELLING STOCKHOLDERS The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of May 31, 1997, as adjusted to reflect the sale of 2,900,000 shares by the Company in the Offering, by (i) each director of the Company, (ii) each of the named executive officers, (iii) each person known to the Company to be the beneficial owner of more than 5% of the Common Stock, (iv) all directors and executive officers of the Company as a group and (v) each Selling Stockholder.
COMMON STOCK COMMON STOCK TO BE BENEFICIALLY BENEFICIALLY OWNED OWNED PRIOR TO OFFERING AFTER THE OFFERING(2) --------------------- ------------------------ NUMBER NUMBER OF NUMBER OF SHARES BEING OF BENEFICIAL OWNERS(1) SHARES PERCENT OFFERED (2) SHARES PERCENT -------------------- ----------- --------- ------------ ------------ ----------- Cornerstone Fund I, L.L.C.(3).............. 4,220,656 38.40% 600,000 3,620,656 26.06% Comerica Incorporat- ed(4).................. 545,000 4.96 -- 545,000 3.92 Brad A. Morrice(5)(6)... 1,223,217 11.13 -- 1,223,217 8.80 Robert K. Cole(5)....... 1,222,735 11.12 -- 1,222,735 8.80 Edward F. Gotschall(5).. 1,119,632 10.19 -- 1,119,632 8.06 Steven G. Holder(5)..... 1,078,391 9.81 -- 1,078,391 7.76 John C. Bentley(7)...... 211,032 1.92 -- 211,032 1.52 Sherman I. Chu(7)....... 211,032 1.92 -- 211,032 1.52 Harlan W. Smith(8)...... 422,064 3.84 -- 422,064 3.04 Martin F. Ryan(9)....... 158,274 1.44 -- 158,274 1.14 Michael M. Sachs(10).... 527,582 4.80 -- 527,582 3.80 Fredric J. Forster...... -- * -- -- * All directors and execu- tive officers as a group (9 persons)...... 5,962,927 54.25% 5,329,831 38.37%
- -------- * Less than one percent. (1) Unless otherwise indicated, each of the stockholders named in this table has sole voting and dispositive power with respect to the shares shown as beneficially owned. (2) Assumes no exercise of the Underwriters' over-allotment option. If the Underwriters' over-allotment option is exercised in full, (i) Cornerstone Fund I, L.L.C. will sell an additional 250,000 shares of Common Stock and the number of shares and the percent of Common Stock to be beneficially owned after the Offering by Cornerstone Fund I, L.L.C. will be 3,370,656 shares and 23.9%, respectively, (ii) Cornerstone Equity Partners, L.L.C. ("CEP") will sell 42,500 shares of Common Stock and the number of shares and the percent of Common Stock to be beneficially owned after the Offering by CEP will be 168,532 shares and 1.19%, respectively and (iii) the number of shares and the percent of Common Stock to be beneficially owned after the Offering by all directors and executive officers as a group will be 5,037,331 and 35.7%, respectively. (3) Such person may be reached at 5050 N. 40th Street, Suite 310, Phoenix, Arizona 85018. The Foundation Companies, Inc. is the managing member of Cornerstone Fund I, L.L.C. and CEP is a member of Cornerstone Fund I, L.L.C. The Foundation Companies, Inc. has sole voting power and shares dispositive power with CEP with respect to the shares owned by Cornerstone Fund I, L.L.C. The Foundation Companies, Inc. is a wholly- owned subsidiary of the Baptist Foundation of Arizona, which may also be deemed to be the beneficial owner of the shares owned by Cornerstone Fund I, L.L.C. (4) Such person may be reached at 3551 Hamlin Road, Auburn Hills, Michigan 48326. (5) Each of such persons may be reached through the Company at 4910 Birch Street, Suite 100, Newport Beach, California 92660. (6) Includes 21,103 shares of Common Stock owned by the Samantha H. Morrice Trust, the sole beneficiary of which is Mr. Morrice's minor daughter. (7) Includes 211,032 shares of Common Stock owned by CEP. As principals of CEP, Messrs. Bentley and Chu share voting and dispositive power of the shares owned by CEP and may be deemed to be the beneficial owners of the shares owned by Cornerstone Fund I, L.L.C. See note (3) above. (8) Includes 211,032 shares of Common Stock owned by Harcol Limited Partnership, of which Mr. Smith is a general partner. (9) All 158,274 shares of Common Stock are owned by The Martin F. Ryan, Ltd., Profit Sharing Plan and Trust, of which Mr. Ryan is the trustee. Martin F. Ryan, a director of the Company, is a director of The Foundation Companies, Inc. See note (3) above. (10) Includes 211,032 shares of Common Stock owned by Westrec Rollover PS Plan, of which Mr. Sachs is the trustee. 69 DESCRIPTION OF CAPITAL STOCK Upon closing of this Offering, the authorized capital stock of the Company will consist of 45,000,000 shares of Common Stock and 7,500,000 shares of Preferred Stock. Upon the closing of the Offering, the Company will have 13,892,373 shares of Common Stock outstanding and no shares of Preferred Stock outstanding. COMMON STOCK Holders of Common Stock are entitled to one vote per share on all matters to be voted upon by the stockholders, including the election of directors. The Company's Certificate of Incorporation does not provide for cumulative voting in the election of directors. Holders of Common Stock are entitled to receive such dividends as may be declared from time to time by the Board of Directors out of funds legally available therefor. The Company does not anticipate paying any cash dividends in the foreseeable future. See "Risk Factors--Absence of Dividends" and "Dividend Policy." In the event of liquidation, dissolution or winding up of the Company, holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities and after satisfaction of the liquidation preference of any outstanding Preferred Stock. Upon completion of the Offering, no holders of Common Stock will have preemptive rights. In addition, holders of Common Stock have no conversion or redemption rights and are not subject to further assessments by the Company. Upon consummation of the Offering, all of the then outstanding shares of Common Stock will be validly issued, fully paid and nonassessable. PREFERRED STOCK The Company's Board of Directors is authorized to issue from time to time, without stockholder authorization, in one or more designated series, any or all of the authorized but unissued shares of Preferred Stock with such dividend, redemption, conversion and exchange provisions as may be provided for the particular series. Any series of Preferred Stock may possess voting, dividend, liquidation and redemption rights superior to those of the Common Stock. The rights of holders of Common Stock will be subject to and may be adversely affected by the rights of the holders of any Preferred Stock that may be issued in the future. Issuance of a new series of Preferred Stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could make it more difficult for a third party to acquire, or discourage a third party from acquiring, the outstanding voting stock of the Company, and make removal of the present Board of Directors more difficult. The Company has no present plans to issue any shares of Preferred Stock. See "Risk Factors--Anti-Takeover Provisions." REGISTRATION RIGHTS After November 22, 1998, holders of approximately 10,392,373 shares of Common Stock, constituting all of the holders of Common Stock prior to the Offering, will be entitled to request that the Company effect a registration under the Securities Act, covering the sale of some or all of the shares owned by such holders, subject to certain conditions. Such holders may request that the Company effect three such registrations. In addition, the Company must use reasonable efforts to make registration statements under Forms S-2 and S-3 available to such holders, but is not obligated to do so. Finally, in the event the Company proposes to register any of its shares of Common Stock under the Securities Act, such holders of Common Stock are entitled to require that the Company include all or a portion of their shares in such registration, subject to certain conditions and limitations, including reductions in the number of shares to be registered. The Company is required to bear all registration expenses incurred in connection with the three demand registrations on Form S-1, and in all Form S-2, S-3 and Company registrations. CERTAIN PROVISIONS OF DELAWARE LAW The Company is a Delaware corporation and is subject to Section 203 of the Delaware General Corporation Law (the "DGCL"). In general, Section 203 prevents an "interested stockholder" (defined generally as a person 70 owning 15% or more of a corporation's outstanding voting stock) from engaging in a "business combination" (as defined therein) with a Delaware corporation for three years following the date such person became an interested stockholder unless (i) before such person became an interested stockholder, the board of directors of the corporation approved the transaction in which the interested stockholder became an interested stockholder or approved the business combination, (ii) upon consummation of the transaction that resulted in the interested stockholder becoming an interested stockholder, the interested stockholder owns at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (excluding shares owned by persons who are both officers and directors of the corporation and shares held by certain employee stock ownership plans) or (iii) following the transaction in which such person became an interested stockholder, the business combination is approved by the board of directors of the corporation and authorized at a meeting of stockholders by the affirmative vote of the holders of at least two-thirds of the outstanding voting stock of the corporation not owned by the interested stockholder. APPLICATION OF THE CALIFORNIA GENERAL CORPORATION LAW TO THE COMPANY If the Company's equity securities are held by less than 800 stockholders and a majority of its outstanding shares are held by persons with California addresses and the Company has operational characteristics that indicate that it has significant contacts to California, the Company may be subject to Section 2115 of the California Corporations Code. In such event, the Company would be subject to certain key provisions of the California General Corporation Law, including, without limitation, those provisions relating to the number of directors to be elected each year (all directors would be required to be elected each year under California law applicable to companies with less than 800 beneficial holders of their equity securities), the stockholders' right to cumulate votes at elections of directors (cumulative voting would be mandatory under California law applicable to companies with less than 800 beneficial holders of their equity securities), the stockholders' right to remove directors without cause (which under California law is subject to the stockholders' right to cumulative voting), the Company's ability to indemnify its officers, directors and employees (which generally is more limited in certain situations in California than in Delaware), the Company's ability to make distributions, dividends or repurchases (which generally is more restrictive in California than in Delaware), inspection of corporate records (which is generally more available in California than in Delaware), approval of certain corporate transactions, and dissenters' rights. After consultation with the Underwriters of this Offering, the Company anticipates that it will have more than 800 stockholders following the completion of this Offering. LIMITATION OF LIABILITY AND INDEMNIFICATION AGREEMENTS The Company's Certificate of Incorporation provides that to the fullest extent permitted by applicable law a director of the Company shall not be liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director. Under the DGCL, liability of a director may not be limited (i) for any breach of the director's duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) in respect of certain unlawful dividend payments or stock redemptions or repurchases and (iv) for any transaction from which the director derives an improper personal benefit. The effect of the provisions of the Company's Certificate of Incorporation is to eliminate the rights of the Company and its stockholders (through stockholders' derivative suits on behalf of the Company) to recover monetary damages against a director for breach of the fiduciary duty of care as a director (including breaches resulting from negligent or grossly negligent behavior), except as provided in the situations described in clauses (i) through (iv) above. This provision does not limit or eliminate the rights of the Company or any stockholder to seek nonmonetary relief such as an injunction or rescission in the event of a breach of a director's duty of care. The Bylaws of the Company provide that the Company will indemnify its directors and officers to the fullest extent permitted by the DGCL. In addition, the Company has entered into agreements with each of the directors and officers of the Company pursuant to which the Company has agreed to indemnify, subject to certain limitations, such director or officer from claims, liabilities, damages, expenses, losses, costs, penalties or amounts paid in settlement incurred by such director or officer in or arising out of his capacity as a director, officer, 71 employee and/or agent of the Company or any other corporation of which such person is a director or officer at the request of the Company to the maximum extent provided by applicable law. In addition, such director or officer is entitled to an advance of expenses to the maximum extent authorized or permitted by law. PROVISIONS OF CERTIFICATE OF INCORPORATION AND BYLAWS Certain provisions of the Company's Certificate of Incorporation and Bylaws summarized in the following paragraphs may have an anti-takeover effect and may delay, defer or prevent a tender offer or takeover attempt that a stockholder might consider in its best interest, including those attempts that might result in a premium over the market price for the shares held by stockholders. Classified Board of Directors Under the Company's Certificate of Incorporation, the Board of Directors of the Company is divided into three classes, with staggered terms of three years each. Each year the term of one class expires. The Company's Certificate of Incorporation provides that any vacancies on the Board of Directors may be filled by the affirmative vote of a majority of the directors then in office, even if less than a quorum. Stockholders Meeting Requirement Under the Company's Certificate of Incorporation, any election or other action by stockholders of the Company must be effected at an annual or special meeting of stockholders and may not be effected by written consent without a meeting. Advance Notice Requirements Under the Company's Bylaws, stockholders will be required to comply with advance notice provisions with respect to any proposal submitted for stockholder vote. To be timely, a stockholder's notice must be delivered to the Secretary at the principal executive offices of the Company not less than 60 days nor more than 90 days prior to the meeting; provided, however, that in the event that less than 70 days' notice of the date of the meeting is given, notice by the stockholder to be timely must be received no later than the tenth day following the day on which such notice of the date of the meeting was first made by the Corporation. If notice has not been given pursuant to these provisions, the chairman of the meeting may declare to the meeting that the proposed business was not properly brought before the meeting and such business may not be transacted at the meeting. These provisions may preclude some stockholders from bringing matters before the stockholders at an annual or special meeting. Supermajority Voting Requirements Under the Company's Bylaws, a vote of two-thirds of the directors is required to change the number of directors of the Company. LISTING There is no public trading market for the Common Stock. Application has been made to have the Common Stock approved for quotation on Nasdaq under the trading symbol "NCEN." TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Common Stock is U.S. Stock Transfer Corporation. 72 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of the Offering, the Company will have outstanding 13,892,373 shares of Common Stock. Of the outstanding shares, 3,500,000 shares will be freely tradeable without restriction or further registration under the Securities Act unless purchased by "affiliates" of the Company as that term is defined in Rule 144 under the Securities Act. The remaining 10,392,373 shares of Common Stock outstanding are "restricted securities" as that term is defined in Rule 144 promulgated under the Securities Act and are eligible for sale subject to holding period, volume and other limitations imposed by that rule. As described below, Rule 144 permits resales of restricted securities subject to certain restrictions. In addition, stock options for an additional 1,267,520 shares of Common Stock have been granted to certain non-employee directors and employees of the Company under the Stock Option Plan, and options to acquire 441,500 shares will be granted upon the closing of the Offering. Options to acquire 127,500 shares of Common Stock have also been granted or will be granted to two executive officers and two non-employee directors of the Company outside the Stock Option Plan, warrants to purchase 100,000 shares of Common Stock have been issued to Comerica and warrants to purchase an additional 233,333 shares of Common Stock will be issued to Comerica subject to the completion by Comerica of certain performance events. All of the Comerica warrants will have an exercise price equal to the initial public offering price of the Company's Common Stock, subject to vesting in equal installments on December 31, 1997, 1998 and 1999. Accelerated vesting will occur upon (i) certain changes in control of the Company or (ii) the inclusion of the shares underlying the warrants in a registration statement, subject to certain limitations, upon exercise of Comerica's registration rights. An additional 290,980 shares of Common Stock are reserved for future issuance under the Stock Option Plan. The Company and certain stockholders have agreed, subject to certain conditions, that they will not offer, sell or otherwise dispose of any of the shares of Common Stock or securities convertible into Common Stock owned by them for 180 days from the date of this Prospectus and the commencement of the Offering, respectively, without the prior written consent of Montgomery Securities on behalf of the Underwriters. In general, under Rule 144 as in effect as of April 29, 1997, a person (or persons whose shares are aggregated) who has beneficially owned restricted securities for at least one year, will be entitled to sell in any three-month period a number of shares that does not exceed the greater of: (i) 1% of the number of shares of Common Stock then outstanding (approximately 138,924 shares immediately after the Offering) or (ii) the average weekly trading volume of the Company's Common Stock on Nasdaq during the four calendar weeks immediately preceding the date on which the notice of sale is filed with the Securities and Exchange Commission. Sales pursuant to Rule 144 are subject to certain requirements relating to manner of sale, notice and availability of current public information about the Company. A person (or persons whose shares are aggregated) who is not deemed to have been an affiliate of the Company at any time during the 90 days immediately preceding the sale and who has beneficially owned restricted securities for at least two years is entitled to sell such shares pursuant to Rule 144(k) without regard to the limitations and requirements described above. The Company intends to file a registration statement under the Securities Act to register shares of Common Stock reserved for issuance under its Stock Option Plan, thus permitting the resales of such shares by non-affiliates in the public market without restriction under the Securities Act. Such registration statement is expected to be filed shortly after the date of this Prospectus. As of the closing of the Offering, options to purchase an aggregate of 1,709,020 shares of Common Stock will be outstanding under the Stock Option Plan. 73 UNDERWRITING The Underwriters named below represented by Montgomery Securities and Piper Jaffray Inc. (the "Representatives"), have severally agreed, subject to the terms and conditions set forth in the Underwriting Agreement, to purchase from the Company and the Selling Stockholder the number of shares of Common Stock indicated below opposite their respective names at the initial public offering price less the underwriting discount set forth on the cover page of this Prospectus. The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions precedent and that the Underwriters are committed to purchase all of such shares if any are purchased.
NUMBER OF UNDERWRITER SHARES ----------- --------- Montgomery Securities........................................... Piper Jaffray Inc............................................... --------- Total......................................................... 3,500,000 =========
The Representatives have advised the Company and the Selling Stockholder that the Underwriters propose initially to offer the Common Stock to the public on the terms set forth on the cover page of this Prospectus. The Underwriters may allow to selected dealers a concession of not more than $ per share, and the Underwriters may allow, and such dealers may reallow, a concession of not more than $ per share to certain other dealers. After this Offering, the offering price and other selling terms may be changed by the Representatives. The shares of Common Stock are offered subject to receipt and acceptance by the Underwriters, and to certain other conditions, including the right to reject orders in whole or in part. The Company and the Selling Stockholders have granted options to the Underwriters, exercisable during the 30-day period after the date of this Prospectus, to purchase up to a maximum of 525,000 additional shares of Common Stock to cover over-allotments, if any, at the offering price less the underwriting discount set forth on the cover page of this Prospectus. To the extent the Underwriters exercise this option, each of the Underwriters will be committed, subject to certain conditions, to purchase such additional shares in approximately the same proportion as set forth in the above table. The Underwriters may purchase such shares only to cover over-allotments made in connection with Offering. The Underwriters have reserved up to 175,000 shares of Common Stock offered hereby for sale at the Offering price to directors, officers and employees of the Company and to certain other persons. The Underwriting Agreement provides that the Company and the Selling Stockholder will indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, or will contribute to payments the Underwriters may be required to make in respect thereof. The Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. All of the Company's officers and directors and certain of the Company's stockholders have agreed that they will not, without the prior written consent of Montgomery Securities (which consent may be withheld in its sole discretion) and subject to certain limited exceptions, directly or indirectly, sell, offer, contract or grant any option to sell, make any short sale, pledge, transfer, establish an open "put equivalent position" within the meaning of Rule 16a-1(h) under the Exchange Act, or otherwise dispose of any shares of Common Stock, options or warrants to acquire Common Stock, or securities exchangeable or exercisable for or convertible into Common Stock currently owned either of record or beneficially by them or announce the intention to do any of the foregoing, for a period commencing on the date of this Prospectus and continuing to a date 180 days after such date. Montgomery Securities may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to these lock-up agreements. In addition, the Company has agreed that, for a period of 180 days after the date of this Prospectus, it will not, without the consent of Montgomery Securities, issue, offer, 74 sell or grant options to purchase or otherwise dispose of any equity securities or securities convertible into or exchangeable for equity securities except for (i) the issuance of shares of Common Stock offered hereby, (ii) the issuance of shares of Common Stock pursuant to the exercise of outstanding options and (iii) the grant of options to purchase shares of Common Stock pursuant to the Stock Option Plan and shares of Common Stock issued pursuant to the exercise of such options. See "Management--Stock Option Plan" and "Shares Eligible for Future Sale." Prior to this Offering, there has been no public market for the Common Stock. Consequently, the initial public offering price will be determined by negotiations among the Company, the Selling Stockholder and the Representatives. Among the factors to be considered in such negotiations are the history of, and prospects for, the Company and the industry in which it competes, an assessment of the Company management, its past and present operations and financial performance, the prospects for future earnings of the Company, the present state of the Company's development, the general condition of the securities markets at the time of the Offering, the market prices of and demand for publicly traded common stocks of comparable companies in recent periods and other factors deemed relevant. The Representatives have advised the Company that, pursuant to Regulation M under the Securities Act, certain persons participating in this Offering may engage in transactions, including stabilizing bids, syndicate covering transactions or the imposition of penalty bids, which may have the effect of stabilizing or maintaining the market price of the Common Stock at a level above that which might otherwise prevail in the open market. A "stabilizing bid" is a bid for or the purchase of the Common Stock on behalf of the Underwriters for the purpose of fixing or maintaining the price of the Common Stock. A "syndicate covering transaction" is the bid for or the purchase of the Common Stock on behalf of the Underwriters to reduce a short position incurred by the Underwriters in connection with this Offering. A "penalty bid" is an arrangement permitting the Representatives to reclaim the selling concession otherwise accruing to an Underwriter or syndicate member in connection with this Offering if the Common Stock originally sold by such Underwriter or syndicate member is purchased by the Representative in a syndicate covering transaction and has therefore not been effectively placed by such Underwriter or syndicate member. The Representatives have advised the Company that such transactions may be effected on Nasdaq or otherwise and, if commenced, may be discontinued at any time. Montgomery Securities has performed certain investment banking and advisory services for the Company in the past. The Representatives have informed the Company that the Underwriters do not expect to make sales to accounts over which they exercise discretionary authority in excess of 5% of the number of shares of Common Stock offered hereby. LEGAL MATTERS Certain matters relating to this Offering are being passed upon for the Company by O'Melveny & Myers LLP, Newport Beach, California. A partner of such firm owns 211,032 shares of Common Stock of the Company. Brobeck, Phleger & Harrison LLP, Newport Beach, California will act as counsel for the Underwriters. EXPERTS The financial statements of the Company as of December 31, 1996 and December 31, 1995, for the year ended December 31, 1996 and for the period from November 17, 1995 (inception) to December 31, 1995 have been included herein in reliance upon the report of KPMG Peat Marwick LLP, independent auditors appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. 75 AVAILABLE INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission"), in Washington, D.C., a Registration Statement on Form S-1 under the Securities Act with respect to the Common Stock offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits thereto. Certain items are omitted in accordance with the rules and regulations of the Commission. For further information with respect to the Company and the Common Stock offered hereby, reference is made to the Registration Statement and the exhibits filed as a part thereof. Statements contained in this Prospectus as to the contents of any contract or any other document referred to are not necessarily complete and, in each instance, if such contract or document is filed as an exhibit, reference is made to the copy of such contract or document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference to such exhibit. Upon completion of the Offering, the Company will be subject to the informational requirements of the Exchange Act and, in accordance therewith, will file reports and other information with the Commission. The Registration Statement, including exhibits thereto, as well as the reports and other information filed by the Company with the Commission, may be inspected without charge at the Public Reference Room of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's regional offices at Seven World Trade Center, 13th Floor, New York, New York 10048, and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such materials can also be obtained at prescribed rates from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. Electronic filings made through the Electronic Data Gathering Analysis and Retrieval System are publicly available through the Commission's Web Site (http://www.sec.gov). 76 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE REFERENCE --------- Independent Auditors' Report.......................................... F-2 Consolidated Balance Sheets as of December 31, 1996 and 1995........ F-3 Consolidated Statements of Operations for the year ended December 31, 1996, and for the period from November 17, 1995 (inception) to December 31, 1995.................................................. F-4 Consolidated Statements of Changes in Stockholders' Equity for the year ended December 31, 1996, and for the period from November 17, 1995 (inception) to December 31, 1995.............................. F-5 Consolidated Statements of Cash Flows for the year ended December 31, 1996, and for the period from November 17, 1995 (inception) to December 31, 1995.................................................. F-6 Notes to Consolidated Financial Statements for the year ended December 31, 1996, and for the period from November 17, 1995 (inception) to December 31, 1995................................... F-7 Condensed Consolidated Balance Sheets as of March 31, 1997 (unaudited) and December 31, 1996.................................. F-20 Condensed Consolidated Statements of Operations (unaudited) for the three months ended March 31, 1997 and 1996 ........................ F-21 Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 1997 and 1996 ........................ F-22 Notes to Condensed Consolidated Financial Statements (unaudited) for the three months ended March 31, 1997 and 1996..................... F-23
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors New Century Financial Corporation: We have audited the accompanying consolidated balance sheets of New Century Financial Corporation and subsidiary as of December 31, 1996 and 1995 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the year ended December 31, 1996 and the period from November 17, 1995 (inception) to December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 New Century Financial Corporation and subsidiary as of December 31, 1996 and 1995 and the results of their operations and their cash flows for the year ended December 31, 1996 and the period from November 17, 1995 (inception) to December 31, 1995 in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Orange County, California March 7, 1997, except for note 4, which is as of March 28, 1997. F-2 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1996 1995 ------- ------ ASSETS Cash and cash equivalents...................................... $ 3,041 $3,029 Loans receivable held for sale, net (notes 2 and 4)............ 57,990 -- Accrued interest receivable.................................... 786 -- Office property and equipment (notes 3 and 5).................. 1,620 34 Prepaid expenses and other assets.............................. 1,201 88 ------- ------ $64,638 $3,151 ======= ====== LIABILITIES AND STOCKHOLDERS' EQUITY Warehouse lines of credit (note 4)............................. $55,659 $ -- Notes payable (note 5)......................................... 1,326 -- Income taxes payable (note 7).................................. 839 -- Accounts payable and accrued liabilities....................... 2,283 83 Deferred income taxes (note 7)................................. 128 -- ------- ------ 60,235 83 ------- ------ Stockholders' equity (notes 9 and 10): Preferred stock, $.01 par value. Authorized 7,320,000 shares: Series A Convertible Preferred Stock--issued and outstanding 5,500,000 shares.............................. 54 54 Series B Convertible Preferred Stock--issued and outstanding 320,000 shares................................ 4 4 Common Stock, $.01 par value. Authorized 12,963,778 shares; issued and outstanding 528,618 shares....................... 6 6 Additional paid-in capital................................... 3,086 3,086 Retained earnings (deficit), restricted...................... 1,253 (82) ------- ------ Total stockholders' equity............................... 4,403 3,068 Commitments and contingencies (notes 6 and 8).................. Subsequent events (notes 2, 4, 5 and 6)........................ ------- ------ $64,638 $3,151 ======= ======
See accompanying notes to consolidated financial statements. F-3 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
PRO FORMA PERIOD FROM ----------------- NOVEMBER 17, 1995 YEAR ENDED YEAR ENDED (INCEPTION) TO DECEMBER 31, 1996 DECEMBER 31, DECEMBER 31, (NOTE 14) 1996 1995 ----------------- ------------ ----------------- (UNAUDITED) Revenues: Gain on sale of loans (note 2).......................... $ 11,630 $11,630 $-- Interest income.............. 2,846 2,846 14 Servicing fees............... 29 29 -- ---------- ------- ---- Total revenues............ 14,505 14,505 14 ---------- ------- ---- Expenses: Personnel.................... 6,328 6,083 54 General and administrative (note 11)................... 2,456 2,456 11 Interest..................... 1,941 1,941 -- Advertising and promotion.... 1,169 1,169 -- Servicing.................... 269 269 -- Professional services........ 282 282 30 ---------- ------- ---- Total expenses............ 12,445 12,200 95 ---------- ------- ---- Earnings (loss) before income taxes............. 2,060 2,305 (81) Income taxes (note 7)......... 867 970 1 ---------- ------- ---- Net earnings (loss)....... $ 1,193 $ 1,335 $(82) ========== ======= ==== Pro Forma earnings per share.. $ 0.10 ========== Pro Forma weighted average number of shares outstanding. 11,630,439 ==========
See accompanying notes to consolidated financial statements. F-4 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEAR ENDED DECEMBER 31, 1996 AND THE PERIOD FROM NOVEMBER 17, 1995 (INCEPTION) TO DECEMBER 31, 1995 (DOLLARS IN THOUSANDS)
SERIES A SERIES B RETAINED PREFERRED PREFERRED COMMON ADDITIONAL EARNINGS STOCK STOCK STOCK PAID-IN (DEFICIT) AMOUNT AMOUNT AMOUNT CAPITAL RESTRICTED TOTAL --------- --------- ------ ---------- ---------- ------ Balance, November 17, 1995 (inception)....... $-- $-- $-- $ -- $ -- $ -- Proceeds from issuance of Series A Preferred Stock (note 9)......... 54 -- -- 2,696 -- 2,750 Proceeds from issuance of Series B Preferred Stock (note 9)......... -- 4 -- 156 -- 160 Proceeds from issuance of Common Stock (note 9)............... -- -- 6 234 -- 240 Net loss................ -- -- -- -- (82) (82) ---- ---- ---- ------ ------ ------ Balance, December 31, 1995................... 54 4 6 3,086 (82) 3,068 Net earnings............ -- -- -- -- 1,335 1,335 ---- ---- ---- ------ ------ ------ Balance, December 31, 1996................... $ 54 $ 4 $ 6 $3,086 $1,253 $4,403 ==== ==== ==== ====== ====== ======
See accompanying notes to consolidated financial statements. F-5 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31, 1996 AND THE PERIOD FROM NOVEMBER 17, 1995 (INCEPTION) TO DECEMBER 31, 1995 (DOLLARS IN THOUSANDS)
1996 1995 --------- ------ Cash flows from operating activities: Net earnings (loss)........................................ $ 1,335 $ (82) Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation and amortization............................. 260 -- Deferred income taxes..................................... 128 -- Provision for losses...................................... 706 -- Loans originated or acquired for sale..................... (357,727) -- Loan sales, net........................................... 298,713 -- Principal payments on loans receivable held for sale...... 418 -- Increase in accrued interest receivable................... (786) -- Increase in prepaid expenses and other assets............. (1,125) (88) Increase in warehouse lines of credit..................... 55,659 -- Increase in income taxes payable.......................... 839 -- Increase in accounts payable and accrued liabilities...... 2,100 83 --------- ------ Net cash provided by (used in) operating activities..... 520 (87) --------- ------ Cash flows from investing activities--purchase of office property and equipment..................................... (1,834) (34) --------- ------ Cash flows from financing activities: Net proceeds from notes payable............................ 1,326 -- Proceeds from issuance of stock............................ -- 3,150 --------- ------ Net cash provided by financing activities............... 1,326 3,150 --------- ------ Net increase in cash and cash equivalents............... 12 3,029 Cash and cash equivalents at beginning of period............ 3,029 -- --------- ------ Cash and cash equivalents at end of period.................. $ 3,041 $3,029 ========= ====== Supplemental cash flow disclosure: Interest paid.............................................. $ 1,738 $ -- Income taxes............................................... 3 1 ========= ======
See accompanying notes to consolidated financial statements. F-6 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 AND 1995 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization--New Century Financial Corporation (the "Company"), a Delaware corporation, was incorporated on November 17, 1995. The Company's subsidiary commenced operations in February 1996 and is a specialty finance company engaged in the business of originating, purchasing, selling and servicing mortgage loans secured primarily by first mortgages on single family residences. Principles of Consolidation--The accompanying consolidated financial statements include the accounts of the Company's wholly owned subsidiary, New Century Mortgage Corporation. All material intercompany balances and transactions are eliminated in consolidation. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. Cash and Cash Equivalents--For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. Cash equivalents consist of cash on hand and due from banks. Loans Receivable Held for Sale--Mortgage loans held for sale are stated at the lower of amortized cost or market as determined by outstanding commitments from investors or current investor-yield requirements calculated on an aggregate basis. Interest on loans receivable held for sale is credited to income as earned. Interest is accrued only if deemed collectible. Gains on Sale of Loans--Gains or losses resulting from sales of mortgage loans are recognized at the date of settlement and are based on the difference between the selling price and the carrying value of the related loans sold. Such gains and losses may be increased or decreased by the amount of any servicing released premiums received. Nonrefundable fees and direct costs associated with the origination of mortgage loans are deferred and recognized when the loans are sold. Allowance for Repurchase Losses--The allowance for repurchase losses on loans sold relates to costs incurred due to the repurchase of loans or indemnification of losses based on alleged violations of representations and warranties customary to the mortgage banking industry. The allowance represents the Company's estimate of losses expected to occur and is considered to be adequate. Provisions for losses are charged to expense and credited to the allowance and are determined to be adequate by management based upon the Company's evaluation of the potential exposure related to the loan sale agreements. Office Property and Equipment--Office property and equipment are stated at cost. The straight-line method of depreciation is followed for financial reporting purposes. Depreciation and amortization are provided in amounts sufficient to relate the cost of assets to operations over their estimated service lives or the lives of the respective leases. The estimated service lives for furniture and office equipment, computer hardware/software and leasehold improvements are five years, three years and five years, respectively. Organization Costs--Organization costs incurred in connection with the formation of the Company amounted to approximately $63,000 and are being amortized over a five-year period using the straight-line method. At December 31, 1996 and 1995, accumulated amortization was $12,000 and $0, respectively. Financial Statement Presentation--The Company prepares its financial statements using an unclassified balance sheet presentation as is customary in the mortgage banking industry. A classified balance sheet F-7 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) presentation would have aggregated current assets, current liabilities and net working capital as of December 31, 1996 as follows (dollars in thousands): Current assets................................. $63,018 Current liabilities............................ 59,240 ------- Net working capital........................... $ 3,778 =======
Errors and Omissions Policy--In connection with the Company's lending activities, the Company has Fidelity Bond and Errors and Omissions insurance coverage of $500,000 each at December 31, 1996. Income Taxes--The Company intends to file consolidated Federal and combined state tax returns. The Company accounts for income taxes using the asset and liability method. Under the asset and liability method, 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. 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. Residual Interests in Securitizations--Residual interests in securitizations of real estate mortgage investment conduits (REMICs) are recorded as a result of the sale of loans through securitization. At the closing of each securitization, the Company removes from its balance sheet the mortgage loans held for sale and adds to its balance sheet (i) the cash received, (ii) the estimated fair value of the residuals from the securitizations which consists of (a) an overcollateralization amount (OC) and (b) a net interest receivable (NIR). The excess of the cash received and assets retained by the Company over the carrying value of the loans sold, less transaction costs, equals the gain on sale of loans recorded by the Company. The Company allocates its basis in the mortgage loans between the portion of the mortgage loans sold through mortgage backed securities (the senior certificates) and the portion retained (the residual interests) based on the relative fair values of those portions on the date of the sale. The Company may recognize gains or losses attributable to the change in the fair value of the residual interests, which are recorded at estimated fair value and accounted for as "held-for-trading" securities. The Company is not aware of an active market for the purchase or sale of residual interests; accordingly, the Company estimates fair value of the residual interests by calculating the present value of the estimated expected future cash flows using a discount rate commensurate with the risks involved. NIRs are determined by using the amount of the excess of the weighted- average coupon on the loans sold over the sum of: (1) the coupon on the senior certificates, (2) a base servicing fee paid to the servicer of the loans, (3) expected losses to be incurred on the portfolio of loans sold over the lives of the loans and (4) other expenses and revenues, which includes anticipated prepayment penalties. The significant assumptions used by the Company to estimate NIR cash flows are anticipated prepayments and estimated credit losses. The Company estimates prepayments by evaluating historical prepayment performance of comparable loans and the impact of trends in the industry. The Company estimates credit losses using available historical loss data for comparable loans and the specific characteristics of the loans included in the Company's securitizations. The OC represents the portion of the loans which are held by the trust as overcollateralization for the senior certificates sold and along with a certificate guarantor insurance policy serves as credit enhancement to the senior certificate holders. The OC initially consists of the excess of the principal balance of the mortgage loans sold to F-8 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) the trust, less the principal balance of the certificates sold to investors. The OC is required to be maintained at a specified target level of the principal balance of the certificates, which can be increased significantly in the event delinquencies and or losses exceed certain specified levels. Cash flows received by the trust in excess of the obligations of the trust are deposited into the overcollateralization account until the target OC is reached. Once the target OC is reached, distributions of excess cash are remitted to the Company. Use of Estimates--Management of the Company has made certain estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in accordance with generally accepted accounting principles. Actual results could differ from these estimates. Advertising--The Company accounts for its advertising costs as nondirect response advertising. Accordingly, advertising costs are expensed as incurred. Reclassification--Certain amounts for 1995 have been reclassified to conform to the 1996 presentation. Recent Accounting Developments--In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 125 (FASB No. 125), "Accounting for Transfer and Servicing of Financial Assets and Extinguishment of Liabilities." FASB No. 125 addresses the accounting for all types of securitization transactions, securities lending and repurchase agreements, collateralized borrowing arrangements and other transactions involving the transfer of financial assets. FASB No. 125 distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. FASB No. 125 is effective for transactions that occur after December 31, 1996 and it is to be applied prospectively. FASB No. 125 will require the Company to allocate its basis in the mortgage loans between the portion of the mortgage loans sold through mortgage backed securities and the portion retained (the residual interests) based on the relative fair values of those portions on the date of the sale. The pronouncement requires the Company to account for the residual interests as "held-for-trading" securities which are to be recorded at fair value in accordance with SFAS No. 115. The Company adopted FASB No. 125 on January 1, 1997 and there was no material impact on the Company's financial position or results of operations. 2. LOANS RECEIVABLE HELD FOR SALE A summary of loans receivable held for sale, at the lower of cost or market at December 31, 1996 follows (dollars in thousands): Mortgage loans receivable........................................ $57,701 Net deferred origination costs................................... 289 ------- $57,990 =======
The Company had no loans receivable held for sale at December 31, 1995. At December 31, 1996, the Company had loans receivable held for sale of approximately $1.1 million, on which the accrual of interest had been discontinued. If these loans receivable had been current throughout their terms, interest would have increased by approximately $26,000. F-9 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) Gain on Sale of Loans--Gain on sale of loans for the year ended December 31, 1996 was comprised of the following components (dollars in thousands): Gain from whole loan sale transactions.......................... $15,052 Provision for losses............................................ (706) Nonrefundable fees.............................................. 3,548 Premiums, net................................................... (1,973) Origination costs............................................... (4,291) ------- $11,630 =======
Originations and Purchases--During the year ended December 31, 1996, approximately 62.4% and 15.7% of the Company's total loan originations and purchases were in the states of California and Illinois, respectively. Significant Customers--The Company has entered into a number of transactions with two customers which accounted for more than 10% of the Company's loan sales. During the year ended December 31, 1996, the Company sold a total of approximately 51.4% and 32.2% of the loans sold to these two customers and recognized gross gains on sales of approximately 50.9% and 39.3% of the total gross gains. 3. OFFICE PROPERTY AND EQUIPMENT Office property and equipment consist of the following at December 31 (dollars in thousands):
1996 1995 ------ ---- Leasehold improvements....................................... $ 93 $ 2 Furniture and office equipment............................... 547 4 Computer hardware and software............................... 1,228 28 ------ --- 1,868 34 Less accumulated depreciation and amortization............... (248) -- ------ --- $1,620 $34 ====== ===
4. WAREHOUSE LINES OF CREDIT Warehouse lines of credit consist of the following at December 31 (dollars in thousands):
1996 1995 ------- ----- A $55 million line of credit expiring in June 1997 secured by loans receivable held for sale, bearing interest based on one month LIBOR (5.54% at December 31, 1996)........... $41,702 $ -- A $175 million master repurchase agreement bearing interest based on one month LIBOR (5.54% at December 31, 1996). The agreement may be terminated by the lender giving 28 days written notice............................................ 13,957 -- ------- ----- $55,659 $ -- ======= =====
The warehouse line of credit agreements contain certain restrictive financial and other covenants which require the Company to, among other requirements, restrict dividends, and maintain certain levels of net worth, liquidity of at least $1.5 million, debt to net worth ratios and maintenance of compliance with regulatory and investor requirements. At December 31, 1996, the Company was in compliance with these financial and other covenants. F-10 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) On March 14, 1997, the Company amended the $55 million line of credit agreement to include a working capital line of credit with the bank whereby the Company will be able to borrow up to $2.5 million. The working capital line of credit expires in June 1997, is unsecured and bears interest based on the bank's prime rate. On March 28, 1997, the $55 million line of credit was amended whereby the Company will be able to borrow up to $85 million. The terms and conditions of the amended line of credit are the same as the original terms and conditions mentioned above. 5. NOTES PAYABLE Notes payable consists of a financing line of credit of $1.5 million, collateralized by office property and equipment, bears interest at rates varying from 8.82% to 9.05% and expires in May 1997. The Company had borrowed approximately $1.3 million under this line as of December 31, 1996. The borrowings are payable in blended monthly payments of principal and interest and mature commencing from May 1999 to December 1999. The maturities of notes payable at December 31, 1996 are as follows (dollars in thousands): Due in 1 year or less............................................. $ 459 Due after 1 through 5 years....................................... 867 ------ $1,326 ======
In February 1997, the financing line of credit was amended whereby the Company will be able to borrow up to $2.5 million. The terms and conditions of the amended line of credit are the same as the original terms and conditions mentioned above. 6. COMMITMENTS AND CONTINGENCIES Servicing--The Company's portfolio of mortgage loans serviced for others is comprised of approximately $102 million at December 31, 1996, all of which were serviced on a temporary basis under interim servicing arrangements which the Company contracted with a subservicer to perform. The Company has a subservicing contract with a subservicer to service its loans receivable held for sale portfolio which together with the interim servicing portfolio noted above, totaled approximately $160 million at December 31, 1996. Related Party--The Company entered into employment agreements on December 1, 1995 with four executive officers (the "Founding Managers") of the Company expiring through December 1998. The Company is committed to pay minimum aggregate compensation of $720,000 per annum. In addition, the executive officers are entitled to certain employment-related benefits. In December 1996, the Company adopted the Founding Manager's Incentive Compensation Plan (the "Plan") for the benefit of the Founding Managers. The Plan provides for payment of incentive compensation equal to 12.5% of the Company's earnings before income taxes, provided that these earnings represent greater than 17.5% return on stockholders' equity as defined. In the event the aggregate incentive compensation amounts payable to Founding Managers for a fiscal year exceeds the aggregate base salaries of the Founding Managers, 50% of the excess amount will be distributed at the discretion of the Compensation Committee in cash installments or granted as a nonqualified stock option, and the remaining 50% will be distributed at the discretion of each Founding Manager in cash installments or granted as a nonqualified stock option. As of December 31, 1996 and 1995, the Company accrued $318,000 and $0, respectively, of incentive compensation under the Plan. F-11 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) Operating Leases--The Company and its subsidiary lease certain facilities under noncancelable operating leases, which expire at various dates through 2002. Total rental expenditures under these leases were approximately $389,000 and $0 for the year ended December 31, 1996 and the period from November 17, 1995 (inception) to December 31, 1995, respectively. Minimum rental commitments for these leases are as follows (dollars in thousands): Year ending December 31: 1997............................................................. $ 852 1998............................................................. 722 1999............................................................. 475 2000............................................................. 251 2001............................................................. 156 Thereafter....................................................... 8 ------ $2,464 ======
The Company is in the process of negotiating a new lease for its administrative offices. The initial monthly rental payment is estimated to be $75,000 and is anticipated to expire in 2002. Loan Commitments--Commitments to fund loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Also, external market forces impact the probability of commitments being exercised; therefore, total commitments outstanding do not necessarily represent future cash requirements. The Company quotes interest rates to borrowers which are subject to change by the Company. Although the Company generally honors such interest rate quotes, the quotes do not constitute interest rate locks, minimizing any potential interest rate risk exposure. The Company had commitments to fund loans of approximately $37.7 million at December 31, 1996. The Company had no commitments to sell loans at December 31, 1996. As of December 31, 1996, the Company was committed to provide an investment banking firm with a right to purchase whole loans and/or to lead underwrite loans sold through securitization by the Company in an aggregate amount of $500 million. In February 1997, the Company securitized through this investment banking firm approximately $99.1 million in loans. In conjunction with this securitization, the Company borrowed $7.5 million from this same firm which is renewable monthly, bears interest based on one month LIBOR and is collateralized by the Company's retained residual interest in the securitization. Contingencies--The Company has entered into loan sale agreements with investors in the normal course of business which include standard representations and warranties customary to the mortgage banking industry. Violations of these representations and warranties may require the Company to repurchase loans previously sold or to reimburse investors for losses incurred. In the opinion of management, the potential exposure related to the Company's loan sale agreements will not have a material adverse effect on the financial position and operating results of the Company. The Company sold loans in September and December 1996 under an agreement to repurchase those loans which were delinquent at a specific date in December 1996 and January 1997. In accordance with this loan sale agreement, the Company repurchased loans with an outstanding principal balance of approximately $1.7 million for the year ended December 31, 1996. Subsequent to year-end, the Company repurchased additional loans with an outstanding principal balance of approximately $2.3 million. F-12 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) At December 31, 1996 and 1995, included in other liabilities are $100,000 and $0, respectively, in allowances for repurchase losses related to possible off-balance sheet recourse and repurchase agreement provisions. The activity in the allowance related to possible off-balance sheet recourse and repurchase agreement provisions for the year ended December 31, 1996 is summarized as follows (dollars in thousands): Balance, beginning of year.......................................... $ -- Provision for losses................................................ 706 Charge-offs, net.................................................... (606) ---- Balance, end of year................................................ $100 ====
Litigation--The Company is a party to legal actions arising in the normal course of business. In the opinion of management, based in part on discussions with outside legal counsel, resolution of such matters will not have a material adverse effect on the financial position and operating results of the Company. 7. INCOME TAXES Components of the Company's provision for income taxes for the year ended December 31, 1996 and for the period from November 17, 1995 (inception) to December 31, 1995 are as follows (dollars in thousands):
1996 1995 ---- ---- Current: Federal........................................................ $650 $ 1 State.......................................................... 192 -- ---- ---- 842 1 ---- ---- Deferred: Federal........................................................ 66 -- State.......................................................... 62 -- ---- ---- 128 -- ---- ---- $970 $ 1 ==== ====
Actual income taxes differ from the amount determined by applying the statutory Federal rate of 34% for the year ended December 31, 1996 and for the period from November 17, 1995 (inception) to December 31, 1995 to earnings (loss) before taxes as follows (dollars in thousands):
1996 1995 ---- ---- Computed "expected" income taxes............................. $784 $(27) State tax, net............................................... 174 -- Valuation reserve............................................ (28) 28 Other........................................................ 40 -- ---- ---- $970 $ 1 ==== ====
F-13 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 are as follows (dollars in thousands):
1996 1995 ---- ---- Deferred tax assets: Allowance for loan losses.................................... $229 $-- Accruals for tax purposes not deductible..................... 40 -- State taxes.................................................. 86 -- Net operating losses......................................... -- 28 ---- ---- 355 28 Valuation allowance....................................... -- (28) ---- ---- 355 -- ---- ---- Deferred tax liabilities: Deferred loan fees........................................... (448) -- Office property and equipment................................ (35) -- ---- ---- (483) -- ---- ---- Net deferred income tax liability......................... $128 $-- ==== ====
The valuation allowance for deferred tax assets was $0 and $28,000 at December 31, 1996 and 1995, respectively. The net change in the total valuation allowance for the year ended December 31, 1996 was $28,000. Deferred tax assets are initially recognized for differences between the financial statement carrying amount and the tax bases of assets and liabilities which will result in future deductible amounts and operating loss and tax credit carryforwards. A valuation allowance is then established to reduce that deferred tax asset to the level at which it is more likely than not that the tax benefits will be realized. Realization of tax benefits of deductible temporary differences and operating loss or tax credit carryforwards depends on having sufficient taxable income of an appropriate character within the carryback and carryforward periods. Sources of taxable income that may allow for the realization of tax benefits include: (1) taxable income in the current year or prior years that is available through carryback, (2) future taxable income that will result from the reversal of existing taxable temporary differences, (3) future taxable income generated by future operations and (4) tax planning strategies that, if necessary, would be implemented to accelerate taxable income into years in which net operating losses might otherwise expire. 8. EMPLOYEE BENEFIT PLAN On July 1, 1996, the Company established the New Century Financial Corporation 401(k) Profit Sharing Plan (the Plan) for the benefit of eligible employees and their beneficiaries. The Plan is a defined contribution 401(k) plan which allows eligible employees to save for retirement through pretax contributions. Under the Plan, employees of the Company may contribute up to the statutory limit. The Company will match 25% of the first 6% of compensation contributed by the employee. An additional Company contribution may be made at the discretion of the Company. Contributions to the Plan by the Company for the year ended December 31, 1996 were $47,000. 9. STOCKHOLDERS' EQUITY Convertible Preferred Stock--On November 22, 1995, the Company issued 5,000,000 shares of Series A Preferred Stock. In December 1995, the Company issued an additional 500,000 shares of Series A Preferred Stock. The Company received $2.75 million from the issuances. The holders of the Series A Preferred Stock are F-14 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) entitled to convert each share of Series A Preferred Stock into one share of Common Stock. Upon liquidation, the Series A Preferred Stock is entitled to receive, in preference to any payment on Series B Preferred Stock and Common Stock, an amount equal to $0.50 per share and a 12% annual return. On November 22, 1995, the Company issued 320,000 shares of Series B Preferred Stock. The Company received $160,000 from this issue. The holders of the Series B Preferred Stock are entitled to convert each share of Series B Preferred Stock into one share of Common Stock. Upon liquidation, after the payments to Series A Preferred Stock as described above, the Series B Preferred Stock is entitled to receive, in preference to any payment on Common Stock, an amount equal to $0.50 per share and a 6% annual return. Common Stock--On November 22, 1995, the Company issued 528,618 shares of Common Stock. The Company received $240,000 from this issue. Stock Split--On September 19, 1996, the Company authorized a 2-for-1 stock split of all classes of stock. The Company also authorized an additional 1,500,000 shares each of Common Stock and Preferred Stock, the terms and preferences of which may be determined by the Board of Directors without further shareholder approval. All references in the consolidated financial statements to number of shares, per share amounts and market prices of the Company's Preferred and Common Stock have been retroactively restated to reflect the increased number of preferred and common shares outstanding. Warrants--Each share of Common Stock issued on November 22, 1995 had a warrant attached which entitles the holder to purchase 2.78 shares of Common Stock of the Company at $1.00, $2.00 and $3.00 per share. The warrants are exercisable at any time prior to January 31, 2003. In December 1996, the Company issued warrants to purchase an aggregate of 512,384 shares of Common Stock, exercisable at $3.50 per share, to the Company's existing stockholders. Such warrants were granted to stockholders on a pro rata basis in satisfaction of the stockholders' respective preemptive rights. 10. STOCK OPTIONS In 1995, the Company adopted and received stockholders' approval of the qualified 1995 Stock Option Plan (the "Plan") pursuant to which the Company's Board of Directors may grant stock options to officers and key employees. The Plan authorizes grants of options to purchase up to 705,402 shares of authorized but unissued Common Stock. Stock options granted under the Plan have terms of ten years and vest over a range from December 1996 to December 2001. In addition to the Plan, in December 1996, the Company authorized 120,000 nonqualified stock options to certain executive officers of the Company that vest in December 1999 and expire five years from the grant date. All stock options are granted with an exercise price equal to the stock's fair market value at the date of grant. At December 31, 1996, there were 160,802 shares available for grant under the Plan. Of the options outstanding at December 31, 1996 and 1995, 14,600 and zero, respectively, were exercisable with a weighted-average exercise price of $3.17. The per share weighted-average fair value of stock options granted during the year ended December 31, 1996 and the period from November 17, 1995 (inception) to December 31, 1995 was $1.05 and $.20 at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
1996 1995 ---- ---- Expected life (years)......................................... 9.1 10 Risk-free interest rate....................................... 6.0% 6.0% Volatility.................................................... 45.0% 45.0% Expected dividend yield....................................... -- -- ==== ====
F-15 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) The Company applies APB Opinion No. 25 in accounting for its plans and, accordingly, no compensation cost has been recognized for its stock options in the consolidated financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation," the Company's net earnings (loss) would have been reduced to the pro forma amounts indicated below (dollars in thousands):
PERIOD FROM NOVEMBER 17, 1995 (INCEPTION) YEAR ENDED TO DECEMBER 31, DECEMBER 31, 1996 1995 ------------ ------------ Net earnings (loss): As reported................................... $1,335 $(82) Pro forma..................................... 1,329 (82) ====== ====
Stock options activity during the year ended December 31, 1996 and the period from November 17, 1995 (inception) to December 31, 1995 is as follows:
WEIGHTED- NUMBER OF AVERAGE SHARES EXERCISE PRICE --------- -------------- Granted.......................................... 73,000 $ .50 Exercised........................................ -- -- Canceled......................................... -- -- ------- ----- Balance at December 31, 1995................... 73,000 .50 Granted.......................................... 595,600 1.92 Exercised........................................ -- -- Canceled......................................... (4,000) 0.50 ------- ----- Balance at December 31, 1996................... 664,600 $1.77 ======= =====
At December 31, 1996, the range of exercise prices, the number outstanding, weighted-average remaining term and weighted-average exercise price of options outstanding and the number exercisable and weighted-average price of options currently exercisable are as follows:
WEIGHTED- WEIGHTED- WEIGHTED- RANGE OF NUMBER AVERAGE AVERAGE NUMBER AVERAGE EXERCISE PRICES OUTSTANDING REMAINING TERM EXERCISE PRICE EXERCISABLE EXERCISE PRICE - --------------- ----------- -------------- -------------- ----------- -------------- $0.50 -- 0.50 282,000 9.67 $0.50 14,600 $0.50 1.75 -- 1.75 174,000 9.75 1.75 -- -- 3.50 -- 3.50 208,600 10.00 3.50 -- -- ======== ======= ===== ===== ====== =====
F-16 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 11. GENERAL AND ADMINISTRATIVE EXPENSES A summary of general and administrative expenses follows (dollars in thousands):
1996 1995 ------ ---- Occupancy.................................................... $ 389 $-- Telephone.................................................... 336 -- Travel and entertainment..................................... 277 6 Depreciation and amortization................................ 260 -- Office supplies.............................................. 238 2 Postage and courier.......................................... 204 -- Equipment rental............................................. 184 -- Other administrative expenses................................ 568 3 ------ ---- $2,456 $ 11 ====== ====
12. FAIR VALUE OF FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is made using estimated fair value amounts that have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions or estimation methodologies may have a material impact on the estimated fair value amounts. The estimated fair values of the Company's financial instruments as of December 31, 1996 are as follows (dollars in thousands):
CARRYING FAIR VALUE VALUE -------- ------- Financial assets: Cash and cash equivalents............................. $ 3,041 $ 3,041 Loans receivable held for sale, net................... 57,990 61,210 Financial liabilities: Warehouse lines of credit............................. 55,659 55,659 Notes payable......................................... 1,326 1,326 ======= =======
The following methods and assumptions were used in estimating the Company's fair value disclosures for financial instruments. Cash and cash equivalents: The fair value of cash and cash equivalents approximates the carrying value reported in the balance sheet. Loans receivable held for sale: The fair value of loans receivable held for sale is determined in the aggregate based on outstanding whole loan commitments from investors or current investor yield requirements. Warehouse lines of credit: The carrying value reported in the balance sheet approximates fair value as the warehouse lines of credit are due upon demand and bear interest at a rate that approximates current market interest rates for similar type lines of credit. Notes payable: The fair value of notes payable is determined by discounting expected cash payments at the current market interest rate over the term of the notes payable. F-17 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 13. CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY The following is condensed information as to the financial condition, results of operations and cash flows of New Century Financial Corporation (dollars in thousands): CONDENSED BALANCE SHEETS
DECEMBER 31, -------------- 1996 1995 ASSETS ------- ------ Cash and cash equivalents....................................... $ 4 $1,151 Investment in subsidiary........................................ 4,273 1,913 Other assets.................................................... 136 53 ------- ------ $ 4,413 3,117 ======= ====== LIABILITIES AND STOCKHOLDERS' EQUITY Other liabilities............................................... $ 10 $ 49 Stockholders' equity............................................ 4,403 3,068 ------- ------ $ 4,413 $3,117 ======= ======
CONDENSED STATEMENTS OF EARNINGS
PERIOD FROM NOVEMBER 17, 1995 (INCEPTION) YEAR ENDED TO DECEMBER 31, DECEMBER 31, 1996 1995 ------------ ------------ Interest income....................................... $ 17 $ 5 Equity in earnings (loss) of subsidiary............... 1,419 (87) ------ ---- 1,436 (82) ------ ---- Personnel............................................. 104 -- General and administrative............................ 46 -- Professional services................................. 10 -- ------ ---- 160 -- ------ ---- Earnings (loss) before income tax benefit........... 1,276 (82) Income tax benefit.................................... (59) -- ------ ---- Net earnings (loss)................................. $1,335 $(82) ====== ====
F-18 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS
PERIOD FROM NOVEMBER 17, 1995 (INCEPTION) YEAR ENDED TO DECEMBER 31, DECEMBER 31, 1996 1995 ------------ ------------ Cash flows from operating activities: Net earnings (loss)................................ $ 1,335 $ (82) Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.................... 11 -- Increase in other assets......................... (94) (53) Increase (decrease) in other liabilities......... (39) 49 Equity in earnings (loss) of subsidiary.......... (1,419) 87 Net cash provided by (used in) operating activities.................................... (206) 1 ------- ------- Cash flows from investing and financing activities: Investment in subsidiary........................... (941) (2,000) Proceeds from issuance of stock.................... -- 3,150 ------- ------- (941) 1,150 ------- ------- Net increase (decrease) in cash................ (1,147) 1,151 Cash and cash equivalents, beginning of period....... 1,151 -- ------- ------- Cash and cash equivalents, end of period............. $ 4 $ 1,151 ======= =======
14. UNAUDITED PRO FORMA STATEMENT OF EARNINGS AND EARNINGS PER SHARE Pro Forma net earnings for the year ended December 31, 1996 represents the results of operations adjusted to reflect the effect of the revised employment agreements and the revised calculation of incentive compensation amounts for the Founding Managers which took effect on May 30, 1997. Pro Forma earnings per share has been computed by dividing pro forma net earnings by the pro forma weighted average number of shares outstanding. In accordance with a regulation of the Securities and Exchange Commission, the pro forma weighted average number of shares includes all options and warrants issued below the estimated initial public offering price within one year prior to the filing of the Registration Statement for the initial public offering and is calculated using the treasury stock method. Historical earnings per share is not presented because it is not indicative of the ongoing entity. F-19 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY CONDENSED CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
PRO FORMA MARCH 31, 1997 MARCH 31, DECEMBER 31, ASSETS (NOTE 5) 1997 1996 ------ --------- --------- ------------ Cash and cash equivalents.................... $ 3,747 $ 3,747 $ 3,041 Loans receivable held for sale, net (notes 2 and 4)...................................... 113,162 113,162 57,990 Accrued interest receivable.................. 364 364 786 Residual interests in securitization (note 3).......................................... 13,243 13,243 -- Office property and equipment................ 1,990 1,990 1,620 Prepaid expenses and other assets............ 2,240 1,076 1,201 --------- -------- -------- $ 134,746 $133,582 $ 64,638 ========= ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Warehouse lines of credit (note 4)........... $ 106,731 $110,534 $ 55,659 Residual financing (note 4).................. 7,248 7,248 -- Notes payable................................ 1,869 3,119 1,326 Income taxes payable......................... 67 131 839 Accounts payable and accrued liabilities..... 4,193 4,041 2,283 Deferred income taxes........................ 1,759 1,759 128 --------- -------- -------- $ 121,867 126,832 60,235 --------- -------- -------- Stockholders' equity: Preferred stock, $.01 par value. Authorized 7,320,000 shares: Series A Convertible Preferred Stock-- issued and outstanding 5,500,000 shares. -- 54 54 Series B Convertible Preferred Stock-- issued and outstanding 320,000 shares... -- 4 4 Common Stock, $.01 par value. Authorized 12,963,778 shares; issued and outstanding 528,618 shares (Pro Forma outstanding 10,992,374 shares)........................ 110 6 6 Additional paid-in capital................. 12,032 3,086 3,086 Retained earnings, restricted.............. 3,512 3,600 1,253 --------- -------- -------- 15,654 6,750 4,403 Deferred compensation costs.............. (2,775) -- -- --------- -------- -------- 12,879 6,750 4,403 --------- -------- -------- Contingencies (note 7) Subsequent events (notes 6 and 7) $ 134,746 $133,582 $ 64,638 ========= ======== ========
See accompanying notes to condensed consolidated financial statements. F-20 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
PRO FORMA THREE MONTHS THREE MONTHS ENDED ENDED MARCH 31, MARCH 31, 1997 ------------- (NOTE 5) 1997 1996 ------------ ------- ----- Revenues Gain on sale of loans (note 2)................... $ 10,012 $10,012 $ -- Interest income.................................. 2,271 2,271 39 Servicing fees................................... 302 302 -- ---------- ------- ----- Total revenues................................. 12,585 12,585 39 ---------- ------- ----- Expenses: Personnel........................................ 3,697 3,545 584 General and administrative....................... 1,954 1,954 144 Interest......................................... 1,808 1,808 14 Advertising and promotion........................ 842 842 106 Servicing........................................ 234 234 -- Professional services............................ 156 156 51 ---------- ------- ----- Total expenses................................. 8,691 8,539 899 ---------- ------- ----- Earnings (loss) before income taxes (benefit).. 3,894 4,046 (860) Income taxes (benefit)............................. 1,635 1,699 (362) ---------- ------- ----- Net earnings (loss)............................ $ 2,259 $ 2,347 $(498) ========== ======= ===== Pro forma earnings per share....................... $ 0.19 ========== Pro forma weighted average number of shares outstanding....................................... 11,643,207 ==========
See accompanying notes to condensed consolidated financial statements. F-21 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
THREE MONTHS ENDED MARCH 31, --------------------- 1997 1996 ---------- --------- Cash flows from operating activities: Net earnings (loss)................................ $ 2,347 $ (498) Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.................... 286 27 Deferred income taxes............................ 1,631 (362) Gain on sale of loans............................ (10,398) -- Net interest receivables collected............... (311) -- Over-collateralization amount released........... 311 -- Provision for losses............................. 495 -- Loans originated or acquired for sale............ (251,652) (4,252) Loan sales, net.................................. 194,848 -- Principal payments of loans receivable held for sale............................................ 1,257 -- Initial over-collateralization amount............ (2,973) -- (Increase) decrease in accrued interest receivable...................................... 422 (2) (Increase) decrease in prepaid expenses and other assets.......................................... 122 (376) Increase in warehouse lines of credit............ 54,875 4,080 Decrease in income taxes payable................. (708) -- Increase in accounts payable and accrued liabilities..................................... 1,638 4 ---------- -------- Net cash (used in) operating activities........ (7,810) (1,379) ---------- -------- Cash flows from investing activities--purchase of office property and equipment....................... (525) (351) ---------- -------- Cash flows from financing activities: Net proceeds from notes payable.................... 1,793 -- Net proceeds from residual financing............... 7,248 -- ---------- -------- Net cash provided by financing activities...... 9,041 -- ---------- -------- Net increase (decrease) in cash and cash equivalents................................... 706 (1,730) Cash and cash equivalents at beginning of period..... 3,041 3,029 ---------- -------- Cash and cash equivalents at end of period........... $ 3,747 $ 1,299 ========== ======== Supplemental cash flow disclosure: Interest paid...................................... $ 1,730 $ 2 Income taxes....................................... 776 2 ========== ========
See accompanying notes to condensed consolidated financial statements. F-22 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) MARCH 31, 1997 AND 1996 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 1997 are not necessarily indicative of the results that may be expected for the year ended December 31, 1997. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 1996 included elsewhere herein. Recent Accounting Developments--In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 125 (FASB No. 125), "Accounting for Transfer and Servicing of Financial Assets and Extinguishment of Liabilities." FASB No. 125 addresses the accounting for all types of securitization transactions, securities lending and repurchase agreements, collateralized borrowing arrangements and other transactions involving the transfer of financial assets. FASB No. 125 distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. FASB No. 125 requires the Company to allocate its basis in the mortgage loans between the portion of the mortgage loans sold through mortgage backed securities and the portion retained (the residual interests) based on the relative fair values of those portions on the date of the sale. The pronouncement requires the Company to account for the residual interests as "held-for-trading" securities which are to be recorded at fair value in accordance with SFAS No. 115. The Company adopted FASB No. 125 on January 1, 1997. In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 128, (FASB No. 128), "Earnings Per Share." FASB No. 128 supersedes APB Opinion No. 15, (APB 15), "Earnings Per Share" and specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock. FASB No. 128 was issued to simplify the computation of EPS and to make the U.S. standard more compatible with the EPS standards of other countries and that of the International Accounting Standards Committee (IASC). It replaces the presentation of primary EPS with a presentation of basic EPS and fully diluted EPS with diluted EPS. Basic EPS, unlike primary EPS, excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS under APB No. 15. FASB No. 128 is effective for financial statements for both interim and annual periods ending after December 15, 1997. Earlier application is not permitted. After adoption, all prior-period EPS data presented shall be restated to conform with FASB No. 128. The Company has determined that this statement will increase the earnings per share computation under Basic EPS as compared to primary EPS. F-23 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) FASB No. 129, Disclosure of Information about Capital Structure, is effective for financial statements for periods ending after December 15, 1997. It is not expected that the issuance of FASB No. 129 will require significant revision of prior disclosures since the Statement lists required disclosures that had been included in a number of previously existing separate statements and opinions. Residual interests in securitizations--of real estate mortgage investment conduits (REMICs) are recorded as a result of the sale of loans through securitization. At the closing of each securitization, the Company removes from its balance sheet the mortgage loans held for sale and adds to its balance sheet (i) the cash received, (ii) the estimated fair value of the residuals from the securitizations which consists of (a) an overcollateralization amount (OC) and (b) a net interest receivable (NIR). The excess of the cash received and assets retained by the Company over the carrying value of the loans sold, less transaction costs, equals the gain on sale of loans recorded by the Company. The Company allocates its basis in the mortgage loans between the portion of the mortgage loans sold through mortgage backed securities (the senior certificates) and the portion retained (the residual interests) based on the relative fair values of those portions on the date of the sale. The Company may recognize gains or losses attributable to the change in the fair value of the residual interests, which are recorded at estimated fair value and accounted for as "held-for-trading" securities. The Company is not aware of an active market for the purchase or sale of residual interests; accordingly, the Company estimates fair value of the residual interests by calculating the present value of the estimated expected future cash flows using a discount rate commensurate with the risks involved. NIRs are determined by using the amount of the excess of the weighted- average coupon on the loans sold over the sum of: (1) the coupon on the senior certificates, (2) a base servicing fee paid to the servicer of the loans, (3) expected losses to be incurred on the portfolio of loans sold over the lives of the loans and (4) other expenses and revenues, which includes anticipated prepayment penalties. The significant assumptions used by the Company to estimate NIR cash flows are anticipated prepayments and estimated credit losses. The Company estimates prepayments by evaluating historical prepayment performance of comparable loans and the impact of trends in the industry. The Company estimates credit losses using available historical loss data for comparable loans and the specific characteristics of the loans included in the Company's securitizations. The OC represents the portion of the loans which are held by the trust as overcollateralization for the senior certificates sold and along with a certificate guarantor insurance policy serves as credit enhancement to the senior certificate holders. The OC initially consists of the excess of the principal balance of the mortgage loans sold to the trust, less the principal balance of the certificates sold to investors. The OC is required to be maintained at a specified target level of the principal balance of the certificates, which can be increased significantly in the event delinquencies and or losses exceed certain specified levels. Cash flows received by the trust in excess of the obligations of the trust are deposited into the overcollateralization account until the target OC is reached. Once the target OC is reached, distributions of excess cash are remitted to the Company. F-24 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 2. LOANS RECEIVABLE HELD FOR SALE A summary of loans receivable held for sale, at the lower of cost or market at March 31, 1997 and December 31, 1996 follows (dollars in thousands):
MARCH 31, DECEMBER 31, 1997 1996 --------- ------------ Mortgage loans receivable.......................... $112,723 $57,701 Net deferred origination costs..................... 439 289 -------- ------- $113,162 $57,990 ======== =======
Gain on Sale of Loans--Gain on sale of loans for the three months ended March 31, 1997 and 1996 was comprised of the following components (dollars in thousands):
1997 1996 ------- ---- Gain from whole loan sale transactions and securitization.......... $11,903 $-- Unrealized gain on held- for-trading securities. 1,267 -- Provision for losses.... (495) -- Nonrefundable fees...... 3,311 -- Premiums, net........... (1,803) -- Origination costs....... (4,171) -- ------- ---- $10,012 $-- ======= ====
3. RESIDUAL INTERESTS IN SECURITIZATION Residual interests in securitization consists of the following components at March 31, 1997 (dollars in thousands): Over-collateralization amount.................................... $ 2,973 Net interest receivable (NIR).................................... 10,270 ------- $13,243 =======
The following table summarizes activity in NIR interests at March 31, 1997 (dollars in thousands): Balance, beginning of period..................................... $ -- NIR recognized................................................... 10,398 Amortization..................................................... (128) ------- Balance, end of period........................................... $10,270 =======
F-25 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 4. WAREHOUSE LINES OF CREDIT Warehouse lines of credit consist of the following at March 31, 1997 and December 31, 1996 (dollars in thousands):
MARCH 31, DECEMBER 31, 1997 1996 --------- ------------ A $85 million line of credit expiring in May 1998 secured by loans receivable held for sale, bearing interest based on one month LIBOR (5.71% at March 31, 1997)............................... $ 65,803 $41,702 A $175 million master repurchase agreement bearing interest based on one month LIBOR (5.71% at March 31, 1997). The agreement may be terminated by the lender giving 28 days written notice............. 44,731 13,957 -------- ------- 110,534 55,659 A residual financing line renewable monthly, secured by residual interests in securitization bearing interest based on one month LIBOR (5.71% at March 31, 1997)............................... 7,248 -- -------- ------- $117,782 $55,659 ======== =======
The warehouse line of credit agreements contain certain restrictive financial and other covenants which require the Company to, among other requirements, restrict dividends, maintain certain levels of net worth, liquidity of at least $1.5 million, debt to net worth ratios and maintenance of compliance with regulatory and investor requirements. At March 31, 1997, the Company was in compliance with these financial and other covenants. Advances under the residual financing line are made at the sole discretion of the lender and are based upon a percentage of the amount of loans securitized. 5. UNAUDITED PRO FORMA FINANCIAL INFORMATION The pro forma financial information shows what the significant effects on the historical financial information would have been had the Company revised the employment agreements and the calculation of incentive compensation amounts. The following pro forma adjustments have been made for the three months ended March 31, 1997. Pro forma net earnings for the three months ended March 31, 1997 represents the results of operations adjusted to reflect the effect of the revised employment agreements and the revised calculation of incentive compensation amounts for the Founding Managers which took effect on May 30, 1997. The adjustment for the retroactive application of the revised salary for fiscal 1997 will be earned by the Founding Managers as of May 30, 1997. Pro forma earnings per share for the three months ended March 31, 1997 has been computed by dividing pro forma net earnings by the pro forma weighted average number of shares outstanding. In accordance with a regulation of the Securities and Exchange Commission, the pro forma weighted average number of shares includes all options and warrants issued below the estimated initial public offering price within one year prior to the filing of the Registration Statement for the initial public offering and is calculated using the treasury stock method. Historical earnings per share is not presented because it is not indicative of the ongoing entity. F-26 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Pro forma balance sheet information as of March 31, 1997 has been presented to reflect the adjustments for the revision of employment agreements, calculation of incentive compensation amounts, the grants of restricted stock awards, stocks issued to Comerica Inc. for cash consideration, net of costs, of $3,987,500, stock warrants issued to Comerica Inc., the exercise of outstanding warrants and the conversion of Series A Preferred Stock and Series B Preferred Stock, which took effect on May 30, 1997. The pro forma balance sheet does not reflect the sale of common shares in the initial public offering. 6. STOCK OPTIONS In 1995, the Company adopted and received stockholders' approval of the qualified 1995 Stock Option Plan (the "Plan") pursuant to which the Company's Board of Directors may grant stock options to officers and key employees. The Plan authorizes grants of options to purchase up to 705,402 shares of authorized but unissued Common Stock. Stock options granted under the Plan have terms of ten years and vest over a range from December 1996 to December 2001. In addition to the Plan, in December 1996, the Company authorized 120,000 nonqualified stock options to certain executive officers of the Company that vest in December 1999 and expire five years from the grant date. All stock options are granted with an exercise price equal to the stock's fair market value at the date of grant. At March 31, 1997, there were 172,802 shares available for grant under the Plan. Of the options outstanding at March 31, 1997, 21,450 were exercisable with a weighted-average price of $0.50. Stock options activity during the three months ended March 31, 1997 is as follows:
WEIGHTED- NUMBER OF AVERAGE SHARES EXERCISE PRICE --------- -------------- Balance at December 31, 1996..................... 664,000 $1.77 Granted........................................ -- -- Exercised...................................... -- -- Canceled....................................... (12,000) 0.92 ------- ----- Balance at March 31, 1997.................... 652,600 $1.74 ======= =====
In May 1997, the Company's Board of Directors increased the stock options that may be granted under the Plan to 2 million shares. As of May 31, 1997, the Company had a balance of 1,267,520 shares granted that were outstanding at a weighted-average price of $5.17 per share. On May 31, 1997, the stock warrants issued in November 1995 and December 1996, were exercised by the respective warrantholders. Certain warrantholders exercised their warrants by paying the exercise price of the warrants with shares of common stock of the Company. Such shares of common stock were credited toward the exercise price at the fair market value of the Common Stock. 7. CONTINGENCIES The Company has entered into loan sale agreements with investors in the normal course of business which include standard representations and warranties customary to the mortgage banking industry. Violations of these representations and warranties may require the Company to repurchase loans previously sold or to reimburse investors for losses incurred. In the opinion of management, the potential exposure related to the Company's loan sale agreements will not have a material adverse effect on the financial position and operating results of the Company. F-27 NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company sold loans in September and December 1996 under an agreement to repurchase those loans which were delinquent at a specific date in December 1996 and January 1997. In accordance with this loan sale agreement, the Company repurchased loans with an outstanding principal balance of approximately $3.5 million in the quarter ended March 31, 1997 and $1.7 million for the year ended December 31, 1996. At March 31, 1997 and December 31, 1996, included in other liabilities are $220,000 and $100,000, respectively, in allowances for repurchase losses related to possible off-balance sheet recourse and repurchase agreement provisions. The activity in the allowance related to possible off-balance sheet recourse and repurchase agreement provisions is summarized as follows (dollars in thousands):
THREE MONTHS ENDED YEAR ENDED MARCH 31, DECEMBER 31, 1997 1996 --------- ------------ Balance, beginning of period.......................... $100 $ -- Provisions for losses................................. 495 706 Charge-offs, net...................................... (375) (606) ---- ---- Balance, end of period................................ $220 $100 ==== ====
The Company has issued to Comerica warrants to purchase 100,000 shares of Common Stock and has agreed to issue warrants to purchase, subject to the completion of certain performance events by Comerica, an additional of 233,333 shares of Common Stock. The warrants are exercisable over five years at an exercise price equal to the initial public offering price of the Company's Common Stock, subject to vesting in equal installments on December 31, 1997, 1998 and 1999. F-28 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- No dealer, salesperson or any other person has been authorized to give any information or to make any representations other than those contained in this Prospectus in connection with the offer made in this Prospectus and, if given or made, such information or representations must not be relied upon as having been authorized by the Company, any of the Underwriters or the Selling Stockholders. This Prospectus does not constitute an offer to sell or a solicitation of any offer to buy any shares of Common Stock other than the shares of Common Stock to which it relates or an offer to, or a solicitation of, any person in any jurisdiction where such an offer or solicitation would be unlawful. Neither the delivery of this Prospectus nor any sale made hereunder shall, under any circumstances, create any implication that the information contained herein is correct as of any time subsequent to the date hereof. ------------------- TABLE OF CONTENTS -------------------
Page ---- Prospectus Summary......................................................... 3 Risk Factors............................................................... 10 Use of Proceeds............................................................ 22 Dividend Policy............................................................ 22 Dilution................................................................... 22 Capitalization............................................................. 24 Selected Consolidated Financial and Other Data............................. 25 Management's Discussion and Analysis of Financial Condition and Results of Operations................................................................ 28 Business................................................................... 39 Management................................................................. 58 Certain Relationships and Related Transactions............................. 68 Beneficial Ownership of Securities and Selling Stockholders................ 69 Description of Capital Stock............................................... 70 Shares Eligible for Future Sale............................................ 73 Underwriting............................................................... 74 Legal Matters.............................................................. 75 Experts.................................................................... 75 Available Information...................................................... 76 Index to Consolidated Financial Statements................................. F-1
Until , 1997 (25 days after the date of this Prospectus), all dealers ef- fecting transactions in the registered securities, whether or not participating in this distribution, may be required to deliver a Prospectus. This is in addi- tion to the obligation of the dealers to deliver a Prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 3,500,000 SHARES [LOGO of New Century FINANCIAL CORPORATION] COMMON STOCK ---------------- PROSPECTUS ---------------- MONTGOMERY SECURITIES PIPER JAFFRAY INC. , 1997 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the expenses, other than the underwriting discount, payable by the Company in connection with the issuance and distribution of the Common Stock being registered. All amounts are estimates except the Securities and Exchange Commission registration fee, the NASD filing fee and the Nasdaq listing fee. Securities and Exchange Commission registration fee........... $ 12,806.00 NASD filing fee............................................... 4,686.00 Nasdaq listing fee............................................ 42,116.00 Accounting fees and expenses.................................. 225,000.00 Legal fees and expenses....................................... 325,000.00 Blue Sky qualification fees and expenses...................... 10,000.00 Printing and engraving expenses............................... 100,000.00 Transfer agent and registrar fees............................. 2,000.00 Road show expenses............................................ 50,000.00 Miscellaneous................................................. 28,392.00 ----------- Total....................................................... $800,000.00 ===========
The Company intends to pay all expenses of registration, issuance and distribution, excluding the underwriters' discount and commissions, with respect to the shares being sold by the Selling Stockholders. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS The Company's Certificate of Incorporation provides that to the fullest extent permitted by applicable law a director of the Company shall not be liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director. Under the DGCL, liability of a director may not be limited (i) for any breach of the director's duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, (iii) in respect of certain unlawful dividend payments or stock redemptions or repurchases and (iv) for any transaction from which the director derives an improper personal benefit. The effect of the provisions of the Company's Certificate of Incorporation is to eliminate the rights of the Company and its stockholders (through stockholders' derivative suits on behalf of the Company) to recover monetary damages against a director for breach of the fiduciary duty of care as a director (including breaches resulting from negligent or grossly negligent behavior), except as provided in the situations described in clauses (i) through (iv) above. This provision does not limit or eliminate the rights of the Company or any stockholder to seek nonmonetary relief such as an injunction or rescission in the event of a breach of a director's duty of care. The Bylaws of the Company provide that the Company will indemnify its directors and officers to the fullest extent permitted by the DGCL. In addition, the Company has entered into agreements with each of the directors and officers of the Company pursuant to which the Company has agreed to indemnify, subject to certain limitations, such director or officer from claims, liabilities, damages, expenses, losses, costs, penalties or amounts paid in settlement incurred by such director or officer in or arising out of his capacity as a director, officer, employee and/or agent of the Company or any other corporation of which such person is a director or officer at the request of the Company to the maximum extent provided by applicable law. In addition, such director or officer is entitled to an advance of expenses to the maximum extent authorized or permitted by law. II-1 The Form of Underwriting Agreement filed as Exhibit 1.1 to this Registration Statement provides for indemnification by the Underwriters of the Company and its directors and officers for certain liabilities arising under the Securities Act or otherwise. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES The following is an historical summary of transactions by the Company since its incorporation involving sales of the Company's securities that were not registered under the Securities Act. The numbers are not adjusted to reflect the 2-for-1 stock split effected by the Company. In November 1995, the Company issued 2,000,000 shares of Series A Preferred Stock to Cornerstone Fund, I, L.L.C. for $2,000,000, 100,000 shares of Series A Preferred Stock to MMSPC Defined Benefit Plan for $100,000, 100,000 shares of Series A Preferred Stock to Harlan W. Smith for $100,000, 100,000 shares of Series A Preferred Stock to Harcol Limited Partnership for $100,000, 100,000 shares of Series A Preferred Stock to David Krinsky for $100,000 and 100,000 shares of Series A Preferred Stock to Cornerstone Equity Partners, L.L.C. for $100,000. The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. In November 1995, the Company issued 70,000 shares of Series B Preferred Stock to Robert K. Cole for $70,000, 70,000 shares of Series B Preferred Stock to Brad A. Morrice for $70,000 and 20,000 shares of Series B Preferred Stock to Edward F. Gotschall for $20,000. The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. In November 1995, the Company issued 88,103 units each consisting of one share of Common Stock together with a warrant ("Warrant") to purchase 7.68505 shares of Common Stock ("Units") to Robert K. Cole for $80,000, 88,103 Units to Brad A. Morrice for $80,000 and 88,103 Units to Edward F. Gotschall for $80,000. In December 1995, the Company increased the total number of shares of Common Stock issuable under each of the Warrants by 57,884 shares, from 677,076 to 734,960 shares. The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. In December 1995, the Company issued 150,000 shares of Series A Preferred Stock to Michael M. Sachs for $150,000, 75,000 shares of Series A Preferred Stock to Martin F. Ryan, Ltd. Defined Benefit Pension Plan for $75,000 and 25,000 shares of Series A Preferred Stock to Oak Craft Inc. Employees Profit Sharing Plan for $25,000. The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. In December 1996, the Company issued an option to purchase 40,000 shares of Common Stock, exercisable at $3.50 per share, to Edward F. Gotschall and an option to purchase 80,000 shares of Common Stock, exercisable at $3.50 per share, to Steve Holder. The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. In December 1996, the Company issued warrants to purchase the following number of shares of Common Stock, exercisable at $3.50 per share, to the following stockholders in satisfaction of their preemptive rights: Cornerstone Fund I, L.L.C. (220,656 shares), Westrec Rollover PS Plan (11,032 shares), Michael M. Sachs (16,550 shares), Harlan W. Smith (11,032 shares), Harcol Limited Partnership (11,032 shares), David Krinsky (11,032 shares), Cornerstone Equity Partners, L.L.C. (11,032 shares), Oak Craft Inc. Employees Profit Sharing Plan (2,758 shares), Martin F. Ryan, Ltd. Defined Benefit Pension Plan (8,274 shares), Robert K. Cole (55,556 shares), Brad A. Morrice (54,453 shares), Samantha H. Morrice Trust (1,103), Edward F. Gotschall (50,040 shares), and Steve Holder (47,834 shares). The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. II-2 In May 1997, the Company issued to the following stockholders the following number of shares of Common Stock upon the exercise by such stockholders of certain Warrants to Purchase Common Stock of the Company at exercise prices ranging from $1.00 to $3.50 per share: Cornerstone Fund I, L.L.C. (220,656 shares), Westrec Rollover PS Plan (11,032 shares), Michael M. Sachs (16,550 shares), Harlan W. Smith (11,032 shares), Harcol Limited Partnership (11,032 shares), David Krinsky (11,032 shares), Cornerstone Equity Partners, L.L.C. (11,032 shares), Oak Craft Inc. Employees Profit Sharing Plan (2,758 shares), Martin F. Ryan, Ltd. Defined Benefit Pension Plan (8,274 shares), Robert K. Cole (858,080 shares), Brad A. Morrice (858,563 shares), Samantha H. Morrice Trust (1,103 shares), Edward F. Gotschall (854,978 shares), and Steve Holder (853,737 shares). The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. In May 1997, the Company issued to the following stockholders the following number of shares of Common Stock upon the conversion by such stockholders of shares of Series A and B Preferred Stock of the Company: Cornerstone Fund I, L.L.C. (4,000,000 shares), Westrec Rollover PS Plan (200,000 shares), Michael M. Sachs (300,000 shares), Harlan W. Smith (200,000 shares), Harcol Limited Partnership (200,000 shares), David Krinsky (200,000 shares), Cornerstone Equity Partners, L.L.C. (200,000 shares), Oak Craft Inc. Employees Profit Sharing Plan (50,000 shares), Martin F. Ryan, Ltd. Defined Benefit Pension Plan (150,000 shares), Robert K. Cole (140,000 shares), Brad A. Morrice (120,000 shares), Samantha H. Morrice Trust (20,000 shares) and Edward F. Gotschall (40,000 shares). The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. In May 1997, the Company issued to Comerica 545,000 shares of Common Stock for $4,087,500. The sale and issuance of securities described in this paragraph were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder. From time to time since its incorporation, the Company issued stock options to purchase Common Stock pursuant to the Company's 1995 Stock Option Plan to officers and employees of the Company. During the period referred to above, no options granted pursuant to the 1995 Stock Option Plan were exercised. With respect to these grants of options, exemption from registration under the Securities Act was unnecessary in that the transaction did not involve a "sale" of securities as such term in used in Section 2(3) of the Securities Act. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) Exhibits.
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------- ---------------------- 1.1 Form of Underwriting Agreement * 3.1 Certificate of Incorporation of the Company * 3.2 First Amended and Restated Certificate of Incorporation of the Company * 3.3 Bylaws of the Company * 3.4 First Amended and Restated Bylaws of the Company 4.1 Specimen stock certificate 5.1 Opinion of O'Melveny & Myers LLP 10.1 Form of Indemnity Agreement between the Company and each of its executive officers and directors *10.2 1995 Stock Option Plan *10.3 Founding Managers' Incentive Compensation Plan *10.4 Agreement by and between New Century Mortgage Corporation and Advanta Mortgage Corporation U.S.A. dated April 4, 1996, as amended on January 1, 1997 *10.5 Sub-Servicing Agreement by and between New Century Mortgage Corporation and Advanta Mortgage Corp. USA dated February 1, 1997 *10.6 Amended and Restated Credit Agreement by and between New Century Mortgage Corporation and First Bank National Association dated October 25, 1996, as amended on December 31, 1996, March 14, 1997, March 28, 1997 and April 16, 1997 *10.7 Form of Warrant to Purchase Common Stock
II-3
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------- ---------------------- *10.8 Pooling and Servicing Agreement by and among Salomon Brothers Mortgage Securities VII, Inc. ("Salomon"), New Century Mortgage Corporation and First Trust National Association, dated February 1, 1997, incorporated by reference from the Form 8-K, dated February 27, 1997, filed by Salomon with the Securities and Exchange Commission *10.9 Agreement by and between Salomon Brothers Realty Corp. and New Century Mortgage dated November 4, 1996 *10.10 Form of Founding Managers' Employment Agreement *10.11 Office Building Lease by and between Koll Center Irvine Number Two and New Century Financial Corporation dated April 11, 1997 *10.12 Registration Rights Agreement, dated May 30, 1997, by and among the Company and certain stockholders of the Company *10.13 Form of Equalization Option granted to two executive officers of the Company *10.14 Amended and Restated 1995 Stock Option Plan 10.15 Stock Purchase Agreement, dated May 30, 1997, by and between the Company and Comerica *10.16 New Century Financial Corporation Warrant to Purchase Common Stock issued to Comerica on May 30, 1997 11.1 Statement re: Computation of Pro forma Earnings Per Share *21.1 List of Subsidiaries 23.1 Consent of KPMG Peat Marwick LLP *23.2 Consent of O'Melveny & Myers LLP (included in Exhibit 5.1) *24.1 Power of Attorney (contained on page II-5) *27.1 Financial Data Schedule
- -------- * Previously filed. (b) Financial Statement Schedules. All schedules are omitted because they are not required, are not applicable, or the information is included in the Consolidated Financial Statements or notes thereto. ITEM 17. UNDERTAKINGS (a) The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in the denominations and registered in the names as required by the Underwriters to permit prompt delivery to each purchaser. (b) Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended (the "Act") may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether the indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (c) The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Act, the information omitted from the form of prospectus filed as part of a registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Act shall be deemed to be part of the registration statement as of the time it was declared effective. (2) For purposes of determining any liability under the Act, each post- effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of those securities at that time shall be deemed to be the initial bona fide offering thereof. II-4 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Amendment No. 2 to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Minneapolis, State of Minnesota, on the 17th day of June, 1997. NEW CENTURY FINANCIAL CORPORATION By: /s/ Brad A. Morrice ---------------------------------- Brad A. Morrice President Pursuant to the requirements of the Securities Act of 1933, as amended, this Amendment No. 2 to the Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- * - ------------------------ Chairman of the Board, Chief June 17, 1997 Robert K. Cole Executive Officer and Director /s/ Brad A. Morrice Vice Chairman of the Board, June 17, 1997 - ------------------------ President, General Counsel, Secretary Brad A. Morrice and Director * Vice Chairman of the Board, Chief June 17, 1997 - ------------------------ Operating Officer-- Edward F. Gotschall Finance/Administration and Director (Principal Financial and Accounting Officer) * Vice Chairman of the Board, Chief June 17, 1997 - ------------------------ Operating Officer--Loan Steven G. Holder Production/Operations and Director * - ------------------------ Director June 17, 1997 John C. Bentley * - ------------------------ Director June 17, 1997 Sherman I. Chu * - ------------------------ Director June 17, 1997 Harlan W. Smith * - ------------------------ Director June 17, 1997 Martin F. Ryan * - ------------------------ Director June 17, 1997 Michael M. Sachs *By: /s/ Brad A. Morrice June 17, 1997 -------------------- Brad A. Morrice Attorney-in-fact
II-5 EXHIBIT INDEX
EXHIBIT SEQUENTIALLY NO. DESCRIPTION NUMBERED PAGE ------- ----------- ------------- 1.1 Form of Underwriting Agreement * 3.1 Certificate of Incorporation of the Company * 3.2 First Amended and Restated Certificate of Incorporation of the Company * 3.3 Bylaws of the Company * 3.4 First Amended and Restated Bylaws of the Company 4.1 Specimen stock certificate 5.1 Opinion of O'Melveny & Myers LLP 10.1 Form of Indemnity Agreement between the Company and each of its executive officers and directors *10.2 1995 Stock Option Plan *10.3 Founding Managers' Incentive Compensation Plan *10.4 Agreement by and between New Century Mortgage Corporation and Advanta Mortgage Corporation U.S.A. dated April 4, 1996, as amended on January 1, 1997 *10.5 Sub-Servicing Agreement by and between New Century Mortgage Corporation and Advanta Mortgage Corp. USA dated February 1, 1997 *10.6 Amended and Restated Credit Agreement by and between New Century Mortgage Corporation and First Bank National Association dated October 25, 1996, as amended on December 31, 1996, March 14, 1997, March 28, 1997 and April 16, 1997 *10.7 Form of Warrant to Purchase Common Stock *10.8 Pooling and Servicing Agreement by and among Salomon Brothers Mortgage Securities VII, Inc. ("Salomon"), New Century Mortgage Corporation and First Trust National Association, dated February 1, 1997, incorporated by reference from the Form 8-K, dated February 27, 1997, filed by Salomon with the Securities and Exchange Commission *10.9 Agreement by and between Salomon Brothers Realty Corp. and New Century Mortgage dated November 4, 1996 *10.10 Form of Founding Managers' Employment Agreement *10.11 Office Building Lease by and between Koll Center Irvine Number Two and New Century Financial Corporation dated April 11, 1997 *10.12 Registration Rights Agreement, dated May 30, 1997, by and among the Company and certain stockholders of the Company *10.13 Form of Equalization Option granted to two executive officers of the Company *10.14 Amended and Restated 1995 Stock Option Plan 10.15 Stock Purchase Agreement, dated May 30, 1997, by and between the Company and Comerica *10.16 New Century Financial Corporation Comerica Warrant to Purchase Common Stock issued to Comerica on May 30, 1997 11.1 Statement re: Computation of Pro forma Earnings Per Share *21.1 List of Subsidiaries 23.1 Consent of KPMG Peat Marwick LLP *23.2 Consent of O'Melveny & Myers LLP (included in Exhibit 5.1) *24.1 Power of Attorney (contained on page II-5) *27.1 Financial Data Schedule
- ------- * Previously filed. EX-1.1 2 FORM OF UNDERWRITING AGREEMENT EXHIBIT 1.1 MONTGOMERY SECURITIES FORM OF UNDERWRITING AGREEMENT 3,500,000 Shares NEW CENTURY FINANCIAL CORPORATION COMMON STOCK UNDERWRITING AGREEMENT DATED JUNE __, 1997 Table of Contents
Page Section 1. Representations and Warranties................................................... 2 A. Representations and Warranties of the Company.................................... 2 (a) Compliance with Registration Requirements................................. 2 (b) Offering Materials Furnished to Underwriters.............................. 2 (c) Distribution of Offering Material By the Company.......................... 2 (d) The Underwriting Agreement................................................ 3 (e) Authorization of the Common Shares........................................ 3 (f) No Applicable Registration or Other Similar Rights........................ 3 (g) No Material Adverse Change................................................ 3 (h) Independent Accountants................................................... 3 (i) Preparation of the Financial Statements................................... 3 (j) Incorporation and Good Standing of the Company and its Subsidiaries....... 4 (k) Capitalization and Other Capital Stock Matters............................ 4 (l) Stock Exchange Listing.................................................... 4 (m) Non-Contravention of Existing Instruments; No Further Authorizations or Approvals Required..................................................... 4 (n) No Material Actions or Proceedings........................................ 5 (o) Intellectual Property Rights.............................................. 5 (p) All Necessary Permits, Etc................................................ 5 (q) Title to Properties....................................................... 6 (r) Tax Law Compliance........................................................ 6 (s) Company Not an "Investment Company."...................................... 6 (t) Insurance................................................................. 6 (u) No Price Stabilization or Manipulation.................................... 6 (v) Related Party Transactions................................................ 7 (w) No Unlawful Contributions or Other Payments............................... 7 (x) Company's Accounting System............................................... 7 (y) Compliance with Environmental Laws........................................ 7 (z) ERISA Compliance.......................................................... 8 (aa) Financial Projections..................................................... 8 (bb) Events of Default......................................................... 8 (cc) Past Securitizations...................................................... 9 (dd) Exchange Act Filings...................................................... 9 (ee) Whole Loan Sales.......................................................... 9 (ff) Regulation................................................................ 9 B. Representations and Warranties of the OA Stockholders............................ 9 (a) The Underwriting Agreement................................................ 9 (b) The Custody Agreement and Power of Attorney............................... 9 (c) Title to Common Shares to be Sold; All Authorizations Obtained............ 10 (d) Delivery of the Common Shares to be Sold.................................. 10 (e) Non-Contravention; No Further Authorizations or Approvals Required.................................................................. 10 (f) No Registration or Other Similar Rights................................... 10
i
(g) No Further Consents, Etc.................................................. 11 (h) Disclosure Made by Such OA Stockholder in the Prospectus.................. 11 (i) No Price Stabilization or Manipulation.................................... 11 (j) Confirmation of Company Representations and Warranties.................... 11 Section 2. Purchase, Sale and Delivery of the Common Shares................................. 11 Section 3. Additional Covenants............................................................. 14 A. Covenants of the Company......................................................... 14 (a) Representative's Review of Proposed Amendments and Supplements............ 14 (b) Securities Act Compliance................................................. 14 (c) Amendments and Supplements to the Prospectus and Other Securities Act Matters............................................................... 14 (d) Copies of any Amendments and Supplements to the Prospectus................ 14 (e) Blue Sky Compliance....................................................... 15 (f) Use of Proceeds........................................................... 15 (g) Transfer Agent............................................................ 15 (h) Earnings Statement........................................................ 15 (i) Periodic Reporting Obligations............................................ 15 (j) Agreement Not To Offer or Sell Additional Securities...................... 15 (k) Future Reports to the Representatives..................................... 16 B. Covenants of the OA Stockholders................................................. 16 (a) Agreement Not to Offer or Sell Additional Securities...................... 16 (b) Delivery of Forms W-8 and W-9............................................. 16 Section 4. Payment of Expenses.............................................................. 16 Section 5. Conditions of the Obligations of the Underwriters................................ 17 (a) Accountants' Comfort Letter............................................... 17 (b) Compliance with Registration Requirements; No Stop Order; No Objection from NASD....................................................... 18 (c) No Material Adverse Change or Ratings Agency Change....................... 18 (d) Opinion of Counsel for the Company........................................ 18 (e) Opinion of Counsel for the Underwriters................................... 18 (f) Officers' Certificate..................................................... 19 (g) Bring-down Comfort Letter................................................. 19 (i) Selling Stockholder's and OA Stockholders' Certificates................... 19 (j) Selling Stockholder's and OA Stockholders' Documents...................... 19 (k) Lock-Up Agreement from Certain Stockholders of the Company Other than the Selling Stockholder and the OA Stockholders...................... 20 (l) Additional Documents...................................................... 20 Section 6. Reimbursement of Underwriters' Expenses.......................................... 20 Section 7. Effectiveness of this Agreement.................................................. 20
ii
Section 8. Indemnification 21 (a) Indemnification of the Underwriters....................................... 21 (b) Indemnification of the Company, its Directors and Officers................ 22 (c) Notifications and Other Indemnification Procedures........................ 22 (d) Settlements............................................................... 23 Section 9. Contribution...................................................................... 23 Section 10. Default of One or More of the Several Underwriters............................... 25 Section 11. Termination of this Agreement.................................................... 25 Section 12. Representations and Indemnities to Survive Delivery.............................. 26 Section 13. Notices.......................................................................... 26 Section 14. Successors ...................................................................... 27 Section 15. Partial Unenforceability......................................................... 27 Section 16.................................................................................... 27 (a) Governing Law Provisions.................................................. 27 (b) Consent to Jurisdiction................................................... 27 (c) Waiver of Immunity........................................................ 27 Section 17. Failure of One or More of the OA Stockholders to Sell and Deliver Common Shares.................................................................... 28 Section 18. General Provisions............................................................... 28
iii UNDERWRITING AGREEMENT June __, 1997 MONTGOMERY SECURITIES 600 Montgomery Street San Francisco, California 94111 PIPER JAFFRAY INC. 222 South Ninth Street Minneapolis, Minnesota 55402 As Representatives of the several Underwriters Ladies and Gentlemen: INTRODUCTORY. New Century Financial Corporation, a Delaware corporation (the "Company), proposes to issue and sell to the several underwriters named in Schedule A (the "Underwriters") an aggregate of 2,900,000 shares of its Common - ---------- Stock, par value $.01 per share (the "Common Stock"); and Cornerstone Fund I, L.L.C. (the "Selling Stockholder") proposes to sell to the Underwriters an aggregate of 600,000 shares of Common Stock. The 2,900,000 shares of Common Stock to be sold by the Company and the 600,000 shares of Common Stock to be sold by the Selling Stockholder are collectively called the "Firm Common Shares". In addition, the Company, the Selling Stockholder and Cornerstone Equity Partners, L.L.C. (collectively, the "OA Stockholders") have severally granted to the Underwriters an option to purchase up to an additional 525,000 shares (the "Optional Common Shares") of Common Stock, as provided in Section 2, each OA Stockholder selling up to the amount set forth opposite such OA Stockholder's name in Schedule B. The Firm Common Shares and, if and to the ---------- extent such option is exercised, the Optional Common Shares are collectively called the "Common Shares". Montgomery Securities and Piper Jaffray Inc. have agreed to act as representatives of the several Underwriters (in such capacity, the "Representatives") in connection with the offering and sale of the Common Shares. The Company has prepared and filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form S-1 (File No. 333-25483), which contains a form of prospectus to be used in connection with the public offering and sale of the Common Shares. Such registration statement, as amended, including the financial statements, exhibits and schedules thereto, in the form in which it was declared effective by the Commission under the Securities Act of 1933 and the rules and regulations promulgated thereunder (collectively, the "Securities Act"), including any information deemed to be a part thereof at the time of effectiveness pursuant to Rule 430A or Rule 434 under the Securities Act, is called the "Registration Statement". Any registration statement filed by the Company pursuant to Rule 462(b) under the Securities Act is called the "Rule 462(b) Registration Statement," and from and after the date and time of filing of the Rule 462(b) Registration Statement the term "Registration Statement" shall include the Rule 462(b) Registration Statement. Such prospectus, in the form first used by the Underwriters to confirm sales of the Common Shares, is called the "Prospectus"; provided, however, if the Company has, with the consent of Montgomery Securities, elected to rely upon Rule 434 under the Securities Act, the term "Prospectus" shall mean the Company's prospectus subject to completion (each, a "preliminary prospectus") dated June 10, 1997 (such preliminary prospectus is called the "Rule 434 preliminary prospectus"), together with the applicable term sheet (the "Term Sheet") prepared and filed by the Company with the Commission under Rules 434 and 424(b) under the Securities Act and all references in this Agreement to the date of the Prospectus shall mean the date of the Term Sheet. All references in this Agreement to the Registration Statement, the Rule 462(b) Registration Statement, a preliminary prospectus, the Prospectus or the Term Sheet, or any amendments or supplements to any of the foregoing, shall include any copy thereof filed with the Commission pursuant to its Electronic Data Gathering, Analysis and Retrieval System ("EDGAR"). The Company the Selling Stockholder and each of the OA Stockholders hereby confirm their respective agreements with the Underwriters as follows: SECTION 1. REPRESENTATIONS AND WARRANTIES. A. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company hereby represents, warrants and covenants to each Underwriter as follows: (a) Compliance with Registration Requirements. The Registration Statement and any Rule 462(b) Registration Statement have been declared effective by the Commission under the Securities Act. The Company has complied to the Commission's satisfaction with all requests of the Commission for additional or supplemental information. No stop order suspending the effectiveness of the Registration Statement or any Rule 462(b) Registration Statement is in effect and no proceedings for such purpose have been instituted or are pending or, to the best knowledge of the Company, are contemplated or threatened by the Commission. Each preliminary prospectus and the Prospectus when filed complied in all material respects with the Securities Act and, if filed by electronic transmission pursuant to EDGAR (except as may be permitted by Regulation S-T under the Securities Act), was identical to the copy thereof delivered to the Underwriters for use in connection with the offer and sale of the Common Shares. Each of the Registration Statement, any Rule 462(b) Registration Statement and any post-effective amendment thereto, at the time it became effective and at all subsequent times, complied and will comply in all material respects with the Securities Act and did not and will 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 not misleading. The Prospectus, as amended or supplemented, as of its date and at all subsequent times through the end of the Prospectus Delivery Period, did not and will not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. The representations and warranties set forth in the two immediately preceding sentences do not apply to statements in or omissions from the Registration Statement, any Rule 462(b) Registration Statement, or any post-effective amendment thereto, or the Prospectus, or any amendments or supplements thereto, made in reliance upon and in conformity with information relating to any Underwriter or with respect to the Underwriting section of the Prospectus furnished to the Company in writing by the Representatives expressly for use therein. There are no contracts or other documents required to be described in the Prospectus or to be filed as exhibits to the Registration Statement which have not been described or filed as required. (b) Offering Materials Furnished to Underwriters. The Company has delivered to the Representative(s) one complete manually signed copy of the Registration Statement and of each consent and certificate of experts filed as a part thereof, and conformed copies of the Registration Statement (without exhibits) and preliminary prospectuses and the 2 Prospectus, as amended or supplemented, in such quantities and at such places as the Representatives have reasonably requested for each of the Underwriters. (c) Distribution of Offering Material By the Company. The Company has not distributed and will not distribute, prior to the later of the Second Closing Date (as defined below) and the completion of the Underwriters' distribution of the Common Shares, any offering material in connection with the offering and sale of the Common Shares other than a preliminary prospectus, the Prospectus, the Registration Statement and any other materials permitted by the Securities Act. (d) The Underwriting Agreement. This Agreement has been duly authorized, executed and delivered by, and is a valid and binding agreement of, the Company, enforceable in accordance with its terms, except as rights to indemnification hereunder may be limited by applicable law and except as the enforcement hereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting the rights and remedies of creditors or by general equitable principles. (e) Authorization of the Common Shares. The Common Shares to be purchased by the Underwriters from the Company have been duly authorized for issuance and sale pursuant to this Agreement and, when issued and delivered by the Company pursuant to this Agreement, will be validly issued, fully paid and nonassessable. (f) No Applicable Registration or Other Similar Rights. There are no persons with registration or other similar rights to have any equity or debt securities registered for sale under the Registration Statement or included in the offering contemplated by this Agreement, other than the OA Stockholders (including the Selling Stockholder) with respect to the Common Shares included in the Registration Statement, except for such rights as have been duly waived. (g) No Material Adverse Change. Except as otherwise disclosed in the Prospectus, subsequent to the respective dates as of which information is given in the Prospectus: (i) there has been no material adverse change, or any development that could reasonably be expected to result in a material adverse change, in the condition, financial or otherwise, or in the earnings, business, operations or prospects, whether or not arising from transactions in the ordinary course of business, of the Company and its subsidiaries, considered as one entity (any such change is called a "Material Adverse Change"); (ii) the Company and its subsidiaries, considered as one entity, have not incurred any material liability or obligation, indirect, direct or contingent, not in the ordinary course of business nor entered into any material transaction or agreement not in the ordinary course of business; and (iii) there has been no dividend or distribution of any kind declared, paid or made by the Company or, except for dividends paid to the Company or other subsidiaries, any of its subsidiaries on any class of capital stock or repurchase or redemption by the Company or any of its subsidiaries of any class of capital stock. (h) Independent Accountants. KPMG Peat Marwick LLP, who have expressed their opinion with respect to the financial statements (which term as used in this Agreement includes the related notes thereto) and supporting schedules filed with the Commission as a part of the Registration Statement and included in the Prospectus, are independent public or certified public accountants as required by the Securities Act. 3 (i) Preparation of the Financial Statements. The financial statements and related notes thereto filed with the Commission as a part of the Registration Statement and included in the Prospectus present fairly in all material respects the consolidated financial position of the Company and its subsidiaries as of and at the dates indicated and the results of their operations and cash flows for the periods specified. The supporting schedules included in the Registration Statement present fairly the information required to be stated therein. Such financial statements and supporting schedules have been prepared in conformity with generally accepted accounting principles as applied in the United States applied on a consistent basis throughout the periods involved, except as may be expressly stated in the related notes thereto. No other financial statements or supporting schedules are required to be included in the Registration Statement. The financial data set forth in the Prospectus under the captions "Prospectus Summary--Summary Consolidated Selected Financial and Other Data," "Selected Consolidated Financial and Other Data" and "Capitalization" fairly present the information set forth therein on a basis consistent with that of the audited financial statements contained in the Registration Statement. (j) Incorporation and Good Standing of the Company and its Subsidiaries. Each of the Company and its subsidiaries has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation and has corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Prospectus and, in the case of the Company, to enter into and perform its obligations under this Agreement. Each of the Company and each subsidiary is duly qualified as a foreign corporation to transact business and is in good standing in the State of California and each other jurisdiction in which such qualification is required, whether by reason of the ownership or leasing of property or the conduct of business, except for such jurisdictions (other than the State of California) where the failure to so qualify or to be in good standing would not, individually or in the aggregate, result in a Material Adverse Change. All of the issued and outstanding capital stock of each subsidiary has been duly authorized and validly issued, is fully paid and nonassessable and is owned by the Company, directly or through subsidiaries, free and clear of any security interest, mortgage, pledge, lien, encumbrance or claim. The Company does not own or control, directly or indirectly, any corporation, association or other entity other than the subsidiaries listed in Exhibit 21.1 to the Registration Statement. (k) Capitalization and Other Capital Stock Matters. The authorized, issued and outstanding capital stock of the Company is as set forth in the Prospectus under the caption "Capitalization" (other than for subsequent issuances, if any, pursuant to employee benefit plans described in the Prospectus or upon exercise of outstanding options or warrants described in the Prospectus). The Common Stock (including the Common Shares) conforms in all material respects to the description thereof contained in the Prospectus. All of the issued and outstanding shares of Common Stock (including the shares of Common Stock owned by the OA Stockholders (including the Selling Stockholder)) have been duly authorized and validly issued, are fully paid and nonassessable and have been issued in all material respects compliance with federal and state securities laws. None of the outstanding shares of Common Stock were issued in violation of any preemptive rights, rights of first refusal or other similar rights to subscribe for or purchase securities of the Company. There are no authorized or outstanding options, warrants, preemptive rights, rights of first refusal or other rights to purchase, or equity or debt securities convertible into or exchangeable or exercisable for, any capital stock of the Company or any of its subsidiaries other than those accurately described in the Prospectus. The description of the Company's stock option, stock bonus and other stock plans or arrangements, and the options or 4 other rights granted thereunder, set forth in the Prospectus accurately and fairly presents in all material respects the information required to be shown with respect to such plans, arrangements, options and rights. (l) Stock Exchange Listing. The Common Shares have been approved for listing on the Nasdaq National Market, subject only to official notice of issuance. (m) Non-Contravention of Existing Instruments; No Further Authorizations or Approvals Required. Neither the Company nor any of its subsidiaries is in violation of its charter or by-laws or is in default (or, with the giving of notice or lapse of time, would be in default) ("Default") under any indenture, mortgage, loan or credit agreement, note, contract, franchise, lease or other instrument to which the Company or any of its subsidiaries is a party or by which it or any of them may be bound (including, without limitation, the Company's revolving credit facilities with [First Bank National Association and Guaranty Federal Bank and Salomon Brothers], as lenders, or to which any of the property or assets of the Company or any of its subsidiaries is subject (each, an "Existing Instrument"), except for such Defaults as would not, individually or in the aggregate, result in a Material Adverse Change. The Company's execution, delivery and performance of this Agreement and consummation of the transactions contemplated hereby and by the Prospectus (i) have been duly authorized by all necessary corporate action and will not result in any violation of the provisions of the charter or by-laws of the Company or any subsidiary, (ii) will not conflict with or constitute a breach of, or Default or a Debt Repayment Triggering Event (as defined below) under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or any of its subsidiaries pursuant to, or require the consent of any other part to, any Existing Instrument, except for such conflicts, breaches, Defaults, Debt Repayment Triggering Event, liens, charges or encumbrances as would not, individually or in the aggregate, result in a Material Adverse Change and (iii) will not result in any violation of any law, administrative regulation or administrative or court decree applicable to the Company or any subsidiary. No consent, approval, authorization or other order of, or registration or filing with, any court or other governmental or regulatory authority or agency, is required for the Company's execution, delivery and performance of this Agreement and consummation of the transactions contemplated hereby, except such as have been obtained or made by the Company and are in full force and effect under the Securities Act, the Securities Exchange Act of 1934, applicable state securities or blue sky laws and from the National Association of Securities Dealers, Inc. (the "NASD"). As used herein, a "Debt Repayment Triggering Event" means any event or condition which gives, or with the giving of notice or lapse of time would give, the holder of any note, debenture or other evidence of indebtedness (or any person acting on such holder's behalf) the right to require the repurchase, redemption or repayment of all or a portion of such indebtedness by the Company or any of its subsidiaries. (n) No Material Actions or Proceedings. There are no legal or governmental actions, suits or proceedings pending or, to the best of the Company's knowledge, threatened (i) against or, to the Company's knowledge affecting the Company or any of its subsidiaries, (ii) which has as the subject thereof any officer or director (in their capacities as such) of, or property owned or leased by, the Company or any of its subsidiaries or (iii) relating to environmental or discrimination matters, where in any such case (A) there is a reasonable possibility that such action, suit or proceeding might be determined adversely to the Company or such subsidiary and (B) any such action, suit or proceeding, if so determined adversely, would result in a Material Adverse Change or adversely affect the consummation of the transactions contemplated by this Agreement. No material labor dispute with the employees of the Company 5 or any of its subsidiaries exists or, to the best of the Company's knowledge, is threatened or imminent. (o) Intellectual Property Rights. The Company and its subsidiaries own or possess sufficient trademarks, trade names, patent rights, copyrights, licenses, approvals, trade secrets and other similar rights (collectively, "Intellectual Property Rights") reasonably necessary to conduct their businesses as now conducted; and the expected expiration of any of such Intellectual Property Rights would not result in a Material Adverse Change. Neither the Company nor any of its subsidiaries has received any notice of infringement or conflict with asserted Intellectual Property Rights of others, which infringement or conflict, if the subject of an unfavorable decision, would result in a Material Adverse Change. (p) All Necessary Permits, Etc. The Company and each subsidiary possess such valid and current certificates, authorizations or permits issued by the appropriate state, federal or foreign regulatory agencies or bodies necessary to conduct their respective businesses, the absence of which would result in a Material Adverse Change and neither the Company nor any subsidiary has received any notice of proceedings relating to the revocation or modification of, or non-compliance with, any such certificate, authorization or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, could result in a Material Adverse Change. (q) Title to Properties. The Company and each of its subsidiaries has good and marketable title to all the properties and assets reflected as owned in the financial statements referred to in Section 1(A) (i) above (or elsewhere in the Prospectus), in each case free and clear of any security interests, mortgages, liens, encumbrances, equities, claims and other defects, except such as do not materially and adversely affect the value of such property and do not materially interfere with the use made or proposed to be made of such property by the Company or such subsidiary. The material real property, improvements, equipment and personal property held under lease by the Company or any subsidiary are held under valid and enforceable leases, with such exceptions as are not material and do not materially interfere with the use made or proposed to be made of such material real property, improvements, equipment or personal property by the Company or such subsidiary. (r) Tax Law Compliance. The Company and its consolidated subsidiaries have filed all necessary federal, state and foreign income and franchise tax returns and have paid all taxes required to be paid by any of them, the failure to pay or file would result in a Material Adverse Change and, if due and payable, any related or similar assessment, fine or penalty levied against any of them. The Company has made adequate charges, accruals and reserves in the applicable financial statements referred to in Section 1 (A) (i) above in respect of all material federal, state and foreign income and franchise taxes for all periods as to which the tax liability of the Company or any of its consolidated subsidiaries has not been finally determined. (s) Company Not an "Investment Company." The Company has been advised of the rules and requirements under the Investment Company Act of 1940, as amended (the "Investment Company Act"). The Company is not, and after receipt of payment for the Common Shares will not be, an "investment company" within the meaning of Investment Company Act and intends to conduct its business in a manner so that it will not become subject to the Investment Company Act. 6 (t) Insurance. Each of the Company and its subsidiaries are insured by recognized, financially sound and reputable institutions with policies in such amounts and with such deductibles and covering such risks as are generally deemed adequate and customary for their businesses including, but not limited to, policies covering real and personal property owned or leased by the Company and its subsidiaries against theft, damage, destruction, acts of vandalism and earthquakes. The Company does not to believe that it or any subsidiary will not be able (i) to renew its existing insurance coverage as and when such policies expire or (ii) to obtain comparable coverage from similar institutions as may be necessary or appropriate to conduct its business as now conducted and at a cost that would not result in a Material Adverse Change. Neither of the Company nor any subsidiary has been denied any insurance coverage which it has sought or for which it has applied. (u) No Price Stabilization or Manipulation. The Company has not taken and will not take, directly or indirectly, any action designed to or that might be reasonably expected to cause or result in stabilization or manipulation of the price of the Common Stock to facilitate the sale or resale of the Common Shares. (v) Related Party Transactions. There are no business relationships or related-party transactions involving the Company or any subsidiary or any other person required under the Securities Act to be described in the Prospectus which have not been described as required. (w) No Unlawful Contributions or Other Payments. Neither the Company nor any of its subsidiaries nor, to the best of the Company's knowledge, any employee or agent of the Company acting on behalf of the Company or any subsidiary, has made any contribution or other payment to any official of, or candidate for, any federal, state or foreign office in violation of any law or of the character required to be disclosed in the Prospectus. (x) Company's Accounting System. The Company maintains a system of accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorization; (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets; (iii) access to assets is permitted only in accordance with management's general or specific authorization; and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (y) Compliance with Environmental Laws. Except as would not, individually or in the aggregate, result in a Material Adverse Change: (i) neither the Company nor any of its subsidiaries is in violation of any federal, state, local or foreign law or regulation relating to pollution or protection of human health or the environment (including, without limitation, ambient air, surface water, groundwater, land surface or subsurface strata) or wildlife, including without limitation, laws and regulations relating to emissions, discharges, releases or threatened releases of chemicals, pollutants, contaminants, wastes, toxic substances, hazardous substances, petroleum and petroleum products (collectively, "Materials of Environmental Concern"), or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Materials of Environment Concern (collectively, "Environmental Laws"), which violation includes, but is not limited to, noncompliance with any permits or other governmental authorizations required for the operation of the business of the Company or its subsidiaries under 7 applicable Environmental Laws, or noncompliance with the terms and conditions thereof, nor has the Company or any of its subsidiaries received any written communication, whether from a governmental authority, citizens group, employee or otherwise, that alleges that the Company or any of its subsidiaries is in violation of any Environmental Law; (ii) there is no claim, action or cause of action filed with a court or governmental authority, no investigation with respect to which the Company has received written notice, and no written notice by any person or entity alleging potential liability for investigatory costs, cleanup costs, governmental responses costs, natural resources damages, property damages, personal injuries, attorneys' fees or penalties arising out of, based on or resulting from the presence, or release into the environment, of any Material of Environmental Concern at any location owned, leased or operated by the Company or any of its subsidiaries, now or in the past (collectively, "Environmental Claims"), pending or, to the best of the Company's knowledge, threatened against the Company or any of its subsidiaries or any person or entity whose liability for any Environmental Claim the Company or any of its subsidiaries has retained or assumed either contractually or by operation of law; and (iii) to the best of the Company's knowledge, there are no past or present actions, activities, circumstances, conditions, events or incidents, including, without limitation, the release, emission, discharge, presence or disposal of any Material of Environmental Concern, that reasonably could result in a violation of any Environmental Law or form the basis of a potential Environmental Claim against the Company or any of its subsidiaries or against any person or entity whose liability for any Environmental Claim the Company or any of its subsidiaries has retained or assumed either contractually or by operation of law. (z) ERISA Compliance. The Company and its subsidiaries and any "employee benefit plan" (as defined under the Employee Retirement Income Security Act of 1974, as amended, and the regulations and published interpretations thereunder (collectively, "ERISA")) established or maintained by the Company, its subsidiaries or their "ERISA Affiliates" (as defined below) are in compliance in all material respects with ERISA. "ERISA Affiliate" means, with respect to the Company or a subsidiary, any member of any group of organizations described in Sections 414(b),(c),(m) or (o) of the Internal Revenue Code of 1986, as amended, and the regulations and published interpretations thereunder (the "Code") of which the Company or such subsidiary is a member. No "reportable event" (as defined under ERISA) has occurred or is reasonably expected to occur with respect to any "employee benefit plan" established or maintained by the Company, its subsidiaries or any of their ERISA Affiliates. No "employee benefit plan" established or maintained by the Company, its subsidiaries or any of their ERISA Affiliates, if such "employee benefit plan" were terminated, would have any "amount of unfunded benefit liabilities" (as defined under ERISA). Neither the Company, its subsidiaries nor any of their ERISA Affiliates has incurred or reasonably expects to incur any liability under (i) Title IV of ERISA with respect to termination of, or withdrawal from, any "employee benefit plan" or (ii) Sections 412, 4971, 4975 or 4980B of the Code. Each "employee benefit plan" established or maintained by the Company, its subsidiaries or any of their ERISA Affiliates that is intended to be qualified under Section 401(a) of the Code is so qualified and nothing has occurred, whether by action or failure to act, which would cause the loss of such qualification. (aa) Events of Default. No Master Servicer Event of Default or increase in the Overcollateralization amount (as defined in the Pooling and Servicing Agreement, dated as of February 1, 1997 by and among Salomon Brothers Mortgage Securities VII, Inc., New Century Mortgage Corporation and First Trust National Association), no Event of Default (as defined in the Insuarnace and Indemnity Agreement, dated as of February 27, 1997, by and among Financial Security Assurance Inc., New Century Mortgage Corporation and Salomon 8 Brothers Mortgage Securities VII, Inc.), no Event of Default (as defined in the Amended and Restated Credit Agreement, dated October 25, 1996, by and among New Century Mortgage Corporation, First Bank National Association and the banks party therto, as the same has been amended as of the date of this Agreement), no Termination Event (as defined in the leter agreement, dated November 4, 1996, between Solomon Brothers Realty Corp and New Century Mortgage Corporation) has occurred and, to the best of the Company's knowledge, there is no event which, with the giving of notice or the passage of time or both, would give rise to such a Default, Event of Default or Events of Servicing Termination. (bb) Past Securitizations. The description of past securitization transactions effected by the Company, as contained in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus), is true and complete in all material respects and to the Company's best knowledge, no event or series of events has occurred that would result in any of the securities issued in connection with any of such transactions being downgraded or placed on a watch list with negative implications by any rating agency or similar organization, or that would impair the Company's or its subsidiaries' ability to consummate future securitization transactions upon economic terms consistent with past securitization transactions or otherwise cause the Company and its subsidiaries to suffer any Material Adverse Change with respect to any past or future securitization transaction (other than any such event or series of events described in the Prospectus, or, if the Prospectus is not yet in existence, the most recent Preliminary Prospectus). (cc) Exchange Act Filings. The Company has filed all reports required under the Exchange Act with respect to the registration statements filed in connection with the asset securitizations sponsored by the Company. (dd) Whole Loan Sales. The description of whole loan sales effected by the Company, as contained in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus), is true and complete in all material respects and no event or series of events has occurred that would result in any of the securities issued in securitizations using such loans being downgraded or placed on a watch list with negative implications by any rating agency or similar organization, or that would impair the Company's or New Century Mortgage Corporation's (the "Subsidiary") ability to consummate future whole loan sales or to securitize such loans itself upon economic terms consistent with past whole loan sales and securitizations of such loans or otherwise cause the Company and the Subsidiary to suffer any Material Adverse Change with respect to any past or future whole loan sale or securitization (other than any such event or series of events described in the Prospectus, (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). (ee) Regulation. The description of government rules and regulations as contained in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus) under the captions "Risk Factors" and "Regulation" are true and correct in all material respects. Any certificate signed by an officer of the Company and delivered to the Representatives or to counsel for the Underwriters shall be deemed to be a representation and warranty by the Company to each Underwriter as to the matters set forth therein. 9 B. REPRESENTATIONS AND WARRANTIES OF THE OA STOCKHOLDERS. Each OA Stockholder including the Selling Stockholder represents, warrants and covenants to each Underwriter as follows: (a) The Underwriting Agreement. This Agreement has been duly authorized, executed and delivered by or on behalf of such OA Stockholder and is a valid and binding agreement of such OA Stockholder, enforceable in accordance with its terms, except as rights to indemnification hereunder may be limited by applicable law and except as the enforcement hereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting the rights and remedies of creditors or by general equitable principles. (b) The Custody Agreement and Power of Attorney. Each of the (i) Custody Agreement signed by such OA Stockholder and [___], as custodian (the "Custodian"), relating to the deposit of the Common Shares to be sold by such OA Stockholder (the "Custody Agreement") and (ii) Power of Attorney appointing certain individuals named therein as such OA Stockholder's attorneys-in-fact (each, an "Attorney-in-Fact") to the extent set forth therein relating to the transactions contemplated hereby and by the Prospectus (the "Power of Attorney"), of such OA Stockholder has been duly authorized, executed and delivered by such OA Stockholder and is a valid and binding agreement of such OA Stockholder, enforceable in accordance with its terms, except as rights to indemnification thereunder may be limited by applicable law and except as the enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting the rights and remedies of creditors or by general equitable principles. (c) Title to Common Shares to be Sold; All Authorizations Obtained. Such OA Stockholder has, and on the First Closing Date and the Second Closing Date (as defined below) will have, good and valid title to all of the Common Shares which may be sold by such OA Stockholder pursuant to this Agreement on such date and the legal right and power, and all authorizations and approvals required by law and under its charter or by- laws, partnership agreement, trust agreement or other organizational documents to enter into this Agreement and its Custody Agreement and Power of Attorney, to sell, transfer and deliver all of the Common Shares which may be sold by such OA Stockholder pursuant to this Agreement and to comply with its other obligations hereunder and thereunder. (d) Delivery of the Common Shares to be Sold. Delivery of the Common Shares which are sold to the Underwriters by such OA Stockholder pursuant to this Agreement against payment therefor as provided herein will pass good and valid title to such Common Shares, free and clear of any security interest, mortgage, pledge, lien, encumbrance or other claim (assuming that the Underwriters are not acquiring such Common Shares in good faith and without knowledge of any adverse claims with respect thereto). (e) Non-Contravention; No Further Authorizations or Approvals Required. The execution and delivery by such OA Stockholder of, and the performance by such OA Stockholder of its obligations under, this Agreement, the Custody Agreement and the Power of Attorney will not contravene or conflict with, result in a breach of, or constitute a Default under, or require the consent of any other party to, the charter or by- laws, partnership agreement, trust agreement or other organizational documents of such OA Stockholder or any other agreement or instrument to which such OA Stockholder is a party or by which it is bound or under which it is entitled to any right or benefit, any provision of applicable law or any judgment, order, decree or regulation applicable to such OA Stockholder of any court, regulatory body, administrative 10 agency, governmental body or arbitrator having jurisdiction over such OA Stockholder. No consent, approval, authorization or other order of, or registration or filing with, any court or other governmental authority or agency, is required for the consummation by such OA Stockholder of the transactions contemplated in this Agreement, except such as have been obtained or made and are in full force and effect under the Securities Act, applicable state securities or blue sky laws and from the NASD. (f) No Registration or Other Similar Rights. Such OA Stockholder does not have any registration or other similar rights to have any equity or debt securities registered for sale by the Company under the Registration Statement or included in the offering contemplated by this Agreement, except for such rights as are described in the Prospectus under "Shares Eligible for Future Sale". (g) No Further Consents, Etc. Except for the (i) exercise by such OA Stockholder of certain registration rights pursuant to the Registration Rights Agreement dated as of [___] (which registration rights have been duly exercised pursuant thereto), (ii) consent of such OA Stockholder to the respective number of Common Shares to be sold by all of the OA Stockholders pursuant to this Agreement and (iii) waiver by certain other holders of Common Stock of certain registration rights pursuant to such Registration Rights Agreement, no consent, approval or waiver is required under any instrument or agreement to which such OA Stockholder is a party or by which it is bound or under which it is entitled to any right or benefit, in connection with the offering, sale or purchase by the Underwriters of any of the Common Shares which may be sold by such OA Stockholder under this Agreement or the consummation by such OA Stockholder of any of the other transactions contemplated hereby. (h) Disclosure Made by Such OA Stockholder in the Prospectus. All information furnished by or on behalf of such OA Stockholder in writing expressly for use in the Registration Statement and Prospectus is, and on the First Closing Date and the Second Closing Date will be, true, correct, and complete in all material respects, and does not, and on the First Closing Date and the Second Closing Date will not, contain any untrue statement of a material fact or omit to state any material fact necessary to make such information not misleading. Such OA Stockholder confirms as accurate the number of shares of Common Stock set forth opposite such OA Stockholder's name (and in the associated footnotes) in the Prospectus under the caption "Principal and Selling Stockholders" (both prior to and after giving effect to the sale of the Common Shares). (i) No Price Stabilization or Manipulation. Such OA Stockholder has not taken and will not take, directly or indirectly, any action designed to or that might be reasonably expected to cause or result in stabilization or manipulation of the price of the Common Stock to facilitate the sale or resale of the Common Shares. (j) Confirmation of Company Representations and Warranties. Such OA Stockholder does not believe that the representations and warranties of the Company contained in Section 1(A) hereof are not true and correct in all material respects, is familiar with the Registration Statement and the Prospectus and has no knowledge of any material fact, condition or information not disclosed in the Registration Statement or the Prospectus which has had a Material Adverse Effect. 11 Any certificate signed by or on behalf of any OA Stockholder and delivered to the Representatives or to counsel for the Underwriters shall be deemed to be a representation and warranty by such OA Stockholder to each Underwriter as to the matters covered thereby. SECTION 2. PURCHASE, SALE AND DELIVERY OF THE COMMON SHARES. The Firm Common Shares. Upon the terms herein set forth, (i) the Company agrees to issue and sell to the several Underwriters an aggregate of 2,500,000 Firm Common Shares and (ii) the Selling Stockholder agrees to sell to the several Underwriters an aggregate of 500,000 Firm Common Shares. On the basis of the representations, warranties and agreements herein contained, and upon the terms but subject to the conditions herein set forth, the Underwriters agree, severally and not jointly, to purchase from the Company and the Selling Stockholder the respective number of Firm Common Shares set forth opposite their names on Schedule A. The purchase price per Firm Common Share to be paid by the ---------- several Underwriters to the Company and the Selling Stockholder (and to the OA Stockholders for each Optional Common Stock) shall be $[___] per share. The First Closing Date. Delivery of certificates for the Firm Common Shares to be purchased by the Underwriters and payment therefor shall be made at the offices of O'Melveny & Myers LLP, 610 Newport Center Drive, Suite 1700, Newport Beach, California (or such other place as may be agreed to by the Company and the Representatives) at 6:00 a.m. San Francisco time, on June ____, 1997, or such other time and date not later than 10:30 a.m. San Francisco time, on June ____, 1997 as the Representatives shall designate by notice to the Company (the time and date of such closing are called the "First Closing Date"). The Company and the Selling Stockholder hereby acknowledge that circumstances under which the Representatives may provide notice to postpone the First Closing Date as originally scheduled include, but are in no way limited to, any determination by the Company or the Representatives to recirculate to the public copies of an amended or supplemented Prospectus or a delay as contemplated by the provisions of Section 10. The Optional Common Shares; the Second Closing Date. In addition, on the basis of the representations, warranties and agreements herein contained, and upon the terms but subject to the conditions herein set forth, the OA Stockholders hereby grant an option to the several Underwriters to purchase, severally and not jointly, up to an aggregate of 450,000 Optional Common Shares from the OA Stockholders at the purchase price per share to be paid by the Underwriters for the Firm Common Shares. The option granted hereunder is for use by the Underwriters solely in covering any over-allotments in connection with the sale and distribution of the Firm Common Shares. The option granted hereunder may be exercised at any time (but not more than once) upon notice by the Representatives to the OA Stockholders (with a copy to the Company), which notice may be given at any time within 30 days from the date of this Agreement. Such notice shall set forth (i) the aggregate number of Optional Common Shares as to which the Underwriters are exercising the option, (ii) the names and denominations in which the certificates for the Optional Common Shares are to be registered and (iii) the time, date and place at which such certificates will be delivered (which time and date may be simultaneous with, but not earlier than, the First Closing Date; and in such case the term "First Closing Date" shall refer to the time and date of delivery of certificates for the Firm Common Shares and the Optional Common Shares). Such time and date of delivery, if subsequent to the First Closing Date, is called the "Second Closing Date" and shall be determined by the Representatives and shall not be earlier than three nor later than five full business days after delivery of such notice of exercise. If any Optional Common Shares are to be purchased, (a) each Underwriter agrees, severally and not jointly, to purchase the number of Optional Common Shares (subject to such adjustments to eliminate fractional shares as the Representatives may determine) that bears the same proportion to the total number of Optional Common Shares to be 12 purchased as the number of Firm Common Shares set forth on Schedule A opposite ---------- the name of such Underwriter bears to the total number of Firm Common Shares and (b) each OA Stockholder agrees, severally and not jointly, to sell the number of Optional Common Shares set forth in Schedule B opposite the name of such OA ---------- Stockholder. The Representatives may cancel the option at any time prior to its expiration by giving written notice of such cancellation to the OA Stockholders (with a copy to the Company). Public Offering of the Common Shares. The Representatives hereby advise the Company and the OA Stockholders that the Underwriters intend to offer for sale to the public, as described in the Prospectus, their respective portions of the Common Shares as soon after this Agreement has been executed and the Registration Statement has been declared effective as the Representatives, in their sole judgment, have determined is advisable and practicable. Payment for the Common Shares. Payment for the Common Shares to be sold by the Company shall be made at the First Closing Date (and, if applicable, at the Second Closing Date) by wire transfer of immediately available funds to the order of the Company. Payment for the Common Shares to be sold by the Selling Stockholder and the OA Stockholders shall be made at the First Closing Date (and, if applicable, at the Second Closing Date) by wire transfer of immediately available funds to the order of the Custodian. It is understood that the Representatives have been authorized, for their own account and the accounts of the several Underwriters, to accept delivery of and receipt for, and make payment of the purchase price for, the Firm Common Shares and any Optional Common Shares the Underwriters have agreed to purchase. Either Montgomery Securities or Piper Jaffray, in their individual capacities and not as the Representatives of the Underwriters, may (but shall not be obligated to) make payment for any Common Shares to be purchased by any Underwriter whose funds shall not have been received by the Representatives by the First Closing Date or the Second Closing Date, as the case may be, for the account of such Underwriter, but any such payment shall not relieve such Underwriter from any of its obligations under this Agreement. The Selling Stockholder and each OA Stockholder hereby agree that (i) each will pay all stock transfer taxes, stamp duties and other similar taxes, if any, payable upon the sale or delivery of the Common Shares to be sold by such Selling Stockholder or such OA Stockholder to the several Underwriters, or otherwise in connection with the performance of such Selling Stockholder's or such OA Stockholder's obligations hereunder and (ii) the Custodian is authorized to deduct for such payment any such amounts from the proceeds to such Selling Stockholder or such OA Stockholder hereunder and to hold such amounts for the account of such Stockholder or such OA Stockholder with the Custodian under the Custody Agreement. Delivery of the Common Shares. The Company and the Selling Stockholder shall deliver, or cause to be delivered, to the Representatives for the accounts of the several Underwriters certificates for the Firm Common Shares to be sold by them at the First Closing Date, against the irrevocable release of a wire transfer of immediately available funds for the amount of the purchase price therefor. The Company and the OA Stockholders shall also deliver, or cause to be delivered, to the Representatives for the accounts of the several Underwriters, certificates for the Optional Common Shares the Underwriters have agreed to purchase from them at the First Closing Date or the Second Closing Date, as the case may be, against the irrevocable release of a wire transfer of immediately available funds for the amount of the purchase price therefor. The certificates for the Common Shares shall be in definitive form and registered in such names and denominations as the Representatives shall have requested at least two full 13 business days prior to the First Closing Date (or the Second Closing Date, as the case may be) and shall be made available for inspection on the business day preceding the First Closing Date (or the Second Closing Date, as the case may be) at a location in New York City as the Representatives may designate. Time shall be of the essence, and delivery at the time and place specified in this Agreement is a further condition to the obligations of the Underwriters. Delivery of Prospectus to the Underwriters. Not later than 12:00 p.m. on the second business day following the date the Common Shares are released by the Underwriters for sale to the public, the Company shall deliver or cause to be delivered copies of the Prospectus in such quantities and at such places as the Representatives shall request. SECTION 3. ADDITIONAL COVENANTS. A. COVENANTS OF THE COMPANY. The Company hereby represents, warrants and covenants to each Underwriter as follows: (a) Representatives' Review of Proposed Amendments and Supplements. During such period beginning on the date hereof and ending on the later of the First Closing Date or such date, as in the opinion of counsel for the Underwriters, the Prospectus is no longer required by law to be delivered in connection with sales by an Underwriter or dealer (which period for purposes of this Agreement shall not exceed the date nine months following the First Closing Date) (the "Prospectus Delivery Period"), prior to amending or supplementing the Registration Statement (including any registration statement filed under Rule 462(b) under the Securities Act) or the Prospectus , the Company shall furnish to the Representatives for review a copy of each such proposed amendment or supplement, and the Company shall not file any such proposed amendment or supplement to which the Representatives reasonably objects. (b) Securities Act Compliance. After the date of this Agreement, the Company shall promptly advise the Representatives in writing (i) of the receipt of any comments of, or requests for additional or supplemental information from, the Commission, (ii) of the time and date of any filing of any post-effective amendment to the Registration Statement or any amendment or supplement to any preliminary prospectus or the Prospectus, (iii) of the time and date that any post-effective amendment to the Registration Statement becomes effective and (iv) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or any post-effective amendment thereto or of any order preventing or suspending the use of any preliminary prospectus or the Prospectus, or of any proceedings to remove, suspend or terminate from listing or quotation the Common Stock from any securities exchange upon which it is listed for trading or included or designated for quotation, or of the threatening or initiation of any proceedings for any of such purposes. If the Commission shall enter any such stop order at any time, the Company will use its best efforts to obtain the lifting of such order at the earliest possible moment. Additionally, the Company agrees that it shall comply with the provisions of Rules 424(b), 430A and 434, as applicable, under the Securities Act and will use its reasonable efforts to confirm that any filings made by the Company under such Rule 424(b) were received in a timely manner by the Commission. (c) Amendments and Supplements to the Prospectus and Other Securities Act Matters. If, during the Prospectus Delivery Period, any event shall occur or condition exist as a result of which it is necessary to amend or supplement the Prospectus in order to make the statements therein, in the light of the circumstances when the Prospectus is delivered to a 14 purchaser, not misleading, or if in the opinion of the Representatives or counsel for the Underwriters it is otherwise necessary to amend or supplement the Prospectus to comply with law, the Company agrees to promptly prepare (subject to Section 3(A)(a) hereof), file with the Commission and furnish at its own expense to the Underwriters and to dealers, amendments or supplements to the Prospectus so that the statements in the Prospectus as so amended or supplemented will not, in the light of the circumstances when the Prospectus is delivered to a purchaser, be misleading or so that the Prospectus, as amended or supplemented, will comply with law. (d) Copies of any Amendments and Supplements to the Prospectus. The Company agrees to furnish the Representatives, without charge, during the Prospectus Delivery Period, as many copies of the Prospectus and any amendments and supplements thereto as the Representatives may request. (e) Blue Sky Compliance. The Company shall cooperate with the Representatives and counsel for the Underwriters to qualify or register the Common Shares for sale under (or obtain exemptions from the application of) the state securities or blue sky laws or Canadian provincial Securities laws of those jurisdictions designated by the Representatives, shall comply with such laws and shall continue such qualifications, registrations and exemptions in effect so long as reasonably required for the distribution of the Common Shares. The Company shall not be required to qualify as a foreign corporation or to take any action that would subject it to general service of process in any such jurisdiction where it is not presently qualified or where it would be subject to taxation as a foreign corporation. The Company will advise the Representatives promptly of the suspension of the qualification or registration of (or any such exemption relating to) the Common Shares for offering, sale or trading in any jurisdiction or any initiation or threat of any proceeding for any such purpose, and in the event of the issuance of any order suspending such qualification, registration or exemption, the Company shall use its best efforts to obtain the withdrawal thereof at the earliest practicable moment. (f) Use of Proceeds. The Company shall apply the net proceeds from the sale of the Common Shares sold by it in the manner described under the caption "Use of Proceeds" in the Prospectus. (g) Transfer Agent. The Company shall engage and maintain, at its expense, a registrar and transfer agent for the Common Stock. (h) Earnings Statement. As soon as practicable, the Company will make generally available to its security holders and to the Representatives an earnings statement (which need not be audited) covering the twelve-month period ending __________ that satisfies the provisions of Section 11(a) of the Securities Act. (i) Periodic Reporting Obligations. During the Prospectus Delivery Period the Company shall file, on a timely basis, with the Commission and the Nasdaq National Market all reports and documents required to be filed under the Exchange Act. Additionally, the Company shall file with the Commission all reports on Form SR as may be required under Rule 463 under the Securities Act. (j) Agreement Not To Offer or Sell Additional Securities. During the period of 180 days following the date of the Prospectus, the Company will not, without the prior written 15 consent of Montgomery Securities (which consent may be withheld at the sole discretion of Montgomery Securities), directly or indirectly, sell, offer, contract or grant any option to purchase, pledge, transfer or establish an open "put equivalent position" within the meaning of Rule 16a-1(h) under the Exchange Act, or otherwise dispose of or transfer, or announce the offering of, or file any registration statement under the Securities Act in respect of, any shares of Common Stock, options or warrants to acquire shares of the Common Stock or securities exchangeable or exercisable for or convertible into shares of Common Stock (other than as contemplated by this Agreement with respect to the Common Shares); provided, however, that the Company may issue shares of its Common Stock or a warrant (the "Comerica Warrant") to Comerica Incorporated exercisable for up to 100,000 shares of Common Stock or Common Stock upon exercise of the Comerica Warrant or options to purchase its Common Stock, or Common Stock upon exercise of options, pursuant to any stock option, stock bonus or other stock plan or arrangement described in the Prospectus, but only if the holders of such shares, options, or shares issued upon exercise of such options, agree in writing not to sell, offer, dispose of or otherwise transfer any such shares or options during such 180 day period without the prior written consent of Montgomery Securities (which consent may be withheld at the sole discretion of the Montgomery Securities). (k) Future Reports to the Representatives. During the period of five years hereafter the Company will furnish to the Representatives at 600 Montgomery Street, San Francisco, CA 94111 Attention:[ ]: (i) as soon as practicable after the end of each fiscal year, copies of the Annual Report of the Company containing the balance sheet of the Company as of the close of such fiscal year and statements of income, stockholders' equity and cash flows for the year then ended and the opinion thereon of the Company's independent public or certified public accountants; (ii) as soon as practicable after the filing thereof, copies of each proxy statement, Annual Report on Form 10-K, Quarterly Report on Form 10-Q, Current Report on Form 8-K or other report filed by the Company with the Commission, the NASD or any securities exchange; and (iii) as soon as available, copies of any report or communication of the Company mailed generally to holders of its capital stock. (l) Amendment to Credit Facility. The Company will use commercially reasonable efforts to within 45 days following the First Closing consummate an amendment to its warehouse line of credit maintained with First Bank National Association increasing the principal amount that may be borrowed under such line to at least $150 million. B. COVENANTS OF THE OA STOCKHOLDERS. Each OA Stockholder (including the Selling Stockholder) further covenants and agrees with each Underwriter: (a) Agreement Not to Offer or Sell Additional Securities. Such OA Stockholder will not, without the prior written consent of Montgomery Securities (which consent may be withheld in its sole discretion), directly or indirectly, sell, offer, contract or grant any option to purchase (including without limitation any short sale), pledge, transfer, establish an open "put equivalent position" within the meaning of Rule 16a-1(h) under the Exchange Act, or otherwise dispose of any shares of Common Stock, options or warrants to acquire shares of Common Stock, or securities exchangeable or exercisable for or convertible into shares of Common Stock currently or hereafter owned either of record or beneficially (as defined in Rule 13d-3 under Securities Exchange Act of 1934, as amended) by the undersigned, or publicly announce the undersigned's intention to do any of the foregoing, for a period commencing on the 16 date hereof and continuing through the close of trading on the date 180 days after the date of the Prospectus. (b) Delivery of Forms W-8 and W-9. To deliver to the Representatives prior to the First Closing Date a properly completed and executed United States Treasury Department Form W-8 (if the Selling Stockholder is a non-United States person) or Form W-9 (if the OA Stockholder is a United States Person). Montgomery Securities, on behalf of the several Underwriters, may, in its sole discretion, waive in writing the performance by the Company or any OA Stockholder of any one or more of the foregoing covenants or extend the time for their performance. SECTION 4. PAYMENT OF EXPENSES. The Company agrees to pay all costs, fees and expenses incurred in connection with the performance of their obligations hereunder and in connection with the transactions contemplated hereby, including without limitation (i) all expenses incident to the issuance and delivery of the Common Shares (including all printing and engraving costs and fees and expenses of the Custodian), (ii) all fees and expenses of the registrar and transfer agent of the Common Stock, (iii) all necessary issue, transfer and other stamp taxes in connection with the issuance and sale of the Common Shares to the Underwriters, (iv) all fees and expenses of the Company's counsel and one counsel for the Selling Stockholder and the OA Stockholders other than the Company, independent public or certified pubic accountants and other advisors, (v) all costs and expenses incurred in connection with the preparation, printing, filing, shipping and distribution of the Registration Statement (including financial statements, exhibits, schedules, consents and certificates of experts), each preliminary prospectus and the Prospectus, and all amendments and supplements thereto, and this Agreement, (vi) all filing fees, reasonable attorneys' fees and expenses incurred by the Company or the Underwriters in connection with qualifying or registering (or obtaining exemptions from the qualification or registration of) all or any part of the Common Shares for offer and sale under the state securities or blue sky laws or the provincial securities laws of Canada, and, if requested by the Representatives, preparing and printing a "Blue Sky Survey" or memorandum, and any supplements thereto, advising the Underwriters of such qualifications, registrations and exemptions, (vii) the filing fees incident to, and the reasonable fees and expenses of counsel for the Underwriters in connection with, the NASD's review and approval of the Underwriters' participation in the offering and distribution of the Common Shares, (viii) the fees and expenses associated with listing the Common Shares on the Nasdaq National Market, and (ix) all other fees, costs and expenses referred to in Item 13 of Part II of the Registration Statement. Except as provided in Section 4, Section 6, Section 8 and Section 9 hereof, the Underwriters shall pay their own expenses, including the fees and disbursements of their counsel. The OA Stockholders (including the Selling Stockholder) further agree with each Underwriter to pay (directly or by reimbursement) all fees and expenses incident to the performance of their obligations under this Agreement which are not otherwise specifically provided for herein, including but not limited to (i) fees and expenses of counsel and other advisors for such OA Stockholders, (ii) fees and expenses of the Custodian and (iii) expenses and taxes incident to the sale and delivery of the Common Shares to be sold by such OA Stockholders to the Underwriters hereunder (which taxes, if any, may be deducted by the Custodian under the provisions of Section 2 of this Agreement). This Section 4 shall not affect or modify any separate, valid agreement relating to the allocation of payment of expenses between the Company, on the one hand, and the OA Stockholders, on the other hand. 17 SECTION 5. CONDITIONS OF THE OBLIGATIONS OF THE UNDERWRITERS. The obligations of the several Underwriters to purchase and pay for the Common Shares as provided herein on the First Closing Date and, with respect to the Optional Common Shares, the Second Closing Date, shall be subject to the accuracy of the representations and warranties on the part of the Company and the OA Stockholders (including the Selling Stockholder) set forth in Sections 1(A) and 1(B) hereof as of the date hereof and as of the First Closing Date as though then made and, with respect to the Optional Common Shares, as of the Second Closing Date as though then made, to the timely performance by the Company and the OA Stockholders (including the Selling Stockholder) of their respective covenants and other obligations hereunder, and to each of the following additional conditions: (a) Accountants' Comfort Letter. On the date hereof, the Representatives shall have received from KPMG Peat Marwick LLP, independent public or certified public accountants for the Company, a letter dated the date hereof addressed to the Underwriters, in form and substance satisfactory to the Representatives, containing statements and information of the type ordinarily included in accountant's "comfort letters" to underwriters, delivered according to Statement of Auditing Standards No. 72 (or any successor bulletin), with respect to the audited and unaudited financial statements and certain financial information contained in the Registration Statement and the Prospectus (and the Representatives shall have received an additional [___] conformed copies of such accountants' letter for each of the several Underwriters). (b) Compliance with Registration Requirements; No Stop Order; No Objection from NASD. For the period from and after effectiveness of this Agreement and prior to the First Closing Date and, with respect to the Optional Common Shares, the Second Closing Date: (i) the Company shall have filed the Prospectus with the Commission (including the information required by Rule 430A under the Securities Act) in the manner and within the time period required by Rule 424(b) under the Securities Act; or the Company shall have filed a post- effective amendment to the Registration Statement containing the information required by such Rule 430A, and such post-effective amendment shall have become effective; or, if the Company elected to rely upon Rule 434 under the Securities Act and obtained the Representatives's consent thereto, the Company shall have filed a Term Sheet with the Commission in the manner and within the time period required by such Rule 424(b); (ii) no stop order suspending the effectiveness of the Registration Statement, any Rule 462(b) Registration Statement, or any post-effective amendment to the Registration Statement, shall be in effect and no proceedings for such purpose shall have been instituted or threatened by the Commission; and (iii) the NASD shall have raised no objection to the fairness and reasonableness of the underwriting terms and arrangements. (c) No Material Adverse Change or Ratings Agency Change. For the period from and after the date of this Agreement and prior to the First Closing Date and, with respect to the Optional Common Shares, the Second Closing Date: (i) in the judgment of the Representatives there shall not have occurred any Material Adverse Change; and 18 (ii) there shall not have occurred any downgrading, nor shall any notice have been given of any intended or potential downgrading or of any review for a possible change that does not indicate the direction of the possible change, in the rating accorded any securities of the Company or any of its subsidiaries by any "nationally recognized statistical rating organization" as such term is defined for purposes of Rule 436(g)(2) under the Securities Act. (d) Opinion of Counsel for the Company. On each of the First Closing Date and the Second Closing Date the Representatives shall have received the favorable opinion of O'Melveny & Myers LLP, counsel for the Company, dated as of such Closing Date, the form of which is attached as Exhibit A --------- (and the Representatives shall have received an additional [___] conformed copies of such counsel's legal opinion for each of the several Underwriters). (e) Opinion of Counsel for the Underwriters. On each of the First Closing Date and the Second Closing Date the Representatives shall have received the favorable opinion of Brobeck, Phleger & Harrison LLP, counsel for the Underwriters, dated as of such Closing Date, with respect to the matters set forth in paragraphs[(i), (vii) (with respect to subparagraph (i) only, (viii), (ix), (x) (xi) and (xiii) (with respect to the captions "Description of Capital Stock" and "Underwriting" under subparagraph (i) only), (xii),] and [the next-to-last paragraph] of Exhibit A (and the --------- Representatives shall have received an additional [___] conformed copies of such counsel's legal opinion for each of the several Underwriters). (f) Officers' Certificate. On each of the First Closing Date and the Second Closing Date the Representatives shall have received a written certificate executed by the Chairman of the Board, Chief Executive Officer or President of the Company and the Chief Financial Officer or Chief Accounting Officer of the Company, dated as of such Closing Date, to the effect set forth in subsections (b)(ii) and (c)(ii) of this Section 5, and further to the effect that: (i) for the period from and after the date of this Agreement and prior to such Closing Date, there has not occurred any Material Adverse Change; (ii) the representations, warranties and covenants of the Company set forth in Section 1(A) of this Agreement are true and correct in all material respects with the same force and effect as though expressly made on and as of such Closing Date; and (iii) the Company has complied in all material respects with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to such Closing Date. (g) Bring-down Comfort Letter. On each of the First Closing Date and the Second Closing Date the Representatives shall have received from KPMG Peat Marwick LLP, independent public or certified public accountants for the Company, a letter dated such date, in form and substance satisfactory to the Representatives, to the effect that they reaffirm the statements made in the letter furnished by them pursuant to subsection (a) of this Section 5, except that the specified date referred to therein for the carrying out of procedures shall be no more than three business days prior to the First Closing Date or Second Closing Date, as the case may be (and the Representatives shall have received an additional [___] conformed copies of such accountants' letter for each of the several Underwriters). 19 (h) Opinion of Counsel for the Selling Stockholder and the OA Stockholders. On each of the First Closing Date (as may be appropriate) and the Second Closing Date the Representatives shall have received the favorable opinion of Quarles & Brady, counsel for the Selling Stockholder and the OA Stockholders (other than the Company), dated as of such Closing Date, the form of which is attached as Exhibit B (and the Representatives --------- shall have received an additional [___] conformed copies of such counsel's legal opinion for each of the several Underwriters). (i) Selling Stockholder's and OA Stockholders' Certificates. On each of the First Closing Date and the Second Closing Date, as may be appropriate, the Representatives shall received a written certificate executed by the Attorney-in-Fact of the Selling Stockholder and the OA Stockholders, dated as of such Closing Date, to the effect that: (i) the representations, warranties and covenants of such Selling Stockholder or such OA Stockholder set forth in Section 1(B) of this Agreement are true and correct in all material respects with the same force and effect as though expressly made by such Selling Stockholder or such OA Stockholder on and as of such Closing Date; and (ii) such Selling Stockholder or such OA Stockholder has complied in all material respects with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to such Closing Date. (j) Selling Stockholder's and OA Stockholders' Documents. On the date hereof, the Company, and the Selling Stockholder and the OA Stockholders shall have furnished for review by the Representatives copies of the Powers of Attorney and Custody Agreements executed by each of the Selling Stockholder and the OA Stockholders and such further information, certificates and documents as the Representatives may reasonably request. (k) Lock-Up Agreement from Certain Stockholders of the Company Other than the Selling Stockholder and the OA Stockholders. On the date hereof, the Company shall have furnished to the Representatives an agreement in the form of Exhibit C hereto from each officer, director and 1% or greater --------- (based on shares outstanding immediately prior to the First Closing) Stockholders of the Company, and such agreements shall be in full force and effect on each of the First Closing Date and the Second Closing Date. (l) Additional Documents. On or before each of the First Closing Date and the Second Closing Date, the Representatives and counsel for the Underwriters shall have received such information, documents and opinions as they may reasonably require for the purposes of enabling them to pass upon the issuance and sale of the Common Shares as contemplated herein, or in order to evidence the accuracy of any of the representations and warranties, or the satisfaction of any of the conditions or agreements, herein contained. If any condition specified in this Section 5 is not satisfied when and as required to be satisfied, this Agreement may be terminated by the Representatives by notice to the Company, the Selling Stockholder and the OA Stockholders at any time on or prior to the First Closing Date and, with respect to the Optional Common Shares, at any time prior to the Second Closing Date, which termination shall be without liability on the part of any party to any other party, except that Section 4, Section 6, Section 8 and Section 9 shall at all times be effective and shall survive such termination. 20 SECTION 6. REIMBURSEMENT OF UNDERWRITERS' EXPENSES. If this Agreement is terminated prior to the First Closing by the Representatives pursuant to Section 5 (except subsections 5(b)(iii) and 5(e), or Section 11 (except as set forth in clauses (i), (ii) and (iii) of Section 11 or Section 17, or if the sale to the Underwriters of the Common Shares on the First Closing Date is not consummated because of any refusal, inability or failure on the part of the Company or the Selling Stockholder to perform any agreement herein or to comply with any provision hereof, the Company agrees to reimburse the Representatives and the other Underwriters (or such Underwriters as have terminated this Agreement with respect to themselves), severally, upon demand for all out-of-pocket expenses that shall have been reasonably incurred by the Representatives and the Underwriters in connection with the proposed purchase and the offering and sale of the Common Shares, including but not limited to fees and disbursements of counsel, printing expenses, travel expenses, postage, facsimile and telephone charges. SECTION 7. [RESERVED] SECTION 8. INDEMNIFICATION. (a) Indemnification of the Underwriters. Each of the Company, the Selling Stockholder and, subject to Section 8(e) each of the OA Stockholders, jointly and severally, agree to indemnify and hold harmless each Underwriter, its officers and employees, and each person, if any, who controls any Underwriter within the meaning of the Securities Act and the Exchange Act against any loss, claim, damage, liability or expense, as reasonably incurred, to which such Underwriter or such controlling person may become subject, under the Securities Act, the Exchange Act or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of the Company), insofar as such loss, claim, damage, liability or expense (or actions in respect thereof as contemplated below) arises out of or is based (i) upon any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement, or any amendment thereto, including any information deemed to be a part thereof pursuant to Rule 430A or Rule 434 under the Securities Act, or the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading; or (ii) upon any untrue statement or alleged untrue statement of a material fact contained in any preliminary prospectus or the Prospectus (or any amendment or supplement thereto), or the omission or alleged omission therefrom of a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading; or (iii) in whole or in part upon any inaccuracy in the representations and warranties of the Company, the Selling Stockholder or the OA Stockholders contained herein; or (iv) in whole or in part upon any failure of the Company, the Selling Stockholder or the OA Stockholders to perform their respective obligations hereunder or under law; or (v) any act or failure to act or any alleged act or failure to act by any Underwriter in connection with, or relating in any manner to, the Common Stock or the offering contemplated hereby, and which is included as part of or referred to in any loss, claim, damage, liability or action arising out of or based upon any matter covered by clause (i) or (ii) above, provided that the Company shall not be liable under this clause (v) to the extent that a court of competent jurisdiction shall have determined by a final judgment that such loss, claim, damage, liability or action resulted directly from any such acts or failures to act undertaken or omitted to be taken by such Underwriter through its bad faith or willful misconduct; and to reimburse each Underwriter and each such controlling person for any and all reasonable expenses (including the fees and disbursements of counsel chosen by Montgomery Securities) as such expenses are reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending, settling, compromising or paying 21 any such loss, claim, damage, liability, expense or action; provided, however, that the foregoing indemnity agreement shall not apply to any loss, claim, damage, liability or expense to the extent, but only to the extent, arising out of or based upon any untrue statement or alleged untrue statement or omission or alleged omission made in reliance upon and in conformity with written information furnished to the Company, the Selling Stockholder or the OA Stockholders by the Representatives expressly for use in the Registration Statement, any preliminary prospectus or the Prospectus (or any amendment or supplement thereto); and provided, further, that with respect to any preliminary prospectus, the foregoing indemnity agreement shall not inure to the benefit of any Underwriter from whom the person asserting any loss, claim, damage, liability or expense purchased Common Shares, or any person controlling such Underwriter, if copies of the Prospectus were timely delivered to the Underwriter pursuant to Section 2 and a copy of the Prospectus (as then amended or supplemented if the Company shall have furnished any amendments or supplements thereto) was not sent or given by or on behalf of such Underwriter to such person, if required by law so to have been delivered, at or prior to the written confirmation of the sale of the Common Shares to such person, and if the Prospectus (as so amended or supplemented) would have cured the defect giving rise to such loss, claim, damage, liability or expense. The indemnity agreement set forth in this Section 8(a) shall be in addition to any liabilities that the Company, the Selling Stockholder or the OA Stockholders may otherwise have. (b) Indemnification of the Company, its Directors and Officers. Each Underwriter agrees, severally and not jointly, to indemnify and hold harmless the Company, each of its directors, each of its officers who signed the Registration Statement, the Selling Stockholder, the OA Stockholders and each person, if any, who controls the Company, the Selling Stockholder or any OA Stockholder within the meaning of the Securities Act or the Exchange Act, against any loss, claim damage, liability, or expense, as incurred, to which the Company, or any such director, officer, Selling Stockholder, OA Stockholder or controlling person may become subject, under the Securities Act, the Exchange Act, or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of such Underwriter), insofar as such loss, claim, damage, liability or expense (or actions in respect thereof as contemplated below) arises out of or is based upon any untrue or alleged untrue statement of a material fact contained in the Registration Statement, any preliminary prospectus or the Prospectus (or any amendment or supplement thereto), or arises out of or is based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in the Registration Statement, any preliminary prospectus, the Prospectus (or any amendment or supplement thereto), in reliance upon and in conformity with written information furnished to the Company, the Selling Stockholder or the OA Stockholder by the Representatives expressly for use therein; and to reimburse the Company, or any such director, officer, Selling Stockholder, OA Stockholder or controlling person for any legal and other expense as reasonably incurred by the Company, or any such director, officer, Selling Stockholder OA Stockholder or controlling person in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action. Each of the Company, the Selling Stockholder and each of the OA Stockholders hereby acknowledges that the only information that the Underwriters have furnished to the Company, the Selling Stockholder and the OA Stockholders expressly for use in the Registration Statement, any preliminary prospectus or the Prospectus (or any amendment or supplement thereto) are the statements set forth (A) as the last paragraph on the inside front 22 cover page of the Prospectus concerning stabilization and passive market making by the Underwriters and (B) in the table in the first paragraph and as the second paragraph under the caption "Underwriting" in the Prospectus; and the Underwriters confirm that such statements are correct. The indemnity agreement set forth in this Section 8(b) shall be in addition to any liabilities that each Underwriter may otherwise have. (c) Notifications and Other Indemnification Procedures. Promptly after receipt by an indemnified party under this Section 8 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party under this Section 8, notify the indemnifying party in writing of the commencement thereof, but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party for contribution or otherwise than under the indemnity agreement contained in this Section 8 or to the extent it is not prejudiced as a proximate result of such failure. In case any such action is brought against any indemnified party and such indemnified party seeks or intends to seek indemnity from an indemnifying party, the indemnifying party will be entitled to participate in, and, to the extent that it shall elect, jointly with all other indemnifying parties similarly notified, by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party; provided, however, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that a conflict may arise between the positions of the indemnifying party and the indemnified party in conducting the defense of any such action or that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnified party or parties shall have the right to select separate counsel to assume such legal defenses and to otherwise participate in the defense of such action on behalf of such indemnified party or parties. Upon receipt of notice from the indemnifying party to such indemnified party of such indemnifying party's election so to assume the defense of such action and approval by the indemnified party of counsel, the indemnifying party will not be liable to such indemnified party under this Section 8 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof unless (i) the indemnified party shall have employed separate counsel in accordance with the proviso to the next preceding sentence (it being understood, however, that the indemnifying party shall not be liable for the expenses of more than one separate counsel (together with local counsel), approved by the indemnifying party (Montgomery Securities in the case of Section 8(b) and Section 9), representing the indemnified parties who are parties to such action) or (ii) the indemnifying party shall not have employed counsel satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of commencement of the action, in each of which cases the fees and expenses of counsel shall be at the expense of the indemnifying party. (d) Settlements. The indemnifying party under this Section 8 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 against any loss, claim, damage, liability or expense by reason of such settlement or judgment. Notwithstanding the foregoing sentence, if at any time an indemnified party shall have requested an indemnifying party to reimburse the indemnified party for fees and expenses of counsel as contemplated by Section 8(c) hereof, the indemnifying party agrees that it shall be liable for any settlement of any proceeding effected without its written consent if (i) such settlement is entered into more than 30 days after receipt by such indemnifying party of 23 the aforesaid request and (ii) such indemnifying party shall not have reimbursed the indemnified party in accordance with such request prior to the date of such settlement. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement, compromise or consent to the entry of judgment in any pending or threatened action, suit or proceeding in respect of which any indemnified party is or could have been a party and indemnity was or could have been sought hereunder by such indemnified party, unless such settlement, compromise or consent includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such action, suit or proceeding. (e) Limitation Liability. The liability of each OA Stockholder (except the Company) under this Section 8 shall not exceed an amount equal to the proceeds received by such OA Stockholder from the sale of securities pursuant to this Agreement. SECTION 9. CONTRIBUTION. If the indemnification provided for in Section 8 is for any reason held to be unavailable to or otherwise insufficient to hold harmless an indemnified party in respect of any losses, claims, damages, liabilities or expenses referred to therein, then each indemnifying party shall contribute to the aggregate amount paid or payable by such indemnified party, as incurred, as a result of any losses, claims, damages, liabilities or expenses referred to therein (i) in such proportion as is appropriate to reflect the relative benefits received by the Company, the Selling Stockholder and the OA Stockholders, on the one hand, and the Underwriters, on the other hand, from the offering of the Common Shares pursuant to this Agreement or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company, the Selling Stockholder and the OA Stockholders, on the one hand, and the Underwriters, on the other hand, in connection with the statements or omissions or inaccuracies in the representations and warranties herein 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, the Selling Stockholder and the OA Stockholders, on the one hand, and the Underwriters, on the other hand, in connection with the offering of the Common Shares pursuant to this Agreement shall be deemed to be in the same respective proportions as the total net proceeds from the offering of the Common Shares pursuant to this Agreement (before deducting expenses) received by the Company, the Selling Stockholder and the OA Stockholders, and the total underwriting discount received by the Underwriters, in each case as set forth on the front cover page of the Prospectus (or, if Rule 434 under the Securities Act is used, the corresponding location on the Term Sheet) bear to the aggregate initial public offering price of the Common Shares as set forth on such cover. The relative fault of the Company, the Selling Stockholder and the OA Stockholders, on the one hand, and the Underwriters, on the other hand, shall be determined by reference to, among other things, whether any such untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact or any such inaccurate or alleged inaccurate representation or warranty relates to information supplied by the Company, the Selling Stockholder or the OA Stockholders, on the one hand, or the Underwriters, on the other hand, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid or payable by a party as a result of the losses, claims, damages, liabilities and expenses referred to above shall be deemed to include, subject to the limitations set forth in Section 8(c), any legal or other fees or expenses reasonably incurred by such party in connection with investigating or defending any action or claim. The provisions set forth in Section 8(c) with respect to notice of commencement of any action shall apply if a claim for contribution is to be made under this Section 9; provided, however, that no additional notice shall be required with respect to any action for which notice has been given under Section 8(c) for purposes of indemnification. 24 The Company the Selling Stockholder, the OA Stockholders and the Underwriters agree that it would not be just and equitable if contribution pursuant to this Section 9 were determined by pro rata allocation (even if the Underwriters 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 in this Section 9. Notwithstanding the provisions of this Section 9, no Underwriter shall be required to contribute any amount in excess of the underwriting commissions received by such Underwriter in connection with the Common Shares underwritten by it and distributed to the public. 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. The Underwriters' obligations to contribute pursuant to this Section 9 are several, and not joint, in proportion to their respective underwriting commitments as set forth opposite their names in Schedule A. For purposes of this Section 9, each officer and employee of an - ---------- Underwriter and each person, if any, who controls an Underwriter within the meaning of the Securities Act and the Exchange Act shall have the same rights to contribution as such Underwriter, and each director of the Company, each officer of the Company who signed the Registration Statement, and each person, if any, who controls the Company with the meaning of the Securities Act and the Exchange Act shall have the same rights to contribution as the Company. SECTION 10. DEFAULT OF ONE OR MORE OF THE SEVERAL UNDERWRITER. If, on the First Closing Date or the Second Closing Date, as the case may be, any one or more of the several Underwriters shall fail or refuse to purchase Common Shares that it or they have agreed to purchase hereunder on such date, and the aggregate number of Common Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase does not exceed 10% of the aggregate number of the Common Shares to be purchased on such date, the other Underwriters shall be obligated, severally, in the proportions that the number of Firm Common Shares set forth opposite their respective names on Schedule A ---------- bears to the aggregate number of Firm Common Shares set forth opposite the names of all such non-defaulting Underwriters, or in such other proportions as may be specified by the Representatives with the consent of the non-defaulting Underwriters, to purchase the Common Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase on such date. If, on the First Closing Date or the Second Closing Date, as the case may be, any one or more of the Underwriters shall fail or refuse to purchase Common Shares and the aggregate number of Common Shares with respect to which such default occurs exceeds 10% of the aggregate number of Common Shares to be purchased on such date, and arrangements satisfactory to the Representatives and the Company for the purchase of such Common Shares are not made within 48 hours after such default, this Agreement shall terminate without liability of any party to any other party except that the provisions of Section 4, Section 8 and Section 9 shall at all times be effective and shall survive such termination. In any such case either the Representatives or the Company shall have the right to postpone the First Closing Date or the Second Closing Date, as the case may be, but in no event for longer than seven days in order that the required changes, if any, to the Registration Statement and the Prospectus or any other documents or arrangements may be effected. As used in this Agreement, the term "Underwriter" shall be deemed to include any person substituted for a defaulting Underwriter under this Section 10. Any action taken under this Section 10 shall not relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. SECTION 11. TERMINATION OF THIS AGREEMENT. Prior to the First Closing Date this Agreement may be terminated by the Representatives by notice given to the Company and the Selling Stockholder if at any time (i) trading or quotation in any of the Company's securities shall have been suspended or 25 limited by the Commission or by the Nasdaq Stock Market, or trading in securities generally on either the Nasdaq Stock Market or the New York Stock Exchange shall have been suspended or limited, or minimum or maximum prices shall have been generally established on any of such stock exchanges by the Commission or the NASD; (ii) a general banking moratorium shall have been declared by any of federal, New York, Delaware or California authorities; (iii) there shall have occurred any outbreak or escalation of national or international hostilities or any crisis or calamity, or any material adverse change in the United States or international financial markets, or any substantial change or development involving a prospective substantial change in United States' or international political, financial or economic conditions, as in the judgment of the Representatives is material and adverse and makes it impracticable to market the Common Shares in the manner and on the terms described in the Prospectus or to enforce contracts for the sale of securities; (iv) in the judgment of the Representatives there shall have occurred any Material Adverse Change; or (v) the Company shall have sustained a loss by strike, fire, flood, earthquake, accident or other calamity of such character as in the judgment of the Representatives may interfere materially with the conduct of the business and operations of the Company regardless of whether or not such loss shall have been insured. Any termination pursuant to this Section 11 shall be without liability on the part of (a) the Company, the Selling Stockholder or the OA Stockholders to any Underwriter, except that the Company, the Selling Stockholder and the OA Stockholders shall be obligated to reimburse the expenses of the Representatives and the Underwriters pursuant to Sections 4 and 6 hereof, (b) any Underwriter to the Company, the Selling Stockholder and the OA Stockholders, or (c) of any party hereto to any other party except that the provisions of Section 8 and Section 9 shall at all times be effective and shall survive such termination. SECTION 12. REPRESENTATIONS AND INDEMNITIES TO SURVIVE DELIVERY. The respective indemnities, agreements, representations, warranties and other statements of the Company, of its officers, of the Selling Stockholder, of the OA Stockholders and of the several Underwriters set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation made by or on behalf of any Underwriter or the Company or any of its or their partners, officers or directors or any controlling person, the Selling Stockholder or the OA Stockholders, as the case may be, and will survive delivery of and payment for the Common Shares sold hereunder and any termination of this Agreement. SECTION 13. NOTICES. All communications hereunder shall be in writing and shall be mailed, hand delivered or telecopied and confirmed to the parties hereto as follows: If to the Representatives: Montgomery Securities 600 Montgomery Street San Francisco, California 94111 Facsimile: (415) 249-5558 Attention: Richard A. Smith Piper Jaffray Inc. 222 South Ninth Street Minneapolis, Minnesota 55402 Facsimile: (612) 342-1068 Attention: [____________] 26 with a copy to: Montgomery Securities 600 Montgomery Street San Francisco, California 94111 Facsimile: (415) 249-5553 Attention: David A. Baylor, Esq. If to the Company: New Century Financial Corporation 4910 Birch Street, Suite 100 Newport Beach, California 92660 Facsimile: (714) 440-7033 Attention: Robert K. Cole If to the Selling Stockholder: [Custodian] [address] Facsimile: [___] Attention: [___] with a copy to: Quarles & Brady One East Camelback Suite 400 Phoenix, Arizona 85012 Facsimile: (602) 230-5598 Attention: Steven P. Emerick 27 If to the OA Stockholders: [Custodian] [address] Facsimile: [___] Attention: [___] with a copy to: Quarles & Brady One East Camelback Suite 400 Phoenix, Arizona 85012 Facsimile: (602) 230-5598 Attention: Steven P. Emerick Any party hereto may change the address for receipt of communications by giving written notice to the others. SECTION 14. SUCCESSORS. This Agreement will inure to the benefit of and be binding upon the parties hereto, including any substitute Underwriters pursuant to Section 10 hereof, and to the benefit of the employees, officers and directors and controlling persons referred to in Section 8 and Section 9, and in each case their respective successors, and personal representatives, and no other person will have any right or obligation hereunder. The term "successors" shall not include any purchaser of the Common Shares as such from any of the Underwriters merely by reason of such purchase. SECTION 15. PARTIAL UNENFORCEABILITY. The invalidity or unenforceability of any Section, paragraph or provision of this Agreement shall not affect the validity or enforceability of any other Section, paragraph or provision hereof. If any Section, paragraph or provision of this Agreement is for any reason determined to be invalid or unenforceable, there shall be deemed to be made such minor changes (and only such minor changes) as are necessary to make it valid and enforceable. SECTION 16. (a) Governing Law Provisions. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF NEW YORK APPLICABLE TO AGREEMENTS MADE AND TO BE PERFORMED IN SUCH STATE. (b) Consent to Jurisdiction. Any legal suit, action or proceeding arising out of or based upon this Agreement or the transactions contemplated hereby ("Related Proceedings") may be instituted in the federal courts of the United States of America located in the City and County of San Francisco or the courts of the State of California in each case located in the City and County of San Francisco (collectively, the "Specified Courts"), and each party irrevocably submits to the exclusive jurisdiction (except for proceedings instituted in regard to the enforcement of a judgment of any such court (a "Related Judgment"), as to which such jurisdiction is non-exclusive) of such courts in any such suit, action or proceeding. Service of any process, summons, notice or document by mail to such party's address set forth above shall be effective service of process for any suit, action or other proceeding brought in any such court. The parties irrevocably and unconditionally waive any objection to the laying of venue of any suit, action or other proceeding in the Specified Courts and irrevocably and unconditionally waive and agree not 28 to plead or claim in any such court that any such suit, action or other proceeding brought in any such court has been brought in an inconvenient forum. (c) Waiver of Immunity. With respect to any Related Proceeding, each party irrevocably waives, to the fullest extent permitted by applicable law, all immunity (whether on the basis of sovereignty or otherwise) from jurisdiction, service of process, attachment (both before and after judgment) and execution to which it might otherwise be entitled in the Specified Courts, and with respect to any Related Judgment, each party waives any such immunity in the Specified Courts or any other court of competent jurisdiction, and will not raise or claim or cause to be pleaded any such immunity at or in respect of any such Related Proceeding or Related Judgment, including, without limitation, any immunity pursuant to the United States Foreign Sovereign Immunities Act of 1976, as amended. SECTION 17. FAILURE OF ONE OR MORE OF THE OA STOCKHOLDERS TO SELL AND DELIVER COMMON SHARES. If one or more of the Stockholders shall fail to sell and deliver to the Underwriters the Common Shares to be sold and delivered by such OA Stockholders at the Second Closing Date pursuant to this Agreement, then the Underwriters may at their option, by written notice from the Representatives to the Company and the OA Stockholders, either (i) terminate this Agreement without any liability on the part of any Underwriter or, except as provided in Sections 4, 6, 8 and 9 hereof, the Company, the Selling Stockholder or the OA Stockholders, or (ii) purchase the shares which other OA Stockholders have agreed to sell and deliver in accordance with the terms hereof. If one or more of the OA Stockholders shall fail to sell and deliver to the Underwriters the Common Shares to be sold and delivered by such OA Stockholders pursuant to this Agreement at the Second Closing Date, then the Underwriters shall have the right, by written notice from the Representatives to the Company and the OA Stockholders, to postpone the Second Closing Date, as the case may be, but in no event for longer than seven days in order that the required changes, if any, to the Registration Statement and the Prospectus or any other documents or arrangements may be effected. SECTION 18. GENERAL PROVISIONS. This Agreement constitutes the entire agreement of the parties to this Agreement and supersedes all prior written or oral and all contemporaneous oral agreements, understandings and negotiations with respect to the subject matter hereof. This Agreement may be executed in two or more counterparts, each one of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement may not be amended or modified unless in writing by all of the parties hereto, and no condition herein (express or implied) may be waived unless waived in writing by each party whom the condition is meant to benefit. The Table of Contents and the Section headings herein are for the convenience of the parties only and shall not affect the construction or interpretation of this Agreement. Each of the parties hereto acknowledges that it is a sophisticated business person who was adequately represented by counsel during negotiations regarding the provisions hereof, including, without limitation, the indemnification provisions of Section 8 and the contribution provisions of Section 9, and is fully informed regarding said provisions. Each of the parties hereto further acknowledges that the provisions of Sections 8 and 9 hereto fairly allocate the risks in light of the ability of the parties to investigate the Company, its affairs and its business in order to assure that adequate disclosure has been made in the Registration Statement, any preliminary prospectus and the Prospectus (and any amendments and supplements thereto), as required by the Securities Act and the Exchange Act. 29 If the foregoing is in accordance with your understanding of our agreement, kindly sign and return to the Company and the Custodian the enclosed copies hereof, whereupon this instrument, along with all counterparts hereof, shall become a binding agreement in accordance with its terms. Very truly yours, NEW CENTURY FINANCIAL CORPORATION By:__________________________ Robert K. Cole President SELLING STOCKHOLDER By:__________________________ (Attorney-in-fact) OA STOCKHOLDERS By:__________________________ (Attorney-in-fact) The foregoing Underwriting Agreement is hereby confirmed and accepted by the Representatives in San Francisco, California as of the date first above written. MONTGOMERY SECURITIES PIPER JAFFRAY INC. Acting as Representatives of the several Underwriters named in the attached Schedule A. By: MONTGOMERY SECURITIES By:_____________________________ 30 SCHEDULE A
NUMBER OF FIRM COMMON SHARES TO BE UNDERWRITERS PURCHASED ------------ ------------------- Montgomery Securities [_____] Piper Jaffray Inc. [_____] [_____] [_____] [_____] [_____] [_____] [_____] Total 3,500,000
SA-1 SCHEDULE B
MAXIMUM NUMBER OF OPTIONAL COMMON SHARES TO OA STOCKHOLDER BE SOLD - -------------- ---------------- Cornerstone Fund I, L.L.C. 5050 North 40th Street Suite 310 Phoenix, Arizona 85018 Attention: Sherman I. Chu............... [257,400] Cornerstone Equity Partners L.L.C. 5050 North 40th Street Suite 310 Phoenix, Arizona 85018 Attention: Sherman I. Chu............... [35,100] New Century Financial Corporation 4910 Birch Street, Suite 100 Newport Beach, California 92660 232,500 Attention: Brad Morrice................. Total:.......................... 525,000
SB-1 EXHIBIT A The final opinion in draft form should be attached as Exhibit A at the time this Agreement is executed. Opinion of counsel for the Company to be delivered pursuant to Section 5(e) of the Underwriting Agreement. References to the Prospectus in this Exhibit A include any supplements thereto --------- at the Closing Date. (i) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the State of Delaware. (ii) The Company has corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Prospectus and to enter into and perform its obligations under the Underwriting Agreement. (iii) The Company is duly qualified as a foreign corporation to transact business and is in good standing in the State of California and in each other jurisdiction in which such qualification is required, whether by reason of the ownership or leasing of property or the conduct of business, except for such jurisdictions (other than the State of California) where the failure to so qualify or to be in good standing would not, individually or in the aggregate, result in a Material Adverse Change. (iv) Each significant subsidiary (as defined in Rule 405 under the Securities Act) has been duly incorporated and is validly existing as a corporation in good standing under the laws of the jurisdiction of its incorporation, has corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Prospectus and, to the best knowledge of such counsel, is duly qualified as a foreign corporation to transact business and is in good standing in each jurisdiction in which such qualification is required, whether by reason of the ownership or leasing of property or the conduct of business, except for such jurisdictions where the failure to so qualify or to be in good standing would not, individually or in the aggregate, result in a Material Adverse Change. (v) All of the issued and outstanding capital stock of each such significant subsidiary has been duly authorized and validly issued, is fully paid and non-assessable and is owned by the Company, directly or through subsidiaries, free and clear of any security interest, mortgage, pledge, lien, encumbrance or, to the best knowledge of such counsel, any pending or threatened claim. (vi) The authorized, issued and outstanding capital stock of the Company (including the Common Stock) conform to the descriptions thereof set forth or incorporated by reference in the Prospectus. All of the outstanding shares of Common Stock (including the shares of Common Stock owned by the OA Stockholders) have been duly authorized and validly issued, are fully paid and nonassessable and, to the best of such counsel's knowledge , have been issued in compliance with the registration and qualification requirements of federal and state securities laws. The form of certificate used to evidence the Common Stock is in due and proper form and complies with all applicable requirements of the charter and by-laws of the Company and the General Corporation Law of the State of Delaware. The description of the Company's stock option, stock bonus and other stock plans or arrangements, and the options or other rights granted and exercised thereunder, set forth in the Prospectus accurately and fairly presents the information required to be shown with respect to such plans, arrangements, options and rights. EA-1 (vii) No stockholder of the Company or any other person has any preemptive right, right of first refusal or other similar right to subscribe for or purchase securities of the Company arising (i) by operation of the charter or by-laws of the Company or the General Corporation Law of the State of Delaware or (ii) to the best knowledge of such counsel, otherwise. (viii) The Underwriting Agreement has been duly authorized, executed and delivered by, and is a valid and binding agreement of, the Company, enforceable in accordance with its terms, except as rights to indemnification thereunder may be limited by applicable law and except as the enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles. (ix) The Common Shares to be purchased by the Underwriters from the Company have been duly authorized for issuance and sale pursuant to the Underwriting Agreement and, when issued and delivered by the Company pursuant to the Underwriting Agreement against payment of the consideration set forth therein, will be validly issued, fully paid and nonassessable. (x) Each of the Registration Statement and the Rule 462(b) Registration Statement, if any, has been declared effective by the Commission under the Securities Act. To the best knowledge of such counsel, no stop order suspending the effectiveness of either of the Registration Statement or the Rule 462(b) Registration Statement, if any, has been issued under the Securities Act and no proceedings for such purpose have been instituted or are pending or are contemplated or threatened by the Commission. Any required filing of the Prospectus and any supplement thereto pursuant to Rule 424(b) under the Securities Act has been made in the manner and within the time period required by such Rule 424(b). (xi) The Registration Statement, including any Rule 462(b) Registration Statement, the Prospectus including any document incorporated by reference therein, and each amendment or supplement to the Registration Statement and the Prospectus including any document incorporated by reference therein, as of their respective effective or issue dates (other than the financial statements and supporting schedules included or incorporated by reference therein or in exhibits to or excluded from the Registration Statement, as to which no opinion need be rendered) comply as to form in all material respects with the applicable requirements of the Securities Act. (xii) The Common Shares have been approved for listing on the Nasdaq National Market. (xiii) The statements (i) in the Prospectus under the captions "Risk Factors--," "Description of Capital Stock," "Management's Discussion and Analysis and Results of Operations--Liquidity," "Business--Litigation," "Business--Intellectual Property," "Certain Relationships and Related Transactions," "Shares Eligible for Future Sale," "Certain United States Income Tax Considerations" and "Underwriting" and (ii) in Item 14 and Item 15 of the Registration Statement, insofar as such statements constitute matters of law, summaries of legal matters, the Company's charter or by-law provisions, documents or legal proceedings, or legal conclusions, has been reviewed by such counsel and fairly present and summarize, in all material respects, the matters referred to therein. (xiv) To the best knowledge of such counsel, there are no legal or governmental actions, suits or proceedings pending or threatened which are required to be disclosed in the Registration Statement, other than those disclosed therein. EA-2 (xv) To the best knowledge of such counsel, there are no Existing Instruments required to be described or referred to in the Registration Statement or to be filed as exhibits thereto other than those described or referred to therein or filed or incorporated by reference as exhibits thereto; and the descriptions thereof and references thereto are correct in all material respects. (xvi) No consent, approval, authorization or other order of, or registration or filing with, any court or other governmental authority or agency, is required for the Company's execution, delivery and performance of the Underwriting Agreement and consummation of the transactions contemplated thereby and by the Prospectus, except as required under the Securities Act, applicable state securities or blue sky laws and from the NASD. (xvii) The execution and delivery of the Underwriting Agreement by the Company and the performance by the Company of its obligations thereunder (other than performance by the Company of its obligations under the indemnification section of the Underwriting Agreement, as to which no opinion need be rendered) (i) have been duly authorized by all necessary corporate action on the part of the Company; (ii) will not result in any violation of the provisions of the charter or by-laws of the Company or any subsidiary; (iii) will not constitute a breach of, or Default or a Debt Repayment Triggering Event under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or any of its subsidiaries pursuant to, (A) the Company's revolving credit facilities with First Bank National Association and Guaranty Federal Bank and Salomon Brothers, as lenders, or (B) to the best knowledge of such counsel, any other material Existing Instrument; or (iv) to the best knowledge of such counsel, will not result in any violation of any law, administrative regulation or administrative or court decree applicable to the Company or any subsidiary. (xviii) The Company is not, and after receipt of payment for the Common Shares will not be, an "investment company" within the meaning of Investment Company Act. (xix) Except as disclosed in the Prospectus, to the best knowledge of such counsel, there are no persons with registration or other similar rights to have any equity or debt securities registered for sale under the Registration Statement or included in the offering contemplated by the Underwriting Agreement, other than the OA Stockholders, except for such rights as have been duly waived. (xx) To the best knowledge of such counsel, neither the Company nor any subsidiary is in violation of its charter or by-laws or any law, administrative regulation or administrative or court decree applicable to the Company or any subsidiary or is in Default in the performance or observance of any obligation, agreement, covenant or condition contained in any material Existing Instrument, except in each such case for such violations or Defaults as would not, individually or in the aggregate, result in a Material Adverse Change. [(xxi) [No Default] or [Event of Default] (as defined in that certain Mortgage Loan Purchase Agreement by and between Salomon Brothers Mortgage Securities VII, Inc. ("Salomon Brothers") and New Century Mortgage Corporation dated February 25, 1997), no [Events of Servicing Termination or increase in the Reserve Account Required Amount] (as defined in that certain Pooling and Servicing Agreement by and among Salomon Brothers, the Subsidiary and First Trust National Association, dated February 1, 1997) has occurred and, to the best of the such counsels knowledge, there is no event which, with the giving of notice or the passage of time or both, would give rise to such an event.] EA-3 (xxii) The description of whole loan sales effected by the Company, as contained in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus), is true and complete in all material respects and no event or series of events has occurred that would result in any of the securities issued in securitizations using such loans being downgraded or placed on a watch list with negative implications by any rating agency or similar organization, or that would impair the Company's or New Century Mortgage Corporation's (the "Subsidiary") ability to consummate future whole loan sales or to securitize such loans itself upon economic terms consistent with past whole loan sales and securitizations of such loans or otherwise cause the Company and the Subsidiary to suffer any Material Adverse Change with respect to any past or future whole loan sale or securitization (other than any such event or series of events described in the Prospectus, (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus). (xxiii) The Company has filed all reports required under the Exchange Act with respect to the registration statements filed in connection with the asset securitizations sponsored by the Company. (xxiv) The description of past securitization transactions effected by the Company, as contained in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus), is true and complete in all material respects and to the Company's best knowledge, no event or series of events has occurred that would result in any of the securities issued in connection with any of such transactions being downgraded or placed on a watch list with negative implications by any rating agency or similar organization, or that would impair the Company's or its subsidiaries' ability to consummate future securitization transactions upon economic terms consistent with past securitization transactions or otherwise cause the Company and its subsidiaries to suffer any Material Adverse Effect with respect to any past or future securitization transaction (other than any such event or series of events described in the Prospectus, or, if the Prospectus is not yet in existence, the most recent Preliminary Prospectus). (xxv) The description of government rules and regulations as contained in the Registration Statement and the Prospectus (or, if the Prospectus is not in existence, the most recent Preliminary Prospectus) under the captions "Risk Factors" and "Regulation" are true and correct in all material respects. In addition, such counsel shall state that they have participated in conferences with officers and other representatives of the Company, representatives of the independent public or certified public accountants for the Company and with representatives of the Underwriters at which the contents of the Registration Statement and the Prospectus, and any supplements or amendments thereto, and related matters were discussed and, although such counsel is not passing upon and does not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement or the Prospectus (other than as specified above), and any supplements or amendments thereto, on the basis of the foregoing, nothing has come to their attention which would lead them to believe that either the Registration Statement or any amendments thereto, at the time the Registration Statement or such amendments became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading or that the Prospectus, as of its date or at the First Closing Date or the Second Closing Date, as the case may be, contained an untrue statement of a material fact or omitted to state a material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading (it being understood that such counsel need express no belief as to the financial statements or EA-4 schedules or other financial or statistical data derived therefrom, included or incorporated by reference in the Registration Statement or the Prospectus or any amendments or supplements thereto). In rendering such opinion, such counsel may rely (A) as to matters involving the application of laws of any jurisdiction other than the General Corporation Law of the State of Delaware, the General Corporation Law of the State of California or the federal law of the United States, to the extent they deem proper and specified in such opinion, upon the opinion (which shall be dated the First Closing Date or the Second Closing Date, as the case may be, shall be satisfactory in form and substance to the Underwriters, shall expressly state that the Underwriters may rely on such opinion as if it were addressed to them and shall be furnished to the Representatives) of other counsel of good standing whom they believe to be reliable and who are satisfactory to counsel for the Underwriters; provided, however, that such counsel shall further state that they believe that they and the Underwriters are justified in relying upon such opinion of other counsel, and (B) as to matters of fact, to the extent they deem proper, on certificates of responsible officers of the Company and public officials. EA-5 EXHIBIT B The final opinion in draft form should be attached as Exhibit B at the time this Agreement is executed. The opinion of such counsel pursuant to Section 5(h) shall be rendered to the Representatives at the request of the Company and shall so state therein. References to the Prospectus in this Exhibit B include any supplements thereto --------- at the Closing Date. All references to the OA Stockholders shall include reference to the Selling Stockholder. (i) The Underwriting Agreement has been duly authorized, executed and delivered by or on behalf of, and is a valid and binding agreement of, such OA Stockholder, enforceable in accordance with its terms, except as rights to indemnification thereunder may be limited by applicable law and except as the enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles. (ii) The execution and delivery by such OA Stockholder of, and the performance by such OA Stockholder of its obligations under, the Underwriting Agreement and its Custody Agreement and its Power of Attorney will not contravene or conflict with, result in a breach of, or constitute a default under, the charter or by-laws, partnership agreement, trust agreement or other organizational documents, as the case may be, of such OA Stockholder, or, to the best of such counsel's knowledge, violate or contravene any provision of applicable law or regulation, or violate, result in a breach of or constitute a default under the terms of any other agreement or instrument to which such OA Stockholder is a party or by which it is bound, or any judgment, order or decree applicable to such OA Stockholder of any court, regulatory body, administrative agency, governmental body or arbitrator having jurisdiction over such OA Stockholder. (iii) Such OA Stockholder has good and valid title to all of the Common Shares which may be sold by such OA Stockholder under the Underwriting Agreement and has the legal right and power, and all authorizations and approvals required under its charter and by-laws, partnership agreement, trust agreement or other organizational documents, as the case may be, to enter into the Underwriting Agreement and its Custody Agreement and its Power of Attorney, to sell, transfer and deliver all of the Common Shares which may sold by such OA Stockholder under the Underwriting Agreement and to comply with its other obligations under the Underwriting Agreement, its Custody Agreement and its Power of Attorney. (iv) Each of the Custody Agreement and Power of Attorney of such OA Stockholder has been duly authorized, executed and delivered by such OA Stockholder and is a valid and binding agreement of such OA Stockholder, enforceable in accordance with its terms, except as rights to indemnification thereunder may be limited by applicable law and except as the enforcement thereof may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by general equitable principles. Assuming that the Underwriters purchase the Common Shares which are sold by such OA Stockholder pursuant to the Underwriting Agreement for value, in good faith and without notice of any adverse claim, the delivery of such Common Shares pursuant to the Underwriting Agreement will pass good and valid title to such Common Shares, free and clear of any security interest, mortgage, pledge, lieu encumbrance or other claim. EB-1 (v) To the best of such counsel's knowledge, no consent, approval, authorization or other order of, or registration or filing with, any court or governmental authority or agency, is required for the consummation by such OA Stockholder of the transactions contemplated in the Underwriting Agreement, except as required under the Securities Act, applicable state securities or blue sky laws, and from the NASD. In rendering such opinion, such counsel may rely (A) as to matters involving the application of laws of any jurisdiction other than the General Corporation Law of the State of Delaware, the General Corporation Law of the State of California or the federal law of the United States, to the extent they deem proper and specified in such opinion, upon the opinion (which shall be dated the First Closing Date or the Second Closing Date, as the case may be, shall be satisfactory in form and substance to the Underwriters, shall expressly state that the Underwriters may rely on such opinion as if it were addressed to them and shall be furnished to the Representatives) of other counsel of good standing whom they believe to be reliable and who are satisfactory to counsel for the Underwriters; provided, however, that such counsel shall further state that they believe that they and the Underwriters are justified in relying upon such opinion of other counsel, and (B) as to matters of fact, to the extent they deem proper, on certificates of the Selling Stockholder, the OA Stockholders and public officials. EB-2 EXHIBIT C NEW CENTURY FINANCIAL CORPORATION Form of Selling & Non-Selling Stockholders Lockup Agreement __________, 1997 Montgomery Securities As Representatives of the Several Underwriters 600 Montgomery Street San Francisco, CA 94111 Ladies and Gentlemen: The undersigned is the beneficial owner of ___________ shares of the common stock ("Common Stock") of New Century Financial Corporation, a Delaware corporation (the "Company"). The undersigned understands that the Company has filed a Registration Statement on Form S-1 (the "Registration Statement") with the Securities and Exchange Commission (the "Commission") for the registration of 3,450,000 shares of Common Stock (including 450,000 shares subject to an over-allotment option) (the "Offering"). The undersigned further understands that you are contemplating entering into an Underwriting Agreement with the Company in connection with the Offering. All terms not otherwise defined herein shall have the same meanings as in the Underwriting Agreement. In order to induce the Company, you and the other Underwriters to enter into the Underwriting Agreement and to proceed with the Offering, the undersigned agrees, for the benefit of the Company, you and the Underwriters, that should the Offering be effected, the undersigned will not, without the prior written consent of Montgomery Securities, on behalf of the Underwriters, directly or indirectly, offer, sell, offer to sell, contract to sell, pledge, transfer, grant any option to purchase (including, without limitation, any short sale), establish an open "put equivalent position" within the meaning of Rule 16a-1(h) under the Exchange Act, or otherwise dispose of or transfer (or announce any intention to do the foregoing) (i) any shares of Common Stock or such similar securities or (ii) any other securities convertible into or exchangeable or exercisable for any shares of Common Stock or such similar securities, beneficially owned (within the meaning the Rule 13d-3 under the Securities Exchange Act of 1934, as amended) by the undersigned on the date hereof or hereafter acquired for a period of 180 days (the "Lockup Period") subsequent to the date of the final Prospectus filed with the Commission pursuant to Rule 424(b) of the Securities Act of 1933, as amended (the "Act") promulgated by the Commission or if no filing under Rule 424(b) is made, the date of the final Prospectus included in the Registration Statement when declared effective under the Act. The Representative may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to this Agreement. EC-1 Further, the undersigned agrees that prior to the effective date of the Registration Statement, the undersigned will not, without the prior written consent of Montgomery Securities on behalf of the Underwriters, directly or indirectly, offer, offer to sell, sell, contract to sell or grant any option to purchase or otherwise dispose or transfer (or announce any offer, offer of sale, sale, contract of sale or grant of any option to purchase or other disposition or transfer) of (i) any shares of Common Stock or of securities substantially similar thereto or (ii) any other securities convertible into, or exchangeable or exercisable for, any shares of Common Stock or such similar securities, beneficially owned (within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934, as amended) by the undersigned on the date hereof or hereafter acquired without first requiring any such offering or acquiring parties to execute and deliver to you an agreement of substantially the tenor hereof. Notwithstanding the foregoing, this Agreement does not prohibit (i) the exercise of outstanding warrants and options to purchase Common Stock beneficially owned by the undersigned (but applies to the Common Stock issued upon the exercise thereof), as described in the Prospectus; and (ii) any bonafide gift or gifts provided that any such donee(s) executes an agreement subjecting all such shares of Common Stock to this Agreement for the balance of the Lockup Period. This Agreement shall terminate if the Registration Statement does not become effective on or before July 31, 1997. The undersigned, whether or not participating in the offering, confirms that he, she or it understands that the Underwriters and the Company will rely upon the representations set forth in this agreement in proceeding with the Offering. This agreement shall be binding on the undersigned and his, or its respective successors, heirs, personal representatives and assigns. Very truly yours, By: By: ---------------------------- ------------------------ Print Stockholder's Name Stockholder's Signature The foregoing is accepted and agreed to as of the date first above written: MONTGOMERY SECURITIES By: ----------------------------- EC-2 EX-4.1 3 SPECIMEN STOCK CERTIFICATE EXHIBIT 4.1 COMMON STOCK COMMON STOCK NUMBER SHARES SD NEW CENTURY FINANCIAL CORPORATION INCORPORATED UNDER THE LAWS SEE REVERSE FOR CERTAIN DEFINITIONS OF THE STATE OF DELAWARE CUSIP 64352D 10 1 This certifies that is the record holder of FULLY PAID AND NONASSESSABLE SHARES OF COMMON STOCK, $.01 PAR VALUE, OF NEW CENTURY FINANCIAL CORPORATION transferable on the books of the Corporation in person or by duly authorized attorney on surrender of this certificate properly endorsed. This certificate shall not be valid until countersigned and registered by the Transfer Agent and Registrar. WITNESS the facsimile seal of the Corporation and the signature of its duly authorized officers. [SEAL] /s/ /s/ Secretary President The Corporation shall furnish without charge to each stockholder who so requests a statement of the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock of the Corporation or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. Such requests shall be made to the Corporation's Secretary at the principal office of the Corporation. The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations:
TEN COM - as tenants in common UNIF GIFT MIN ACT - Custodian ------------------------- TEN ENT - as tenants by the entireties (Cust) (Minor) JT TEN - as joint tenants with right of under Uniform Gifts to survivorship and not as tenants Minors Act _______________ in common (State) COM PROP - as community property UNIF TRF MIN ACT - Custodian (until age ) -------------------------- (Cust) ____________ under Uniform (Minor) Transfers to Minors Act __________________________ (State)
Additional abbreviations may also be used though not in the above list. For Value Received, _______________________ hereby sell(s), assign(s) and transfer(s) unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER OF ASSIGNEE ______________________________________ ________________________________________________________________________________ (PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE OF ASSIGNEE) ________________________________________________________________________________ ________________________________________________________________________________ _________________________________________________________________________ shares of the capital stock represented by the within Certificate, and do hereby irrevocably constitute and appoint _______________________________________________________________ attorney-in-fact to transfer the said stock on the books of the within named Corporation with full power of substitution in the premises. Dated __________________ ___________________________________________________________ NOTICE: THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME AS WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATSOEVER. Signature Guaranteed: _________________________________________ THE SIGNATURE SHOULD BE GUARANTEED BY A COMMERCIAL BANK OR A MEMBER BROKER OF EITHER THE NEW YORK STOCK EXCHANGE, AMERICAN STOCK EXCHANGE, MIDWEST STOCK EXCHANGE OR PACIFIC COAST STOCK EXCHANGE. EX-5.1 4 OPINION OF O'MELVENY & MYERS LLP EXHIBIT 5.1 June 17th 1 9 9 7 619,481-3 NB1-312357.V1 New Century Financial Corporation 4910 Birch Street, Suite 100 Newport Beach, California 92660 Re: New Century Financial Corporation Form S-1 Registration Statement --------------------------------- Ladies and Gentlemen: At your request, we have examined the Registration Statement on Form S-1 filed by you with the Securities and Exchange Commission in connection with the registration under the Securities Act of 1933, as amended, of 4,025,000 shares of Common Stock, $0.01 par value (the "Shares"), of New Century Financial Corporation, a Delaware corporation (the "Corporation"). We are familiar with the proceedings taken and proposed to be taken by you in connection with the authorization and proposed issuance and sale of the Shares. It is our opinion that, subject to said proceedings being duly taken and completed by you as now contemplated prior to the issuance of the Shares, which proceedings include the approval of the initial public offering price by the Board of Directors or a committee thereof, payment for the Shares by the underwriters and the execution and delivery by the Company of certificates representing the Shares, the Shares will, upon issuance and sale thereof in the manner referred to in the Registration Statement, be legally and validly issued, fully paid and nonassessable shares of Common Stock of the Corporation. The law covered by this opinion is limited to the present General Corporation Law of the State of Delaware. We express no opinion as to the laws of any other jurisdiction and no opinion regarding the statutes, administrative decisions, rules, regulations or requirements of any county, municipality, subdivision or local authority of any jurisdiction. Page 2 - New Century Financial Corporation - June 17, 1997 We consent to your filing this opinion as an exhibit to the Registration Statement and to the reference to us in the Registration Statement under the heading "Legal Matters." Respectfully submitted, /s/ O'Melveny & Myers LLP EX-10.1 5 INDEMNIFICATION AGREEMENT EXHIBIT 10.1 INDEMNIFICATION AGREEMENT This Indemnification Agreement (this "Agreement") is made as of ____________, 1997 by and between New Century Financial Corporation, a Delaware corporation (the "Company"), and the individual whose name appears below the word "Indemnitee" on the signature page (the "Indemnitee"), a director and/or officer of the Company. BACKGROUND A. The Indemnitee is currently serving as a director and/or officer of the Company and in such capacity has rendered valuable services to the Company. B. The Company has investigated the availability and sufficiency of liability insurance and Delaware statutory indemnification provisions to provide its directors and officers with adequate protection against various legal risks and potential liabilities to which directors and officers are subject due to their position with the Company and has concluded that insurance and statutory provisions may provide inadequate and unacceptable protection to certain individuals requested to serve as its directors and officers. C. In order to induce and encourage highly experienced and capable persons, such as the Indemnitee, to continue to serve as a director and/or officer of the Company, the Board of Directors has determined, after due consideration and investigation of the terms and provisions of this Agreement and the various other options available to the Company and the Indemnitee in lieu of this Agreement, that this Agreement is not only reasonable and prudent but necessary to promote and ensure the best interests of the Company and its stockholders. AGREEMENT In consideration of the continued services of the Indemnitee and in order to induce the Indemnitee to continue to serve as a director and/or officer of the Company, the Company and the Indemnitee agree as follows: SECTION 1. DEFINITIONS ----------- As used in this Agreement: (a) A "Change in Control" shall occur if (i) any "person" (as that term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company or a 1 corporation owned directly or indirectly by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company, becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing 20% or more of the total voting power represented by the Company's then outstanding voting securities, or (ii) during any period of two consecutive years, individuals who at the beginning of the two year period constitute the Board of Directors of the Company and any new director whose election by the Board of Directors or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority of the Board of Directors, or (iii) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior to such a merger or consolidation continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least 80% of the total voting power represented by the voting securities of the Company or the surviving entity outstanding immediately after the merger or consolidation, or the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company (in one transaction or a series of transactions) of all or substantially all the Company's assets. (b) The term "Expenses" includes, without limitation, attorneys' fees, disbursements and retainers, accounting and witness fees, travel and deposition costs, expenses of investigations, judicial or administrative proceedings or appeals, amounts paid in settlement by or on behalf of Indemnitee, and any expenses of establishing a right to indemnification, pursuant to this Agreement or otherwise, including reasonable compensation for time spent by the Indemnitee in connection with the investigation, defense or appeal of a Proceeding or action for indemnification for which the Indemnitee is not otherwise compensated by the Company or any third party. The term "Expenses" does not include the amount of judgments, fines, penalties or ERISA excise taxes actually levied against the Indemnitee. (c) The term "Indemnified Costs" means all Expenses, judgments, fines, penalties and ERISA excise taxes actually and reasonably incurred by the Indemnitee in connection with the investigation, defense, appeal or settlement of any Proceeding. (d) A "Potential Change in Control" shall occur if (i) the Company enters into an agreement or arrangement, the 2 consummation of which would result in the occurrence of a Change in Control; (ii) any person (including the Company) publicly announces an intention to take or to consider taking actions which if consummated would constitute a Change in Control; or (iii) the Board adopts a resolution to the effect that, for purposes of this Agreement, a Potential Change in Control has occurred. (e) The term "Proceeding" shall include any threatened, pending or completed action, suit or proceeding (including appeals thereof), whether brought by or in the name of the Company or otherwise and whether of a civil, criminal or administrative or investigative nature, by reason of the fact that the Indemnitee is or was a director and/or officer of the Company, or is or was serving at the request of the Company as a director, officer, employee or agent of another enterprise, whether or not the Indemnitee is serving in such capacity at the time any liability or Expense is incurred for which indemnification or reimbursement is to be provided under this Agreement. SECTION 2. INDEMNIFICATION --------------- 2.1 Indemnification in Third Party Actions. The Company shall indemnify -------------------------------------- the Indemnitee if the Indemnitee is a party to, is threatened to be made a party to, is a witness or other participant in, or is otherwise involved in any Proceeding (other than a Proceeding by or in the name of the Company to procure a judgment in its favor), because the Indemnitee is or was a director and/or officer of the Company or is or was serving at the request of the Company as a director, officer, employee or agent of another enterprise, against all Indemnified Costs, to the fullest extent permitted by applicable law. Any settlement must be approved in writing by the Company. 2.2 Indemnification in Proceedings By or In the Name of the Company. The --------------------------------------------------------------- Company shall indemnify the Indemnitee if the Indemnitee is a party to, is threatened to be made a party to, is a witness or other participant in, or is otherwise involved in any Proceeding by or in the name of the Company to procure a judgment in its favor by reason of the fact that Indemnitee was or is a director and/or officer of the Company or is or was serving at the request of the Company as a director, officer, employee or agent of another enterprise, against all Expenses actually and reasonably incurred by Indemnitee in connection with the defense or settlement of the Proceeding, to the fullest extent permitted by applicable law. 2.3 Partial Indemnification. If the Indemnitee is entitled under any ----------------------- provision of this Agreement to indemnification by the Company for some or a portion of, but not the total amount of, the Indemnified Costs, the Company shall nevertheless 3 indemnify the Indemnitee for the portion of the Indemnified Costs to which the Indemnitee is entitled. 2.4 Indemnification Hereunder Not Exclusive. The indemnification provided --------------------------------------- by this Agreement is not exclusive of any other rights to which the Indemnitee may be entitled under the Company's Certificate of Incorporation, its Bylaws, any agreement, any vote of stockholders or disinterested directors, applicable law, or otherwise, both as to action in the Indemnitee's official capacity and as to action in another capacity on behalf of the Company. 2.5 Indemnification of Expenses of Successful Party. Notwithstanding any ----------------------------------------------- other provisions of this Agreement, to the extent that the Indemnitee has been successful in defense of any Proceeding or in defense of any claim, issue or matter in the Proceeding, on the merits or otherwise, including, but not limited to, the dismissal of a Proceeding without prejudice, the Indemnitee shall be indemnified against all Indemnified Costs incurred in connection therewith to the fullest extent permitted by applicable law. 2.6 Advances of Expenses. The Indemnified Costs by the Indemnitee in any -------------------- Proceeding shall be paid promptly by the Company in advance of the final disposition of the Proceeding at the written request of the Indemnitee to the fullest extent permitted by applicable law. The advances to be made will be paid by the Company to the Indemnitee within 30 days following delivery to the Company of such written request which is accompanied by substantiating documentation. 2.7 Limitations on Indemnification. No payments pursuant to this ------------------------------ Agreement shall be made by the Company to: (a) indemnify or advance Indemnified Costs to the Indemnitee with respect to Proceedings initiated or brought voluntarily by the Indemnitee and not by way of defense, except with respect to Proceedings brought to establish or enforce a right to indemnification under this Agreement or any other statute or law or otherwise as required under applicable law; provided, however, that the indemnification or advancement of Indemnified Costs may be provided by the Company with respect to Proceedings initiated or brought voluntarily by the Indemnitee and not by way of defense if the Board of Directors finds such indemnification or advancement appropriate; (b) indemnify the Indemnitee for any Indemnified Costs for which payment is actually made to the Indemnitee under a valid and collectible insurance policy, except for any excess beyond the amount of payment under the policy; 4 (c) indemnify the Indemnitee for any Indemnified Costs sustained in any Proceeding for an accounting of profits made from the purchase or sale by the Indemnitee of securities of the Company pursuant to the provisions of Section 16(b) of the Exchange Act, the rules and regulations promulgated thereunder and amendments thereto or similar provisions of any federal, state or local statutory law; (d) indemnify the Indemnitee for any Indemnified Costs resulting from Indemnitee's conduct which is finally adjudged by a court of competent jurisdiction to have been willful misconduct, knowingly fraudulent or deliberately dishonest; or (e) indemnify the Indemnitee if a court of competent jurisdiction shall finally determine that such payment is unlawful. SECTION 3. PRESUMPTIONS ------------ 3.1 Presumption Regarding Standard of Conduct. The Indemnitee shall be ----------------------------------------- conclusively presumed to have met the relevant standards of conduct as defined by applicable law for indemnification pursuant to this Agreement unless a determination that the Indemnitee has not met the relevant standards is made by (i) a majority vote of the directors of the Company who are not parties to the Proceeding, even though less than a quorum, (ii) a majority vote of the stockholders of the Company, or (iii) in a written opinion by independent legal counsel, selection of whom has been made by the Company's Board of Directors and approved by the Indemnitee. 3.2 Determination of Right to Indemnification. ----------------------------------------- (a) If a claim under this Agreement is not paid by the Company within 30 days of receipt of written notice, the right to indemnification as provided by this Agreement shall be enforceable by the Indemnitee in any court of competent jurisdiction. The Company shall bear the burden of proving by clear and convincing evidence that indemnification or advances are not appropriate. Neither (i) the failure of the directors, stockholders or independent legal counsel to have made a determination prior to the commencement of the action that indemnification or advances are proper in the circumstances because the Indemnitee has met the applicable standard of conduct, nor (ii) an actual determination by the directors, stockholders or independent legal counsel that the Indemnitee has not met the applicable standard of conduct, shall be a defense to the action or create a presumption that the Indemnitee has not met the applicable standard of conduct. (b) The Indemnitee's Expenses incurred in connection with any Proceeding concerning the Indemnitee's right to 5 indemnification or advances in whole or in part pursuant to this Agreement shall also be indemnified by the Company regardless of the outcome of the Proceeding, unless a court of competent jurisdiction determines that each of the material assertions made by the Indemnitee in the Proceeding was not made in good faith or was frivolous. SECTION 4. CHANGE IN CONTROL ----------------- The Company agrees that if there is a Change in Control or Potential Change in Control of the Company (other than a Change in Control or Potential Change in Control which has been approved by a majority of the Company's Board of Directors who were directors immediately prior to the Change in Control or Potential Change in Control), then with respect to all matters thereafter arising concerning the rights of Indemnitee to be indemnified for Indemnified Costs, the Company shall seek legal advice only from independent counsel who is selected by Indemnitee and reasonably satisfactory to the Company and who has not otherwise performed services for the Company or Indemnitee within the last five years (the "Special Independent Counsel"). The Special Independent Counsel, among other things, shall render its written opinion to the Company and Indemnitee as to whether and to what extent the Indemnitee would be permitted to be indemnified under applicable law. The Company agrees to pay the reasonable fees and expenses of the Special Independent Counsel and may fully indemnify the Special Independent Counsel against any and all expenses (including attorneys' fees), claims, liabilities and damages arising out of or relating to this Agreement. SECTION 5. INDEMNIFICATION PROCEDURE ------------------------- 5.1 Notice. Promptly after receipt by the Indemnitee of notice of the ------ commencement of any Proceeding, the Indemnitee will, if a claim is to be made against the Company under this Agreement, notify the Company of the commencement of the Proceeding. The failure to notify the Company will not relieve the Company from any liability which the Company may have to the Indemnitee, except to the extent the Company is materially damaged by the failure of the Indemnitee to so notify the Company. 5.2 Company Participation. With respect to any Proceeding for which --------------------- indemnification is requested, the Company will be entitled to participate in the Proceeding at its own expense and, except as otherwise provided below, to the extent that it may desire, the Company may assume the defense of the Proceeding, with counsel reasonably satisfactory to the Indemnitee. After the Company notifies the Indemnitee of the Company's election to assume the defense of a Proceeding, during the Company's good faith active defense the Company will not be 6 liable to the Indemnitee under this Agreement for any legal or other expenses subsequently incurred by the Indemnitee in connection with the defense of the Proceeding, other than reasonable costs of investigation, out-of-pocket or as otherwise provided below. The Indemnitee shall have the right to employ the Indemnitee's counsel in any Proceeding but the fees and expenses of the counsel incurred after notice from the Company of its assumption of the defense of the Proceeding shall be at the expense of the Indemnitee, unless (i) the employment of counsel by the Indemnitee has been authorized by the Company, (ii) the Indemnitee has reasonably concluded that there may be a conflict of interest between the Company and the Indemnitee in the conduct of the defense of a Proceeding, (iii) the Company has not in fact employed counsel to assume the defense of a Proceeding, or (iv) the Company has returned defense of the Proceeding to Indemnitee. In each of the foregoing cases the reasonable fees and expenses of the Indemnitee's counsel shall be at the expense of the Company. The Company shall not be entitled to assume the defense of any Proceeding brought by or on behalf of the Company or as to which the Indemnitee has made the conclusion that there may be a conflict of interest between the Company and the Indemnitee. 5.3 Settlement. Neither the Company nor the Indemnitee shall settle or ---------- compromise any Proceeding in any manner which would impose any penalty or limitation on either the Indemnitee or the Company without the written consent of either the Company or the Indemnitee, as the case may be; provided, however, that neither the Company nor the Indemnitee shall unreasonably withhold such consent. 5.4 Subrogation. If the Company pays Indemnified Costs, the Company will ----------- be subrogated to the extent of such payment to all of the rights of recovery of the Indemnitee against third parties. The Indemnitee will do all things reasonably necessary to secure such rights, including the execution of documents necessary to enable the Company effectively to bring suit to enforce such rights. SECTION 6. MAINTENANCE OF LIABILITY INSURANCE ---------------------------------- 6.1 Affirmative Covenant of the Company. As long as the Indemnitee shall ----------------------------------- continue to serve as a director and/or officer of the Company and thereafter so long as the Indemnitee shall be subject to any possible Proceeding, the Company shall promptly obtain and maintain in full force and effect directors' and officers' liability insurance ("D&O Insurance") in reasonable amounts from established and reputable insurers which shall include, without limitation, coverage for securities liabilities. Notwithstanding the foregoing, the Company shall have no obligation to obtain or maintain D&O Insurance if the Company determines in good faith that insurance is not reasonably available, the premium costs for insurance are disproportionate 7 to the amount of coverage provided, the coverage provided by insurance is so limited by exclusions that it provides an insufficient benefit, or the Indemnitee is covered by similar insurance maintained by a subsidiary of the Company. If the Company has D&O Insurance at the time the Company receives notice that a Proceeding has commenced, the Company will give prompt notice of such commencement to the insurers as required by the applicable insurance policies. The Company will thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of the Indemnitee, all amounts payable as a result of such Proceeding in accordance with the terms of such policies. 6.2 Indemnitee Named as Insured. In all D&O Insurance policies, the --------------------------- Indemnitee shall be named as an insured in a manner that provides the Indemnitee the same rights and benefits as are accorded to the most favorably insured of the Company's directors and/or officers. SECTION 7. AGREEMENT TO SERVE; REPAYMENT ----------------------------- 7.1 Agreement to Serve. Indemnitee will serve or continue to serve as a ------------------ director and/or officer of the Company for so long as the Indemnitee is duly elected or appointed or until the Indemnitee voluntarily resigns. Any present or future employment agreement between the Indemnitee and the Company is not modified by this Agreement and nothing contained herein creates in the Indemnitee any right of continued employment. 7.2 Repayment of Indemnified Costs. The Indemnitee will reimburse the ------------------------------ Company for all Indemnified Costs paid by the Company in defending any Proceeding against the Indemnitee if and only to the extent that a court of competent jurisdiction finally decides that the Indemnitee is not entitled to be indemnified by the Company for such Indemnified Costs under the provisions of applicable law, the Company's Certificate of Incorporation, its Bylaws, this Agreement, or otherwise. The Indemnitee will repay such amounts advanced only if, and to the extent that, it is ultimately determined that Indemnitee is not entitled to be indemnified for such Indemnified Costs by the Company pursuant to this Agreement. 7.3 Repayment. The Indemnitee will promptly repay to the Company any --------- amounts paid to the Indemnitee pursuant to other rights of indemnification or under any insurance policy, to the extent those payments are duplicative of payments under this Agreement. SECTION 8. MISCELLANEOUS ------------- 8.1 Successors and Assigns. This Agreement shall be binding upon, and ---------------------- shall inure to the benefit of the Indemnitee and the Indemnitee's spouse, heirs, successors, personal 8 representatives and assigns, and the Company and its successors and assigns. Nothing in this Agreement, express or implied, is intended to confer any rights or remedies upon any other person. 8.2 Separability. Each provision of this Agreement is a separate and ------------ distinct agreement and independent of the others, so that if any provision of this Agreement shall be held to be invalid or unenforceable for any reason, the invalidity or unenforceability shall not affect the validity or enforceability of the other provisions of this Agreement. To the extent required, any provision of this Agreement may be modified by a court of competent jurisdiction to preserve its validity and to provide the Indemnitee with the broadest possible indemnification permitted under applicable law. 8.3 Savings Clause. If this Agreement or any portion of it is invalidated -------------- on any ground by any court of competent jurisdiction, then the Company shall nevertheless indemnify Indemnitee as to Indemnified Costs with respect to any Proceeding to the full extent permitted by any applicable portion of this Agreement that shall not have been invalidated or by any other applicable law. 8.4 Interpretation; Governing Law. This Agreement shall be construed as a ----------------------------- whole and in accordance with its fair meaning. Headings are for convenience only and shall not be used in construing meaning. This Agreement shall be governed and interpreted in accordance with the laws of the State of Delaware. 8.5 Amendments; Waivers; Nature of Rights. No amendment, waiver, ------------------------------------- modification, termination or cancellation of this Agreement shall be effective unless in writing signed by the party against whom enforcement is sought. No failure or delay in exercising any right will be deemed a waiver of such right. The indemnification rights afforded to the Indemnitee by this Agreement are contract rights and may not be diminished, eliminated or otherwise affected by amendments to the Company's Certificate of Incorporation, its Bylaws or any agreement, including, without limitation, D&O Insurance policies. 8.6 Counterparts. This Agreement may be executed in one or more ------------ counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each party and delivered to the other. 8.7 Notices. Any notice required to be given hereunder shall be in ------- writing and, if directed to the Company, at 4910 Birch Street, Suite 100, Newport Beach, California, 92660, Attention: Brad A. Morrice, and, if directed to the Indemnitee, at the Indemnitee's most recent address on the books and records of the Company, or to another address as either shall designate in writing. 9 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. INDEMNITEE ___________________________________ Print Name: _______________________ NEW CENTURY FINANCIAL CORPORATION, a Delaware corporation By:________________________________ Title:_____________________________ 10 EX-10.15 6 STOCK PURCHASE AGREEMENT EXHIBIT 10.15 STOCK PURCHASE AGREEMENT This Stock Purchase Agreement is made and entered into as of May 30, 1997, between Comerica Incorporated, a Delaware corporation and bank holding company ("Buyer") and New Century Financial Corporation, a Delaware corporation (the "Seller"). R E C I T A L S WHEREAS, Seller desires to sell, and Buyer desires to acquire 545,000 shares of Common Stock of the Seller (the "Stock"), subject to the terms and conditions of this Agreement and for the consideration described herein. A G R E E M E N T NOW, THEREFORE, in consideration of the mutual promises contained herein and intending to be legally bound the parties agree as follows: ARTICLE I PURCHASE & SALE 1.1 Sale of Stock. Subject to the terms and conditions of this Agreement, Seller agrees to sell to Buyer the Stock and deliver the certificates evidencing the Stock to Buyer at the closing of the transactions contemplated by this Agreement (the "Closing"), which shall occur contemporaneously with the execution and delivery of this Agreement. 1.2 Purchase Price and Number of Shares. Buyer agrees to acquire the Stock at a purchase price (the "Purchase Price") of $7.50 per share of Stock. 1.3 Receipt of Purchase Price. Buyer hereby acknowledges receipt in the sum of $4,087,500 as payment in full for the stock. ARTICLE II REPRESENTATIONS AND WARRANTIES OF SELLER Seller represents, warrants and agrees: 2.1 Organization and Standing. Seller is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Seller has all necessary corporate power and authority to execute and deliver this Agreement and to perform its obligations hereunder. Seller has all requisite corporate power and authority to lease, own and operate its properties and assets and to carry on its business as now conducted. 2.2 Authorized Capital Stock. Effective as of the Closing or within five (5) business days thereafter, the authorized capital stock of the Seller consists, or will consist, of 45,000,000 shares of Common Stock, $0.01 par value, and 7,500,000 shares of Preferred Stock, $0.01 par value, of which no shares are, or will be, issued and outstanding. The issued shares of Common Stock and the number of authorized and outstanding warrants and options after the Closing and after the Seller's proposed initial public offering shall be as set forth on Exhibit G hereto. The Stock has been duly authorized by all necessary corporate action on the part of the Seller and, upon payment for and delivery of the Stock in accordance with this Agreement, the Stock will be validly issued, fully paid and non-assessable. 2.3 No Conflicts. The execution, delivery and performance of this Agreement by Seller will not (i) violate any provision of Seller's charter documents or bylaws, (ii) violate any statute or law or any judgment, decree, order, regulation or rule of any court or governmental authority to which Seller is bound or affected, (iii) result in the breach (or an event which, with notice or lapse of time or both, would constitute a breach) under any term or provision of, or constitute a default under, any agreement listed in an exhibit to Seller's Registration Statement on Form S-1, as filed with the Securities and Exchange Commission (the "SEC") on April 18, 1997 (the "Registration Statement"), or (iv) violate any other agreement to which Seller is a party. 2.4 Authorization. The execution, delivery and performance of this Agreement by Seller has been duly and validly authorized by the Board of Directors and stockholders of Seller and by all other necessary corporate action on the part of Seller. This Agreement constitutes the legally valid and binding obligation of Seller, enforceable against Seller in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium and other similar laws and equitable principles relating to or limiting creditors' rights generally. 2.5 Consents. All material consents or approvals of third parties necessary for the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby by Seller have been obtained. 2.6 Licenses and Permits. All licenses and permits necessary for the conduct of Seller's business are in full force and effect to the extent material to the conduct of Seller's business. 2.7 Compliance with Law. Seller is organized and has conducted business in accordance with applicable laws in all material respects and the practices of Seller are in compliance with all such laws, to the extent applicable, in all material respects. 2.8 Legal Proceedings. There is no order or action pending, or, to the best knowledge of Seller, threatened, against or affecting Seller or its assets that if determined adversely would reasonably be expected to have a material adverse effect on the Seller's business or on Seller's ability to perform its obligations hereunder. 2.9 Tax Matters. Seller has timely filed, or will file, (or where permitted or required, its direct or indirect parents have timely filed or will file) all tax returns required of it and has paid all taxes due for all periods or portions of periods ending on or before the Closing (except as provided in the following sentence). Adequate provision has been made in the books and records of Seller, and to the extent required by GAAP in the Financial Statements for all taxes whether or not due and payable and whether or not disputed to the extent not paid. 2.10 Performance of Obligations. Seller has performed in all material respects all of the obligations required to be performed by it under any covenant, contract, lease, indentures or other covenant to which it is a party and is not in default or material breach of any term of the foregoing. ARTICLE III REPRESENTATIONS AND WARRANTIES OF BUYER Buyer represents, warrants and agrees: 3.1 Organization and Related Matters. Buyer is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Buyer has the necessary corporate power and authority to execute and deliver this Agreement and to perform its obligations hereunder. 3.2 Consents and Authorization. All material consents or approvals of third parties necessary for the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby by Buyer have been obtained. The execution, delivery and performance of this Agreement by Buyer has been duly and validly authorized by all necessary corporate action on the part of Buyer. This Agreement constitutes the legally valid and binding obligation of Buyer, enforceable against Buyer in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium and other similar laws and equitable principles relating to or limiting creditors' rights generally. 3.3 No Conflicts. The execution, delivery and performance of this Agreement by Buyer will not (i) violate any provision in the Buyer's charter documents or bylaws, (ii) result in the breach (or an event which, with notice or lapse of time or both, would constitute a breach) under any term or provision of, or constitute a default under, any material indenture, mortgage, deed of trust or other agreement or arrangement to which Buyer is a party or by which it is bound, or (iii) violate any statute or law or any judgment, decree, order, regulation or rule of any court or governmental authority to which Buyer is bound or affected. 3.4 Investment. Buyer is acquiring the Stock from Seller for Buyer's own account, for investment purposes only and not with a view to or for sale in connection with the distribution thereof. 3.5 Business Relationship. Buyer is generally familiar with the business and affairs of Seller and has discussed with Seller and its plans, operations and financial condition with one or more of the officers or directors of Seller. Buyer has read and analyzed, and is familiar with the information contained in, the Registration Statement, including all of the documents incorporated therein by reference. 3.6 Qualified Institutional Buyer. Buyer represents that it is a "qualified institutional buyer" (as such term is defined in Rule 144A under the Securities Act of 1933, as amended (the "Act")). 3.7 Accredited Investor. Buyer represents that it is an "accredited investor" (as such term is defined in Regulation D under the Act) and it is knowledgeable, sophisticated and experienced in business and financial matters and has previously invested in securities similar to the Stock being acquired hereunder. 3.8 Disclosure. Seller has disclosed to Buyer that: (i) the sale of the Stock has not been registered under the Act, or qualified under the securities laws of any state and the Stock must be held indefinitely unless a sale or transfer of the Stock is subsequently registered under the Act and qualified under applicable state securities laws or exemptions therefrom are available; and (ii) any certificates representing the Stock will bear the following legend restricting transfer: "The shares represented by this certificate have not been registered under the Securities Act of 1933, but are issued in reliance on the representation that they are taken for investment and not for redistribution. As a condition of any transfer hereof, the Company may require an opinion of counsel satisfactory to it that all statutory registration provisions have been met or do not apply. The Company is authorized to issue stock in one or more classes or series. The Company will furnish without charge to any shareholder who so requests a statement as to the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. The shares of capital stock of the Company represented by this stock certificate and the disposition thereof are subject to the terms of a Shareholders Agreement dated as of November 22, 1995 (the "Shareholders Agreement") by and among the Company and certain other parties. A copy of the Shareholders Agreement is on file at the principal office of the Company and may be inspected by the registered owner of this stock certificate or a duly authorized representative of such owner upon request during the Company's normal business hours." 3.9 Rule 144. Buyer understands that, in addition to the restrictions described above: (i) the shares which constitute the Stock are restricted securities within the meaning of Rule 144 promulgated under the Act; (ii) exemption from registration under Rule 144 will not be available in any event for at least one year from the date of sale of the Stock to Buyer, and even then, Rule 144 will not be available unless: (a) a public trading market then exists for the Common Stock of Seller, (b) adequate information concerning Seller is then available to the public, and (c) the other terms and conditions of Rule 144 are met; and (iii) any unregistered sale of the Stock may be made by Buyer only in accordance with the terms and conditions of Rule 144. 3.10 Discharge of Implied Warranties. Buyer represents to Seller that Buyer has performed extensive due diligence and investigations with respect to Seller with the intention of forming its own conclusions regarding the condition (financial and otherwise), value, property, liabilities, contracts, contingencies, prospects, risks and other incidents of the business of Seller in response to the parties' express intention and agreement that as of the Closing, the sale hereunder shall be without representation and warranty of any kind (express or implied) regarding the Seller or the Stock, except as set forth in Section 2 hereof. Buyer will rely solely on its own business judgment and investigations with respect to Seller and the Stock. Buyer expressly acknowledges and agrees that Seller has not provided any further representations or warranties (express or implied) to Buyer. ARTICLE IV COVENANT OF BUYER Upon request of the underwriters of the Offering, Buyer agrees to execute and deliver a 180-day Lock-Up Agreement in substantially the form of Exhibit A hereto. ARTICLE V DOCUMENTS DELIVERED CONTEMPORANEOUSLY WITH PURCHASE 5.1 The parties have executed and delivered the following agreements on the date hereof; 1. Letter of Intent providing for the negotiation, execution and delivery of the following documents in substantially the form set forth in Exhibit B: (a) Sub-Servicing Agreement with respect to the time period prior to Seller's sale of loans in the secondary market; (b) Sub-Servicing Agreement with respect to the time period after Seller's securitization of loans or sale of loans on a servicing- retained basis; (c) Service Provider Agreement regarding loan referrals from Buyer's bank and mortgage branches; and (d) A Service Provider Agreement regarding loan referrals resulting from Buyer's consumer loan portfolio. 2. The First Amendment to Shareholders' Agreement substantially in the form of Exhibit D (it has been acknowledged by the parties that the Shareholders Agreement will be terminated upon the closing of Seller's contemplated initial public offering); 3. A Registration Rights Agreement substantially in the form of Exhibit C hereto; 4. A letter agreement(with respect to the waiver of preemptive rights and related matters) by the stockholders of Seller substantially in the form of Exhibit E; 5. Additional representation by Seller. Seller hereby represents and warrants to Buyer that: (a) Stockholders of Seller holding not less than ninety percent (90%) of the 4,922,144 outstanding warrants to purchase shares of Seller's Common Stock have elected to exercise such warrants for cash or on a cashless basis in accordance with the terms thereof; and (b) Stockholders of Seller holding not less than ninety percent (90%) of the 5,820,000 outstanding shares of Series A and Series B Preferred Stock of the Seller shall have elected to convert such preferred shares into Common Stock of the Seller. ARTICLE VI CONVENANT OF SELLER On the date hereof, Seller has issued a warrant to Buyer for 100,000 shares of Seller's Common Stock. Seller shall issue to Buyer additional warrants to purchase the number of additional shares of Seller's Common Stock indicated below, such warrants to be in substantially the form attached hereto as Exhibit F, upon the occurrence of the following events: (i) 50,000 shares upon the commencement of servicing operations pursuant to the Sub-Servicing Agreements contemplated by the Letter of Intent (provided, however, that the grant of such warrants shall not be deferred if Buyer is prepared to commence servicing operations but such commencement is delayed beyond September 30, 1997 because Seller is not prepared to commence servicing operations) (ii) 50,000 shares after one (1) year of operations under the Sub- Servicing Agreements contemplated by the Letter of Intent; provided that at the end of such year Buyer is not in material default under or in material breach of the terms of such Sub-Servicing Agreements after having had an opportunity to cure; (iii) 25,000 shares upon the funding by Seller of an aggregate of $10.0 million of loans resulting from the First Service Provider Agreement referred to in the Letter of Intent; (iv) 25,000 shares upon the execution by Buyer and the funding by Seller of an aggregate of $10.0 million of loans resulting from the Second Service Provider Agreement referred to in the Letter of Intent; and (v) 83,333 shares upon the agreement of Buyer and Seller to one or more additional strategic relationships between Buyer and Seller, such agreement to be based upon one or more proposals to be made by Buyer, which proposals shall not be unreasonably declined by Seller. The Purchase Price for shares purchased under the foregoing warrants shall be equal to the greater of (A) $7.50 per share or, (B) if Seller completes an initial public offering of its Common Stock within six months after the Closing, the initial public offering price. The five year exercise period for all of the foregoing warrants shall commence on the date of the Closing and each such warrant shall vest whether or not already awarded in three equal installments on December 31, 1997, 1998 and 1999, respectively, subject to satisfaction (but not conditioned by) of the performance events specified above and subject to acceleration under the circumstances set forth in the form of warrant attached hereto as Exhibit F. ARTICLE VII [INTENTIONALLY LEFT BLANK] ARTICLE VIII GENERAL 8.1 No Brokers or Finders. Seller and Buyer each represent to the other that, except for Seller's retention of Montgomery Securities, no agent, broker, finder or investment or commercial banker, or other firms engaged by or acting on behalf of either Buyer, Seller or any of their affiliates in connection with the negotiation, execution or performance of this Agreement or the transactions contemplated by this Agreement, is or will be entitled to any broker's or finder's or similar fees or other commissions as a result of this Agreement or such transactions, and that Seller shall pay the fees of Montgomery Securities. 8.2 Amendments; Waivers. This Agreement and any schedule or exhibit attached hereto may be amended only by agreement in writing of Buyer and Seller. No waiver of any provision nor consent to any exception to the terms of this Agreement or any agreement contemplated hereby shall be effective unless in writing and signed by the party to be bound and then only to the specific purpose, extent and instance so provided. 8.3 Schedules; Exhibits; Integration. Each schedule delivered pursuant to the terms of this Agreement shall be in writing and shall constitute a part of this Agreement, although schedules need not be attached to each copy of this Agreement. This Agreement, together with such schedules and the exhibits attached hereto, constitutes the entire agreement among the parties pertaining to the subject matter hereof and supersedes all prior agreements and understandings of the parties in connection therewith. 8.4 Further Assurances. Each party agrees to cooperate fully with the other party and to execute and deliver such further instruments, certificates, agreements and other documents and take such other actions as may be necessary or appropriate to consummate or implement the transactions contemplated hereby or to evidence such events or matters. 8.5 Governing Law. This Agreement and the legal relations between the parties shall be governed by and construed in accordance with the laws of the State of California applicable to contracts made and performed in such State and without regard to conflicts of law doctrines, except to the extent that certain matters are preempted by federal law or are governed by the law of the jurisdiction of organization of the respective parties. Any court action arising out of this Agreement shall be brought in any court of competent jurisdiction within the State of California, County of Orange. 8.6 No Assignment. Neither this Agreement nor any rights or obligations under it are assignable. 8.7 Headings. The descriptive headings of the Articles, Sections and subsections of this Agreement are for convenience only and do not constitute a part of this Agreement. 8.8 Counterparts. This Agreement and any amendment hereto or any other agreement (or document) delivered pursuant hereto may be executed in one or more counterparts and by different parties in separate counterparts. All of such counterparts shall constitute one and the same agreement (or other document) and shall become effective (unless otherwise provided therein) when one or more counterparts have been signed by each party and delivered to the other party. 8.9 Publicity and Reports. For a period of three (3) months after the date hereof, Seller and Buyer shall coordinate all publicity relating to the transactions contemplated by this Agreement and no party shall issue any press release, publicity statement or other public notice relating to this Agreement, or the transactions contemplated by this Agreement, without obtaining the prior consent of Seller and Buyer and their respective counsel, except to the extent that either party and its counsel in good faith conclude a particular action is required under federal securities or other applicable law. 8.10 Parties in Interest. This Agreement shall be binding upon and inure to the benefit of each party, and nothing in this Agreement, express or implied, is intended to confer upon any other person any rights or remedies of any nature whatsoever under or by reason of this Agreement. Nothing in this Agreement is intended to relieve or discharge the obligation of any third person to any party to this Agreement. 8.11 Notices. Any notice or other communication hereunder must be given in writing and (a) delivered in person, (b) transmitted by telex, telefax or telecommunications mechanism or (c) mailed by certified or registered mail, postage prepaid, receipt requested as follows: If to Buyer, addressed to: Comerica, Incorporated Comerica Tower at One Detroit 500 Woodward, MC 3391 Detroit, Michigan 48226 Facsimile Number: (313) 222-9480 Attn: Mark W. Yonkman, Assistant Secretary With a copy to: Comerica Incorporated 3551 Hamlin Road M/C 7132 Auburn Hills, Michigan 48326 Facsimile Number: 810-370-6907 Attn: John R. Haggerty, Executive Vice President If to Seller, addressed to: New Century Financial Corporation 4910 Birch Street, Suite 100 Newport Beach, California 92660 Facsimile Number: (714) 440-7033 Attn: Brad A. Morrice, President With a copy to: O'Melveny & Myers LLP 610 Newport Center Drive, Suite 1700 Newport Beach, California 92660-6429 Facsimile Number: (714) 669-6994 Attn: David A. Krinsky, Esq. or to such other address or to such other person as either party shall have last designated by such notice to the other party. Each such notice or other communication shall be effective (i) if given by telecommunication, when transmitted to the applicable number so specified in (or pursuant to) this Section 7.11 and an appropriate answer back is received, (ii) if given by mail, three days after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid or (iii) if given by any other means, when actually received at such address. 8.12 Expenses and Attorneys Fees. Seller and Buyer shall each pay their own expenses incident to the negotiation, preparation and performance of this Agreement and the transactions contemplated hereby, including but not limited to the fees, expenses and disbursements of their respective accountants and counsel. 8.13 Survival. The representations and warranties contained in or made pursuant to this Agreement shall expire on the first anniversary of the Closing. IN WITNESS WHEREOF, each of the parties hereto has caused this Agreement to be executed by its duly authorized officers as of the day and year first above written. BUYER: COMERICA INCORPORATED, a Delaware corporation By: /s/ MARK W. YONKMAN ____________________________ Name: Mark W. Yonkman Its: First Vice President and Assistant Secretary SELLER: NEW CENTURY FINANCIAL CORPORATION, a Delaware corporation By: /s/ ROBERT K. COLE ____________________________ Name: Robert K. Cole Its: Chairman & CEO Exhibits EXHIBIT A Form of Lock-Up Agreement EXHIBIT B Letter of Intent regarding the following: (a) Subservicing Agreement with respect to the time period prior to Seller's sale of loans in the secondary market; (b) Subservicing Agreement with respect to the time period after Seller's securitization of loans or sale of loans on a servicing retained basis; (c) Service Provider Agreement regarding loan referrals from Buyer's bank and mortgage branches; and (d) Service Provider Agreement regarding loan referrals resulting from Buyer's consumer loan portfolio EXHIBIT C Form of Registration Rights Agreement EXHIBIT D Form of First Amendment to Stockholders' Agreement EXHIBIT E Form of Waiver of Preemptive Rights EXHIBIT F Form of Warrant EXHIBIT G Schedule of Outstanding Shares, Options and Warrants EX-11.1 7 STATEMENT RE: COMPUTATION PER SHARE EXHIBIT 11.1 NEW CENTURY FINANCIAL CORPORATION STATEMENT REGARDING COMPUTATION OF PRO FORMA PER SHARE EARNINGS
YEAR ENDED DECEMBER 31, MARCH 31, 1996 1997 PRO FORMA PRIMARY EARNINGS PER SHARE ------------ ---------- Computation for Statement of Operations: Net earnings per Statement of Operations used in Primary Earnings Per Share computation............... $1,335,000 $2,347,000 Adjustment related to revisions in compensation and incentive compensation plan............................ (142,000) (88,000) ---------- ---------- Net Earnings as Adjusted................................ $1,193,000 $2,259,000 ========== ========== Weighted Average Number of Shares Outstanding........... 10,992,374 10,992,374 Shares issuable pursuant to the assumption of the exercise of warrants and options, as determined by the application of the Treasury Stock Method............... 638,065 650,833 ---------- ---------- Weighted Average Number of Shares Outstanding........... 11,630,439 11,643,207 ========== ========== Pro Forma Primary Earnings Per Share, As Adjusted....... $ 0.10 $ 0.19
Fully diluted earnings per share were not materially different. EX-23.1 8 CONSENT/KPMG PEAT MARWICK LLP EXHIBIT 23.1 The Board of Directors of New Century Financial Corporation: We consent to the use of our report included herein and to the reference to our firm under the headings "Selected Consolidated Financial and Other Data" and "Experts" in the Prospectus. /s/ KPMG Peat Marwick LLP ------------------------------------- KPMG Peat Marwick LLP Orange County, California June 17, 1997 -----END PRIVACY-ENHANCED MESSAGE-----