Prepared by R.R. Donnelley Financial -- New Century Financial Form 10-K
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-K
 
(Mark One)
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
   
 
For the fiscal year ended December 31, 2001
 
OR
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
   
 
For the transition period from                  to                 
 
Commission File Number 000-22633
 

 
NEW CENTURY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
(State or other jurisdiction
incorporation or organization)
 
33-0683629
(I. R. S. Employer
Identification Number)
18400 Von Karman, Suite 1000, Irvine, California
(Address of principal executive offices)
 
92612
(Zip Code)
 
Registrant’s telephone number, including area code: (949) 440-7030
 

 
Securities registered pursuant to Section 12(b) of the Act:
None
 
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
 

 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨
 
The aggregate market value of Common Stock held by non-affiliates of the Registrant on February 14, 2002 was approximately $126 million based on the closing sales price for the Common Stock on such date of $14.14 as reported on the Nasdaq National Market.
 
As of February 14, 2002, the Registrant had 20,635,981 shares of Common Stock outstanding.
 
PART III incorporates information by reference from the Registrant’s definitive Proxy Statement for its 2002 Annual Meeting of Stockholders to be filed with the Commission within 120 days of December 31, 2001.
 


 
PART I
 
Item 1.     Business
 
General
 
We are a leading nationwide specialty mortgage banking company that originates, purchases and sells residential mortgage loans secured primarily by first mortgages on single-family residences. We offer mortgage products that focus on borrowers who generally do not satisfy the credit, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers, such as Fannie Mae and Freddie Mac. We originate and purchase loans on the basis of the borrower’s ability to repay the mortgage loan, the borrower’s historical pattern of debt repayment and the amount of equity in the borrower’s property (as measured by the borrower’s loan-to-value ratio, or LTV). We have been originating and purchasing these types of loans since 1996 and believe we have developed a comprehensive and sophisticated process of credit evaluation and risk-based pricing that allows us to effectively manage the potentially higher risks associated with this segment of the mortgage industry.
 
Our borrowers generally have considerable equity in the properties securing their loans, but have impaired or limited credit profiles or higher debt-to-income ratios than traditional mortgage lenders allow. Our borrowers also include individuals who, due to self-employment or other circumstances, have difficulty verifying their income through conventional methods, and who prefer the prompt and personalized service we provide.
 
We originate and purchase approximately 80% of our loans through our wholesale network of 9,900 independent mortgage brokers, and the remainder through our retail network of 65 branch offices located in 25 states, our central retail unit and through our anyloan.com website. Although a significant percentage of our loans are originated in California, we are authorized to do business in all 50 states and regularly originate and purchase loans throughout the country. Wholesale originations and purchases are through independent mortgage brokers who provide loans through the Wholesale Division of our subsidiary, New Century Mortgage Corporation, as well as its subsidiary, Worth Funding. Retail originations occur through our network of branch offices, through our Central Retail Division and through our subsidiary, The Anyloan Company’s strategic alliances with mortgage companies and other financial institutions.
 
Historically, our loan sales strategy focused on a balanced combination of securitizations and whole loan sales in order to achieve our goal of enhancing profits while managing cash flows. However, our previous securitizations required us to make significant investments of cash at the time of securitization, and were not expected to generate significant cash flow to us for an extended period. In fiscal 2000, we changed our loan sales strategy to selling our loans in a way so as to optimize cash revenue and improve liquidity. To effect this strategy, we sold loans through whole loan sale transactions and cash flow-positive securitizations. Whole loan sale transactions enable us to generate current cash flow, protect against the potential volatility of the securitization market and reduce the risks inherent in retaining residual interests. Recent changes in market conditions have also allowed us to generate cash revenues from securitizations. In our 2001 securitizations, we employed a structure that allowed us to receive initial cash proceeds similar to those received through whole loan sales completed during this same period. For our 2001 sales transactions, 84.0% were whole loan sales while the remainder were cash flow-positive securitizations. We expect to continue to employ a combination of whole loan sales and cash flow-positive securitizations in order to maximize our operating flexibility and to maintain multiple loan sales channels.
 
Recent Operational Highlights
 
We have implemented several strategic initiatives that have reduced our risk profile and significantly improved our operating performance and financial results. These initiatives allowed us to achieve our goal of positive cash flow from operations for 2001. These key initiatives include:
 
 
 
Transition to Cash Flow-Positive Loan Sales Strategy.    As part of our strategy to improve cash flows, beginning in the first quarter of 2000, we transitioned from securitizing the majority of our loans to

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selling the majority of production for cash in whole loan sales and, beginning in 2001, cash flow-positive securitizations. To that end, during the year ended December 31, 2001, we completed whole loan sales of $4.7 billion and two securitizations totaling $898 million, with accompanying net interest margin securities, or NIMS. The net cash proceeds from the securitizations and accompanying NIMS resulted in cash proceeds in amounts similar to whole loan sales. This transition increased our cash revenues and reduced our need for additional capital or borrowings in order to fund operations. We plan to continue to execute loan sales strategies that optimize cash revenues and liquidity.
 
 
 
Restructured and Reduced Debt.    In March 2001, we restructured nearly all of our residual financing, which eliminated our exposure to margin calls on that debt. In addition, during 2001, we repaid $96.9 million in residual financing and extended the maturity of our subordinated debt to December 31, 2003, which allowed us to more closely match our payment obligations with the projected cash flows from our residual interests. We expect to repay all outstanding residual financing by the end of the third quarter of 2002.
 
 
 
Reduction of Loan Acquisition Costs.    We reduced our loan acquisition costs to 2.27% of loan production for the quarter ended December 31, 2001 from 2.69% for the quarter ended December 31, 2000. Loan acquisition costs are the fees paid to wholesale brokers and correspondents, plus direct loan origination costs (including commissions and corporate overhead costs), less the sum of points and fees received from borrowers, divided by total production volume. We achieved this reduction in our loan acquisition costs through a combination of: (i) decreasing corporate overhead and commission expense; (ii) reducing marketing costs; (iii) consolidating operations; (iv) managing premiums paid to wholesale brokers and correspondent lenders; (v) closing unprofitable branches; and (vi) increasing our loan origination volume.
 
 
 
Sale of Servicing Rights.    In March 2001, we sold to Ocwen Federal Bank FSB, one of the country’s highest rated special servicers, for $19.7 million, the servicing rights on $4.8 billion of our servicing portfolio which was comprised of 25 separate asset-backed securities. Ocwen also reimbursed us for our outstanding servicing advance receivables and assumed responsibility for all future servicing advance obligations on the purchased securities. We used the sale proceeds to: (i) repay the portion of our warehouse line of credit that was secured by servicing advances; (ii) repay the outstanding balance of $22.5 million under our working capital line of credit with U.S. Bank; and (iii) increase our liquidity.
 
 
 
Raised Capital.    In July 2001, we completed a private placement managed by Friedman, Billings, Ramsey, Inc. of 1.44 million shares of common stock. We received approximately $14 million of new capital after all costs and expenses. In October 2001, we completed a follow-on public offering with Friedman, Billings, Ramsey, Inc. as lead underwriter and Jefferies and Company, Inc. and Advest, Inc. as co-underwriters. Due to a strong demand for the shares, the offering was increased from 3.0 to 3.5 million shares at $11.00 per share, including the sale of 300,000 shares by certain selling stockholders. The underwriters elected to exercise their option to purchase an additional 525,000 shares from us to cover over-allotments. We received approximately $38 million of new capital after deducting offering expenses. We intend to use the net proceeds for general corporate purposes, including an increase in our capital base to support expansion of credit facilities and additional growth.
 
 
 
Improved Underwriting Controls.    We implemented a process designed to monitor and adjust our underwriting guidelines to originate loans that are widely accepted by loan buyers. We also took steps to further reduce documentation errors, better identify borrower misrepresentation and reduce early payment default with the goal of decreasing the number of loans sold at a discount.
 
 
 
Management Reorganization.    During the first quarter of 2001, we announced several senior management changes designed to improve accountability and increase the efficiency of our operations. Most notably, Brad Morrice, our Vice Chairman and President, assumed the additional role of Chief Operating Officer and also became the sole Chairman and Chief Executive Officer of our subsidiary, New Century Mortgage.

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Growth and Operating Strategies
 
The following are our growth and operating strategies:
 
 
 
Increase Loan Originations.    We plan to pursue geographic expansion of our wholesale business, particularly into the Northeast and Mid-Atlantic areas of the country. Our Wholesale Division can expand quickly into new markets with limited investment in infrastructure. For retail expansion, we will continue our practice of reviewing demographic information about potential markets and opening branches in markets that we conclude can support a retail branch. We plan to continue to deploy new marketing and technology initiatives and expand our product line and sales personnel in an effort to increase our existing market penetration.
 
 
 
Develop Strategic Alliance Program.    We are developing a strategic alliance program to provide our products to customers of banks, thrifts and other financial institutions and mortgage companies who do not offer such products. We hired a team of individuals during 2001 with extensive experience developing such alliances. We began originating loans under this program in December 2001.
 
 
 
Continue to Emphasize Cash Flow-Positive Operations.    We plan to continue to focus our secondary marketing on sales strategies that will optimize revenues and cash flow. We also intend to continue to utilize securitization structures that generate cash in excess of origination costs, as well as selected sales of servicing rights.
 
 
 
Optimize Net Interest Income.    Our current levels of cash, capital and financing sources allow us to hold loans for a longer period of time prior to sale or securitization. We earn net interest income on loans held for sale as a result of the spread between the interest rate that we pay on our warehouse and aggregation lines and the interest rate we receive on our loans. As a result, by optimizing the number of days that we hold the loans prior to sale, we will optimize the amount of interest income that we earn.
 
 
 
Reduce Loans Sold at a Discount.    We are devoting significant efforts to reduce the losses that result from loans we sell at a discount to par value. Loans are typically sold at a discount when (i) there are documentation deficiencies, (ii) the loans have characteristics that are outside the guidelines of whole loan buyers, or (iii) the borrower defaults on the first payment. In order to accomplish these objectives, we appointed a corporate level Chief Credit Officer, improved the analytics used in evaluating discount loans and eliminated products resulting in disproportionately high levels of discount loans. While loans sold at a discount increased for the year ended December 31, 2001 compared to 2000, they decreased during 2001, from over $190 million in the first half of 2001 to $46 million in the second half.
 
 
 
Continue to Manage Loan Acquisition Costs.    We continue to focus our efforts on reducing our loan acquisition costs by improving efficiencies and increasing loan origination volume. In the fourth quarter of 2001, our loan acquisition cost was 2.27% of loan originations. While we continue to focus on reducing operating expenses, we are not expecting further decreases in this measure during the first few quarters of 2002, due to the fact that the percentage of production from Wholesale continues to grow and Wholesale has slightly higher loan acquisition costs. In addition, we plan to invest in the technology, training and other infrastructure necessary to support future growth, improve loan quality and set the stage for future cost reductions.
 
 
 
Pay Off Residual Financing.    As of December 31, 2001, we owed approximately $79.9 million in residual financing to Salomon Smith Barney. This financing matures on December 31, 2002. However, we expect to repay all outstanding residual financing by the end of the third quarter of 2002. Upon the full repayment of the residual financing, we will be able to retain all of the cash flow from the residual interests. This will reduce the interest expense that we incur and, as a result, enhance our operating results.
 
 
 
Re-establish Servicing Platform.    We intend to re-establish our servicing operations in 2002. To that end, we have hired our former Senior Vice President of Servicing who is in turn recruiting an experienced team of managers. We believe that establishing in-house servicing capability will enhance our value as a full-service mortgage banking franchise, and that it will provide an additional source of revenue and

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profits. During the period we are rebuilding servicing, we intend to continue to use Ocwen to service our new originations. We also expect to continue to sell to Ocwen a significant volume of servicing rights in 2002. We anticipate that we will begin boarding some production on our servicing platform in the fourth quarter of 2002.
 
Strengths and Competitive Advantages
 
We believe that we have several strengths and competitive advantages that will allow us to compete effectively in our business, including:
 
 
 
Management Experience and Depth.    The members of our senior management team have on average over 18 years of experience in the consumer finance sector.
 
 
 
High Quality Customer Service.    We strive to make the origination process easy for our borrowers and brokers by providing prompt responses, consistent and clear procedures and an emphasis on ease of use.
 
 
 
Strong Secondary Market Relationships.    We have developed relationships with a variety of large institutional loan buyers, including Salomon Smith Barney, CSFB, Morgan Stanley and Deutsche Bank, who consistently bid on and buy large loan pools from us.
 
 
 
Advanced Technology for Credit Evaluation.    The implementation of our proprietary credit grading and pricing engines has allowed us to produce a more consistent and predictable portfolio of loans.
 
 
 
Award-Winning Website.    E-Qual, our Wholesale Division’s website won the 2000 Website of the Year Award from Mortgage Technology Magazine. The site’s features make the loan process easier for our brokers which in turn helps to solidify our relationships with them.
 
 
 
Significant Cash Flows from Residuals.    Our residual interests provide significant cash flows that we expect will allow us to repay our long-term debt aggressively. Once the debt has been repaid, we expect that the continued cash flow from residual interests will provide significant growth and operating capital in the future.
 
Product Types
 
We offer both fixed-rate and adjustable-rate loans, or ARMs. We also offer loans with an interest rate that is initially fixed for a period of time and that subsequently converts to an adjustable-rate. Most of the ARMs that we originate are offered at a low initial interest rate, sometimes referred to as a “start rate.” At each interest rate adjustment date, we adjust the rate, subject to certain limitations on the amount of any single adjustment and a cap on the aggregate of all adjustments.
 
In addition, our products are available at different interest rates and with different origination and application points and fees depending on the particular borrower’s risk classification (see “Business—Underwriting Standards”). Borrowers may choose to increase or decrease their interest rate through the payment of different levels of origination fees. Many of our fixed-rate borrowers, in particular, choose to “buy down” their interest rate through the payment of additional origination fees. Our maximum loan amounts are generally $500,000 with a loan-to-value ratio of up to 80%. We do, however, offer larger loans with lower loan-to-value ratios on a case-by-case basis. We also offer products that permit a loan-to-value ratio of up to 95% for selected borrowers with a risk classification of “A+” or of up to 90% for selected borrowers with a risk classification of “A-”. We have also introduced our “Prime Alternative” product designed to appeal to borrowers of higher credit quality.
 
Loans originated or purchased by us during 2001 had an average loan amount of approximately $138,000 and an average loan-to-value ratio of approximately 78.7%. If permitted by applicable law and agreed to by the borrower, our loans may also include a prepayment charge that is triggered by the loan’s full or substantial prepayment early in the loan term. Approximately 84.2% of the loans we originated or purchased during 2001 included some form of prepayment charge.

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Loan Originations and Purchases
 
We originate and purchase loans through the New Century Mortgage Wholesale Division, Retail Branch Operations Division, Central Retail Division, and through Worth Funding, a wholly-owned subsidiary of New Century Mortgage. In late 2001, we began originating loans through The Anyloan Company, another subsidiary of New Century Financial Corporation. These divisions originate and purchase loans as follows:
 
 
 
The Wholesale Division originates and purchases loans through a network of independent mortgage brokers and correspondents solicited by our account executives. These account executives provide on-site customer service to the broker to facilitate the funding of the loan.
 
 
 
Worth Funding originates and purchases loans by soliciting and servicing brokers through its centralized telemarketing approach, operating from a central office where all decisions can be made promptly.
 
 
 
The Retail Branch Operations Division originates loans direct to the consumer through 65 retail branch offices located in 25 states.
 
 
 
The Central Retail Division originates loans nationwide through one central office. Leads are generated through radio, direct mail, telemarketing, and the Internet.
 
 
 
The Anyloan Company originates loans by developing alliances with mortgage companies and other financial institutions that do not offer our products.
 
Characteristics of the loans we originated and purchased during 2001 include:
 
 
 
66.3% were to borrowers within our three highest credit grades even though our underwriting guidelines include six levels of credit risk classifications;
 
 
 
93.2% were secured by the primary residences of our borrowers;
 
 
 
99.3% were secured by first mortgages and the remainder were secured by second mortgages; and
 
 
 
82.9% were refinances of existing loans, while the remaining 17.1% represented loans for a borrower’s purchase of a residential property.
 
Wholesale and Worth Funding
 
During 2001, our wholesale originations and purchases totaled $5.1 billion, or 81.2% of our total loan production, including $439.4 million, or 7.0%, which was originated through Worth Funding. As of December 31, 2001, the Wholesale Division operated through five regional operating centers located in Southern California, Northern California, Schaumburg, Illinois, Greenwood Village, Colorado, and Tampa, Florida. The Wholesale Division also operated through 31 additional sales offices located in Alabama, California, Florida, Georgia, Idaho, Indiana, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Missouri (2), Nevada, New Mexico, Ohio (3), Oregon, Rhode Island, South Carolina, Tennessee, Texas (2), Utah, Virginia, Washington (2), West Virgina and Wisconsin (2). As of December 31, 2001, the Wholesale Division employed 209 account executives.
 
As of December 31, 2001, approximately 9,900 mortgage brokers were approved by us to submit loans. We originated loans through approximately 6,000 brokers during 2001. During this period, our ten largest producing brokers originated 5.7% of our wholesale production.
 
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 our liaison with the borrower through the lending process. We review and underwrite the application submitted by the broker, approve or deny the application, set the interest rate and other terms of the loan and, upon acceptance by the borrower and satisfaction of all conditions imposed by us, fund the loan. Because brokers conduct their own marketing and employ their own personnel to complete loan applications and maintain contact with borrowers, originating loans through the Wholesale Division allows us to increase loan volume without incurring the higher marketing, labor and other overhead costs associated with increased retail originations.
 

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Mortgage brokers generally submit loan applications to an account executive in one of our sales offices. The sales office then forwards the application to the closest regional operating center where the loan is logged in for 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, we attempt to respond to each application as quickly as possible. If approved, we issue a “conditional approval” to the broker with a list of specific conditions that have to be met (for example, credit verifications and independent third–party appraisals) and additional documents to be supplied prior to the funding of the loan. An account manager and the account executive who originated the loan work directly with the submitting mortgage broker to collect the requested information and to meet the underwriting conditions and other requirements. In most cases, we fund loans within 30 days after approval of the application.
 
The Wholesale Division also purchases closed loans on an individual or “flow” basis from independent mortgage brokers and financial institutions. We review an application for approval from each lender that seeks to sell us a closed loan. We analyze the mortgage broker’s underwriting guidelines and financial condition, including its licenses and financial statements. We require each mortgage broker to enter into a purchase and sale agreement with customary representations and warranties regarding the loans such mortgage broker will sell to us. These representations and warranties are comparable to those given by us, through our subsidiary, NC Capital, to our loan purchasers.
 
The following table sets forth selected information relating to loan originations through the Wholesale Division and Worth Funding during the periods shown:
 
    
For the Quarters Ended

 
    
March 31, 2001

    
June 30, 2001

    
September 30, 2001

    
December 31, 2001

 
Principal balance (in thousands)
  
$
807,954
 
  
$
1,103,235
 
  
$
1,493,309
 
  
$
1,663,968
 
Average principal balance per loan (in thousands)
  
$
140
 
  
$
143
 
  
$
150
 
  
$
153
 
Combined weighted average initial loan-to-value ratio
  
 
78.4
%
  
 
78.8
%
  
 
79.2
%
  
 
79.2
%
Percent of first mortgage loans
  
 
98.7
 
  
 
99.5
 
  
 
100.0
 
  
 
100.0
 
Property securing loans:
                                   
Owner occupied
  
 
92.1
 
  
 
91.7
 
  
 
93.1
 
  
 
93.3
 
Non-owner occupied
  
 
7.9
 
  
 
8.3
 
  
 
6.9
 
  
 
6.7
 
Weighted average interest rate:
                                   
Fixed-rate
  
 
10.5
 
  
 
9.7
 
  
 
9.4
 
  
 
8.7
 
ARMs
  
 
9.9
 
  
 
9.6
 
  
 
9.3
 
  
 
9.1
 
Margin—ARMs
  
 
6.5
 
  
 
6.6
 
  
 
6.6
 
  
 
6.7
 
 
Retail Branch Operations Division, Central Retail Division and The Anyloan Company.
 
During 2001, the Retail Branch Operations Division originated $868.4 million in loans, or 13.9% of our total loan production. As of December 31, 2001, the Retail Branch Operations Division employed 288 retail loan officers. These employees were located in 65 sales offices in Arizona (3), California (18), Colorado, Florida (4), Georgia, Hawaii, Illinois (2), Kentucky, Louisiana, Massachusetts, Michigan, Minnesota (2), Missouri (2), Montana, Nevada (2), New Jersey, New Mexico, Ohio (3), Oklahoma, Oregon (2), Pennsylvania (2), Texas (8), Utah, Virginia (2), and Washington (3).
 
During 2001, the Central Retail Division originated $307.3 million, or 4.9%, of our total loan production. As of December 31, 2001, the Central Retail Division employed 82 loan officers at its offices in Irvine, California.
 
During 2001, The Anyloan Company, which began its lending activities in November 2001, originated $846,000 in loans. As of December 31, 2001, The Anyloan Company employed 4 loan officers at its offices in Irvine, California.
 

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By creating a direct relationship with the borrower, retail lending provides a more sustainable loan origination franchise and greater control over the lending process. Loan origination fees contribute to profitability and cash flow and offset the higher costs of retail lending.
 
The following table sets forth selected information relating to loan originations through the Retail Branch Operations Division, Central Retail Division and The Anyloan Company during the periods shown:
 
    
For the Quarters Ended

 
    
March 31, 2001

    
June 30, 2001

    
September 30, 2001

    
December 31, 2001

 
Principal balance (in thousands)
  
$
218,579
 
  
$
280,684
 
  
$
322,220
 
  
$
355,022
 
Average principal balance per loan (in thousands)
  
$
95
 
  
$
104
 
  
$
113
 
  
$
117
 
Combined weighted average initial loan-to-value ratio
  
 
76.1
%
  
 
78.2
%
  
 
77.7
%
  
 
77.9
%
Percent of first mortgage loans
  
 
95.2
 
  
 
96.9
 
  
 
98.4
 
  
 
99.2
 
Property securing loans:
                                   
Owner occupied
  
 
96.6
 
  
 
96.7
 
  
 
97.2
 
  
 
97.0
 
Non-owner occupied
  
 
3.4
 
  
 
3.3
 
  
 
2.8
 
  
 
3.0
 
Weighted average interest rate:
                                   
Fixed-rate
  
 
10.8
 
  
 
10.6
 
  
 
9.9
 
  
 
9.1
 
ARMs
  
 
10.1
 
  
 
9.6
 
  
 
9.5
 
  
 
9.2
 
Margins—ARMs
  
 
6.4
 
  
 
6.5
 
  
 
6.7
 
  
 
6.6
 
 
Marketing
 
Wholesale Division and Worth Funding Marketing
 
The marketing strategy of the Wholesale Division of New Century Mortgage and of Worth Funding focuses on the sales efforts of their account executives, and on providing prompt, consistent service to brokers and their customers. These efforts are supplemented with direct mail and fax programs to brokers, advertisements in trade publications, in-house production of collateral sales material, seminar sponsorships, tradeshow attendance, periodic sales contests and the Wholesale Division’s e-commerce website.
 
Retail Branch Marketing
 
The Retail Branch Operations Division of New Century Mortgage relies primarily on targeted direct mail and outbound telemarketing to attract borrowers. New Century Mortgage’s direct mail programs are managed by a centralized staff who create a targeted mailing list for each branch market and oversee the completion of mailings by a third party mailing vendor. All calls or written inquiries from potential borrowers that result from the mailings are tracked centrally and then forwarded to each branch location and handled by branch loan officers. This division’s website (www.newcenturymortgage.com) is used in the direct mail program to provide information to prospective borrowers and to allow them to complete an application online. Under the Central Telemarketing Program, the telemarketing staff solicits prospective borrowers, makes a preliminary evaluation of the applicant’s credit and the value of the collateral property and refers qualified leads to loan officers in the retail branch closest to the customer.
 
Central Retail Marketing
 
The Central Retail Division of New Century Mortgage engages in a variety of direct response advertising, such as purchased leads from aggregators, radio advertising, direct mail, search engine placement, banner ads, e-mail campaigns and links to related websites. The Central Retail Division also markets to the current customer base of New Century Mortgage through direct mail and outbound telemarketing. In addition, this division maintains a comprehensive database on all customers with whom it has had contact and markets to these potential customers in an effort to convert them to application.
 

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Financing Loan Originations and Loans Held for Sale
 
We require access to credit facilities in order to originate and purchase mortgage loans and to hold them pending their sale or securitization. In particular, we rely on a $300 million syndicated warehouse credit facility led by U.S. Bank and a $200 million warehouse and aggregation facility with CDC Mortgage Capital to fund our originations and purchases. We also rely on aggregation financing facilities totaling $1.2 billion with Salomon Brothers Realty Corp. and Morgan Stanley Dean Witter Mortgage Capital to finance the loans pending their sale or securitization. See “—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”
 
Underwriting Standards
 
We originate or purchase our mortgage loans in accordance with the underwriting guidelines described below. The loans we originate or purchase generally do not satisfy conventional underwriting standards, such as those utilized by Fannie Mae or Freddie Mac. Therefore, our loans are likely to have higher delinquency and foreclosure rates than portfolios of mortgage loans underwritten to conventional Fannie Mae and Freddie Mac standards.
 
Our underwriting guidelines take into account the applicant’s credit history and capacity to repay the proposed loan as well as the secured property’s value and adequacy as collateral for the loan. Each applicant completes an application that includes information on the applicant’s liabilities, income, credit history, employment history and personal information. Based on review of the loan application and other data from the applicant against our underwriting guidelines, we determine the loan terms, including the interest rate and maximum loan-to-value ratio.
 
Credit History
 
Our underwriting guidelines require a credit report on each applicant from a credit reporting company. In evaluating an applicant’s credit history, we utilize credit bureau risk scores, or a FICO score, which is a statistical ranking of likely future credit performance developed by Fair, Isaac & Company and the three national credit data repositories—Equifax, TransUnion and Experian.
 
Collateral Review
 
All mortgaged properties are appraised by qualified independent appraisers prior to the loan’s funding. The appraiser inspects and appraises the property and verifies that it is in acceptable condition. Following each appraisal, the appraiser prepares a report that includes a market value analysis based on recent sales of comparable homes in the area and, when 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 Fannie Mae and Freddie Mac. Our underwriting guidelines require a review of the appraisal by one of our qualified employees or by a qualified review appraiser that we have retained. Our underwriting guidelines then require our underwriters to be satisfied that the value of the property being financed, as indicated by the appraisal, currently supports the outstanding loan balance.
 
Income Documentation
 
Our underwriting guidelines include three levels of income documentation requirements, referred to as the “full documentation,” “limited documentation” and “stated income documentation” programs. Under the full documentation program, applicants generally are required to submit two written forms of verification of stable income for at least twelve months. Under the limited documentation program, applicants are generally required to submit twelve consecutive monthly bank statements on their individual bank account. Under the stated income

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documentation program, an applicant may be qualified based upon monthly income as stated on the mortgage loan application if the applicant meets certain criteria. All of these documentation programs require that, with respect to salaried employees, the applicant’s employment be verified by telephone. In the case of a purchase money loan, verification of the source of funds, if any, to be deposited by the applicant into escrow is required. Under each of these programs, we review the applicant’s source of income, calculate the amount of income from sources indicated on the loan application or similar documentation, review the applicant’s credit history, calculate the debt service-to-income ratio to determine the applicant’s ability to repay the loan, review the type and use of the property being financed, and review the property. Our underwriters use a qualifying rate that is equal to the initial interest rate on the loan, in determing the applicant’s ability to repay an adjustable-rate loan.
 
Underwriting Requirements
 
In general, the maximum loan amount for our mortgage loans is $500,000. Our underwriting guidelines permit loans on one-to-four-family residential properties to have:
 
 
 
a loan-to-value ratio at origination of up to 95% with respect to non-conforming first liens;
 
 
 
a combined loan-to-value ratio at origination of up to 100% with respect to non-conforming second liens; and
 
 
 
a combined loan-to-value ratio at origination of up to 100% with respect to conforming second liens.
 
The applicability of the above ratios depends on, among other things, the purpose of the mortgage loan, a borrower’s credit history, the borrower’s repayment ability and debt service-to-income ratio, and the type and use of the property. The loan-to-value of a mortgage loan that is secured by mortgaged properties acquired by a borrower under a “lease option purchase” is determined in one of two ways. If the “lease option price” was set less than twelve months prior to origination, the loan-to-value of the related mortgage loan is based on the lower of the appraised value at the time of origination of the mortgage loan or the sale price of the related mortgaged property. If the “lease option price” was set twelve months or more prior to origination, the loan-to-value of the related mortgage is based on the appraised value at the time of origination.
 

9


 
Our underwriting guidelines for first lien mortgage loans have the following categories and criteria for grading the potential likelihood that an applicant will satisfy the repayment obligations of a mortgage loan:
 
Summary of Principal Underwriting Guidelines (1)
 
   
Prime Alternative

 
A+ Risk

 
A-  Risk

 
B Risk

 
C Risk

 
C-  Risk

Existing mortgage history
 
Maximum one 30–day late payment w/in last 12 months.
 
Maximum one 30–day late payment and no 60-day late payments w/in last 12 mos.; must have an LTV of 95% or less.
 
Maximum three 30–day late payments and no 60–day late payments w/in last 12 mos.; must have an LTV of 90% or less.
 
Maximum one 60–day late payment within last 12 months; must be less than 90 days late at funding.
 
Maximum one 90–day late payment within last 12 months; must be less than 120 days late at funding.
 
Maximum of two 90–day late payments and one 120–day late payment w/in last 12 months; less than 150 days late at funding. No current Notice of Default.
Other credit
 
FICO score of 625 or higher.
 
4 accts w/30-day late payments or FICO score of 620 or higher; no more than $500 in open collection accounts or charge-offs w/in 12 mos. open after funding.
 
Past/Present 30–day late payments and 1 acct w/60 day late payment or FICO score of 590 or higher; no more than $1,000 in open collection accounts or charge–offs w/in 12 mos. open after funding.
 
Past/Present 30-day late payments and 2 accts w/90 day late payments and 4 accts w/60 day late payments or FICO score of 570 or higher; no more than $2,500 in open collection accts or charge-offs w/in 12 mos. open after funding.
 
Significant prior defaults acceptable; Generally, no more than $5,000 in open collection accounts or charge-offs w/in 12 mos. Open after funding; on a case by case basis.
 
Significant prior defaults acceptable; collection accounts may remain open after funding.
Bankruptcy filings
 
Generally, no Chapter 7 or 13 Bankruptcy discharge in last 2 years or Notice of Default in last 2 years.
 
Generally, no Chapter 7 or 13 Bankruptcy discharge in last 2 years or Notice of Default in last 3 years.
 
Generally, no Bankruptcy filings in last 2 years or Notice of Default filings in last 3 years.
 
Generally, no Bankruptcy discharge in last 18 months or Notice of Default filings in last 2 years.
 
Generally, no Bankruptcy or Notice of Default filings in last 12 months.
 
Chapter 7 Bankruptcy discharge in last 12 mos. Chapter 13 Bankruptcy filing allowed in last 12 months and no current NOD.

10


(Continued)
 
   
Prime Alternative

 
A+ Risk

 
A-  Risk

 
B Risk

 
C Risk

 
C-  Risk

Total debt service to income Ratio
 
Up to 50%
 
45% to 50%
 
50% to 55%
 
55% to 59%
 
55% to 59%
 
50% to 59%
Maximum loan-to-value ratio (“LTV”):(2)
                       
Owner
 
90%
 
95%
 
90%
 
85%
 
75%
 
70%
Occupied:
                       
single family; detached PUD, or
2- unit Owner
 
80%
 
85%
 
85%
 
75%
 
70%
 
65%
Occupied:
                       
condo/three-to-four unit
                       
Non–owner occupied
 
Not applicable
 
85%
 
80%
 
75%
 
70%
 
65%

(1)
 
The letter grades applied to each risk classification reflect our internal standards and do not necessarily correspond to the classifications used by other mortgage lenders.
(2)
 
The maximum LTV set forth in the table is for borrowers providing full documentation. The LTV is reduced 5% for stated income applications, if applicable. Additionally, if the borrower’s FICO score meets or exceeds the risk category and debt ratio guidelines, consumer credit may be disregarded.
 
Prime Alternative Program
 
In 2000, we introduced a “Prime Alternative Program” to attract higher quality “Alternative—A” types of borrowers. We assess the borrower’s mortgage repayment history, any incidents of bankruptcy, mortgage default, or major derogatory credit, and call for a minimum FICO score of 625, which is substantially higher than our “core” product requirements. This program is restricted to owner-occupied properties; single unit, two unit, condominiums or detached PUD’s. We have limitations on loan amount, loan-to-value ratio, income documentation type, and the amount of “cash out” allowed on refinances.
 
Mortgage Credit Only Program
 
In addition to the six risk grade categories described above, New Century Mortgage also has a Mortgage Credit Only program. This program uses the applicant’s mortgage payment history as the primary factor in qualifying the applicant’s ability to repay the loan. The Mortgage Credit Only program allows no more than three 30-day late payments and no 60-day late payments within the last 12 months on an existing mortgage loan and must be current at funding. An existing mortgage loan is not required to be current at the time the application is submitted. Derogatory credit report items are allowed as to non-mortgage credit. In order to qualify for a Mortgage Credit Only loan:
 
 
 
The borrower may not be a participant in our Stated Income Documentation program;

11


 
 
 
No bankruptcy or notice of default filings may have occurred during the preceding two years, unless the borrower’s bankruptcy has been discharged during the past two years and the borrower has re-established a credit history that otherwise complies with the credit parameters set forth above; and
 
 
 
The mortgaged property must be in at least average condition. A maximum loan-to-value of 85% is permitted for a mortgage loan on a single–family owner–occupied property. A maximum loan-to-value of 80% is permitted for a mortgage loan on a non-owner occupied property, second home, owner–occupied condominium, or two- to four-family residential property. The debt service-to-income ratio is generally limited to a maximum of 55%.
 
Home Saver Program
 
We have established a sub-category of our C- credit grade for borrowers faced with at least one of the following credit scenarios: (i) the borrower has an existing mortgage currently in foreclosure; (ii) the borrower is subject to a notice of default filing; or (iii) the borrower has had a serious mortgage delinquency for more than one 120 day period in the last 12 months or is more than 90 days late at the time of funding. This sub-category is known as our Home Saver Program. The Home Saver Program is available only to Full Documentation borrowers and permits a maximum loan-to-value of 65% and a maximum debt service-to-income ratio of 55%. The maximum loan is $300,000 and all derogatory credit report items must either be brought current or paid through the loan proceeds. A maximum of 3% of the loan proceeds may be paid to the borrower in cash. If the borrower is in an open Chapter 13 bankruptcy, the bankruptcy must be discharged through the proceeds of the loan. As of December 31, 2001, Home Saver loans accounted for 1.1% of total loan originations and purchases.
 
Exceptions
 
The categories and criteria described in our underwriting guideline table above are guidelines only. On a case-by-case basis, we may determine that an applicant warrants a loan-to-value exception, a debt service-to-income ratio exception, or another exception. We may allow such an exception if the application reflects certain compensating factors such as low LTV, a maximum of one 30-day late payment on all mortgage loans during the last 12 months, and stable employment or ownership of current residence. We may also allow an exception if the applicant places a down payment through escrow of at least 20% of the purchase price of the mortgage property or if the new loan reduces the applicant’s monthly aggregate mortgage payment. Our automated credit grading system aids in identifying and managing underwriting exceptions. Certain of our loan programs and risk grade classifications limit the approval of exceptions to higher loan approval authority levels.
 
We evaluate our underwriting guidelines on an ongoing basis and periodically modify them to reflect our current assessment of various underwriting issues. We also maintain separate underwriting guidelines appropriate to our non-conforming second lien mortgage loans and adopt new underwriting guidelines appropriate to new loan products we offer.

12


 
Loan Production by Borrower Risk Classification
 
The following table sets forth information concerning the characteristics of our fixed-rate and adjustable-rate loan production by borrower risk classification for the periods shown:
 
    
For the Quarters Ended

 
    
March 31, 2001

    
June 30, 2001

      
September 30, 2001

      
December 31, 2001

 
Prime Alternative Risk Grade:
                               
Percent of total purchases and originations
  
1.9
%
  
3.1
%
    
3.3
%
    
3.6
%
Combined weighted average initial loan-to-value ratio
  
80.0
 
  
79.9
 
    
78.6
 
    
76.0
 
Weighted average interest rate:
                               
Fixed-rate
  
9.7
 
  
9.4
 
    
9.1
 
    
8.0
 
ARMs
  
8.9
 
  
8.7
 
    
8.6
 
    
8.3
 
Margin—ARMs
  
5.3
 
  
5.9
 
    
6.4
 
    
6.3
 
A+ Risk Grade:
                               
Percent of total purchases and originations
  
39.3
%
  
43.9
%
    
47.3
%
    
47.3
%
Combined weighted average initial loan-to-value ratio
  
81.1
 
  
81.4
 
    
81.5
 
    
81.8
 
Weighted average interest rate:
                               
Fixed-rate
  
10.3
 
  
9.6
 
    
9.2
 
    
8.5
 
ARMs
  
9.5
 
  
9.2
 
    
9.0
 
    
8.6
 
Margin—ARMs
  
6.2
 
  
6.3
 
    
6.4
 
    
6.4
 
A- Risk Grade:
                               
Percent of total purchases and originations
  
26.9
%
  
22.6
%
    
21.1
%
    
21.0
%
Combined weighted average initial loan-to-value ratio
  
78.1
 
  
78.5
 
    
78.4
 
    
78.1
 
Weighted average interest rate:
                               
Fixed-rate
  
10.6
 
  
10.1
 
    
9.9
 
    
9.3
 
ARMs
  
9.8
 
  
9.5
 
    
9.3
 
    
9.0
 
Margin—ARMs
  
6.6
 
  
6.6
 
    
6.7
 
    
6.7
 
B Risk Grade:
                               
Percent of total purchases and originations
  
21.9
%
  
21.9
%
    
20.8
%
    
20.8
%
Combined weighted average initial loan-to-value ratio
  
75.8
 
  
77.1
 
    
77.4
 
    
77.2
 
Weighted average interest rate:
                               
Fixed-Rate
  
10.9
 
  
10.4
 
    
10.2
 
    
9.8
 
ARMs
  
10.1
 
  
9.8
 
    
9.7
 
    
9.5
 
Margin—ARMs
  
6.8
 
  
6.8
 
    
6.9
 
    
6.9
 
C Risk Grade:
                               
Percent of total purchases and originations
  
6.5
%
  
5.9
%
    
5.4
%
    
5.3
%
Combined weighted average initial loan-to-value ratio
  
71.5
 
  
71.3
 
    
71.0
 
    
71.9
 
Weighted average interest rate:
                               
Fixed-rate
  
12.3
 
  
11.5
 
    
10.9
 
    
10.6
 
ARMs
  
11.2
 
  
10.8
 
    
10.6
 
    
10.4
 
Margin—ARMs
  
7.0
 
  
7.1
 
    
7.2
 
    
7.2
 
C- Risk Grade:
                               
Percent of total purchases and originations
  
3.5
%
  
2.6
%
    
2.1
%
    
2.0
%
Combined weighted average initial loan–to–value ratio
  
64.0
 
  
61.4
 
    
62.7
 
    
62.4
 
Weighted average interest rate:
                               
Fixed-rate
  
12.8
 
  
12.8
 
    
12.4
 
    
11.5
 
ARMs
  
12.4
 
  
12.1
 
    
11.8
 
    
11.6
 
Margin—ARMs
  
7.1
 
  
7.2
 
    
7.3
 
    
7.2
 

13


 
Geographic Distribution
 
The following table sets forth aggregate dollar amounts (in thousands) and the percentage of all loans we originated or purchased by state for the periods shown:
 
    
For the Quarters Ended

 
    
March 31, 2001

    
June 30, 2001

    
September 30, 2001

    
December 31, 2001

 
    
$
  
%
    
$
  
%
    
$
  
%
    
$
  
%
 
California
  
$
446,880
  
43.5
%
  
$
613,953
  
44.4
%
  
$
780,983
  
43.0
%
  
$
880,779
  
43.6
%
Michigan
  
 
46,486
  
4.5
 
  
 
67,328
  
4.9
 
  
 
100,061
  
5.5
 
  
 
117,688
  
5.8
 
Illinois
  
 
58,690
  
5.7
 
  
 
71,378
  
5.2
 
  
 
100,315
  
5.5
 
  
 
114,018
  
5.7
 
Florida
  
 
59,743
  
5.8
 
  
 
73,877
  
5.3
 
  
 
98,074
  
5.4
 
  
 
98,888
  
4.9
 
Texas
  
 
57,979
  
5.7
 
  
 
69,379
  
5.0
 
  
 
91,335
  
5.0
 
  
 
98,249
  
4.9
 
Colorado
  
 
39,476
  
3.9
 
  
 
46,560
  
3.4
 
  
 
78,277
  
4.3
 
  
 
70,205
  
3.5
 
Massachusetts
  
 
39,577
  
3.9
 
  
 
52,055
  
3.8
 
  
 
63,547
  
3.5
 
  
 
63,205
  
3.1
 
Georgia
  
 
21,798
  
2.1
 
  
 
30,612
  
2.2
 
  
 
39,281
  
2.2
 
  
 
47,141
  
2.3
 
Ohio
  
 
17,702
  
1.7
 
  
 
27,306
  
2.0
 
  
 
41,958
  
2.3
 
  
 
44,111
  
2.2
 
Washington
  
 
14,277
  
1.4
 
  
 
32,355
  
2.3
 
  
 
34,978
  
1.9
 
  
 
37,984
  
1.9
 
Other
  
 
223,925
  
21.8
 
  
 
299,116
  
21.5
 
  
 
386,720
  
21.4
 
  
 
446,722
  
22.1
 
    

  

  

  

  

  

  

  

Total
  
$
1,026,533
  
100.0
%
  
$
1,383,919
  
100.0
%
  
$
1,815,529
  
100.0
%
  
$
2,018,990
  
100.0
%
 
Loan Sales and Securitizations
 
Our subsidiary, NC Capital Corporation, performs secondary marketing functions. NC Capital buys loans from New Century Mortgage within a week or two after origination, paying a price that approximates the loans’ secondary market value. NC Capital then sells the loans through both securitizations and whole loan sales. NC Capital is responsible for determining when and through which channel to sell the loans, and bears the risks of market fluctuations in the period between purchase and sale.
 
Whole Loan Sales
 
As of December 31, 2001, whole loan sales accounted for $4.7 billion, or 84.0% of our total loan sales. The weighted average sales price of our premium whole loan sales during 2001 was equal to 104.4% of the original principal balance of the loans sold, including premiums received for servicing rights.
 
We seek to maximize our premiums on whole loan sale revenue by closely monitoring requirements of institutional purchasers and focusing on originating or purchasing the types of loans that meet those requirements and for which institutional purchasers tend to pay higher premiums. During the year ended December 31, 2001, we sold $2.3 billion in loans to Credit Suisse First Boston Mortgage Capital LLC and $1.8 billion in loans to Morgan Stanley Dean Witter Mortgage Capital Inc., which represented 41.3% and 31.1%, respectively, of total loans sold.
 
Whole loan sales are made on a non-recourse basis pursuant to a purchase agreement in which we give customary representations and warranties regarding the loan characteristics and the origination process. Therefore, we may be required to repurchase or substitute loans in the event of a breach of these representations and warranties. In addition, we generally commit to repurchase or substitute a loan if a payment default occurs within the initial months following the date the loan is funded, unless we make other arrangements with the purchaser.
 
Securitizations
 
In a securitization, we sell a pool of loans to a trust for a cash purchase price and a certificate evidencing our residual interest ownership in the trust. The trust raises the cash portion of the purchase price by selling senior certificates representing senior interests in the loans in the trust. Following the securitization, purchasers of

14


senior certificates receive the principal collected, including prepayments, on the loans in the trust. In addition, they receive a portion of the interest on the loans in the trust equal to the specified “investor pass-through interest rate” on the principal balance. We receive the cash flows from the residual interests, after payment of servicing fees, guarantor fees and other trust expenses, and provided the specified over-collateralization requirements are met. The use of a NIM transaction concurrent with or shortly after a securitization allows us to receive a substantial portion of the gain in cash at the closing of the NIM transaction, rather than over the actual life of the loans.
 
During 2001, we completed two securitizations totaling $898 million of mortgage loans (New Century Home Equity Loan Trust, Series 2001-NC1 and Series 2001-NC2). Following each securitization, we issued a net interest margin security. The initial cash proceeds from these transactions were comparable to cash proceeds we received through whole loan sales. Credit enhancement for each securitization was provided through a fully-funded over-collateralization account of 0.75%. Approximately 86% of the mortgage loans in each pool were covered by a lender paid private mortgage insurance policy for the excess of the LTV over 60%.
 
The following are the material assumptions used to record gain on sale for the New Century Home Equity Loan Trust, Series 2001-NC1:
 
    
2-Year ARM

    
3-Year ARM

    
Fixed

    
Combined Pool

 
% of Pool
  
78.20
%
  
6.30
%
  
15.50
%
  
100.00
%
Weighted Average Life (in years)
  
2.55
 
  
2.90
 
  
3.64
 
  
2.74
 
Static Pool Losses
  
2.68
%
  
2.26
%
  
2.60
%
  
2.64
%
Prepayment Penalty Coverage
                           
1 year
  
4.20
%
  
4.11
%
  
0.90
%
  
3.69
%
2 years
  
74.70
 
  
2.51
 
  
2.66
 
  
58.99
 
3 years
  
6.61
 
  
61.52
 
  
6.65
 
  
10.07
 
4 years
  
0.05
 
  
14.90
 
  
0.89
 
  
1.11
 
5 years
  
0.76
 
  
1.43
 
  
53.97
 
  
9.06
 
Total
  
86.32
%
  
84.47
%
  
65.07
%
  
82.92
%
 
A summary of gain on sale and cash flow from the New Century Home Equity Loan Trust, Series 2001-NC1 is presented below:
 
Gain on Sale Summary
        
Loans (thousands)
  
$
380,242
 
NIM Bonds
  
 
4.08
%
Residual
  
 
0.97
 
Less: Transaction and Other Costs
  
 
(1.30
)
Less: O/C Accounts
  
 
(0.75
)
    


Subtotal
  
 
3.00
 
Interest-Only Certificate
  
 
1.43
 
Servicing Rights
  
 
0.48
 
    


Net Gain on Sale Recorded
  
 
4.91
%
Cash Flow From:
        
NIM Bonds
  
 
4.08
%
Interest-Only Certificate
  
 
1.43
 
Servicing Rights
  
 
0.48
 
Less: Transaction and Other Costs
  
 
(1.30
)
Less: O/C Accounts
  
 
(0.75
)
    


Net Cash Flow At Closing
  
 
3.94
%

15


 
The following are the material assumptions used to record gain on sale for the New Century Home Equity Loan Trust, Series 2001-NC2:
 
    
2-Year ARM

    
3-Year ARM

    
Fixed

    
Combined Pool

 
% of Pool
  
80.43
%
  
3.22
%
  
16.35
%
  
100.00
%
Weighted Average Life (in years)
  
2.55
 
  
2.89
 
  
3.63
 
  
2.74
 
Static Pool Losses
  
3.67
%
  
4.10
%
  
4.64
%
  
3.84
%
Prepayment Penalty Coverage
                           
1 year
  
5.00
%
  
5.47
%
  
1.26
%
  
4.40
%
2 years
  
76.64
 
  
5.70
 
  
4.78
 
  
62.61
 
3 years
  
4.71
 
  
73.43
 
  
7.73
 
  
7.42
 
4 years
  
0.03
 
  
4.39
 
  
0.93
 
  
0.32
 
5 years
  
1.05
 
  
2.27
 
  
56.47
 
  
10.15
 
Total
  
87.43
%
  
91.26
%
  
71.17
%
  
84.90
%
 
A summary of gain on sale and cash flow from the New Century Home Equity Loan Trust, Series 2001-NC2 is presented below:
 
Gain on Sale Summary
        
Loans (thousands)
  
$
518,002
 
NIM Bonds
  
 
4.96
%
Residual
  
 
0.66
%
Less: Transaction and Other Costs
  
 
(1.15
%)
Less: O/C Accounts
  
 
(0.75
%)
    


Subtotal
  
 
3.72
%
Interest-Only Certificate
  
 
0.76
%
Servicing Rights
  
 
0.51
%
    


Net Gain on Sale Recorded
  
 
4.99
%
Cash Flow From:
        
NIM Bonds
  
 
4.96
%
Interest-Only Certificate
  
 
0.76
%
Servicing Rights
  
 
0.51
%
Less: Transaction and Other Costs
  
 
(1.15
%)
Less: O/C Accounts
  
 
(0.75
%)
    


Net Cash Flow At Closing
  
 
4.33
%
 
Loan Servicing and Delinquencies
 
Servicing
 
Loan 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 March 2001, we sold the servicing rights on approximately $4.8 billion of our servicing portfolio to Ocwen Federal Bank FSB for $19.7 million. We also entered into an agreement whereby Ocwen services our remaining servicing portfolio, as well as our loans receivable held for sale. The entire transfer of our servicing portfolio was completed on August 1, 2001. As part of the transaction, we also agreed to sell Ocwen servicing rights with respect to up to $3 billion in mortgage loans between March 2001 and December 31, 2002 at a price to be determined based on the characteristics of those servicing rights. In early 2002, we fulfilled the $3 billion commitment.

16


In February 2002, we announced that we intend to re-establish our loan servicing platform. To that end, we have hired our former Senior Vice President of Servicing who is in turn recruiting an experienced team of managers. We believe that establishing in-house servicing capability will enhance our value as a full-service mortgage banking franchise, and that it will provide and additional source of revenue and profits. During the period we are rebuilding servicing, we intend to continue to use Ocwen to service our new originations. We also expect to continue to sell to Ocwen a significant volume of servicing rights in 2002. We anticipate that we will begin boarding some production on our servicing platform in the fourth quarter of 2002.
 
Delinquencies and Foreclosures
 
The loans we originate or purchase 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 judicial action or non-judicial 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 attorney’s fees, which may be recovered by a lender. After the reinstatement period has expired without the default having been cured, the borrower or junior lien-holder 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, we 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.
 
Delinquency Reporting
 
In February 1996, we began receiving applications for mortgage loans under our regular lending program. During 1996, we sold all of our loans on a whole loan, servicing-released basis. We began selling loans through securitizations in 1997. In connection with these securitizations, we established reporting systems to track historical delinquency, bankruptcy, foreclosure and default experience for the loans included in our securitizations as well as our total portfolio of loans. Current delinquency and loss information is not necessarily representative of future delinquencies and losses.
 
The following table provides information for the loans securitized in 1997 through 2001 that are delinquent over 60 days (dollars in thousands) expressed as a percentage of the current balance of the mortgage loans as of December 31, 2001:
 
                     
Delinquency Rate

 
Risk Grade

  
Original Balance

  
Current Balance

  
Orig. LTV

    
1997

    
1998

    
1999

    
2000

    
2001

    
Combined Pools

 
Prime Alternative
  
$
40,758
  
$
22,068
  
79.9
%
  
—  
%
  
—  
%
  
—  
%
  
3.98
%
  
0.30
%
  
0.58
%
A+
  
 
3,031,547
  
 
1,258,468
  
78.3
 
  
4.33
 
  
9.17
 
  
9.84
 
  
10.34
 
  
2.71
 
  
7.37
 
A-
  
 
2,668,761
  
 
1,044,924
  
77.5
 
  
8.66
 
  
13.65
 
  
15.26
 
  
13.35
 
  
4.49
 
  
12.40
 
B
  
 
1,631,026
  
 
679,979
  
74.7
 
  
11.92
 
  
17.38
 
  
21.05
 
  
22.12
 
  
5.41
 
  
15.74
 
C
  
 
904,420
  
 
319,483
  
70.4
 
  
19.76
 
  
24.94
 
  
26.05
 
  
28.69
 
  
9.70
 
  
23.82
 
C-  
  
 
400,278
  
 
117,634
  
63.7
 
  
37.20
 
  
25.71
 
  
41.35
 
  
39.90
 
  
17.69
 
  
33.28
 
Total
  
$
8,676,790
  
$
3,442,556
  
75.9
%
  
10.23
%
  
14.28
%
  
16.32
%
  
17.98
%
  
4.43
%
  
12.92
%
 

17


The above table indicates that, as anticipated, we are experiencing higher rates of delinquency on lower credit grade loans. In addition, we have repurchased loans from several of our securitizations. The agreements governing the securitizations permit these repurchases, but only to the extent the loans being repurchased are more than 90 days delinquent. We elected to make these repurchases in order to avoid disruption of cash flow from the trusts and to provide us with maximum flexibility in resolving problem loans. In 2002, we expect to make such repurchases from certain of our securitized pools in order to avoid a disruption in residual cash flow that would result if certain delinquency or loss levels are reached.
 
The pooling and servicing agreements for our securitizations typically provide us or the master servicer the right to initiate a call of all outstanding bonds once the current balance of loans in the pool falls below five or ten percent of the original principal balance. During the year ended December 31, 2001, we exercised our clean-up call for securities 1997-NC1, NC2 and NC3, resulting in the repurchase and subsequent resale of the remaining loans in these securities.
 
Interest Rate Risk Management Strategies
 
We try to mitigate interest rate risks by utilizing a variety of strategies. For instance, the interest rate that will be charged to our borrowers is locked on the day the loan funds. This allows us to price our pipeline of approved loans with current market rates. In addition, we may elect to use various financial instruments such as swaps, forwards, options, futures contracts, and other derivative instruments to mitigate interest rate risk. We may use forward loan sale commitments with a predetermined price and delivery date to sell our unsold loan inventory, which protects us from interest rate increases. In order to mitigate the adverse affects resulting from interest rate increases on our residual interests, we first forecast future interest rates utilizing the Forward LIBOR Curve. Then, we may purchase Interest Rate Cap contracts or sell Euro Dollar Futures contracts that are based on our expectations of future interest rates and cash flows. In either case, the cash flow received from the financial instrument used to mitigate interest rate risk is intended to offset the reduction in cash flow realized on our residual interests as a result of interest rate increases.
 
Competition
 
We continue to face intense competition in the business of originating, purchasing and selling mortgage loans. Our competitors include other consumer finance companies, mortgage banking companies, commercial banks, credit unions, thrift institutions, credit card issuers and insurance finance companies. Most notably, in the past two or three years, some large, diversified financial corporations have purchased several of our competitors. Other large financial institutions have gradually expanded their “non-prime” or “sub-prime” lending capabilities. Many of these companies have greater access to capital at a cost lower than our cost of capital under our warehouse, aggregation and residual financing facilities. In addition, many of these competitors have considerably greater technical and marketing resources than we have.
 
At the same time, the two large government-sponsored secondary market purchasers of loans, Fannie Mae and Freddie Mac, have begun purchasing some non-prime loans. This has the potential of increasing competition as lenders without prior non-prime origination expertise begin originating non-prime loans to Fannie Mae’s and Freddie Mac’s guidelines using their automated tools.
 
We also face competition from smaller, recently established wholesale mortgage banking companies that try to attract key managers and account executives as well as our key brokers.
 
Competition among industry participants can take many forms, including convenience in obtaining a loan, customer service, marketing and distribution channels, amount and term of the loan, loan origination fees and interest rates. Additional competition may lower the rates we can charge borrowers, thereby potentially lowering gain on future loan sales and securitizations. Our results of operations, financial condition and business prospects could be materially adversely affected to the extent any of our competitors significantly expands its activities in

18


our markets. Fluctuations in interest rates and general economic conditions may also affect our competitive position. During periods of rising rates, competitors that have locked in low borrowing costs may have a competitive advantage. During periods of declining rates, competitors may solicit our customers to refinance their loans.
 
We believe that one of our key competitive strengths is our employees, with their strong commitment to customer service and their team-oriented approach. In addition to the strength of our work force, we believe that our competitive strengths include:
 
 
 
providing a high level of service to brokers and their customers;
 
 
 
offering competitive loan programs for borrowers whose needs are not met by conventional mortgage lenders;
 
 
 
our high-volume targeted direct mail marketing program; and
 
 
 
our performance-based compensation structure which allows us to attract, retain and motivate qualified personnel.
 
Regulation
 
The mortgage lending industry is a highly regulated industry. Our business is subject to extensive and complex rules and regulations of, and examinations by, various state and federal government authorities. These regulations impose obligations and restrictions on our loan origination, loan purchase and servicing activities. In addition, these regulations may limit the interest rates, finance charges and other fees that we may assess, mandate extensive disclosure to our customers, prohibit discrimination and impose multiple qualification and licensing obligations on us. Failure to comply with these requirements may result in, among other things, loss of approved licensing 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. Our management believes that we are in compliance with these rules and regulations in all material respects.
 
Our loan origination and loan purchase 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 we can charge on our loans. As of December 31, 2001, we were licensed or exempt from licensing requirements by the relevant state banking or consumer credit agencies to originate first mortgages in all 50 states and the District of Columbia and second mortgages in 48 states and the District of Columbia. Our lending activities are also subject to various federal laws, including the Truth in Lending Act, or TILA, 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, and their implementing regulations.
 
We are subject to certain disclosure requirements under 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 gives consumers, among other things, a three–business day right to rescind certain refinance loan transactions that we originate.
 
The Homeownership and Equity Protection Act of 1994, or the High Cost Mortgage Act, amends 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 $480, or (ii) an annual percentage rate of more than ten percentage points higher than United States Treasury securities of comparable maturity. These loans are known as 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

19


on the basis of the borrower’s home equity without regard to the borrower’s ability to repay the loan. The High Cost Mortgage Act also prohibits 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. In addition, the High Cost Mortgage Act restricts, among other things, certain balloon payments and negative amortization features. We commenced originating and purchasing Covered Loans during 1997 and stopped originating and purchasing them in the second quarter of 2000.
 
We are also required to comply with the Equal Credit Opportunity Act of 1974, as amended, and Regulation B promulgated thereunder, the Fair Credit Reporting Act, as amended, the Real Estate Settlement Procedures Act of 1974, as amended, and Regulation X promulgated thereunder, and the Home Mortgage Disclosure Act of 1975, as amended. The Equal Credit Opportunity Act prohibits creditors from discriminating against applicants on the basis of race, color, sex, age, religion, national origin or marital status if all or part of the applicant’s income is derived from a publicly assisted program or if the applicant has in good faith exercised any right under the Consumer Credit Protection Act. 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 disclosures 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, we are required to 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 mortgage loan transactions.
 
In the course of our business, we may acquire properties securing loans that are in default. There is a risk that hazardous or toxic waste could be found on such properties. If this occurs, we could be held responsible under applicable law for the cost of cleaning up or removing the hazardous waste. This cost could exceed the value of the underlying properties.
 
Regulatory Developments
 
During 2000, federal and state legislative and regulatory developments regarding consumer privacy and predatory lending could have a significant impact on our future business activities. The federal Gramm-Leach-Bliley financial reform legislation imposes additional privacy obligations on us with respect to our applicants and borrowers. We adopted a new privacy policy and adopted controls and procedures in order to comply with the law when it took effect on July 1, 2001. In addition, several states are considering even more stringent privacy legislation. If passed, a variety of inconsistent state privacy legislation could substantially increase our compliance costs.
 
Several federal, state and local laws and regulations have been adopted or are under consideration that are intended to eliminate so-called “predatory” lending practices. Many of these laws and regulations impose broad restrictions on certain commonly accepted lending practices, including some of our practices. There can be no assurance that these proposed laws, rules and regulations, or other similar laws, rules or regulations, will not be adopted in the future. Adoption of these laws and regulations could have a material adverse impact on our business by substantially increasing the costs of compliance with a variety of inconsistent federal, state and local rules, or by restricting our ability to charge rates and fees adequate to compensate us for the risk associated with certain loans.
 
In an effort to prevent the origination of loans containing unfair terms or involving predatory practices, we have employed extensive policies and procedures, including:
 
 
 
not offering loans with terms providing for balloon payments, negative amortization or reverse mortgages;
 
 
 
only approving loan applications that evidence a borrower’s ability to repay the loan;

20


 
 
 
confirming that all loans we originate present a tangible benefit to the borrower;
 
 
 
not re-soliciting our own borrowers to refinance frequently;
 
 
 
not selling single premium insurance products with our loans;
 
 
 
maintaining caps on the points and fees that can be charged to borrowers;
 
 
 
offering loans with and without prepayment penalties;
 
 
 
directing marketing efforts throughout the broader geographic areas in which our branches are located;
 
 
 
maintaining a rigorous appraisal review process;
 
 
 
surveying our customers in order to confirm satisfaction;
 
 
 
performing regular random and targeted audits to confirm adherence to fair lending laws and principles;
 
 
 
monitoring the conduct of our brokers and requiring them to agree to adhere to our Broker Code of Conduct;
 
 
 
resolving customer complaints promptly and fairly; and
 
 
 
training our employees to adhere to fair lending principles.
 
We plan to continue to review, revise and improve our practices in order to enhance our fair lending efforts and support the goal of eliminating predatory lending practices.
 
Employees
 
At December 31, 2001, we employed 1,512 full-time employees and 19 part-time employees. None of our employees is subject to a collective bargaining agreement. We believe that our relations with our employees are satisfactory.

21


 
EXECUTIVE OFFICERS OF THE REGISTRANT
 
The following table sets forth information about our executive officers:
 
Name

 
Age

  
Position

Executive Officers:
        
Robert K. Cole
 
55
  
Chairman of the Board and Chief Executive Officer of the Company; Director, New Century Mortgage(1)
          
Brad A. Morrice
 
45
  
Vice Chairman, President, Chief Operating Officer and Director of the Company; Chairman and Chief Executive Officer, New Century Mortgage (1); Chairman and Chief Executive Officer, NC Capital(2)
          
Edward F. Gotschall
 
47
  
Vice Chairman, Chief Financial Officer and Director of the Company; Chief Financial Officer and Treasurer of New Century Mortgage(1)
          
Patrick J. Flanagan
 
37
  
Executive Vice President of the Company; President and Director, New Century Mortgage (1); and Director, NC Capital(2)

(1)
 
New Century Mortgage Corporation (“New Century Mortgage”) is a wholly-owned subsidiary of the Company.
(2)
 
NC Capital Corporation (“NC Capital”) is a wholly-owned subsidiary of New Century Mortgage.
 
Robert K. Cole, one of our co-founders, has been our Chairman of the Board and Chief Executive Officer since December 1995 and one of our directors since November 1995. Mr. Cole also serves as a director 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, a publicly-traded savings and loan holding company specializing in the origination and servicing of residential mortgage loans. In addition, Mr. Cole served as a director of Option One Mortgage Corporation, a subsidiary of Plaza Home Mortgage specializing in the origination, sale and servicing of non-prime mortgage loans. Previously, Mr. Cole was the President of operating subsidiaries of NBD Bancorp and Public Storage. Mr. Cole received a Masters of Business Administration degree from Wayne State University.
 
Brad A. Morrice, one of our co-founders, has been our Vice Chairman since December 1996, our President, and one of our directors since November 1995 and our Chief Operating Officer since January 2001. Mr. Morrice also served as our General Counsel from December 1995 to December 1997 and our Secretary from December 1995 to May 1999. In addition, Mr. Morrice serves as Chairman and Chief Executive Officer of New Century Mortgage and NC Capital. From February 1994 to March 1995, he was the President and Chief Operating Officer-Administration of Plaza Home Mortgage, after serving as its Executive Vice President, Chief Administrative Officer since February 1993. In addition, Mr. Morrice served as General Counsel and a director of Option One. From August 1990 to January 1993, Mr. Morrice was a partner in the law firm of King, Purtich & Morrice, where he specialized in the legal representation of mortgage banking companies. Mr. Morrice previously practiced law at the firms of Fried, King, Holmes & August and Manatt, Phelps & Phillips. He received his law degree from the University of California, Berkeley (Boalt Hall) and a Masters of Business Administration degree from Stanford University.
 
Edward F. Gotschall, one of our co-founders, has been our Vice Chairman since December 1996, our Chief Financial Officer since August 1998, our Chief Operating Officer Finance/Administration from December 1995 to August 1998 and one of our directors since November 1995. Mr. 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,

22


Mr. Gotschall was one of the co-founders and principal architect of the initial business plan for 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 and Chief Financial Officer of The Mortgage Network, a retail mortgage banking company. Mr. Gotschall received his Bachelors of Science Degree in Business Administration from Arizona State University and received his CPA designation during his employment term with Touche Ross (now Deloitte & Touche) in Phoenix, Arizona.
 
Patrick J. Flanagan has been our President of New Century Mortgage Corporation since February 2002. He has also been Executive Vice President of the Company since August 1998. From December 1998 to February 2002 he served as President of NC Capital Corporation. He has been a director of New Century Mortgage since May 1997. From January 1997 to February 2002, Mr. Flanagan has been Executive Vice President and Chief Operating Officer of New Century Mortgage. Mr. Flanagan initially joined New Century Mortgage in May 1996 as Regional Vice President of Midwest Wholesale and Retail Operations. From August 1994 to April 1996, Mr. Flanagan was a Regional Manager with Long Beach Mortgage. From July 1992 to July 1994, he was an Assistant Vice President for First Chicago Bank, from February 1989 to February 1991, he was Assistant Vice President for Banc One in Chicago and from February 1991 to July 1992, he was a Business Development Manager for Transamerica Financial Services. Mr. Flanagan received his Bachelor of Arts degree from Monmouth College.
 

23


RISK FACTORS
 
Stockholders and prospective purchasers of our common stock should carefully consider the risks described below before making a decision to buy our common stock. If any of the following risks actually occurs, our business could be harmed. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. When determining whether to buy our common stock, stockholders and prospective purchasers should also refer to the other information in this Form 10-K, including our financial statements and the related notes.
 
A change in the assumptions we use to determine the value of our residual interests could adversely affect our financial position.
 
As of December 31, 2001, the value of our residual interests from securitization transactions on our balance sheet was $306.9 million. The value of these residuals is a function of the delinquency, loss, prepayment and discount rate assumptions we use to determine their value. During 2000, we changed these assumptions to reflect trends in actual pool performance, prepayment experience and the interest rate environment. As a result of these changes, we recorded reductions in the value of our residuals of $67.0 million. The reductions consisted of the following components:
 
 
 
$25.6 million resulted from changes to the prepayment and loss assumptions used in the valuation of the residual interests;
 
 
 
$14.5 million resulted from a change in the discount rate on our residuals from 12% to 13% and on our NIM bonds from 14% to 15%; and
 
 
 
$26.9 million resulted from the exercise by Salomon Smith Barney, Inc. of the call provision for our 1998-NC5 security in December 2000. We do not have any other residual interests that have a call provision similar to 1998-NC5.
 
In 2001, we increased the loss and delinquency assumptions we use to value our residuals to match the trends we were observing in the actual performance of the underlying pools of mortgages. However, significant declines in interest rates resulted in a compensating increase in the anticipated cash flow from the residuals. As a result, we did not need to adjust the overall value of our residuals.
 
In the future, if our actual experience differs materially from the revised prepayment, delinquency, loss and interest rate assumptions we used to calculate residual value, future cash flows and earnings could be negatively affected.
 
A prolonged economic slowdown or a lengthy or severe recession could hurt our operations, particularly if it results in a decline in the real estate market.
 
The risks associated with our business are more acute during periods of economic slowdown or recession because these periods may be accompanied by decreased demand for consumer credit and declining real estate values. Declining real estate values reduce the ability of borrowers to use home equity to support borrowings because they negatively affect loan-to-value ratios of the home equity collateral. In addition, because we make a substantial number of loans to credit-impaired borrowers, the actual rates of delinquencies, foreclosures and losses on these loans could be higher during economic slowdowns. Any sustained period of increased delinquencies, foreclosures or losses could adversely affect our ability to sell loans, the prices we receive for our loans, or the value of our residual interests in securitizations, which could have a material adverse effect on our results of operations, financial condition and business prospects.
 
High delinquencies or losses on the mortgage loans in our securitizations may decrease our cash flows or impair our ability to sell or securitize loans in the future.
 
Loans we make to lower credit grade borrowers, including credit-impaired borrowers, entail a higher risk of delinquency and higher losses than loans we make to borrowers with better credit. Virtually all of our loans are

24


made to borrowers who do not qualify for loans from conventional mortgage lenders. No assurance can be given that our underwriting criteria or methods will afford adequate protection against the higher risks associated with loans made to lower credit grade borrowers. We continue to be subject to risks of default and foreclosure following the sale of loans through securitization. To the extent such losses are greater than expected, the cash flows we receive through residual interests would be reduced. Increased delinquencies or losses may also reduce our ability to sell or securitize loans in the future. Any such reduction in our cash flows or impairment in our performance could have a material adverse effect on our results of operations, financial condition and business prospects.
 
Our earnings may decrease because of increases or decreases in interest rates.
 
Our profitability may be directly affected by changes in interest rates. First, these changes may reduce the spread we earn between the interest we receive on our loans and our funding costs. Second, a substantial and sustained increase in interest rates could adversely affect borrower demand for our products. Third, during periods of rising interest rates, the value and profitability of our loans may be negatively affected from the date of origination or purchase until the date we sell or securitize the loan. Fourth, our adjustable-rate mortgage loans have periodic and lifetime interest rate caps above which the interest rate on the loans may not rise. In the event of general interest rate increases, the rate of interest on these mortgage loans could be limited, while the rate payable on the senior certificates representing interests in a securitization trust into which these loans are sold may be uncapped. This would reduce the amount of cash we receive over the life of our residual interests, and require us to reduce the carrying value of our residual interests. Fifth, a significant decrease in interest rates could increase the rate at which loans are prepaid, which also could require us to reduce the carrying value of our residual interests. If prepayments are greater than expected, the cash we receive over the life of our residual interests would be reduced. Any such change in interest rates could have a material adverse effect on our results of operations, financial condition and business prospects.
 
If we are unable to maintain adequate financing sources, our earnings and financial position will suffer and jeopardize our ability to continue operations.
 
We require substantial cash to support our operating activities and growth plans, which is provided primarily by $1.7 billion in short-term warehouse and aggregation credit facilities to fund loan originations and purchases pending the pooling and sale of such loans. We also have residual financing agreements that provide us with financing secured by residual interests we have retained in certain securitization transactions and securitization transactions involving net interest margin securities, or NIMs. If we cannot maintain or replace these facilities on comparable terms and conditions, we may incur substantially higher interest expense that would reduce our profitability.
 
During volatile times in the capital markets, access to warehouse, aggregation and residual financing has been severely constricted. If we are unable to maintain adequate financing or other sources of capital are not available, we would be forced to suspend or curtail our operations, which would have a material adverse effect on our results of operations, financial condition and business prospects.
 
An interruption or reduction in the securitization and whole loan markets would hurt our financial position.
 
We are dependent on the securitization market for the sale of our loans because we securitize loans directly and many of our whole loan buyers purchase our loans with the intention to securitize. The securitization market is dependent upon a number of factors, including general economic conditions, conditions in the securities market generally and conditions in the asset–backed securities market specifically. In addition, poor performance of our previously securitized loans could harm our access to the securitization market. Accordingly, a decline in the securitization market or a change in the market’s demand for our loans could have a material adverse effect on our results of operations, financial condition and business prospects.

25


 
Our inability to realize cash proceeds from loan sales and securitizations in excess of the loan acquisition cost could adversely affect our financial position.
 
The net cash proceeds received from loan sales consist of the premiums we receive on sales of loans in excess of the outstanding principal balance, plus the cash proceeds we receive from securitizations, minus the discounts on loans that we have to sell for less than the outstanding principal balance. If we are unable to originate loans at a cost lower than the cash proceeds realized from loan sales, our results of operations, financial condition and business prospects could be materially adversely affected.
 
Our warehouse and aggregation financing is subject to margin calls based on the lender’s opinion of the value of our loan collateral. An unanticipated large margin call could adversely affect our liquidity.
 
The amount of financing we receive under our warehouse and aggregation financing agreements depends in large part on the lender’s valuation of the mortgage loans that secure the financings. Each such credit facility provides the lender the right, under certain circumstances, to reevaluate the loan collateral that secures our outstanding borrowings at any time. In the event the lender determines that the value of the loan collateral has decreased, it has the right to initiate a margin call. A margin call would require us to provide the lender with additional collateral or to repay a portion of the outstanding borrowings. Any such margin call could have a material adverse effect on our results of operations, financial condition and business prospects.
 
Our business is dependent upon conditions in California where we conduct a significant amount of our business.
 
In 2001, approximately 43.6% of the mortgage loans we originated or purchased were secured by property in California. An overall decline in the economy or the residential real estate market, or the occurrence of a natural disaster, such as an earthquake, or a major terrorist attack in California could adversely affect the value of the mortgaged properties in California and increase the risk of delinquency, foreclosure, bankruptcy, or loss on mortgage loans in our portfolio. This would negatively affect our ability to purchase, originate and securitize mortgage loans, which could have a material adverse effect on our business, financial condition and results of operations.
 
In 2001, California experienced energy shortages. As a result, energy costs, including natural gas and electricity, may increase significantly in the future. There may also be limitations in the amount of energy resulting in power “blackouts” during short periods of time. Therefore, because our headquarters, a substantial number of our branch offices and some of the independent brokers in our wholesale network are based in California, our operations may be disrupted and operating expenses may increase in the future. Any such disruption or increase in expenses could be material and could adversely affect our loan originations, margins and our profitability. To date, we have not experienced material increases in our overall operating expenses. However, if the power outages associated with the energy crisis continue or become more severe, we could experience material disruptions or cost increases in the future, which could have a material adverse effect on our results of operations, financial condition and business prospects.
 
Many of our competitors are larger and have greater financial resources than we do, which could make it difficult for us to compete successfully, and we could face new competitors.
 
We face intense competition in the business of originating, purchasing and selling mortgage loans. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. In addition, certain government-sponsored entities, such as Fannie Mae and Freddie Mac, are beginning to purchase some categories of non-prime loans, which may cause new competitors to enter our market and reduce our profit margins.
 
Certain large finance companies and conforming mortgage originators also originate non-prime mortgage loans to customers similar to the borrowers we serve. Competitors with lower costs of capital have a competitive advantage over us. In addition, establishing a wholesale lending operation such as ours requires a relatively small

26


commitment of capital and human resources. This low barrier to entry permits new competitors to enter our markets quickly and compete with our wholesale lending business. Several new wholesale originators have been formed in recent quarters and have recruited former senior managers from our wholesale division. If these competitors are able to attract some of our key employees and disrupt our broker relationships, it could have a material adverse effect on our results of operations, financial condition and business prospects.
 
Changes in the volume and cost of loans originated by our wholesale division may decrease our loan production and decrease our earnings.
 
We depend primarily on independent mortgage brokers and, to a lesser extent, on correspondent lenders for the origination and purchase of our wholesale mortgage loans, which constitute the majority of our loan production. These independent mortgage brokers have relationships with multiple lenders and are not obligated by contract or otherwise to do business with us. We compete with these lenders for the independent brokers’ business on pricing, service, loan fees, costs and other factors. Competition from other lenders and purchasers of mortgage loans could negatively affect the volume and pricing of our wholesale loans, which could have a material adverse effect on our results of operations, financial condition and business prospects.
 
A decline in the quality of servicing could lower the value of our residual interests and our ability to sell or securitize loans.
 
In March 2001, we sold to Ocwen Federal Bank FSB, the servicing rights on $4.8 billion of our servicing portfolio which was comprised of 25 separate asset-backed securities. In August 2001, Ocwen began servicing all of our newly originated loans pending their sale or securitization. In February 2002, we announced the intent to re-establish our loan servicing platform and have begun to add the necessary infrastructure. Ocwen will continue to service the mortgage loans in our existing securities. See “Part I, Item 1. Business—Loan Servicing and Delinquencies.” Poor servicing and collections could adversely affect the value of our residual interests and our ability to sell or securitize loans, which could have a material adverse effect on our results of operations, financial condition and business prospects.
 
We may be required to repurchase mortgage loans or indemnify investors if we breach representations and warranties, which could adversely impact our earnings.
 
When we sell loans, we are required to make customary representations and warranties about such loans to the loan purchaser. Our whole loan sale agreements require us to repurchase or substitute loans in the event we breach a representation or warranty given to the loan purchaser or make a misrepresentation during the mortgage loan origination process. In addition, we may be required to repurchase loans as a result of borrower fraud or in the event of early payment default on a mortgage loan. Likewise, we are required to repurchase or substitute loans if we breach a representation or warranty in connection with our securitizations. The remedies available to a purchaser of mortgage loans are generally broader than those available to us against the originating broker or correspondent. Further, if a purchaser enforces its remedies against us, we may not be able to enforce the remedies we have against the sellers. The repurchased loans typically can only be financed at a steep discount to their repurchase price, if at all. They are also typically sold at a significant discount to the unpaid principal balance. Significant repurchase activity could negatively affect our cash flow and results of operations.
 
New legislation could restrict our ability to make mortgage loans, which could adversely impact our earnings.
 
Several states and cities are considering or have passed laws, regulations or ordinances aimed at curbing predatory lending practices. The federal government is also considering legislative and regulatory proposals in this regard. In general, these proposals involve lowering the existing federal Homeownership and Equity Protection Act thresholds for defining a “high-cost” loan, and establishing enhanced protections and remedies for

27


borrowers who receive such loans. However, many of these laws and rules extend beyond curbing predatory lending practices to restrict commonly accepted lending activities, including some of our activities. For example, some of these laws and rules prohibit any form of prepayment charge or severely restrict a borrower’s ability to finance the points and fees charged in connection with his or her loan. Passage of these laws and rules could reduce our loan origination volume. In addition, for reputation reasons and because of the enhanced risk, many whole loan buyers elect not to purchase any loan labeled as a “high cost” loan under any local, state or federal law or regulation. Accordingly, these laws and rules could severely constrict the secondary market for a significant portion of our loan production. This would effectively preclude us from continuing to originate loans that fit within the newly defined thresholds and would have a material adverse effect on our results of operations, financial condition and business prospects.
 
If many of our borrowers become subject to the Soldiers’ and Sailors’ Civil Relief Act of 1940, our cash flows from our residual securities may be adversely affected.
 
Under the Soldiers’ and Sailors’ Civil Relief Act of 1940, a borrower who enters military service after the origination of his or her mortgage loan generally may not be charged interest above an annual rate of 6% during the period of the borrower’s active duty status. The Act also applies to a borrower who was on reserve status and is called to active duty after origination of the mortgage loan. A significant military mobilization as part of the war on terrorism could increase the number of the borrowers in our securitized pools who are subject to this Act and thereby reduce the interest payments collected from those borrowers. To the extent the number of borrowers who are subject to this Act is significant, the cash flows we receive through residual interests would be reduced, which would cause us to reduce the carrying value of our residual interests. Any such reduction in our cash flows or impairment in our performance could have a material adverse effect on our results of operations, financial condition and business prospects.
 
We are exposed to risk of environmental liabilities with respect to properties to which we take title.
 
In the course of our business, we may foreclose and take title to residential properties, and could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation, and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.
 
Our charter and bylaws and Delaware law contain provisions that could discourage a takeover.
 
Our amended and restated certificate of incorporation and our amended and restated bylaws include various provisions that could delay, defer or prevent a takeover attempt that may be in the best interest of our stockholders. These provisions include the existence of a classified board of directors, the ability of our board of directors to issue additional shares of our preferred stock without any further stockholder approval and requirements that (i) our stockholders give advance notice with respect to certain proposals they may wish to present for a stockholder vote, (ii) our stockholders act only at annual or special meetings and (iii) two-thirds of all directors approve a change in the number of directors on our board of directors. Issuance of our 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 our common stock. In addition, provisions in our 1998 transaction with U.S. Bancorp that provide U.S. Bancorp with certain preemptive rights and anti-dilutive adjustments to its shares may discourage takeover attempts by third parties.
 
We are also subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any interested

28


stockholder for a period of three years following the date that the stockholder became an interested stockholder. The preceding provisions of our charter and bylaws, as well as Section 203 of the Delaware General Corporation Law, could discourage potential acquisition proposals, delay or prevent a change of control and prevent changes in our management.
 
The concentrated ownership of our voting stock by a small group of our stockholders may have an adverse effect on your ability to influence the direction we will take.
 
According to the most recently available SEC filings, a small group of our stockholders, comprised of our management team and directors, U.S. Bancorp and Brookhaven Capital, continue to beneficially own an aggregate of approximately 64% of the total voting power of our voting stock. These stockholders, if they were to act in concert, would have majority control and would have the ability to control the approval of certain fundamental corporate transactions (including mergers, consolidations and sale of assets) and to elect all of the members of our board of directors, whether or not their actions are in the best interests of our other stockholders.
 
Various factors may cause the market price of our common stock to become volatile, which could adversely affect our ability to access the capital markets in the future.
 
The market price of our common stock may experience fluctuations that are unrelated to our operating performance. In particular, the price of our 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. These could include, among other things, interest rate movements, quarterly variations or changes in financial estimates by securities analysts, or a significant reduction in the price of the stock of another participant in the consumer finance industry. This volatility may make it difficult for us to access the capital markets through additional secondary offerings of our common stock, regardless of our financial performance.
 
Item 2.     Properties
 
Our executive, administrative offices and some of our lending offices are located in Irvine, California and consist of approximately 222,000 square feet. The three leases covering the executive, administrative and lending offices expire in June 2002, December 2002 and October 2005, respectively, and the combined monthly rent is $435,900. We have entered into a letter of intent to renew the lease that expires in June 2002. We lease space for our regional operating centers in Schaumburg, Illinois, Rancho Bernardo and San Ramon, California, Tampa, Florida and Greenwood Village, Colorado and Ft. Worth, Texas. As of December 31, 2001, these facilities had a monthly aggregate base rental of approximately $85,800. We also lease space for our sales offices, which range in size from 140 to 2,928 square feet with lease terms typically ranging from one to five years. As of December 31, 2001, annual base rents for the sales offices ranged from approximately $6,000 to $85,000. In general, the terms of these leases expire between February 2002 and November 2005. We are currently in negotiations to renew nine office leases expiring between February 2002 and June 2002.
 
Item 3.    Legal Proceedings
 
FTC Inquiry.    In August 2000, we were informed by the Federal Trade Commission that it was conducting an inquiry to determine whether we had violated the Fair Credit Reporting Act, Federal Trade Commission Act or other statutes administered by the Commission. The Commission subsequently focused its inquiry on whether the pre-approved credit solicitations our retail units generated comply with applicable law. We are cooperating with the inquiry and the Commission is reviewing data and information we have provided to it.
 
Matthews, et al.    In October 2000, Hazel Jean Matthews, Ruth D. Morgan and Marie I. Summerall filed an amended class action suit against New Century Mortgage Corporation, Central Mortgage, Equibanc Mortgage Corporation, Century 21 Home Improvements, and Incredible Exteriors, on behalf of themselves and other consumers located in the State of Ohio whose credit transaction was brokered by Equibanc and Central

29


Mortgage. We were not named in the original complaint. The suit was filed in the Ohio state court and later removed by New Century Mortgage to the U.S. District Court for the Southern District of Ohio. The complaint alleges breaches of the Federal Fair Housing Act, Equal Credit Opportunity Act, Truth in Lending Act, gender discrimination, fraud, unconscionability, civil conspiracy, RICO, as well as other claims against the other defendants. The plaintiffs are seeking injunctive relief, compensatory and punitive damages, attorneys’ fees and costs. We filed a motion to dismiss this complaint in December 2000. Plaintiffs filed their Second Amended Complaint in May 2001. We filed a second motion to dismiss all claims in late August 2001. The judge granted the motion in part, and denied in part, dismissing the claims brought under the Fair Housing Act, 42 U.S.C. § 3604(b). Plaintiffs filed a motion to strike the class allegations on October 2, 2001; the judge granted the motion. The case will proceed as to the individual plaintiffs.
 
Fairbanks.    In May 2001, Fairbanks Capital initiated arbitration against New Century Mortgage Corporation for breach of contract, breach of implied covenant of good faith, fraud and negligent misrepresentation stemming from our decision to sell our servicing rights to Ocwen Federal Bank FSB instead of closing a sub-servcing arrangement that we had negotiated with Fairbanks. Fairbanks sought damages of approximately $3.9 million notwithstanding the fact that we paid Fairbanks a $750,000 break-up fee as specified in our agreement. The arbitration hearing took place in September. In November, the arbitrator issued his award in favor of New Century, finding that Fairbanks was not entitled to any monies other than the previously tendered break-up fee.
 
Grimes.    In June 2001, we were served with a class action complaint filed by Richard L. Grimes and Rosa L. Grimes against New Century Mortgage Corporation. The action was filed in the U.S. District Court for the Northern District of California, and seeks rescission, restitution and damages on behalf of the two plaintiffs, others similarly situated and on behalf of the general public. The complaint alleges a violation of the Federal Truth in Lending Act (TILA) and Business & Professions Code § 17200. Specifically, the complaint alleges that we gave the borrowers the required three-day notice of their right to rescind before the loan transaction had technically been consummated. We filed our answer in July 2001. We filed a motion for Summary Judgment which was granted on January 25, 2002. The judge held that New Century had not violated TILA and dismissed the § 17200 claim without prejudice.
 
Perry.    In July 2001, Charles Perry Jr. filed a class action complaint against New Century Mortgage Corporation and Noreast Mortgage Company, Inc. in the U.S. District Court for the District of Massachusetts. The complaint alleges that certain payments we make to mortgage brokers, sometimes referred to as yield spread premiums, violate the federal Real Estate Settlement Procedures Act. The complaint also alleges that New Century Mortgage Corporation induced mortgage brokers to breach their fiduciary duties to borrowers. We filed our answer in September 2001. We believe the allegations lack merit, especially in light of HUD’s October policy statement upholding the use of yield spread premiums, and will defend ourselves vigorously.
 
Smith.    In August 2001, a former employee named Dean Smith filed a class action complaint against New Century Financial Corporation and New Century Mortgage Corporation for alleged unpaid overtime, penalties and damages on behalf of himself and other loan officers. We filed an answer in September 2001, and we intend to defend the action vigorously.
 
Ngo.    In November 2001, Shirley H. Ngo filed a class action complaint against New Century Mortgage Corporation in the U.S. District Court for the Northern District of Georgia. The complaint alleges that payments we make to mortgage brokers, referred to as yield spread premiums, violate the federal Real Estate Settlement Procedures Act. We filed our answer as well as a motion to stay the action.
 
Barney.    In December 2001, Sandra Barney filed a class action complaint against New Century Mortgage Corporation in the Circuit Court in Cook County, Illinois. The complaint alleges the unauthorized practice of law and violation of the Illinois Consumer Fraud Act for performing document preparation services for a fee by non-lawyers, and seeks to recover the fees charged for the document preparation, compensatory and punitive damages, attorneys’ fees and costs. Our response is due in late February 2002.

30


 
We are also a party to various legal proceedings arising in the ordinary course of our business. Management believes that any liability with respect to these legal actions, individually or in the aggregate, will not have a material adverse effect on our business, results of operations or financial position.
 
Item 4.    Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of our stockholders during the fourth quarter of 2001.

31


 
PART II
 
Item 5.     Market for the Registrant’s Common Equity and Related Stockholder Matters
 
Our common stock trades on the Nasdaq National Market under the symbol “NCEN.” The high and low bid prices of our common stock during each quarter for the fiscal years 2001 and 2000 were as follows:
 
    
Fiscal 2001

  
Fiscal 2000

Quarter

  
High

  
Low

  
High

  
Low

Fourth
  
$
14.02
  
$
9.26
  
$
12.50
  
$
9.75
Third
  
$
12.00
  
$
8.65
  
$
14.25
  
$
7.13
Second
  
$
10.60
  
$
6.59
  
$
10.13
  
$
5.06
First
  
$
11.00
  
$
6.00
  
$
15.75
  
$
6.13
 
As of February 14, 2002, the closing sales price of our common stock, as reported on the Nasdaq National Market, was $14.14.
 
We paid a cash dividend on our common stock on January 31, 2002, at $0.05 per share for common stockholders of record as of January 15, 2002. The declaration of any future dividends will be subject to our earnings, financial position, capital requirements, contractual restrictions and other relevant factors.
 
As of February 14, 2002, the number of holders of record of our common stock was approximately 87.
 
Recent Sales of Unregistered Stock
 
On January 1, 2001, we issued 11,919 shares of common stock to David R. McGee and Melinda L. McGee, Trustees of the David R. McGee and Melinda L. McGee Living Trust dated May 1, 1998 representing $125,000 of the deferred purchase price for the acquisition of Worth Funding Incorporated. The sale and issuance of the shares were exempt from the registration requirements of the Securities Act by virtue of Section 4(2) of the Securities Act and Regulation D thereunder.

32


 
Item 6.     Selected Financial Data (dollars in thousands, except per share data)
 
The following selected consolidated statements of operations and balance sheet data for the years ending December 31, 2001, 2000, 1999, 1998 and 1997 have been derived from our financial statements audited by KPMG LLP, independent auditors, whose report with respect thereto appears elsewhere herein. 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 Year Ended December 31, 2001

  
For the Year Ended December 31, 2000

    
For the Year Ended December 31, 1999

  
For the Year Ended December 31, 1998

  
For the Year Ended December 31, 1997

    
(dollars in thousands, except per share data)
Statement of Operations Data:
                                    
Revenues:
                                    
Gain on sales of loans
  
$
182,612
  
$
14,952
 
  
$
121,672
  
$
105,060
  
$
67,939
Interest income
  
 
62,706
  
 
67,351
 
  
 
61,457
  
 
47,655
  
 
25,071
Residual interest income
  
 
36,356
  
 
49,868
 
  
 
27,385
  
 
14,620
  
 
5,038
Servicing income
  
 
10,616
  
 
30,092
 
  
 
23,428
  
 
9,072
  
 
585
Other income
  
 
1,046
  
 
1,653
 
  
 
—  
  
 
—  
  
 
—  
    

  


  

  

  

Total revenues
  
 
293,336
  
 
163,916
 
  
 
233,942
  
 
176,407
  
 
98,633
Expenses
  
 
209,852
  
 
200,697
 
  
 
167,056
  
 
124,099
  
 
68,041
    

  


  

  

  

Earnings (loss) before income taxes
  
 
83,484
  
 
(36,781
)
  
 
66,886
  
 
52,308
  
 
30,592
Income taxes (benefit)
  
 
35,464
  
 
(13,756
)
  
 
27,377
  
 
21,193
  
 
12,849
    

  


  

  

  

Net earnings (loss)
  
$
48,020
  
$
(23,025
)
  
$
39,509
  
$
31,115
  
$
17,743
    

  


  

  

  

Basic earnings (loss) per share
  
$
2.74
  
$
(1.76
)
  
$
2.59
  
$
2.19
  
$
2.18
    

  


  

  

  

Diluted earnings (loss) per share
  
$
2.28
  
$
(1.76
)
  
$
2.11
  
$
2.03
  
$
1.40
    

  


  

  

  

 
    
As of December 31, 2001

  
As of December 31, 2000

  
As of December 31, 1999

  
As of December 31, 1998

  
As of December 31, 1997

    
(dollars in thousands)
Balance Sheet Data:
                                  
Loans receivable held for sale, net
  
$
1,011,122
  
$
400,089
  
$
442,653
  
$
356,975
  
$
276,506
Residual interests in securitizations
  
 
306,908
  
 
361,646
  
 
364,689
  
 
205,395
  
 
97,260
Total assets
  
 
1,451,318
  
 
837,161
  
 
863,709
  
 
624,727
  
 
398,128
Borrowings under warehouse lines of credit
  
 
506,808
  
 
201,705
  
 
234,778
  
 
191,931
  
 
184,426
Borrowings under aggregation lines of credit
  
 
480,760
  
 
202,741
  
 
193,948
  
 
153,912
  
 
70,937
Subordinated debt
  
 
40,000
  
 
40,000
  
 
20,000
  
 
—  
  
 
—  
Residual financing
  
 
79,941
  
 
176,806
  
 
177,493
  
 
122,298
  
 
53,427
Other liabilities
  
 
96,048
  
 
63,760
  
 
64,527
  
 
41,973
  
 
28,502
Total stockholders’ equity
  
 
247,761
  
 
152,149
  
 
172,963
  
 
114,613
  
 
60,836

33


 
    
As of or For the Year Ended December 31, 2001

    
As of or For the Year Ended December 31, 2000

    
As of or For the Year Ended December 31, 1999

    
As of or For the Year Ended December 31, 1998

    
As of or For the Year Ended December 31, 1997

 
    
(dollars in thousands)
 
Operating Statistics:
                                            
Loan origination and purchase activities:
                                            
Wholesale originations
  
$
5,068,466
 
  
$
3,041,761
 
  
$
2,894,517
 
  
$
2,382,784
 
  
$
1,265,133
 
Retail originations
  
 
1,176,505
 
  
 
1,110,596
 
  
 
1,185,747
 
  
 
942,072
 
  
 
578,674
 
Bulk acquisitions
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
—  
 
  
 
120,794
 
Total loan originations and purchases
  
$
6,244,971
 
  
$
4,152,357
 
  
$
4,080,264
 
  
$
3,324,856
 
  
$
1,964,601
 
    


  


  


  


  


Average principal balance per loan
  
$
138
 
  
$
108
 
  
$
102
 
  
$
96
 
  
$
102
 
Percent of loans secured by first mortgage
  
 
99.3
%
  
 
95.3
%
  
 
96.7
%
  
 
97.2
%
  
 
96.9
%
Weighted average initial loan-to-value ratio
  
 
78.7
%
  
 
78.6
%
  
 
78.8
%
  
 
78.2
%
  
 
74.0
%
Originations by product type
                                            
ARMs
  
$
5,101,783
 
  
$
3,052,481
 
  
$
2,610,475
 
  
$
1,920,686
 
  
$
1,394,133
 
Fixed-rate mortgages
  
 
1,143,188
 
  
 
1,099,876
 
  
 
1,469,789
 
  
 
1,404,170
 
  
 
570,468
 
Weighted average interest rates:
                                            
Fixed-rate mortgages
  
 
9.5
%
  
 
11.0
%
  
 
10.2
%
  
 
10.0
%
  
 
9.8
%
ARMs
  
 
9.4
%
  
 
10.4
%
  
 
9.8
%
  
 
9.7
%
  
 
9.5
%
Margin-ARMs
  
 
6.6
%
  
 
6.2
%
  
 
6.2
%
  
 
6.1
%
  
 
7.0
%
Loan Sales:
                                            
Loans sold through whole loan transactions
  
$
4,723,350
 
  
$
3,133,205
 
  
$
1,033,006
 
  
$
1,477,225
 
  
$
680,900
 
Loans sold through securitizations
  
 
898,244
 
  
 
1,029,477
 
  
 
3,017,658
 
  
 
2,265,700
 
  
 
1,123,618
 
Loans acquired to securitize
  
 
—  
 
  
 
—  
 
  
 
(61,312
)
  
 
(544,704
)
  
 
(63,718
)
Net Loan Sales
  
$
5,621,594
 
  
$
4,162,682
 
  
$
3,989,352
 
  
$
3,198,221
 
  
$
1,740,800
 
    


  


  


  


  


34


 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes contained elsewhere herein.
 
General
 
We are a leading nationwide specialty mortgage banking company that originates, purchases and sells residential mortgage loans secured primarily by first mortgages on single family residences. Our borrowers generally have considerable 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. Our 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 we provide. We originate and purchase loans through our wholesale and retail channels. Wholesale originations and purchases are through independent mortgage brokers who provide loans through the Wholesale Division of our wholly-owned subsidiary, New Century Mortgage Corporation, as well as its subsidiary, Worth Funding. We do not purchase bulk pools of loans. Retail originations are made through New Century Mortgage Corporation’s network of branch offices, through its Central Retail Division and through our strategic alliance program under The Anyloan Company. After originating or purchasing loans, we then sell those loans through whole loan sales or securitizations. We were incorporated in Delaware in November 1995 and commenced lending operations in February 1996.
 
Loan Originations and Purchases
 
As of December 31, 2001, our Wholesale Division operated through five regional operating centers and 31 additional sales offices. The Wholesale Division and our Worth Funding subsidiary originated or purchased $5.1 billion in loans during the year ended December 31, 2001. As of December 31, 2001, our Retail Branch Operations Division operated through 65 sales offices and our Central Retail Division and The Anyloan Company operated through their centralized offices. Retail originations totaled $1.2 billion in loans during the year ended December 31, 2001.
 
Loan Sales and Securitizations
 
One of our primary sources of revenue is the recognition of gain on sale of our loans through whole loan sales and securitizations. In a whole loan sale, we recognize and receive a cash gain upon sale. In a securitization, we recognize a gain on sale at the time the loans are sold, and receive cash flows over the actual life of the loans. The use of a net interest margin security, or NIM, transaction concurrent with or shortly after a securitization allows us to receive a substantial portion of the gain in cash at the closing of the NIM transaction, rather than over the actual life of the loans.
 
Prior to 2000, our loan sale strategy typically included both securitizations and whole loan sales in order to achieve our goal of enhancing profits while managing cash flows. Because residual financing was readily available, we securitized a significant percentage of our loan production in order to enhance operating profits and to benefit from future cash flows generated by the residual interests we retained. The remainder of our production was sold in whole loan sale transactions, which allowed us 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.
 
In 2000, we were unable to obtain the same level of residual financing previously available to us. As a result, and in order to manage cash flows, we transitioned from securitizing the majority of our loans to selling the majority of production for cash in whole loan sales.
 
Market changes in 2001 have allowed us to sell loans through securitization on a cash flow-positive basis through the concurrent use of a NIM transaction. During 2001, we completed two securitizations of fixed- and adjustable-rate mortgage loans underwritten by Salomon Smith Barney, Inc. Following each securitization, we

35


issued a NIM security. The net cash proceeds from the transactions yielded cash proceeds in an amount comparable to whole loan sales. In addition to the cash proceeds, we retained a relatively small residual interest that we recorded at its estimated fair value of less than 1.0% of the securitized collateral.
 
Residual Interests
 
In a securitization transaction, we sell a portfolio of mortgage loans to a special purpose entity established for the limited purpose of buying and reselling mortgage loans. The special purpose entity transfers the mortgage loans to a trust that in turn issues interest-bearing asset-backed securities generally in an amount equal to the aggregate principal balance of the mortgage loans. One or more investors purchase these asset-backed securities for cash. The trust uses the cash proceeds to pay us for the mortgage loans. The trust also issues a certificate representing a residual interest in the payments on the securitized loans. In addition, we provide credit enhancement for the benefit of the investors in the form of additional collateral, referred to as the over-collateralization account, or OC Account.
 
To date, we have elected to fund the required OC Account at the closing of most of our securitizations. The over-collateralization requirement ranges from 0.75% to 4.75% of the initial securitization bond debt principal balance, or 1.5% to 9.5% of the remaining principal balance after thirty to thirty-six months of principal amortization. The actual amount of the OC Account is determined by the rating agencies based upon their assessment of the loan pool characteristics. When funding all of the OC Account up front, we begin to receive cash flow from our residual interests immediately. When we do not fund the OC Account up front, we do not receive cash flow until the OC Account requirement is satisfied. Cash flows from our residual interests are subject to certain delinquency or credit loss tests, as defined by the rating agencies or the bond insurance companies. Over time, we receive distributions from the OC Account subject to the performance of the mortgage loans in each securitization.
 
At the closing of each securitization, we add to our balance sheet the residual interest retained based on our calculation of the present value of estimated future cash flows to be received by us. The residual interest we record consists of the OC Account and the net interest receivable, or NIR. Combined, these are referred to as the residual interests.
 
Management reviews on a quarterly basis the underlying assumptions used to value each residual interest and adjusts the carrying value of the securities based on actual experience and trends in the industry. To determine the residual asset value, cash flow is projected for each security. To project cash flow, we use base assumptions for the constant prepayment rate, or CPR, and losses for each product type based on historical performance. Each security is updated to reflect actual performance to date, and the base assumption for CPR and loss is then used to project performance of the security from that date forward. If the actual performance of the security differs materially from the base assumptions with respect to CPR or loss, adjustments are made. The London Interbank Offer Rate, or LIBOR, forward curve is then used to project future interest rates and finalize cash flow projections for each security. The projected cash flows are then discounted at a range of 13%–20%, depending on the risk profile of the retained interest, to establish the net book value of our residual interests.
 
During the second quarter of 2000, we recorded a $21.2 million write-down to our residual interests issued prior to 2000. This write-down resulted primarily from our decision to increase the discount rates used to value the residual interests. During the fourth quarter of 2000, we recorded a write-down of $45.8 million. Approximately $26.9 million of this write-down stemmed from Salomon Smith Barney’s exercise of the call option in connection with our 1998-NC5 securitization transaction with Salomon. None of our other securitization transactions contains such a call feature. The remainder of the fourth quarter write-downs resulted from (i) a continuing increase in prepayment speeds, which occurred despite the increase in interest rates, and (ii) an increase in overall loss assumptions.
 
During the year ended December 31, 2001, based on recent historical experience, we increased the loss assumptions used to determine the value of our residual interests. However, the favorable interest rate

36


environment and the current LIBOR forward curve resulted in an increase in the value of the residual interests that offset the loss in value related to the higher loss assumptions. Therefore, there was no adjustment to the carrying value of the residuals during the year ended December 31, 2001.
 
The following table sets forth loan sales and securitizations for the periods indicated:
 
    
For the Year Ended December 31,

 
    
2001

  
2000

  
1999

 
    
(in thousands)
 
Securitizations
  
$
898,244
  
$
1,029,477
  
$
3,017,658
 
Whole loan sales
  
 
4,723,350
  
 
3,133,205
  
 
1,033,006
 
Subtotal
  
 
5,621,594
  
 
4,162,682
  
 
4,050,664
 
Less: Loans acquired to securitize(1)
  
 
—  
  
 
—  
  
 
(61,312
)
Net loan sales
  
$
5,621,594
  
$
4,162,682
  
$
3,989,352
 

(1)
 
Loans acquired to securitize represent loans sold back to us by whole loan investors for the purpose of securitizing those loans. These loan acquisitions are purchased at current market prices for such loans.
 
During the third quarter of 2000, we revised our underwriting guidelines to eliminate certain loans or loan attributes that our whole loan investors are not willing to buy. These guideline adjustments, such as the elimination of high-cost mortgages and loans to borrowers whose credit bureau scores are less than 500, were designed to allow us to originate the types of loans that are more closely aligned to the guidelines of our whole loan investors. We are continuing to focus on changes that will increase the percentage of our loans that are sold at a premium and reduce the severity of loss on loans sold at a discount.
 
During the year ended December 31, 2001, we sold approximately $236.7 million in loans at a discount to their outstanding principal balance. The majority of these loans were originated prior to December 31, 2000. These loans consisted of delinquent loans, loans with documentation defects or loans that were rejected by whole loan buyers because of certain characteristics. The weighted-average gain on sale on the whole loans we sold at a premium during the year was 104.4%. After taking into account discounted loan sales, the net gain on sale of whole loan sales was reduced to 103.6%. As a result of the high volume of discounted loan sales, the unsold aged inventory of loans held for sale decreased to $54.3 million as of December 31, 2001, from $78.6 million as of December 31, 2000.
 
Results of Operations
 
The following table sets forth our results of operations as a percentage of total revenues for the periods indicated:
 
    
For the Year Ended December 31,

 
    
2001

    
2000

    
1999

 
Revenues:
                    
Gain on sale of loans
  
62.2
%
  
9.1
%
  
52.0
%
Interest income
  
21.4
 
  
41.1
 
  
26.3
 
Residual interest income
  
12.4
 
  
30.4
 
  
11.7
 
Servicing income
  
3.6
 
  
18.4
 
  
10.0
 
Other income
  
0.4
 
  
1.0
 
  
—  
 
Total revenues
  
100.0
 
  
100.0
 
  
100.0
 
Total expenses
  
71.5
 
  
122.4
 
  
71.4
 
Earnings (loss) before income taxes (benefit)
  
28.5
 
  
(22.4
)
  
28.6
 
Income taxes (benefit)
  
12.1
 
  
(8.4
)
  
11.7
 
Net earnings (loss)
  
16.4
%
  
(14.0
)%
  
16.9
%
 

37


 
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
 
Originations and Purchases
 
We originated and purchased $6.2 billion in loans for the year ended December 31, 2001, compared to $4.2 billion for the year ended December 31, 2000, an increase of 50.4%. Wholesale loan originations and purchases were $5.1 billion, or 81.2%, of total originations and purchases for the year ended December 31, 2001. Retail loan originations and purchases were $1.2 billion, or 18.8%, of total originations and purchases for the year ended December 31, 2001. For the same period in 2000, wholesale and retail originations and purchases totaled $3.0 billion, or 73.3%, and $1.1 billion, or 26.7%, respectively, of total originations and purchases.
 
Loan Sales and Securitizations
 
Whole loan sales increased to $4.7 billion for the year ended December 31, 2001, from $3.1 billion for the corresponding period in 2000, an increase of 50.8%. This increase is the result of higher production volume in 2001, as well as an increase in the percentage of whole loan sales versus securitizations in 2001. Loans sold through whole loan sales represented 84.0% of total loan sales in the year ended December 31, 2001, compared to 75.3% for the corresponding period in 2000. Securitizations decreased to $898.2 million for the year ended December 31, 2001, from $1.0 billion for the comparable period in 2000, a decrease of 12.7%.
 
Revenues
 
Total revenues for the year ended December 31, 2001 increased by 79.0% to $293.3 million, from $163.9 million for the year ended December 31, 2000. This increase was primarily due to $67.0 million in fair value adjustments to residual interests during 2000, which reduced gain on sale of loans during this period. After the effect of the adjustment, revenues for the year ended December 31, 2001 increased by $62.4 million, or 38.1%. This increase was the result of higher gain on sale of loans during 2001, partially offset by decreases in interest and servicing income.
 
Gain on Sale
 
The components of the gain on sale of loans are illustrated in the following table:
 
      
For the Year Ended December 31,

 
      
2001

    
2000

 
      
(in thousands)
 
Gain from whole loan sale transactions
    
$
170,717
 
  
$
73,737
 
Gain from securitization of loans
    
 
15,894
 
  
 
54,035
 
Cash gain from securitization of loans
    
 
32,402
 
  
 
2,062
 
Non-cash gain from servicing asset
    
 
4,938
 
  
 
8,009
 
Cash gain on sale of servicing rights
    
 
11,273
 
  
 
—  
 
Securitization expenses
    
 
(3,820
)
  
 
(4,637
)
Accrued interest
    
 
(4,455
)
  
 
(7,201
)
Provision for losses
    
 
(15,106
)
  
 
(15,451
)
Fair value adjustment of residual interests
    
 
—  
 
  
 
(67,006
)
Non-refundable loan fees(1)
    
 
67,645
 
  
 
61,085
 
Premiums paid(2)
    
 
(30,242
)
  
 
(27,287
)
Origination costs
    
 
(60,700
)
  
 
(62,800
)
Hedging gains (losses)
    
 
(5,934
)
  
 
406
 
Gain on sales of loans
    
$
182,612
 
  
$
14,952
 

(1)
 
Non-refundable loan fees represent points and fees collected from borrowers.
(2)
 
Premiums paid represent fees paid to brokers for wholesale loan originations and purchases.

38


 
Interest Income.    Interest income decreased by 6.9% to $62.7 million for the year ended December 31, 2001, compared to $67.4 million for the same period in 2000, primarily as a result of lower average loans receivable held for sale. While loan production volume was significantly higher in 2001, the holding period for loans in the first half of the year averaged less than 30 days from funding. In the second half of 2001, as part of our growth and operating strategies, we increased the holding period to approximately 45 to 60 days in order to optimize net interest income.
 
Residual Interest Income.    Residual interest income decreased to $36.4 million for the year ended December 31, 2001 from $49.9 million for the corresponding period in 2000, a decrease of 27.1%, primarily as a result of the decrease in the average balance of residual interests in securitizations.
 
Servicing Income.    Servicing income decreased by 64.7% to $10.6 million for the year ended December 31, 2001, from $30.1 million for the year ended December 31, 2000. This decrease resulted from the sale of servicing rights to $4.8 billion in mortgage loans to Ocwen Federal Bank FSB during the first quarter of 2001. The initial transfer of $242.1 million of this servicing portfolio to Ocwen was completed in June 2001, and the balance was transferred to Ocwen in August 2001. Subsequent to August 2001, we no longer receive servicing fees and related income on this portion of our portfolio.
 
Expenses
 
Operating expenses increased slightly to $209.9 million for the year ended December 31, 2001 from $200.7 million for the comparable period in 2000, an increase of 4.6%. Personnel expenses increased to $83.4 million for the year ended December 31, 2001 from $57.4 million for the same period in 2000 as a result of higher loan origination and purchase volume. The increase in personnel expense was partially offset by a decrease in interest expense, to $54.1 million for the year ended December 31, 2001 from $72.1 million for the same period in 2000, primarily due to a significant decrease in the interest rates charged on our financing facilities. All other expense categories remained relatively the same in 2001.
 
Income Taxes
 
Income taxes increased to $35.5 million for the year ended December 31, 2001 from a benefit of $13.8 million for the comparable period in 2000. This increase resulted from an increase in pretax income, as well as an increase in the effective tax rate to 42.5% for the year ended December 31, 2001, from 37.4% for the comparable period in 2000. The effective tax rate for 2000 was affected by the non-deductibility of certain net operating losses for tax purposes, which reduces the income tax benefit derived from recording pre-tax losses.
 
Residual Interests
 
Residual interests in securitizations decreased to $306.9 million at December 31, 2001, from $361.6 million at December 31, 2000, a decrease of 15.1%. The decrease resulted from the call of security 1998-NC5 in January of 2001, as well as cash flows received during the year that reduce the carrying value of residual interests.
 
During the year ended December 31, 2001, based on recent historical experience, we increased the loss assumptions used to determine the value of our residual interests. However, the favorable interest rate environment and the current LIBOR forward curve resulted in an increase in the value of the residual interests that offset the loss in value related to the higher loss assumptions. Therefore, there was no adjustment to the carrying value of the residuals at December 31, 2001.

39


 
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
 
Originations and Purchases
 
We originated and purchased $4.2 billion in loans for the year ended December 31, 2000, compared to $4.1 billion for the year ended December 31, 1999, an increase of 1.8%. Loans originated and purchased through our Wholesale Division and Worth Funding were $3.1 billion, or 73.3%, of total originations and purchases for the year ended December 31, 2000. Loans originated through our Retail Branch Operations and Central Retail Division were $1.1 billion, or 26.7%, of total originations and purchases for the year ended December 31, 2000. Our subsidiary, Primewest Funding, merged with another subsidiary, New Century Mortgage Corporation, during the latter part of 2000 and became a part of our Central Retail Operations.
 
Loan Sales and Securitizations
 
Whole loan sales for the year ended December 31, 2000 increased to approximately $3.2 billion, or 203.3%, from $1.0 billion for the corresponding period in 1999. This increase was the result of our election to sell a greater percentage of our loan originations and purchases through whole loan sales during 2000. Securitizations decreased to $1.0 billion for the year ended December 31, 2000, from $3.0 billion for the year ended December 31, 1999, a decrease of 65.9%.
 
Revenues
 
Total revenues for the year ended December 31, 2000 decreased to $163.9 million, or 29.9%, from $233.9 million for the year ended December 31, 1999, due primarily to $67.0 million in adjustments recorded to our residual interests in securitizations, including a $26.9 million loss resulting from the call and subsequent resale of the collateral underlying the 1998 NC-5 security. This adjustment reduced the gain on sale of loans, which decreased to $15.0 million for the year ended December 31, 2000, or 87.7%, from $121.7 million for the year ended December 31, 1999.
 
We sold $4.2 billion in loans for the year ended December 31, 2000, consisting of $3.2 billion through whole loan sale transactions and $1.0 billion through securitizations.
 
Gain On Sale.    The components of the gain on sale of loans are illustrated in the following table:
 
    
For the Years Ended December 31,

 
    
2000

    
1999

 
    
(in thousands)
 
Gain from whole loan sale transactions
  
$
73,737
 
  
$
30,749
 
Non-cash gain from securitizations (NIR gains)
  
 
54,035
 
  
 
169,980
 
Non-cash gain from servicing asset
  
 
8,009
 
  
 
16,368
 
Cash gain (loss) from securitizations/NIMs transactions
  
 
2,062
 
  
 
(4,670
)
Securitization expenses
  
 
(4,637
)
  
 
(17,161
)
Accrued interest
  
 
(7,201
)
  
 
(14,807
)
Fair value adjustment of residual interests
  
 
(67,006
)
  
 
(23,000
)
Provision for losses
  
 
(15,451
)
  
 
(2,549
)
Non-refundable loan fees
  
 
61,085
 
  
 
54,598
 
Premiums, net
  
 
(27,287
)
  
 
(22,355
)
Origination costs
  
 
(62,800
)
  
 
(63,300
)
Hedging gains (losses)
  
 
406
 
  
 
(2,181
)
Gain on sales of loans
  
$
14,952
 
  
$
121,672
 
 
Interest Income.    Interest income for the year ended December 31, 2000 increased to $67.4 million, or 9.6%, from $61.5 million for the same period in 1999. Interest income is earned on loans held in inventory for sale. This interest income accrues during periods when loans are accumulated for future sales and increases as

40


loan originations and purchases increase. The increase in interest income for the year ended December 31, 2000 was the result of a higher average inventory of loans held for sale compared to the corresponding period in 1999. The average inventory held for sale for the year ended December 31, 2000, based on quarter-end balances, was $452.5 million, compared to $387.7 million for the corresponding period in 1999.
 
Servicing Income.    Servicing income for the year ended December 31, 2000 increased to $30.1 million, or 28.4%, from $23.4 million for the year ended December 31, 1999. This increase was a result of the increase in the size of our servicing portfolio.
 
Residual Interest Income.    Residual interest income for the year ended December 31, 2000 increased to $49.9 million, or 82.1%, from $27.4 million for the year ended December 31, 1999. Residual interest income increased as a result of the increase in the average balance of residual interests in securitizations, from $261.3 million in 1999 to $385.5 million in 2000.
 
Expenses
 
Operating expenses increased by 20.1% to $200.7 million for the year ended December 31, 2000, from $167.1 million for 1999. Interest expense increased to $72.1 million for the year ended December 31, 2000 from $53.2 million for the year ended December 31, 1999, as a result of the higher average loan inventory and related warehouse and aggregation borrowings, as well as an increase in subordinated debt and residual financing outstanding. General and administrative expenses increased to $52.6 million for the year ended December 31, 2000 from $42.7 million for 1999 as a result of (i) costs incurred to develop new technology, including our automated credit grading system, (ii) costs incurred to develop our anyloan.com website, and (iii) separation expenses associated with the decrease in staff from 1,770 employees at December 31, 1999 to 1,511 employees at December 31, 2000.
 
Income Taxes
 
Income taxes decreased to a benefit of $13.8 million for the year ended December 31, 2000, from an expense of $27.4 million for 1999. This decrease resulted from a decrease in pretax income, as well as a different effective tax rate applied to the two periods. The effective tax rate of 37.4% used to calculate the tax benefit for the year ended December 31, 2000 was reduced from 40.9% by the effect of the portion of the Company’s stated net operating loss carryforward that was forfeited under California tax law.
 
Residual Interests
 
The carrying value of our residual interests at December 31, 1999 and December 31, 2000 is summarized below:
 
    
As of December 31,

 
    
2000

  
1999

 
    
(in thousands)
 
Book value of securities
  
$
361,646
  
$
369,689
 
Less: General valuation allowance for NIR
  
 
—  
  
 
(5,000
)
Net carrying value
  
$
361,646
  
$
364,689
 
 
During the second quarter of 2000, we recorded a $21.2 million write-down to our residual interests we issued prior to 2000. This write-down resulted primarily from our decision to increase the discount rates used to value our residual interests. During the fourth quarter of 2000, we recorded a total write-down of $45.8 million. Approximately $26.9 million of this adjustment stemmed from Salomon Smith Barney’s exercise of a call option for our 1998-NC5 securitization transaction. None of our other securitization transactions contain such a call feature. The remainder of the fourth quarter write-downs resulted from (i) a continuing increase in prepayment speeds which occurred despite the increase in interest rates, and (ii) an increase in overall loss assumptions.

41


 
Liquidity and Capital Resources
 
We need to borrow substantial sums of money each quarter to originate and purchase mortgage loans. We need separate credit arrangements to hold these loans until we have aggregated a pool that we sell through securitizations or whole loan sales.
 
We use our syndicated warehouse line of credit led by U.S. Bank National Association, as well as the warehouse and aggregation facility with CDC Mortgage Capital, to finance the actual funding of our loan originations and purchases. After we fund loans on our warehouse lines and all loan documentation is complete, we generally transfer the loans to one of our aggregation facilities. We then sell the loans through securitizations or whole loan sales within one to three months and pay down the aggregation facilities with the proceeds.
 
In prior periods, when we securitized loans, we generally needed financing secured by the residual interests that we received in the transaction. The investment bank that underwrote the securitization typically provided this financing. During 2001, as a result of NIM transactions closed concurrent with our securitizations, we realized net cash proceeds in an amount similar to whole loan sales. Subject to market conditions, we expect to continue to utilize this form of securitization in future periods.
 
Our credit facilities contain customary covenants including maintaining specified levels of liquidity and net worth, restricting indebtedness and investments and requiring compliance with applicable laws. If we fail to comply with any of these covenants, the lender has the right to terminate the facility and require immediate repayment. In addition, if we default under one facility, it would generally trigger a default under our other facilities. The material terms and features of our various credit facilities are as follows:
 
The U.S. Bank Warehouse Credit Agreement.    We have a $300.0 million syndicated warehouse line of credit led by U.S. Bank National Association that expires in May 2002 and bears interest at a rate equal to the one-month LIBOR plus 1.625%. At December 31, 2001, the balance outstanding under the warehouse line of credit was $307.8 million (including loans closed by payable-through drafts, which are not formally advanced until the drafts are presented for payment). We are currently in initial discussions to renew and expand this facility.
 
Borrowings under the warehouse line are generally secured by first mortgages funded through the facility. Within seven business days of funding, we are required to deposit the mortgage note and file with U.S. Bank to be held as collateral. If the file is incomplete, U.S. Bank ceases to count the loan when it calculates our available borrowing capacity. As a consequence, we are essentially forced to use our own cash to carry the loan until the file defect can be cured and the loan can be resubmitted under the warehouse line. As of December 31, 2001, our “zero collateral” balance was not material and did not affect our liquidity.
 
The warehouse line is contingent upon having a committed “take-out”—generally a committed aggregation facility or a forward sale commitment—for the financed loans. The advance rate for a loan on the warehouse line is generally calculated as the lesser of (i) 99% of the unpaid principal balance of the loan and (ii) the take-out commitment level minus 2.0%.
 
CDC Warehouse and Aggregation Facility.    In July 2001, we entered into a $200 million repurchase agreement with CDC Mortgage Capital. The agreement allows for both funding of loan originations and aggregation of loans for up to six months pending their sale or securitization. The facility expires in July 2002 and bears interest at rates ranging from 0.95% to 1.25% above the one-month LIBOR. The advance rate on loans is a maximum of 100% of the outstanding principal balance. As of December 31, 2001, the balance outstanding under this facility was $199.0 million.
 
Salomon Aggregation Facility.    As of December 31, 2001, we had a $800 million aggregation facility with Salomon Smith Barney, which bears interest at a rate generally equal to the one-month LIBOR plus 0.90%. This facility expires in December 2002. As of December 31, 2001, the outstanding balance under the facility was $228.8 million.

42


 
Salomon Loan Agreement for Delinquent and Problem Loans.    We also have a $25.0 million Master Loan and Security Agreement with Salomon that is secured by delinquent or problem loans and by properties we obtained in foreclosures. This facility expires in April 2002 and bears interest at a rate equal to the one-month LIBOR plus 2.00%. As of December 31, 2001, the outstanding balance under this facility was $5.7 million.
 
 
Morgan Stanley Aggregation Facility.    We also have a $400 million aggregation facility with Morgan Stanley Dean Witter Mortgage Capital. This facility expires in November 2002 and bears interest at a rate generally equal to the one-month LIBOR plus 1.05%. As of December 31, 2001, the balance outstanding under this facility was $246.3 million.
 
PaineWebber Aggregation and Residual Financing Facility.    In addition, during 2001 we had a $300 million uncommitted aggregation and residual financing facility with PaineWebber Real Estate Securities. We terminated this facility in the third quarter of 2001, upon retirement of the outstanding residual financing.
 
Residual Financing Arrangements.    As of December 31, 2001, we have a residual financing agreement with Salomon. The Salomon facility is structured as a repurchase arrangement and does not have a specified limit. All cash flows from the financed residuals are directed to pay down the facility. Based upon current projections, we expect these cash flows to be adequate to cover the minimum monthly and quarterly pay-down obligations. If there is a shortfall, we will be required to make up the difference using our general working capital. As of December 31, 2001, the outstanding balance under the Salomon facility was $79.9 million. We expect the facility to be repaid by the end of the third quarter of 2002.
 
During the year ended December 31, 2001, we terminated our residual financing facilities with Greenwich Capital Markets, PaineWebber and Countrywide Warehouse Lending.
 
Other Borrowings
 
During 1999 and 2000, U.S. Bancorp provided us with a total of $40 million in subordinated debt secured by a second lien on our Warehouse Agreement collateral as well as subordinate interests in our residuals. This debt bears interest at a rate of 12% per year and expires in December 2003.
 
We have a discretionary, non-revolving $5.0 million line of credit with an affiliate of U.S. Bank that is secured by our 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. In addition, we enter into equipment lease arrangements from time to time that are treated as capital leases for financial statement purposes. As of December 31, 2001, the balance outstanding under these borrowing arrangements was $9.7 million.
 
Residual Cash Flows
 
We expect to have repaid all residual financing by the end of the third quarter of 2002. The majority of the funds for the repayment come from the residual cash flows themselves. Once the residual financing is repaid, we anticipate that the residual cash flows will be a significant source of liquidity and working capital for us to support future operations.
 
Private Placement
 
In July 2001, we raised gross proceeds of approximately $15 million through a private placement of 1,442,308 shares of our common stock at $10.40 per share. Friedman, Billings, Ramsey & Co., Inc. served as placement agent for this transaction. Net proceeds to us totaled approximately $14.15 million. In connection with this transaction, we registered for resale the shares sold in the private placement, effective as of August 20, 2001, and agreed to maintain the effectiveness of the registration for up to two years, subject to customary exceptions.

43


 
Secondary Public Offering
 
In October 2001, we raised gross proceeds of approximately $41.5 million through a public offering of 3,775,000 shares of our common stock at $11.00 per share. Friedman, Billings, Ramsey & Co., Inc. served as underwriter for this transaction. Net proceeds to us, after deducting underwriting fees and offering expenses, totaled approximately $37.8 million.
 
Off-Balance Sheet Arrangements
 
In connection with our loans sold through securitization, as of December 31, 2001 there are $4.0 billion in loans owned by off-balance sheet trusts. Under generally accepted accounting principles, we have included our residual interests in these loans on our balance sheet as of December 31, 2001. Had these off-balance sheet trusts been included in our consolidated financial statements, total assets and total liabilities would have increased by $3.7 billion.
 
Cash Flow
 
For the year ended December 31, 2001, cash flow from operations provided approximately $96.9 million in cash, resulting in a cash balance of $106.7 million at year-end. Positive cash flow from operations resulted primarily from the focus on a loan sale strategy that emphasizes optimization of cash flow and a cost reduction strategy to improve both cash flow and profit margins. We made significant progress during 2001 in achieving our goals relative to both optimizing cash flow from loan sales and reducing operating expenses.
 
Our loan origination and purchase programs still require significant cash investments, including the funding of: (i) fees paid to brokers and correspondents in connection with generating loans through wholesale lending activities; (ii) commissions paid to sales employees to originate loans; (iii) any difference between the amount funded per loan and the amount advanced under the current warehouse facility; (iv) principal and interest payments on residual financing in excess of cash flows we have received from residuals; and (v) income tax payments arising from the recognition of gain on sale of loans. We also require cash to fund ongoing operating and administrative expenses, including capital expenditures and debt service. Our sources of operating cash flow include: (i) the premium advance component of the aggregation facilities; (ii) cash premiums obtained in whole loan sales and securitizations; (iii) mortgage origination income and fees; (iv) interest income on loans held for sale; and (v) cash flows from residual interests in securitizations.
 
Liquidity Strategy for 2002
 
We intend to continue to concentrate on improving cash flow in order to maintain cash flow-positive operations. Our principal strategies will be (i) continuing to maintain low loan acquisition costs for loans, (ii) reducing the number of loans that we must sell at a discount as a result of defects because they are rejected by loan buyers or because the borrower failed to make the first payment, (iii) reducing the size of the average loss on sale for those loans that are sold at a discount, (iv) improving the gain on sale of loans sold at a premium, and (v) optimizing net interest income by holding loans for a longer period of time prior to their sale or securitization. There can be no assurance that we will be able to achieve these goals and operate on a cash flow neutral or cash flow positive basis.
 
Subject to the various uncertainties described above, and assuming that we will be able to successfully execute our liquidity strategy, we anticipate that our liquidity, credit facilities and capital resources will be sufficient to fund our operations for the foreseeable future.
 
Income Taxes
 
We account for income taxes by 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.

44


 
Newly Issued Accounting Pronouncements
 
In July 2001, FASB issued SFAS No. 141, “Accounting for Business Combinations,” and SFAS No. 142, “Accounting for Goodwill and Intangible Assets.” SFAS No. 141 eliminates the ability to utilize the pooling of interests method of accounting for business combination transactions initiated after June 30, 2001. The purchase method of accounting is now required. SFAS 142 eliminates the existing requirement to amortize goodwill through a periodic charge to earnings. For existing goodwill, the elimination of the amortization requirement is effective beginning January 1, 2002. As of that date, and at least annually thereafter, goodwill must be evaluated for impairment based on estimated fair value. As of December 31, 2001, we had goodwill of $3.3 million. Since the goodwill and related amortization has not been significant to the consolidated balance sheet and results of operations, the implementation of this standard is not expected to be material to the consolidated balance sheet or results of operations.
 
In June 2001, FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs would be capitalized as part of the carrying amount of the long-lived asset and depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. The provisions of SFAS No. 143 are effective for fiscal years beginning after June 15, 2002. Management has not yet determined the impact, if any, of adoption of SFAS No. 143.
 
In August 2001, FASB issued Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No. 144), which supersedes both FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (SFAS No. 121) and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (Opinion 30), for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 retains the fundamental provisions in SFAS No. 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to disposed of by sale, while also resolving significant implementation issues associated with SFAS No. 121. For example, SFAS No. 144 provides guidance on how a long-lived asset that is used as a part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. SFAS No. 144 retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business).
 
The Company is required to adopt SFAS No. 144 no later than the year beginning after December 15, 2001, and plans to adopt its provisions for the quarter ending March 31, 2002. Management does not expect the adoption of SFAS No. 144 for long-lived assets held for use to have a material impact on the Company’s financial statements because the impairment assessment under SFAS No. 144 is largely unchanged from SFAS No. 121. The provisions of the statement for assets held for sale or other disposal generally are required to be applied prospectively after the adoption date to newly initiated disposal activities. Therefore, management cannot determine the potential effects that adoption of SFAS No. 144 will have on the Company’s financial statements.

45


FORWARD-LOOKING STATEMENTS
 
This Report on Form 10-K contains or incorporates by reference certain forward-looking statements and we intend that such forward-looking statements be subject to the safe harbor provisions of the federal securities laws. When used, statements which are not historical in nature, including those containing words such as “anticipate,” “estimate,” “should,” “expect,” “believe,” “intend,” and similar expressions are intended to identify forward-looking statements. Statements regarding the following subjects are forward-looking by their nature:
 
 
 
our business strategy;
 
 
 
our understanding of our competition;
 
 
 
market trends;
 
 
 
projected sources and uses of funds from operations;
 
 
 
potential liability with respect to legal proceedings; and
 
 
 
potential effects of proposed legislation and regulatory action.
 
Additional forward-looking statements include the following:
 
 
 
Our expectations regarding our ability to manage effectively the potentially higher risks of our industry;
 
 
 
Our expected secondary marketing strategy;
 
 
 
Our assumptions regarding the early repayment of our residual financing and its effect on our operating results;
 
 
 
Our plans regarding the use of proceeds from our 2001 private placement and secondary offering;
 
 
 
Our goal to reduce the number of loans we sell at a discount;
 
 
 
Our wholesale and retail expansion plans;
 
 
 
Our plans regarding our strategic alliance program;
 
 
 
Our expectations regarding operating costs;
 
 
 
Our plan to re-establish servicing operations and our beliefs regarding its potential benefits;
 
 
 
The assumptions underlying our residual values;
 
 
 
Our expectation regarding our continued sale of servicing rights to Ocwen;
 
 
 
Our plan to continue to evaluate and undertake selective repurchases of delinquent loans from our securitized pools;
 
 
 
Our hedging strategies;
 
 
 
Our plans to continue to enhance our fair lending efforts;
 
 
 
Our belief regarding the state of our relationship with our employees;
 
 
 
Our expectations regarding residual cash flows; and
 
 
 
Our expectations regarding the potential effects of newly issued accounting pronouncements.
 
These forward-looking statements are subject to various risks and uncertainties, including those relating to:
 
 
 
our access to funding sources and our ability to renew, replace or add to our existing credit facilities on terms comparable to the current terms;

46


 
 
 
initiation of a margin call under our warehouse, aggregation or residual financing agreements;
 
 
 
assumptions underlying our residual values and loan loss allowances;
 
 
 
an increase in the prepayment speed or default rate of our borrowers;
 
 
 
the effect of changes in interest rates;
 
 
 
the condition of the secondary markets for our products;
 
 
 
the negative impact of economic slowdowns or recessions;
 
 
 
management’s ability to manage our growth and planned expansion;
 
 
 
the effect of the competitive pressures from other lenders or suppliers of credit in our market;
 
 
 
our ability to reduce the number of loans sold at a discount;
 
 
 
our ability to re-establish our servicing operations;
 
 
 
our ability to expand origination volume while maintaining low overhead; and
 
 
 
the impact of new state or federal legislation or court decisions restricting the activities of lenders or suppliers of credit in our market.
 
Other risks, uncertainties and factors, including those discussed under “Risk Factors” in this report on Form 10-K, could cause our actual results to differ materially from those projected in any forward-looking statements we make. We are not obligated to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
 
Item 7A.    Quantitative and Qualitative Disclosures About Market Risk
 
General
 
We carry interest-sensitive assets on our balance sheet that are financed by interest-sensitive liabilities. Since the interval for re-pricing of the assets and liabilities is not matched, we are subject to interest-rate risk. A sudden, sustained increase or decrease in interest rates would impact our net interest income, as well as the fair value of our residual interests in securitizations. We employ hedging strategies from time to time to manage the interest-rate risk inherent in our assets and liabilities. These strategies are designed to create gains when movements in interest rates would cause the value of our assets to decline, and result in losses when movements in interest rates cause the value of our assets to increase.

47


 
The following table illustrates the timing of the re-pricing of our interest-sensitive assets and liabilities as of December 31, 2001. Management has made certain assumptions in determining the timing of re-pricing of such assets and liabilities. One of the more significant assumptions is that all of our loans receivable held for sale will be sold in the first six months of 2002. In addition, the timing of re-pricing or maturity of our residual interests in securitizations is based on certain prepayment and loss assumptions (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” for further details).
 
Description

 
Zero to Six Months

 
Six months to One Year

   
1-2 Years

 
3-4 Years

 
5-6 Years

  
Thereafter

 
Total

 
Fair Value

Interest—sensitive assets:
                                    
Cash and cash equivalents
 
$
106,679
                        
106,679
 
106,679
Loans receivable held for sale, net
 
 
1,011,122
                        
1,011,122
 
1,042,243
Residual interests in securitizations
 
 
38,636
 
45,239
 
 
50,905
 
57,235
 
42,709
  
72,184
 
306,908
 
306,908
Interest rate cap
 
 
500
                        
500
 
500
   

 

 
 
 
  
 
 
Total interest—sensitive assets
 
$
1,156,937
 
45,239
 
 
50,905
 
57,235
 
42,709
  
72,184
 
1,425,209
 
1,456,330
Interest—sensitive liabilities:
                                    
Warehouse and aggregation lines of credit
 
 
987,568
                        
987,568
 
987,568
Residual financing payable
 
 
33,700
 
46,241
 
                  
79,941
 
79,941
Subordinated debt
             
40,000
              
40,000
 
40,000
Note payable
 
 
2,385
 
2,353
 
 
3,868
 
1,140
          
9,746
 
9,746
   

 

 
 
 
  
 
 
Total interest—sensitive liabilities
 
$
1,023,653
 
48,594
 
 
43,868
 
1,140
 
—  
  
—  
 
1,117,255
 
1,117,255
Excess of interest—sensitive assets over interest—sensitive liabilities
 
 
133,284
 
(3,355
)
 
7,037
 
56,095
 
42,709
  
72,184
 
307,954
 
339,075
   

 

 
 
 
  
     
Cumulative net interest—sensitivity gap
 
$
133,284
 
129,929
 
 
136,966
 
193,061
 
235,770
  
307,954
     
339,075
   

 

 
 
 
  
     
 
The following table illustrates the timing of the re-pricing of our interest-sensitive assets and liabilities as of December 31, 2000. Management has made certain assumptions in determining the timing of re-pricing of such assets and liabilities. One of the more significant assumptions is that all of our loans receivable held for sale will be sold in the first six months of 2001. In addition, the timing of re-pricing or maturity of our residual interests in securitizations is based on certain prepayment and loss assumptions (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” for further details).
 
Description

  
Zero to Six Months

    
Six months to One Year

    
1-2 Years

    
3-4 Years

  
5-6 Years

  
Thereafter

  
Total

  
Fair Value

Interest—sensitive assets:
                                               
Cash and cash equivalents
  
$
10,283
 
                               
10,283
  
10,283
Loans receivable held for sale, net
  
 
400,089
 
                               
400,089
  
406,420
Residual interests in securitizations
  
 
39,531
 
  
13,694
 
  
91,815
 
  
113,169
  
27,289
  
76,148
  
361,646
  
361,646
Interest rate cap
  
 
881
 
                               
881
  
881
    


  

  

  
  
  
  
  
Total interest—sensitive assets
  
$
450,784
 
  
13,694
 
  
91,815
 
  
113,169
  
27,289
  
76,148
  
772,899
  
779,230
Interest—sensitive liabilities:
                                               
Warehouse and aggregation lines of credit
  
 
404,446
 
                               
404,446
  
404,446
Residual financing payable
  
 
176,806
 
                               
176,806
  
176,806
Subordinated debt
                  
40,000
 
                 
40,000
  
40,000
Note payable
  
 
23,201
 
  
491
 
  
431
 
  
217
            
24,340
  
24,340
    


  

  

  
  
  
  
  
Total interest—sensitive liabilities
  
$
604,453
 
  
491
 
  
40,431
 
  
217
  
—  
  
—  
  
645,592
  
645,592
Excess of interest—sensitive assets over interest—sensitive liabilities
  
 
(153,669
)
  
13,203
 
  
51,384
 
  
112,952
  
27,289
  
76,148
  
127,307
  
133,638
    


  

  

  
  
  
       
Cumulative net interest—sensitivity gap
  
$
(153,669
)
  
(140,466
)
  
(89,082
)
  
23,870
  
51,159
  
127,307
       
133,638
    


  

  

  
  
  
       

48


 
Item 8.    Financial Statements and Supplementary Data
 
Information with respect to this item is set forth in “Index to Consolidated Financial Statements.”
 
Item 9.    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
 
Not applicable.

49


 
PART III
 
Item 10.    Directors and Executive Officers of the Registrant
 
The names and ages of our executive officers and the positions each of them has held for the past five years are included in Part I of this Form 10-K as permitted by the General Instruction G(3). The information required by this item regarding our directors will be included in our Proxy Statement with respect to its 2002 Annual Meeting of Stockholders to be filed with the Commission within 120 days of December 31, 2001, under the caption “Board of Directors and Committees of the Board” and is incorporated herein by this reference as if set forth in full herein.
 
Item 11.    Executive Compensation
 
The information required by this item will be included in our Proxy Statement with respect to its 2002 Annual Meeting of Stockholders to be filed with the Commission within 120 days of December 31, 2001 under the captions “Executive Compensation,” “Board of Directors and Committees of the Board,” “Report of Compensation Committee,” “Performance Graph,” and “Compensation Committee Interlocks and Insider Participation” and is incorporated herein by this reference as if set forth in full herein.
 
Item 12.    Security Ownership of Certain Beneficial Owners and Management
 
The information required by this item will be included in our Proxy Statement with respect to its 2002 Annual Meeting of Stockholders to be filed with the Commission within 120 days of December 31, 2001 under the caption “Security Ownership of Principal Stockholders and Management,” and is incorporated herein by this reference as if set forth in full herein.
 
Item 13.    Certain Relationships and Related Transactions
 
The information required by this item will be included in our Proxy Statement with respect to its 2002 Annual Meeting of Stockholders to be filed with the Commission within 120 days of December 31, 2001 under the caption “Certain Relationships and Related Transactions,” and is incorporated herein by this reference as if set forth in full herein.
 
PART IV
 
Item 14.    Exhibits, Financial Statement Schedules and Reports on Form 8-K
 
 
(a)  The following documents are filed as part of this report:
 
1.  Consolidated Financial Statements—See “Index to Consolidated Financial Statements”
 
2.  Consolidated Financial Statement Schedule—See “Index to Consolidated Financial Statements”
 
3.  Exhibits—See “Exhibit Index”
 
(b)  We filed the following reports on Form 8-K during the fourth quarter of 2001:
 
1.  On December 18, 2001, we filed a report on Form 8-K updating certain information with respect to litigation involving us.
 
2.  On December 21, 2001, we filed a report on Form 8-K announcing the declaration of a cash dividend to holders of our common stock.

50


SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
NEW CENTURY FINANCIAL CORPORATION
By:
 
/s/    BRAD A. MORRICE        

   
Brad A. Morrice
Vice Chairman, President and Chief Operating Officer
 
Each person whose signature appears below hereby authorizes Brad A. Morrice and Edward F. Gotschall or either of them, as attorneys-in-fact to sign on his behalf, individually, and in each capacity stated below and to file all amendments and/or supplements to the Annual Report on Form 10-K.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
 
Signature

  
Title

 
Date

/s/    Brad A. Morrice        

Brad A. Morrice
  
Vice Chairman, President and Chief Operating Officer
 
February 22, 2002
/s/    Edward F. Gotschall      

Edward F. Gotschall
  
Vice Chairman and Chief Financial Officer
 
February 22, 2002
/s/    Robert K. Cole            

Robert K. Cole
  
Chairman of the Board and Chief Executive Officer
 
February 22, 2002
/s/    Fredric J. Forster            

Fredric J. Forster
  
Director
 
February 22, 2002
            /s/    Michael M. Sachs

Michael M. Sachs
  
Director
 
February 22, 2002
            /s/    Terrence P. Sandvik

Terrence P. Sandvik
  
Director
 
February 22, 2002
/s/    Richard A. Zona            

Richard A. Zona
  
Director
 
February 22, 2002

51


 
NEW CENTURY FINANCIAL CORPORATION
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
    
Page Reference

  
F–2
  
F–3
  
F–4
  
F–5
  
F–6
  
F–7

F-1


 
INDEPENDENT AUDITOR’S REPORT
 
The Board of Directors
New Century Financial Corporation:
 
We have audited the accompanying consolidated balance sheets of New Century Financial Corporation and subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2001. 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 auditing standards generally accepted in the United States of America. 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 subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America.
 
 
 
KP
MG LLP
 
Los Angeles, California
January 31, 2002

F-2


NEW CENTURY FINANCIAL CORPORATION
AND SUBSIDIARIES
 
Consolidated Balance Sheets
 
December 31, 2001 and 2000
 
    
2001

    
2000

 
    
(Dollars in thousands, except per share amounts)
 
ASSETS

               
Cash and cash equivalents
  
$
106,679
 
  
10,283
 
Loans receivable held for sale, net (notes 2 and 6)
  
 
1,011,122
 
  
400,089
 
Residual interests in securitizations (notes 3 and 6)
  
 
306,908
 
  
361,646
 
Mortgage servicing assets (note 4)
  
 
—  
 
  
22,945
 
Accrued interest receivable
  
 
1,548
 
  
1,588
 
Office property and equipment (notes 5 and 8)
  
 
10,860
 
  
3,171
 
Prepaid expenses and other assets
  
 
14,201
 
  
37,439
 
    


  

Total assets
  
$
1,451,318
 
  
837,161
 
    


  

 
LIABILITIES AND STOCKHOLDERS’ EQUITY

               
Warehouse and aggregation lines of credit (notes 2 and 6)
  
$
987,568
 
  
404,446
 
Residual financing (notes 3 and 6)
  
 
79,941
 
  
176,806
 
Subordinated debt (note 7)
  
 
40,000
 
  
40,000
 
Notes payable (note 8)
  
 
9,746
 
  
24,340
 
Income taxes payable (note 11)
  
 
6,592
 
  
7,498
 
Accounts payable and accrued liabilities (notes 10 and 13)
  
 
45,457
 
  
24,040
 
Deferred income taxes (note 11)
  
 
34,253
 
  
7,882
 
    


  

Total liabilities
  
 
1,203,557
 
  
685,012
 
    


  

Commitments and contingencies (note 10)
               
Stockholders’ equity (notes 13 and 14):
               
Preferred stock, $0.01 par value. Authorized 7,500,000 shares;
               
issued and outstanding 40,000 shares; liquidation preference $40,000
  
 
—  
 
  
—  
 
Common stock, $0.01 par value. Authorized 45,000,000 shares;
               
issued and outstanding 20,504,444 shares at December 31, 2001
               
and 14,852,931 shares at December 31, 2000
  
 
205
 
  
149
 
Additional paid-in capital
  
 
143,659
 
  
90,579
 
Retained earnings, restricted
  
 
105,547
 
  
61,426
 
    


  

    
 
249,411
 
  
152,154
 
Deferred compensation costs
  
 
(1,650
)
  
(5
)
    


  

Total stockholders’ equity
  
 
247,761
 
  
152,149
 
    


  

Total liabilities and stockholders’ equity
  
$
1,451,318
 
  
837,161
 
    


  

 
See accompanying notes to consolidated financial statements.

F-3


NEW CENTURY FINANCIAL CORPORATION
AND SUBSIDIARIES
 
Consolidated Statements of Operations
 
Years ended December 31, 2001, 2000 and 1999
 
 
    
2001

  
2000

    
1999

    
(In thousands, except per share and share data)
Revenues:
                  
Gain on sale of loans (note 2)
  
$
182,612
  
14,952
 
  
121,672
Interest income (note 2)
  
 
62,706
  
67,351
 
  
61,457
Residual interest income (note 3)
  
 
36,356
  
49,868
 
  
27,385
Servicing income (note 4)
  
 
10,616
  
30,092
 
  
23,428
Other income
  
 
1,046
  
1,653
 
  
    

  

  
Total revenues
  
 
293,336
  
163,916
 
  
233,942
    

  

  
Expenses:
                  
Personnel (notes 10 and 12)
  
 
83,427
  
57,418
 
  
54,634
Interest
  
 
54,127
  
72,126
 
  
53,193
General and administrative (notes 10 and 15)
  
 
52,787
  
52,601
 
  
42,732
Advertising and promotion
  
 
11,610
  
12,681
 
  
11,767
Professional services
  
 
7,901
  
5,871
 
  
4,730
    

  

  
Total expenses
  
 
209,852
  
200,697
 
  
167,056
    

  

  
Earnings (loss) before income taxes (benefit)
  
 
83,484
  
(36,781
)
  
66,886
Income taxes (benefit) (note 11)
  
 
35,464
  
(13,756
)
  
27,377
    

  

  
Net earnings (loss)
  
 
48,020
  
(23,025
)
  
39,509
Dividends paid on preferred stock
  
 
2,900
  
2,900
 
  
2,111
    

  

  
Net earnings (loss) available to common stockholders
  
$
45,120
  
(25,925
)
  
37,398
    

  

  
Basic earnings (loss) per share (note 18)
  
 
2.74
  
(1.76
)
  
2.59
Diluted earnings (loss) per share (note 18)
  
 
2.28
  
(1.76
)
  
2.11
Basic weighted average shares outstanding
  
 
16,481,119
  
14,727,582
 
  
14,414,565
Diluted weighted average shares outstanding
  
 
21,066,584
  
14,727,582
 
  
18,698,904
Dividend per share
  
$
0.05
  
 
  
 
See accompanying notes to consolidated financial statements.

F-4


 
NEW CENTURY FINANCIAL CORPORATION
AND SUBSIDIARIES
 
Consolidated Statements of Changes in Stockholders’ Equity
 
Years ended December 31, 2001, 2000 and 1999
 
      
Preferred 
shares 
outstanding

    
Preferred 
stock 
amount

  
Common 
shares 
outstanding

    
Common 
stock 
amount

    
Additional 
paid-in 
capital

    
Retained 
earnings, 
restricted

      
Deferred 
compensation

    
Total

 
(In thousands)
                                                         
Balance December 31, 1998
    
20
    
$
  
14,474
 
  
$
145
 
  
65,241
 
  
49,953
 
    
(726
)
  
114,613
 
Proceeds from issuance of common stock
    
— 
    
 
  
271
 
  
 
3
 
  
1,135
 
  
— 
 
    
— 
 
  
1,138
 
Issuance of common stock for acquisition
                                                             
of subsidiary
    
— 
    
 
  
10
 
  
 
— 
 
  
108
 
  
— 
 
    
— 
 
  
108
 
Proceeds from issuance of preferred stock
    
20
    
 
  
— 
 
  
 
— 
 
  
20,000
 
  
— 
 
    
— 
 
  
20,000
 
Purchase of treasury stock
    
— 
    
 
  
(60
)
  
 
(1
)
  
(859
)
  
— 
 
    
— 
 
  
(860
)
Amortization of deferred compensation
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
— 
 
    
566
 
  
566
 
Net earnings
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
39,509
 
    
— 
 
  
39,509
 
Preferred stock dividends
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
(2,111
)
    
— 
 
  
(2,111
)
      
    

  

  


  

  

    

  

Balance December 31, 1999
    
40
    
 
  
14,695
 
  
 
147
 
  
85,625
 
  
87,351
 
    
(160
)
  
172,963
 
Proceeds from issuance of common stock
    
— 
    
 
  
149
 
  
 
1
 
  
912
 
  
— 
 
    
— 
 
  
913
 
Issuance of common stock for acquisition
                                                             
of subsidiary
    
— 
    
 
  
69
 
  
 
1
 
  
792
 
  
— 
 
    
— 
 
  
793
 
Purchase of treasury stock
    
— 
    
 
  
(60
)
  
 
— 
 
  
(562
)
  
— 
 
    
— 
 
  
(562
)
Issuance of warrants
    
— 
    
 
  
— 
 
  
 
— 
 
  
3,812
 
  
— 
 
    
— 
 
  
3,812
 
Amortization of deferred compensation
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
— 
 
    
155
 
  
155
 
Net loss
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
(23,025
)
    
— 
 
  
(23,025
)
Preferred stock dividends
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
(2,900
)
    
— 
 
  
(2,900
)
      
    

  

  


  

  

    

  

Balance December 31, 2000
    
40
    
 
  
14,853
 
  
 
149
 
  
90,579
 
  
61,426
 
    
(5
)
  
152,149
 
Proceeds from issuance of common stock
    
— 
    
 
  
5,544
 
  
 
55
 
  
54,461
 
  
— 
 
    
— 
 
  
54,516
 
Issuance of common stock for acquisition
                                                             
of subsidiary
    
— 
    
 
  
12
 
  
 
— 
 
  
125
 
  
— 
 
    
— 
 
  
125
 
Issuance of restricted stock
    
— 
    
 
  
214
 
  
 
2
 
  
2,188
 
  
— 
 
    
(2,190
)
  
— 
 
Purchase of treasury stock
    
— 
    
 
  
(119
)
  
 
(1
)
  
(1,063
)
  
— 
 
    
— 
 
  
(1,064
)
Cancelation of warrants
    
— 
    
 
  
— 
 
  
 
— 
 
  
(2,631
)
  
— 
 
    
— 
 
  
(2,631
)
Amortization of deferred compensation
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
— 
 
    
545
 
  
545
 
Net earnings
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
48,020
 
    
— 
 
  
48,020
 
Preferred stock dividends
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
(2,900
)
    
— 
 
  
(2,900
)
Common stock dividends
    
— 
    
 
  
— 
 
  
 
— 
 
  
— 
 
  
(999
)
    
— 
 
  
(999
)
      
    

  

  


  

  

    

  

Balance December 31, 2001
    
40
    
$
  
20,504
 
  
$
205
 
  
143,659
 
  
105,547
 
    
(1,650
)
  
247,761
 
      
    

  

  


  

  

    

  

 
See accompanying notes to consolidated financial statements.

F-5


 
NEW CENTURY FINANCIAL CORPORATION
AND SUBSIDIARIES
 
Consolidated Statements of Cash flows
 
Years ended December 31, 2001, 2000 and 1999
 
    
2001

    
2000

    
1999

 
    
(In thousands)
 
Cash flows from operating activities:
                      
Net earnings (loss)
  
$
48,020
 
  
(23,025
)
  
39,509
 
Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:
                      
Depreciation and amortization
  
 
8,080
 
  
11,540
 
  
6,226
 
Deferred income taxes
  
 
26,371
 
  
(19,612
)
  
14,750
 
NIR gains
  
 
(15,894
)
  
(54,035
)
  
(169,980
)
Initial deposits to over-collateralization accounts
  
 
(6,738
)
  
(23,927
)
  
(87,940
)
Cash received from residual interests
  
 
65,794
 
  
55,025
 
  
28,154
 
Servicing gains
  
 
(4,938
)
  
(8,009
)
  
(16,368
)
Accretion of NIRs
  
 
(36,525
)
  
(49,705
)
  
(23,685
)
Fair value adjustment of residual securities
  
 
—  
 
  
67,006
 
  
23,000
 
Net proceeds from NIMS transaction
  
 
—  
 
  
8,679
 
  
76,098
 
Provision for losses
  
 
15,106
 
  
15,451
 
  
2,549
 
Loans originated or acquired for sale
  
 
(6,250,934
)
  
(4,148,208
)
  
(4,082,145
)
Loan sales, net
  
 
5,621,734
 
  
4,162,682
 
  
3,984,597
 
Principal payments on loans receivable held for sale
  
 
18,847
 
  
31,545
 
  
12,336
 
Increase (decrease) in warehouse and aggregation lines of credit
  
 
583,122
 
  
(30,083
)
  
82,883
 
Net change in other assets and liabilities
  
 
24,832
 
  
(26,120
)
  
(6,985
)
    


  

  

Net cash provided by (used in) operating activities
  
 
96,877
 
  
(30,796
)
  
(117,001
)
    


  

  

Cash flows from investing activities:
                      
Sale of mortgage servicing rights
  
 
24,748
 
  
—  
 
  
—  
 
Purchase of office property and equipment
  
 
(3,045
)
  
(1,312
)
  
(2,131
)
Purchase of mortgage servicing rights
  
 
—  
 
  
(115
)
  
—  
 
Net proceeds from calls of residuals
  
 
22,204
 
  
—  
 
  
—  
 
Acquisition of Primewest
  
 
—  
 
  
(43
)
  
—  
 
    


  

  

Net cash provided by (used in) investing activities
  
 
43,907
 
  
(1,470
)
  
(2,131
)
    


  

  

Cash flows from financing activities:
                      
Net proceeds from (repayments of) residual financing
  
 
(70,968
)
  
(687
)
  
55,195
 
Proceeds from issuance of subordinated debt
  
 
—  
 
  
20,000
 
  
20,000
 
Proceeds from (net repayments of) notes payable
  
 
(23,972
)
  
21,289
 
  
(934
)
Payment of dividends on convertible preferred stock
  
 
(2,900
)
  
(2,900
)
  
(1,786
)
Proceeds from issuance of stock
  
 
54,516
 
  
913
 
  
21,138
 
Purchase of treasury stock
  
 
(1,064
)
  
(562
)
  
(860
)
    


  

  

Net cash provided by (used in) financing activities
  
 
(44,388
)
  
38,053
 
  
92,753
 
    


  

  

Net increase (decrease) in cash and cash equivalents
  
 
96,396
 
  
5,787
 
  
(26,379
)
Cash and cash equivalents, beginning of year
  
 
10,283
 
  
4,496
 
  
30,875
 
    


  

  

Cash and cash equivalents, end of year
  
$
106,679
 
  
10,283
 
  
4,496
 
    


  

  

Supplemental cash flow disclosure:
                      
Interest paid
  
$
54,063
 
  
72,647
 
  
52,005
 
Income taxes paid
  
 
9,999
 
  
5,857
 
  
14,865
 
Supplemental noncash financing activity:
                      
Restricted stock issued
  
 
2,190
 
  
—  
 
  
—  
 
Stock issued in connection with acquisitions
  
 
125
 
  
793
 
  
108
 
Warrants issued to US Bank
  
 
—  
 
  
3,812
 
  
—  
 
Accrued dividends on common and preferred stock
  
 
1,482
 
  
483
 
  
483
 
Cancelation of warrants
  
 
2,631
 
  
—  
 
  
—  
 
Net assets acquired through acquisition of subsidiary
  
 
—  
 
  
553
 
  
—  
 
Fixed assets acquired through capital leases
  
 
9,378
 
  
—  
 
  
—  
 
 
See accompanying notes to consolidated financial statements.

F-6


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001 and 2000
 
(1)    Summary of Significant Accounting Policies
 
(a)  Organization
 
New Century Financial Corporation (the Company), a Delaware corporation, was incorporated on November 17, 1995. New Century Mortgage Corporation, a wholly-owned subsidiary, commenced operations in February 1996 and is a specialty finance company engaged in the business of originating, purchasing and selling mortgage loans secured primarily by first and second mortgages on single family residences. PWF Corporation (Primewest), a retail sub-prime originator, was a wholly-owned subsidiary acquired in January 1998 and merged into New Century Mortgage Corporation in December 2000. NC Capital Corporation, a wholly-owned subsidiary of New Century Mortgage Corporation, was formed in December 1998 to conduct the secondary marketing activities of the Company. Anyloan Financial Corporation (formerly Anyloan Holdings, Inc.), a wholly-owned subsidiary of the Company, and its subsidiaries, The Anyloan Company and NC Insurance Services, were formed in October 1999 and May 2000, respectively, to conduct the Company’s web-based lending and mortgage servicing-related insurance operations. Worth Funding Inc., a wholly-owned subsidiary of New Century Mortgage Corporation, was acquired in March 2000 to conduct the Company’s centralized operations.
 
(b)  Principles of Consolidation
 
The accompanying consolidated financial statements include the financial statements of the Company’s wholly-owned subsidiaries, New Century Mortgage Corporation and Anyloan Financial Corporation. All material intercompany balances and transactions are eliminated in consolidation. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America.
 
(c)  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. Cash and cash equivalents include $6.4 million in cash held in a restricted margin account associated with the Company’s interest rate risk management activities as of December 31, 2001.
 
(d)  Loans Receivable Held for Sale
 
Mortgage loans held for sale are stated at the lower of amortized cost or fair value 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.
 
(e)  Gain on Sales of Loans
 
Gains or losses resulting from sales or securitizations of mortgage loans are recognized at the date of settlement and are based on the difference between the selling price for sales or securitizations 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.
 
Loan sales and securitizations are accounted for as sales when control of the loans is surrendered, to the extent that consideration other than beneficial interests in the loans transferred is received in the exchange.

F-7


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Liabilities and derivatives incurred or obtained by the transfer of loans are required to be measured at fair value, if practicable. Also, servicing assets and other retained interests in the loans are measured by allocating the previous carrying value between the loans sold and the interest retained, if any, based on their relative fair values at the date of transfer.
 
(f)  Derivatives
 
On January 1, 2001 the Company adopted the provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This standard obligates the Company to record all derivatives at fair value and permits the Company to designate derivative instruments as being used to hedge changes in fair value or changes in cash flows. Changes in the fair value of derivatives that offset changes in cash flows of hedged items are recorded initially in other comprehensive income. Amounts recorded in other comprehensive income are subsequently reclassified into earnings during the same period in which the hedged item affects earnings. If a derivative qualifies as a fair value hedge, then changes in fair value of the hedging derivative are recorded in earnings and are offset by changes in fair value attributable to the hedged risk of the hedged item. Any portion of the change in the fair value of derivatives designated as hedge that is deemed ineffective is recorded in earnings along with changes in the fair value of derivatives with no hedge designation.
 
Upon the implementation of SFAS NO. 133, there was no transition adjustment required since all derivatives were already recognized at fair value on the balance sheet.
 
As of December 31, 2001, no hedge designation was specified for the outstanding derivatives. Certain interest rate caps were used to protect against interest rate risk on residual interests in securitizations. Such caps had a value of $500,000 at December 31, 2001 and are included in other assets on the consolidated balance sheet.
 
Additionally, the Company uses Euro futures contracts to provide protection against interest rate risk on its residual interests in securitizations. As of December 31, 2001, the Company had recognized a hedge loss of $2.9 million, which is included in accounts payable and accrued liabilities on the balance sheet.
 
(g)  Allowance for Losses
 
The allowance for losses on loans sold relates to expenses incurred due to the potential repurchase of loans or indemnification of losses based on alleged violations of representations and warranties which are customary to the mortgage banking industry. The allowance represents the Company’s estimate of the total losses expected to occur and is considered to be adequate. Provisions for losses are charged to gain on sale of loans 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 over the life of the associated loans sold.
 
(h)  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, whichever is shorter. The estimated service lives for furniture and office equipment, computer hardware/software, and leasehold improvements are five years, three years, and five years, respectively.
 
(i)  Goodwill
 
Goodwill recorded in connection with the January 1998 acquisition of Primewest totaled $5.2 million and is being amortized over a seven-year period using the straight-line method. Goodwill recorded in connection with

F-8


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

the March 2000 acquisition of Worth Funding Inc., a wholly-owned subsidiary of New Century Mortgage Corporation, totaled $553,000 and is being amortized over a seven-year period using the straight-line method. Effective January 1, 2002, goodwill will no longer be amortized. Goodwill will be reviewed for possible impairment by discounting the operating income at an appropriate discount rate. Accumulated amortization was $2.7 million and $1.7 million at December 31, 2001 and 2000, respectively.
 
(j)  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 presentation would have aggregated current assets, current liabilities, and net working capital as of December 31, 2001 as follows (dollars in thousands):
 
Current assets
  
$
1,217,425
Current liabilities
  
 
1,124,296
    

Net working capital
  
$
93,129
    

 
(k)  Errors and Omissions Policy
 
In connection with the Company’s lending activities, the Company has Fidelity Bond and Errors and Omissions insurance coverage of $5.0 million each at December 31, 2001.
 
(l)  Income Taxes
 
The Company files 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.
 
(m)  Residual Interests in Securitizations
 
Residual interests in securitizations (Residuals) are recorded as a result of the sale of loans through securitizations and the sale of residual interests in securitizations through what are sometimes referred to as net interest margin securities (NIMS).
 
The loan securitizations are generally structured as follows. First, the Company sells a portfolio of mortgage loans to a special purpose entity (SPE) which has been established for the limited purpose of buying and reselling mortgage loans. The SPE then transfers the same mortgage loans to a Real Estate Mortgage Investment Conduit or Owners Trust (the REMIC or Trust), and the Trust in turn issues interest-bearing asset-backed securities (the Certificates) generally in an amount equal to the aggregate principal balance of the mortgage loans. The Certificates are typically sold at face value and without recourse except that representations and warranties customary to the mortgage banking industry are provided by the Company to the Trust. One or more investors purchase these Certificates for cash. The Trust uses the cash proceeds to pay the Company the cash portion of the purchase price for the mortgage loans. The Trust also issues a certificate representing a residual interest in the payments on the securitized loans. In addition, the Company may provide a credit enhancement for the benefit of

F-9


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

the investors in the form of additional collateral (over-collateralization account or OC Account) held by the Trust. The OC Account is required by the servicing agreement to be maintained at certain levels.
 
At the closing of each securitization, the Company removes from its consolidated balance sheet the mortgage loans held for sale and adds to its consolidated balance sheet (i) the cash received, (ii) the estimated fair value of the interest in the mortgage loans retained from the securitizations (Residuals), which consist of (a) the OC Account and (b) the net interest receivable (NIR) and (iii) the estimated fair value of the servicing asset. The NIR represents the discounted estimated cash flows to be received by the Company in the future. The excess of the cash received and the assets retained by the Company over the carrying value of the loans sold, less transaction costs, equals the net gain on sale of mortgage loans recorded by the Company.
 
The NIMS are generally structured as follows: First, the Company sells or contributes the Residuals to an SPE which has been established for the limited purpose of receiving and selling asset-backed residual interests in securitization certificates. Next, the SPE transfers the Residuals to an Owner Trust (the Trust) and the Trust in turn issues interest-bearing asset-backed securities (the bonds and certificates). The Company sells these Residuals without recourse except that normal representations and warranties are provided by the Company to the Trust. One or more investors purchase the bonds and certificates and the proceeds from the sale of the bonds and certificates, along with a residual interest certificate that is subordinate to the bonds and certificates, represent the consideration to the Company for the sale of the Residuals.
 
At closing of each NIMS, the Company removes from its consolidated balance sheet the carrying value of the Residuals sold and adds to its consolidated balance sheet (i) the cash received, and (ii) the estimated fair value of the portion of the Residuals retained, which consists of a net interest receivable (NIR). The excess of the cash received and assets retained over the carrying value of the Residuals sold, less transaction costs, equals the net gain or loss on the sale of Residuals recorded by the Company.
 
The Company allocates its basis in the mortgage loans and residual interests between the portion of the mortgage loans and residual interests sold through the Certificates and the portion retained (the Residuals and servicing assets) based on the relative fair values of those portions on the date of sale. The Company may recognize gains or losses attributable to the changes in the fair value of the Residuals, 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 Residuals and, accordingly, the Company determines the estimated fair value of the Residuals by discounting the expected cash flows released from the OC Account (the cash out method) using a discount rate commensurate with the risks involved. The Company utilizes an effective discount rate of approximately 13.0% on the estimated cash flows released from the OC Account to value the Residuals through securitization and a range of 15.0% to 20.0% on the estimated cash flows released from the Trust to value Residuals through NIMS.
 
The Company is entitled to the cash flows from the Residuals that represent collections on the mortgage loans in excess of the amounts required to pay the Certificate principal and interest, the servicing fees and certain other fees such as trustee and custodial fees. At the end of each collection period, the aggregate cash collections from the mortgage loans are allocated first to the base servicing fees and certain other fees such as trustee and custodial fees for the period, then to the Certificateholders for interest at the pass-through rate on the Certificates plus principal as defined in the servicing agreements. If the amount of cash required for the above allocations exceeds the amount collected during the collection period, the shortfall is drawn from the OC Account. If the cash collected during the period exceeds the amount necessary for the above allocation, and there is no shortfall in the related OC Account, the excess is released to the Company. If the OC Account balance is not at the required credit enhancement level, the excess cash collected is retained in the OC Account until the specified

F-10


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

level is achieved. The cash and collateral in the OC Account is restricted from use by the Company. Pursuant to certain servicing agreements, cash held in the OC Account may be used to make accelerated principal paydowns on the Certificates to create additional excess collateral in the OC Account which is held by the Trusts on behalf of the Company as the Residual holder. The specified credit enhancement levels are defined in the servicing agreements as the OC Account balance expressed generally as a percentage of the current collateral principal balance.
 
For NIMS transactions, the Company will receive cash flows once the holders of the senior bonds and certificates created in the NIMS transaction are fully paid.
 
The Annual Percentage Rate (APR) on the mortgage loans is relatively high in comparison to the pass-through rate on the Certificates. Accordingly, the Residuals described above are a significant asset of the Company. In determining the value of the Residuals, the Company must estimate the future rates of prepayments, prepayment penalties to be received by the Company, delinquencies, defaults and default loss severity as they affect the amount and timing of the estimated cash flows. The Company estimates average cumulative losses as a percentage of the original principal balance of the mortgage loans of 2.30% to 3.65% for adjustable-rate securities and 2.30% to 3.88% for fixed-rate securities. These estimates are based on historical loss data for comparable loans, the specific characteristics of the loans originated by the Company, and the existence of mortgage insurance. The Company estimates prepayments by evaluating historical prepayment performance of comparable mortgage loans and the impact of trends in the industry. The Company has used a prepayment curve to estimate the prepayment characteristics of the mortgage loans. The rate of increase, duration, severity, and decrease of the curve depends on the age and nature of the mortgage loans, primarily whether the mortgage loans are fixed or adjustable and the interest rate adjustment characteristics of the mortgage loans (6-month, 1-year, 2-year, 3-year, or 5-year adjustment periods). The Company’s prepayment curve and default estimates have resulted in weighted average lives of between 2.75 to 2.99 years for its adjustable-rate securities and 2.77 to 4.24 years for its fixed-rate securities.
 
Historically, the Company performs an evaluation of its Residuals quarterly, which takes into consideration trends in actual cash flow performance, industry and economic developments, as well as other relevant factors.
 
The Bond and Certificate holders and their securitization trusts have no recourse to the Company for failure of mortgage loan borrowers to pay when due. The Company’s Residuals are subordinate to the Bonds and Certificates until the Bond and Certificate holders are fully paid.
 
(n)  Mortgage Servicing Asset
 
In March 2001, the Company sold the majority of its servicing rights to Ocwen Federal Bank FSB (Ocwen). In connection with this transaction, the Company contracted with Ocwen to sub-service all of the Company’s loans held for sale and loans serviced for others. Ocwen assumed these servicing responsibilities in August 2001. For the year ended December 31, 2000, the Company performed all of the servicing functions for its securitizations, loans serviced for others, and loans held for sale.
 
The Company recognizes a servicing asset based on the excess of the fees received for the servicing and collection of the mortgage loans over the subservicer fees and the costs incurred by the Company in performing the servicing functions. This servicing asset is amortized in proportion to, and over the period of, estimated net servicing income.
 
For the purposes of measuring impairment, the Company stratifies the mortgage loans it services using the type of loan as the primary risk. Impairment is measured utilizing the current estimated fair value of the mortgage servicing asset.

F-11


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
(o)  Stock Option Plan
 
The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board Opinion No.25, Accounting for Stock Issued to Employees, (APB 25), and related interpretation. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. However, the Company provides pro forma net earnings (loss) and pro forma net earnings (loss) per share disclosures as if the fair value of all stock options as of the grant date were recognized as expense over the vesting period.
 
(p)  Earnings Per Share
 
Basic earnings per share (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 from issuance of common stock that then shared in earnings.
 
(q)  Use of Estimates
 
Management of the Company has made certain estimates and assumptions relating to the reporting of assets, liabilities, results of operations, and the disclosure of contingent assets and liabilities to prepare these financial statements in accordance with accounting principles generally accepted in the United States of America. Actual results could differ from these estimates.
 
(r)  Advertising
 
The Company accounts for its advertising costs as nondirect response advertising. Accordingly, advertising costs are expenses as incurred.
 
(s)  Reclassification
 
Certain amounts for prior years’ presentation have been reclassified to conform to the current year’s presentation.
 
(t)  Segment Reporting
 
The Company, through the branch network of its subsidiary, New Century Mortgage Corporation, provides a broad range of mortgage products. While the Company’s management monitors the revenue streams through wholesale and retail loan originations, operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, all of the Company’s operations are considered by management to be aggregated in one reportable operating segment.
 
(u)  Recent Accounting Developments
 
In July 2001, FASB issued SFAS No. 141, Accounting for Business Combinations and SFAS No. 142, Accounting for Goodwill and Intangible Assets. SFAS No. 141 eliminates the ability to utilize the pooling of interests method of accounting for business combination transactions initiated after June 30, 2001. The purchase method of accounting is now required. SFAS 142 eliminates the existing requirement to amortize goodwill through a periodic charge to earnings. For existing goodwill, the elimination of the amortization requirement is effective for the Company beginning January 1, 2002. As of that date, and at least annually thereafter, goodwill

F-12


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

must be evaluated for impairment based on estimated fair value. As of December 31, 2001, the Company had goodwill of $3.3 million. Since the goodwill and related amortization has not been significant to the consolidated balance sheet and results of operations, the implementation of this standard is not expected to be material to the consolidated balance sheet or results of operations.
 
In June 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations, which requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs would be capitalized as part of the carrying amount of the long-lived asset and depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. The provisions of SFAS No. 143 are effective for fiscal years beginning after June 15, 2002. Management has not yet determined the impact, if any, of adoption of SFAS No. 143.
 
In August 2001, FASB issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144), which supersedes both FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (SFAS No. 121) and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (Opinion 30), for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 retains the fundamental provisions in SFAS No. 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with SFAS No. 121. For example, SFAS No. 144 provides guidance on how a long-lived asset that is used as a part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. SFAS No. 144 retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business).
 
The Company is required to adopt SFAS No. 144 no later than the year beginning after December 15, 2001, and plans to adopt its provisions for the quarter ending March 31, 2002. Management does not expect the adoption of SFAS No. 144 for long-lived assets held for use to have a material impact on the Company’s financial statements because the impairment assessment under SFAS No.144 is largely unchanged from SFAS No. 121. The provisions of the statement for assets held for sale or other disposal generally are required to be applied prospectively after the adoption date to newly initiated disposal activities. Therefore, management cannot determine the potential effects that adoption of SFAS No. 144 will have on the Company’s financial statements.
 
(2)    Loans Receivable Held for Sale
 
A summary of loans receivable held for sale, at the lower of cost or fair value at December 31 is as follows (dollars in thousands):
 
    
2001

  
2000

 
Mortgage loans receivable:
             
First trust deeds
  
$
1,007,788
  
376,080
 
Second trust deeds
  
 
3,334
  
25,059
 
Net deferred origination costs (fees)
  
 
  
(1,050
)
    

  

    
$
1,011,122
  
400,089
 
    

  

F-13


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
At December 31, 2001 and 2000 the Company had loans receivable held for sale of approximately $10.9 million and $23.5 million, respectively, on which the accrual of interest had been discontinued. If these loans receivable had been current throughout their terms, interest income would have increased by approximately $719,000 and $952,000 in the years ended December 31, 2001 and 2000, respectively.
 
(a)  Interest Income
 
The following table presents the components of interest income for the years ended December 31 (dollars in thousands):
 
    
2001

  
2000

  
1999

Interest on loans receivable held for sale
  
$
62,002
  
65,022
  
59,504
Interest on cash and cash equivalents
  
 
704
  
2,329
  
1,953
    

  
  
    
$
62,706
  
67,351
  
61,457
    

  
  
 
(b)  Gain on Sales of Loans
 
Gain on sales of loans was comprised of the following components for the years ended December 31 (dollars in thousands):
 
    
2001

    
2000

    
1999

 
Gain from whole loan sale transactions
  
$
170,717
 
  
73,737
 
  
30,749
 
Non-cash gain from securitizations (NIR gains)
  
 
15,894
 
  
54,035
 
  
169,980
 
Non-cash gain from servicing asset
  
 
4,938
 
  
8,009
 
  
16,368
 
Cash gain from sales of servicing rights
  
 
11,273
 
  
 
  
 
Cash gain (loss) from securitizations/NIM transactions
  
 
32,402
 
  
2,062
 
  
(4,670
)
Securitization expenses
  
 
(3,820
)
  
(4,637
)
  
(17,161
)
Accrued interest
  
 
(4,455
)
  
(7,201
)
  
(14,807
)
Write down of NIR
  
 
 
  
(67,006
)
  
(23,000
)
Provision for losses
  
 
(15,106
)
  
(15,451
)
  
(2,549
)
Nonrefundable fees
  
 
67,645
 
  
61,085
 
  
54,598
 
Premiums, net
  
 
(30,242
)
  
(27,287
)
  
(22,355
)
Origination costs
  
 
(60,700
)
  
(62,800
)
  
(63,300
)
Derivative gains (losses)
  
 
(5,934
)
  
406
 
  
(2,181
)
    


  

  

    
$
182,612
 
  
14,952
 
  
121,672
 
    


  

  

 
(c)  Originations and Purchases
 
During the year ended December 31, 2001 approximately 43.6% and 5.5% of the Company’s total loan originations and purchases were in the states of California and Illinois, respectively. During the year ended December 31, 2000 approximately 37.9% and 5.6% of the Company’s total loan originations and purchases were in the states of California and Illinois, respectively.
 
(d)  Significant Customers
 
During the year ended December 31, 2001 the Company sold $2.3 billion in loans to CS First Boston and $1.8 billion in loans to Morgan Stanley Dean Witter, which represented 41.3% and 31.1%, respectively, of total loans sold. During the year ended December 31, 2000 the Company sold $1.3 billion in loans to CS First Boston and $483.4 million in loans to CIT, which represented 31.9% and 11.6%, respectively, of total loans sold.

F-14


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
(3)    Residual Interest in Securitizations
 
Residual interests in securitizations consist of the following components for the years ended December 31 (dollars in thousands):
 
    
2001

  
2000

Over-collateralization amount
  
$
206,935
  
242,636
Net interest receivable (NIR)
  
 
99,973
  
119,010
    

  
    
$
306,908
  
361,646
    

  
 
The following table for the activity in the over-collateralization account at December 31 (dollars in thousands):
 
    
2001

    
2000

 
Balance, beginning of year
  
$
242,636
 
  
184,545
 
Initial deposits to OC accounts
  
 
6,738
 
  
23,927
 
Reclassification of NIR to OC
  
 
—  
 
  
15,479
 
Call transactions
  
 
(56,449
)
  
—  
 
Additional deposits to OC accounts
  
 
24,120
 
  
26,601
 
Release of cash from OC accounts
  
 
(10,110
)
  
(7,916
)
    


  

    
$
206,935
 
  
242,636
 
    


  

 
The following table summarizes activity in NIR interests at December 31 (dollars in thousands):
 
    
2001

    
2000

 
Balance, beginning of year
  
$
119,010
 
  
185,144
 
NIR gains
  
 
15,894
 
  
54,035
 
Cash received from NIRs
  
 
(79,804
)
  
(73,710
)
Accretion of NIR
  
 
36,525
 
  
49,705
 
Reclassification of NIR to OC
  
 
—  
 
  
(15,479
)
Sale of NIRs through NIMs
  
 
(15,692
)
  
(8,679
)
Write down of NIR
  
 
—  
 
  
(72,006
)
Increase in NIR through call transactions
  
 
24,040
 
  
—  
 
    


  

    
$
99,973
 
  
119,010
 
    


  

 
During the year ended December 31, 2001 the Company sold $898.2 million in loans through securitization transactions and recognized a pretax gain of $40.0 million, which is included in gain on sale of loans. Concurrent with the securitizations, the Company sold a portion of the residual interest through NIM transactions. In future periods, the Company will receive NIR from the securitizations, once the NIM bonds are repaid. Purchasers of securitization bonds and certificates have no recourse against the other assets of the Company, other than the assets of the trust. The value of the Company’s retained interests is subject to credit, prepayment and interest rate risk on the transferred financial assets.
 
The Company uses certain assumptions and estimates to determine the fair value allocated to the retained interest at the time of initial sale and each subsequent sale in accordance with SFAS No. 140. These assumptions and estimates include projections concerning the various rate indices applicable to the Company’s loans and the pass-through rate paid to bondholders, credit loss experience, prepayments rates, and a discount rate commensurate with the risks involved. These assumptions are reviewed periodically by management. If these assumptions change, the related asset and income would be affected.

F-15


NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 
For the NIMs transactions completed in 2001, the fair value assigned to the retained interests at the date of securitization, was $15.9 million. Key economic assumptions used to measure the retained interest at this date were as follows: prepayment curves which resulted in a weighted average life of 2.74 years; a weighted average static pool loss ranging from 2.64% to 3.84%; a discount rate of 20%; and the actual LIBOR forward curve at the time of the securitization.
 
At December 31, 2001 key economic assumptions and the sensitivity of the current fair value of residual interests in securitization to immediate 10% and 20% adverse changes in those assumptions are illustrated in the following table (dollars in thousands):
 
    
Security type

    
Fixed

    
Adjustable

    
Total

Carrying value/fair value of residual interests
  
$
128,597
 
  
178,311
 
  
306,908