Form 10-Q for period ended June 30, 2005
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2005

 

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 001-32314

 


 

NEW CENTURY FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 


 

MARYLAND   56-2451736

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

18400 VON KARMAN, SUITE 1000,

IRVINE, CALIFORNIA

  92612
(Address of principal executive offices)   (Zip code)

 

Registrant’s telephone number, including area code: (949) 440-7030

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 


 

Indicate by check   ¨ 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 twelve 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  ¨ whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    YES  x    NO  ¨

 

As of July 31, 2005, the registrant had 56,352,490 shares of common stock outstanding.

 



Table of Contents

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

FORM 10-Q

QUARTER ENDED JUNE 30, 2005

 

INDEX

 

     Page

PART I—FINANCIAL INFORMATION

    

Item 1. Financial Statements

   4

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   34

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   60

Item 4. Controls and Procedures

   61

PART II—OTHER INFORMATION

    

Item 1. Legal Proceedings

   62

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   65

Item 4. Submission of Matters to a Vote of Security Holders

   65

Item 6. Exhibits

   65

SIGNATURES

   66

EXHIBIT INDEX

   67

 

2


Table of Contents

Certain information included in this Form 10-Q may include “forward-looking” statements under federal securities laws, and the company intends that such forward-looking statements be subject to the safe-harbor created thereby. Such statements include, without limitation, (i) the company’s expectation that its portfolio of mortgage assets will provide a relatively stable source of revenues and will contribute a significant portion of the company’s earnings in 2005; (ii) the company’s expectation that it will retain between 20% and 30% of its total loan production for investment on its balance sheet for 2005; (iii) the company’s belief that a substantial majority of its loan sales will occur during the second half of 2005; (iv) the company’s expectation that its reported earnings in the second half of 2005 will exceed its reported earnings in the first half of 2005; (v) the company’s belief that its REIT structure provides the most tax-efficient way to hold mortgage loans on its balance sheet; (vi) the company’s expectation that it will continue to increase the size of its on-balance sheet mortgage loan portfolio, producing more diverse revenues across a variety of interest rate environments; (vii) the company’s intention to evaluate, from time to time, whether it should engage in various capital raising activities, which may include offerings of debt, preferred stock, common stock or equity-linked securities; (viii) the company’s expectation that a significant source of its revenue prospectively will be interest income generated from its portfolio of mortgage loans held by the company’s REIT and its qualified REIT subsidiaries; (ix) the company’s expectation that it will continue to generate revenue through its taxable REIT subsidiaries from the sale of loans, servicing income and loan origination fees; (x) the company’s expectation that the primary components of its expenses will be interest expense on its credit facilities, securitizations and other borrowings, general and administrative expenses and payroll and related expenses arising from the company’s origination and servicing businesses; (xi) the company’s expectation that a majority of its income will come from the interest it earns on the mortgage assets its holds for investment; (xii) the company’s expectation that it will supplement its income with earnings from its taxable REIT subsidiaries, which will continue to originate, service and sell mortgage loans; (xiii) the company’s assumptions with respect to cumulative credit losses, which it generally assumes to be approximately 3% of the original balance of the loans; (xiv) the company’s expectation that the gain on sale of mortgage loans will remain at lower margins, similar to the margins during the first six months of 2005, through the fourth quarter of 2005; (xv) the company’s belief that it may continue to utilize securitizations structured as sales in the second half of 2005 in order to maximize the secondary market value of its loan production; (xvi) the company’s belief that its current rate of business is sustainable and that its origination strategies and initiatives are consistent with that belief; (xvii) the company’s belief that if it is successful in maintaining its current mix of production, the company’s exposure to interest rate cyclicality will be reduced; (xviii) the company’s belief that its stricter underwriting guidelines and the stronger credit characteristics of its interest-only loans mitigate their perceived higher risk; (xix) the company’s expectation that the recognition of income as interest payments on the underlying mortgage loans will result in higher income recognition in future periods than would a securitization structured as a sale; (xx) the company’s belief that Carrington may acquire additional assets (including regular and residual interests, whole loans, participation certificates, grantor trust and trust certificates, warehousing and servicing interests) in either the primary or secondary markets; (xxi) the company’s underlying assumptions used to value its residual interests in securitizations and to determine the discount rates of projected cash flows for its residual interests and for residual interests through NIMS transactions; (xxii) the estimates and assumptions required by the company’s accounting policies; (xxiii) the company’s estimates and assumptions with respect to the interest rate environment; (xxiv) the company’s estimates and assumptions with respect to the economic environment; (xxv) the company’s estimates and assumptions with respect to secondary market conditions; (xxvi) the company’s estimates and assumptions with respect to the performance of the loans underlying its residual assets and mortgage loans held for investment; (xxvii) the company’s loan loss allowance estimates; (xxiii) the company’s estimates with respect to its average cumulative losses as a percentage of the original principal balance of mortgage loans; (xxix) the company’s beliefs with respect to its legal proceedings; (xxx) the company’s expectations with respect to the renewal or extension of its credit facilities; (xxxi) the company’s expectations regarding its target levels of liquidity and capital; (xxxii) the execution of the company’s strategy to effectively manage the percentage of loans sold through whole loan sales compared to securitizations structured as financings; (xxxiii) the company’s successful execution of its liquidation strategy; (xxxiv) the company’s expectation that its liquidity, credit facilities and capital resources will be sufficient to fund its operations for the foreseeable future, while enabling it to maintain its qualification as a REIT under the requirements of the Code; (xxxv) the company’s expectation that it will access the capital markets when appropriate to support its growth plan; (xxxvi) the company’s expectation that the RBC transaction will be slightly dilutive to its earnings-per-share in 2005 and accretive to its earnings-per-share within the first 12 months following the transaction’s close; (xxxvii) the company’s expectation that the RBC transaction will close in the third quarter of 2005; (xxxviii) the belief that the RBC transaction will establish the company as a leader in the retail origination channel; (xxxix) the company’s belief that RBC’s large purchase business will be significant to growing the company’s business; and (xl) the company’s belief that being a full-service mortgage provider will allow it to build upon the success of its national Home123 branding and marketing campaign.

 

The company cautions that these statements are qualified by important factors that could cause its actual results to differ materially from expected results in the forward-looking statements. Such factors include, but are not limited to, (i) the condition of the U.S. economy and financial system; (ii) the interest rate environment; (iii) the effect of increasing competition in the company’s sector; (iv) the condition of the markets for whole loans and mortgage-backed securities; (v) the stability of residential property values; (vi) the company’s ability to comply with the requirements applicable to REITs; (vii) the company’s ability to increase its portfolio income; (viii) the company’s ability to continue to maintain low loan acquisition costs; (ix) the potential effect of new state or federal laws and regulations; (x) the company’s ability to maintain adequate credit facilities to finance its business; (xi) the outcome of litigation or regulatory actions pending against the company; (xii) the company’s ability to adequately hedge its residual values; (xiii) the accuracy of the assumptions regarding the company’s repurchase allowance and residual valuations, prepayment speeds and loan loss allowance; (xiv) the ability to finalize forward sale commitments; (xv) the ability to deliver loans in accordance with the terms of forward sale commitments; (xvi) the assumptions underlying the company’s risk management practices; (xvii) the ability of the company’s servicing platform to maintain high performance standards; (xviii) the satisfaction of the RBC transaction’s closing conditions; and (xix) the approval of applicable government authorities and regulators of the RBC transaction. Additional information on these and other factors is contained in the company’s Annual Report on Form 10-K for the year ended December 31, 2004, the company’s Quarterly Report on Form 10-Q for the period ended March 31, 2005 and the company’s other periodic filings with the Securities and Exchange Commission.

 

The company assumes no obligation to update the forward-looking statements contained in this Form 10-Q.

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Condensed Consolidated Balance Sheets

 

June 30, 2005 and December 31, 2004

 

(Dollars in thousands, except share amounts)

 

    

June 30,

2005
(unaudited)


   

December 31,

2004


 
Assets               

Cash and cash equivalents

   $ 569,153     842,854  

Restricted cash

     736,259     454,035  

Mortgage loans held for sale, net of reserves of $11,792 and $9,575, respectively

     5,989,211     3,922,865  

Mortgage loans held for investment, net of reserves of $145,565 and $90,227, respectively

     18,482,990     13,195,324  

Residual interests in securitizations

     145,563     148,021  

Mortgage servicing assets

     40,395     8,249  

Accrued interest receivable

     108,350     66,208  

Income taxes, net

     93,122     180,840  

Office property and equipment, net

     72,774     47,266  

Prepaid expenses and other assets

     194,163     186,282  
    


 

Total assets

   $ 26,431,980     19,051,944  
    


 

Liabilities and Stockholders’ Equity               

Credit facilities on mortgage loans held for sale

   $ 5,627,207     3,704,268  

Financing on mortgage loans held for investment, net

     18,343,545     13,105,973  

Accounts payable and accrued liabilities

     411,351     320,108  

Convertible senior notes, net

     4,919     5,392  

Notes payable

     43,904     37,638  
    


 

Total liabilities

     24,430,926     17,173,379  
    


 

Commitments and contingencies

              

Stockholders’ equity:

              

Preferred stock, $0.01 par value, Authorized 10,000,000 shares; issued and outstanding 4,500,000 and zero shares at June 30, 2005 and December 31, 2004, respectively

     45     —    

Common stock, $0.01 par value, Authorized 300,000,000 shares; issued and outstanding 56,179,685 and 54,702,623 shares at June 30, 2005 and December 31, 2004, respectively

     562     547  

Additional paid-in capital

     1,254,763     1,108,590  

Accumulated other comprehensive loss

     (20,668 )   (4,700 )

Retained earnings, restricted

     784,889     781,627  
    


 

       2,019,591     1,886,064  

Deferred compensation costs

     (18,537 )   (7,499 )
    


 

Total stockholders’ equity

     2,001,054     1,878,565  
    


 

Total liabilities and stockholders’ equity

   $ 26,431,980     19,051,944  
    


 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Condensed Consolidated Statements of Earnings

 

(Dollars in thousands, except per share and share data)

 

(Unaudited)

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Interest income

   $ 420,861       191,135     751,932     344,263  

Interest expense

     (218,555 )     (67,306 )   (380,636 )   (123,270 )
    


 


 

 

Net interest income

     202,306       123,829     371,296     220,993  

Provision for losses on mortgage loans held for investment

     (36,875 )     (17,112 )   (67,113 )   (36,981 )
    


 


 

 

Net interest income after provision for losses

     165,431       106,717     304,183     184,012  

Other operating income:

                            

Gain on sale of mortgage loans

     138,704       215,051     278,456     417,027  

Servicing income

     6,631       7,753     13,353     13,649  

Other income

     3,398       829     7,271     829  
    


 


 

 

Total other operating income

     148,733       223,633     299,080     431,505  
    


 


 

 

Operating expenses:

                            

Personnel

     148,061       109,000     276,583     189,966  

General and administrative

     42,324       34,551     84,099     64,383  

Advertising and promotion

     20,711       15,684     40,543     29,249  

Professional services

     9,677       8,729     17,483     13,066  
    


 


 

 

Total operating expenses

     220,773       167,964     418,708     296,664  
    


 


 

 

Earnings before income taxes

     93,391       162,386     184,555     318,853  

Income tax (benefit) expense

     (1,688 )     60,009     4,716     129,231  
    


 


 

 

Net earnings

     95,079       102,377     179,839     189,622  
    


 


 

 

Dividends on preferred stock

     285       —       285     —    
    


 


 

 

Net earnings available to common stockholders

   $ 94,794     $ 102,377     179,554     189,622  
    


 


 

 

Basic earnings per share

   $ 1.71       3.07     3.26     5.72  

Diluted earnings per share

   $ 1.65       2.46     3.13     4.56  

Basic weighted average shares outstanding

     55,376,001       33,299,104     55,079,377     33,129,024  

Diluted weighted average shares outstanding

     57,396,098       42,161,644     57,331,721     42,088,799  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Condensed Consolidated Statements of Comprehensive Income

 

(Dollars in thousands)

 

(Unaudited)

 

    

Three Months Ended

June 30


  

Six Months Ended

June 30


     2005

    2004

   2005

    2004

Net earnings

   $ 95,079     102,377    179,839     189,622

Other comprehensive income (loss):

                       

Unrealized gain (loss) on derivative instruments designated as hedges, net of taxes of ($1.5) million, and $849,000 for the three and six months ended June 30, 2005, respectively, and $21.3 million, and $12.4 million for the three and six months ended June 30, 2004, respectively, net

     (91,805 )   30,585    (15,968 )   18,333
    


 
  

 

Comprehensive income

   $ 3,274     132,962    163,871     207,955
    


 
  

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Consolidated Statements of Changes in Stockholders’ Equity

 

Six Months Ended June 30, 2005

 

(In thousands, except per share amounts)

 

     Preferred
shares
outstanding


  

Preferred

stock amount


  

Common
shares

outstanding


   

Common

stock

amount


   

Additional

paid-in

capital


   

Accumulated Other

Comprehensive

Loss


   

Retained

earnings,

restricted


   

Deferred

compensation


    Total

 

Balance December 31, 2004

   —        —      54,703       547     1,108,590     (4,700 )   781,627     (7,499 )   1,878,565  

Proceeds from issuance of common stock

   —        —      1,381       14     16,919     —       —       —       16,933  

Proceeds from issuance of preferred stock

   4,500      45    —         —       108,911     —       —       —       108,956  

Cancelled shares related to stock options

   —        —      (224 )     (2 )   (9,584 )   —       —             (9,586 )

Conversion of convertible senior notes

   —        —      15       —       500     —       —       —       500  

Issuance of restricted stock, net

   —        —      305       3     14,833     —       —       (14,836 )   —    

Amortization of deferred compensation

   —        —      —         —       —       —       —       3,798     3,798  

Net earnings

   —        —      —         —       —       —       179,839     —       179,839  

Tax benefit related to non-qualified stock options

   —        —      —         —       14,594     —       —       —       14,594  

Other comprehensive loss, net of tax

   —        —      —         —       —       (15,968 )   —       —       (15,968 )

Dividends declared on common stock, $3.15 per share

   —        —      —         —       —       —       (176,292 )   —       (176,292 )

Dividends on preferred stock, $0.06 per share

   —        —      —         —       —       —       (285 )   —       (285 )
    
  

  

 


 

 

 

 

 

Balance June 30, 2005 (unaudited)

   4,500    $ 45    56,180     $ 562     1,254,763     (20,668 )   784,889     (18,537 )   2,001,054  
    
  

  

 


 

 

 

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Condensed Consolidated Statements of Cash Flows

 

(Dollars in thousands)

 

(Unaudited)

 

     Six Months Ended

 
    

June 30,

2005


   

June 30,

2004


 

Cash flows from operating activities:

                

Net earnings

   $ 179,839       189,622  

Adjustments to reconcile net earnings to net cash provided by operating activities:

                

Depreciation and amortization

     57,311       12,105  

Cash flows received from residual interests

     12,210       27,537  

Accretion of Net Interest Receivables, or “NIR”

     (7,927 )     (9,358 )

NIR gains

     1,670       (21,871 )

Initial deposits to over-collateralization accounts

     (7,914 )     (10,871 )

Retained bond

     —         (3,536 )

Servicing gains

     (35,893 )     —    

Fair value adjustment of residual securities

     4,419       6,770  

Provision for losses on mortgage loans held for investment

     67,113       36,981  

Provision for repurchase losses

     6,072       3,184  

Mortgage loans originated or acquired for sale

     (15,587,599 )     (17,234,447 )

Mortgage loan sales, net

     13,520,803       14,140,969  

Principal payments on mortgage loans held for sale

     115,017       55,709  

Increase in credit facilities on mortgage loans held for sale

     1,922,939       2,808,168  

Tax benefit related to non-qualified stock options

     14,594       —    

Net change in other assets and liabilities

     14,765       51,217  
    


 


Net cash provided by operating activities

     277,419       52,179  
    


 


Cash flows from investing activities:

                

Mortgage loans originated or acquired for investment, net

     (8,174,316 )     (3,457,776 )

Principal payments on mortgage loans held for investment

     2,759,900       739,313  

Purchases of office property and equipment

     (35,618 )     (12,594 )
    


 


Net cash used in investing activities

     (5,450,034 )     (2,731,057 )
    


 


Cash flows from financing activities:

                

Proceeds from issuance of financing on mortgage loans held for investment, net

     8,574,456       5,017,915  

Repayments of financing on mortgage loans held for investment

     (2,588,407 )     (640,625 )

Decrease in credit facilities on mortgage loans held for investment

     (756,835 )     (1,680,487 )

Proceeds from issuance of preferred stock

     108,956       —    

Proceeds from notes payable

     15,726       17,756  

Repayment of notes payable

     (9,460 )     (6,248 )

Change in restricted cash

     (282,224 )     (205,486 )

Payment of dividends on common stock

     (168,938 )     (12,132 )

Net proceeds from issuance of stock

     17,433       4,527  

Purchase of treasury stock

     (11,793 )     —    
    


 


Net cash provided by financing activities

     4,898,914       2,495,220  
    


 


Net decrease in cash and cash equivalents

     (273,701 )     (183,658 )

Cash and cash equivalents, beginning of period

     842,854       278,598  
    


 


Cash and cash equivalents, end of period

   $ 569,153       94,940  
    


 


Supplemental cash flow disclosure:

                

Interest paid

   $ 372,065       113,913  

Income taxes paid

     83,223       157,892  

Supplemental non-cash financing activity:

                

Restricted stock issued

   $ 17,966     $ 5,782  

Accrued dividends

     90,176       6,781  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

(Unaudited)

 

June 30, 2005 and 2004

 

1. Basis of Presentation

 

New Century TRS Holdings, Inc. (formerly known as New Century Financial Corporation), a Delaware corporation (“New Century TRS”), was incorporated on November 17, 1995. New Century Mortgage Corporation, a wholly-owned subsidiary of New Century TRS (“New Century Mortgage”), commenced operations in February 1996 and is a mortgage finance company engaged in the business of originating, purchasing, selling and servicing mortgage loans secured primarily by first and second mortgages on single-family residences. NC Capital Corporation, a wholly-owned subsidiary of New Century Mortgage (“NC Capital”), was formed in December 1998 to conduct the secondary marketing activities of New Century (as defined below). New Century Credit Corporation (formerly known as Worth Funding Incorporated) (“New Century Credit”), a wholly-owned subsidiary of New Century, was acquired in March 2000 by New Century Mortgage. NC Residual IV Corporation (“NCRIV”), a wholly-owned subsidiary of New Century, was formed in September 2004 to hold a portfolio of mortgage loans held for investment. After consummation of the Merger (defined below), New Century purchased New Century Credit from New Century Mortgage. The terms “New Century,” “Company,” “we,” “our,” and “us” refer to New Century Financial Corporation, except where the context otherwise requires.

 

On April 5, 2004, New Century TRS’s board of directors approved a plan to change New Century TRS’s capital structure to enable it to qualify as a real estate investment trust, or REIT, for United States federal income tax purposes. The decision to convert to a REIT was based on several factors, including the potential for increased stockholder return, tax efficiency and ability to achieve growth objectives. On April 19, 2004, New Century TRS’s board of directors approved certain legal and financial matters related to the proposed REIT conversion.

 

On April 12, 2004, New Century TRS formed New Century Financial Corporation (formerly known as New Century REIT, Inc.), a Maryland corporation (“New Century”). On September 15, 2004, New Century TRS’s stockholders approved and adopted the Agreement and Plan of Merger dated as of April 21, 2004 (the “Merger Agreement”), by and among New Century TRS, New Century and NC Merger Sub, Inc., a Delaware corporation formed by New Century for purposes of effecting the Merger (“Merger Sub”), which implemented the restructuring of New Century TRS in order for it to qualify as a REIT (the “Merger”).

 

Pursuant to the Merger Agreement, (i) Merger Sub merged with and into New Century TRS, with New Century TRS as the surviving corporation, (ii) each outstanding share of New Century TRS’s common stock was converted into the right to receive one share of common stock, par value of $0.01 per share, of New Century, (iii) New Century TRS became a wholly-owned subsidiary of New Century and changed its name from New Century Financial Corporation to New Century TRS Holdings, Inc., and (iv) New Century REIT, Inc. changed its name to New Century Financial Corporation. The Merger was consummated and became effective on October 1, 2004, and was accounted for on an “as if pooling basis.” These condensed consolidated financial statements give retroactive effect to the Merger for the periods presented. Accordingly, under “as if pooling accounting,” the assets and liabilities of New Century TRS transferred to New Century in connection with the Merger have been accounted for at historical amounts as if New Century TRS was transferred to New Century as of the earliest date presented and the condensed consolidated financial statements of New Century prior to the Merger include the results of operations of New Century TRS. Stockholders’ equity amounts presented for years prior to the formation of New Century are those of New Century TRS, adjusted for the Merger exchange rate.

 

On September 29, 2004, in contemplation of the Merger, New Century TRS requested that The Nasdaq Stock Market, Inc. suspend the listing of the shares of New Century TRS’s common stock on the Nasdaq National Market prior to the commencement of trading on October 1, 2004. Shares of New Century’s common stock, which were issued in exchange for then outstanding shares of New Century TRS’s common stock on a one-for-one basis in connection with the Merger, were approved for listing on the New York Stock Exchange, Inc. and commenced trading on October 1, 2004 under the ticker symbol “NEW.”

 

The accompanying condensed consolidated financial statements include the consolidated financial statements of the Company’s wholly-owned subsidiaries, New Century TRS, New Century Credit, and NCRIV. 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.

 

The Company has prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the consolidated financial statements and notes thereto included in New Century’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission.

 

Reclassification

 

Certain amounts from prior year’s presentation have been reclassified to conform to the current year’s presentation.

 

Recent Accounting Developments

 

In May 2003, the FASB issued FAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” FAS 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 except for mandatory redeemable financial instruments of nonpublic entities. The Company applied the provisions of FAS 150 when the Series A Cumulative Redeemable Preferred Stock was issued in the second quarter of 2005.

 

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R, “Share-based Payment,” or SFAS 123R. SFAS 123R is a revision of FASB Statement No. 123, “Accounting for Stock-based Compensation,” and supercedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires an entity to measure the cost of employee services in exchange for an award of equity instruments based on the grant date fair value of the award (with limited exception). That cost will be recognized over the period during which the employee is required to provide service in exchange for the award, or the requisite service period, which is usually the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. Employee share purchase plans will not result in recognition of compensation expense if certain conditions are met.

 

The notes to financial statements will disclose information to assist users of financial information to understand the nature of share-based payment transactions and the effects of those transactions on the financial statements. In April 2005, the Securities and Exchange Commission deferred the effective date of SFAS 123R. The Company will be required to apply the provisions of SFAS 123R beginning in 2006. There are three methods from which an entity may select to apply the provisions of SFAS 123R during the transition period: modified prospective application, modified retrospective application—all periods, and modified retrospective application—interim periods. The Company provides pro forma disclosure as to the impact of SFAS 123 or 123R in footnote 1 of the Notes to Condensed Consolidated Financial Statements—Stock-Based Compensation.

 

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.

 

Restricted Cash

 

As of June 30, 2005, restricted cash totaled $736.3 million, and included $116.5 million in cash held in a margin account associated with the Company’s interest rate risk management activities, $599.8 million in cash held in custodial accounts associated with its mortgage loans held for investment, and $20.0 million in cash held in a cash reserve account in connection with its asset-backed commercial paper facility. As of December 31, 2004, restricted cash totaled $454.0 million, and included $58.2 million in cash held in a margin account associated with its interest rate risk management activities, $375.8 million in cash held in custodial accounts associated with its mortgage loans held for investment, and $20.0 million in cash held in a cash reserve account in connection with its asset-backed commercial paper facility.

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

Mortgage Loans 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.

 

Mortgage Loans Held for Investment

 

Mortgage loans held for investment represent loans securitized through transactions structured as financings, or pending securitization through transactions that are expected to be structured as financings. Mortgage loans held for investment are stated at amortized cost, including the outstanding principal balance, less the allowance for loan losses, plus net deferred origination costs. The financing related to these securitizations is included in the Company’s condensed consolidated balance sheet as financing on mortgage loans held for investment.

 

Allowance for Losses on Mortgage Loans Held for Investment

 

In connection with its mortgage loans held for investment, the Company establishes an allowance for loan losses based on its estimate of losses inherent and probable as of its balance sheet date. The Company charges off uncollectible loans at the time of liquidation. The Company evaluates the adequacy of this allowance each quarter, giving consideration to factors such as the current performance of the loans, characteristics of the portfolio, the value of the underlying collateral and the general economic environment. In order to estimate an appropriate allowance for losses for loans held for investment, the Company estimates losses using “static pooling,” which stratifies the loans held for investment into separately identified vintage pools. Provision for losses is charged to the Company’s condensed consolidated statement of earnings. Losses incurred are charged to the allowance. Management considers the current allowance to be adequate.

 

Residual Interests in Securitizations

 

Residual interests in securitizations, or Residuals, are recorded as a result of the sale of loans through securitizations that the Company structures as sales rather than financings, referred to as “off-balance sheet securitizations.” The Company may also sell Residuals through what are sometimes referred to as net interest margin securities, or NIMS.

 

In a securitization structured as a sale, the Company sells a pool of loans to a trust for a cash purchase price and a certificate evidencing its 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 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. The Company receives the cash flows from the Residuals after payment of servicing fees, guarantor fees and other trust expenses if the specified over-collateralization requirements are met. Over-collateralization requirements are generally based on a percentage of the original or current unpaid principal balance of the loans and may be increased during the life of the transaction depending upon actual delinquency or loss experience. A NIMS transaction, through which certificates are sold that represent a portion of the spread between the coupon rate on the loans and the investor pass-through rate, may also occur concurrently with or shortly after a securitization. A NIMS transaction allows the Company to receive a substantial portion of the gain in cash at the closing of the NIMS transaction, rather than over the actual life of the loans.

 

The Annual Percentage Rate, or 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 estimates the future rate of prepayments, prepayment penalties that it will receive, 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 1.65% to 4.62% for adjustable-rate securities and 1.44% to 5.13% for fixed-rate securities. The Company bases these estimates on historical loss data for the loans, the specific characteristics of the loans, and the general economic environment. While the range of estimated cumulative pool losses is fairly broad, the weighted average cumulative pool loss estimate for the entire portfolio of residual assets was 3.75% at June 30, 2005. The Company estimates prepayments by evaluating historical prepayment performance of its loans and the impact of current trends. The Company uses 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). These prepayment curve and default estimates have resulted in weighted average lives of between 2.28 to 2.57 years for the Company’s adjustable-rate securities and 2.44 to 3.49 years for its fixed-rate securities.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

During the quarter ended June 30, 2005, the Company completed a $989.2 million securitization structured as a sale resulting in a gain on sale of $21.2 million. In addition, the Company’s retained interest was $6.2 million.

 

During the six months ended June 30, 2005, the Residuals provided $12.2 million in net cash flow to the Company. The Company performs an evaluation of the Residuals quarterly, taking into consideration trends in actual cash flow performance, industry and economic developments, as well as other relevant factors. During the quarter ended June 30, 2005, the Company increased its prepayment rate assumptions based upon actual performance and made minor adjustments to certain other assumptions, resulting in a $3.1 million decrease in the fair value for the quarter and is recorded as a reduction to gain on sale of mortgage loans.

 

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.

 

The Company is party to various transactions that have an off-balance sheet component. In connection with the Company’s off-balance sheet securitization transactions, as of June 30, 2005, there were $1.8 billion in loans owned by the off-balance sheet trusts. The trusts have issued bonds secured by these loans. The bondholders generally do not have recourse to the Company in the event that the loans in the various trusts do not perform as expected. Because these trusts are “qualifying special purpose entities,” in accordance with generally accepted accounting principles, the Company has included only its residual interest in these loans on its condensed consolidated balance sheet. The performance of the loans in the trusts will impact the Company’s ability to realize the current estimated fair value of these residual assets.

 

Derivative Instruments Designated as Hedges

 

The Company accounts for certain Euro Dollar futures and interest rate cap contracts designated and documented as cash flow hedges pursuant to the requirements of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). Pursuant to SFAS 133, these contracts have been designated as hedging the exposure to variability of cash flows from the Company’s variable rate financing on mortgage loans held for investment attributable to changes in interest rates. Cash flow hedge accounting requires that the effective portion of the gain or loss in the fair value of a derivative instrument designated as a hedge be reported in other comprehensive income and the ineffective portion be reported in current earnings. Additionally, certain Euro Dollar futures contracts were designated as hedges of the fair values of certain mortgage loans held for investment and certain mortgage loans held for sale, pursuant to SFAS 133. Fair value hedge accounting requires that for a fair value hedge, changes in the fair value of the derivative instrument and changes in the fair value of the hedged asset or liability attributable to the hedged risk be reported in current earnings.

 

Income Taxes

 

The Company is a REIT for federal income tax purposes and is not generally required to pay federal and most state income taxes if it meets the REIT requirements of the Internal Revenue Code of 1986, as amended, or the Code. Also, the Company’s subsidiaries that meet the requirements of the Code to be a qualified REIT subsidiary, or a QRS, are not generally required to pay federal and most state income taxes. However, the Company must recognize income taxes in accordance with Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes,” (“SFAS 109”) for its taxable REIT subsidiaries, or TRS, whose income is fully taxable at regular corporate rates.

 

SFAS 109 requires that inter-period income tax allocation be based on the asset and liability method. Accordingly, the Company recognizes the tax effects of temporary differences between its tax and financial reporting bases of assets and liabilities that will result in taxable or deductible amounts in future periods.

 

Stock-Based Compensation

 

The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations, in accounting for employee stock options rather than the fair value accounting allowed by

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

Financial Accounting Standards Board (“FASB”) Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). APB 25 provides that compensation expense relative to the Company’s employee stock options is recorded over the vesting period if the current market price of the underlying stock exceeds the exercise price on the date of grant. Under SFAS 123, the fair value of stock options at the date of grant is recognized in earnings over the vesting period of the options. In December 2002, FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”), which amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results.

 

The fair value of each stock option granted is estimated at the date of grant using the Black-Scholes option-pricing model. The weighted average fair value of stock options granted and the weighted average underlying assumptions used to estimate those values for the three and six months ended June 30, 2005 and 2004 are as follows:

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Fair value

   $ 8.98     $ 22.27     $ 9.21     $ 19.06  

Expected life (years)

     4.5       4.5       4.5       4.5  

Risk-free interest rate

     3.8 %     3.8 %     4.2 %     3.3 %

Volatility

     60.0 %     60.6 %     60.5 %     52.2 %

Expected annual dividend yield

     13.78 %     1.80 %     13.68 %     1.76 %

 

As of June 30, 2005 and 2004, there were stock options outstanding for the purchase of 4,394,552 and 5,495,015 shares, respectively, of the Company’s common stock. The following table shows the pro forma net income as if the fair value method of SFAS 123 had been used to account for stock-based compensation expense (dollars in thousands, except per share amounts):

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Basic net earnings available to common shareholders:

                          

As reported

   $ 94,794     102,377     179,554     189,622  

Compensation expense, net of related tax effects

     (1,664 )   (1,325 )   (3,189 )   (2,505 )
    


 

 

 

Pro forma

   $ 93,130     101,052     176,365     187,117  
    


 

 

 

Diluted net earnings available to common shareholders:

                          

As reported

   $ 94,871     103,631     179,649     192,129  

Compensation expense, net of related tax effects

     (1,664 )   (1,325 )   (3,189 )   (2,505 )
    


 

 

 

Pro forma

   $ 93,207     102,306     176,460     189,624  
    


 

 

 

Basic earnings per share:

                          

As reported

   $ 1.71     3.07     3.26     5.72  

Pro forma

     1.68     3.03     3.20     5.65  

Diluted earnings per share:

                          

As reported

   $ 1.65     2.46     3.13     4.56  

Pro forma

     1.64     2.47     3.11     4.59  

Basic weighted average shares outstanding:

                          

As reported

     55,376     33,299     55,079     33,129  

Pro forma

     55,376     33,299     55,079     33,129  

Diluted weighted average shares outstanding:

                          

As reported

     57,396     42,162     57,332     42,089  

Pro forma

     56,684     41,397     56,665     41,319  

 

2. Mortgage Loans Held for Sale

 

A summary of mortgage loans held for sale, at the lower of cost or market at June 30, 2005 and December 31, 2004, is as follows (dollars in thousands):

 

    

June 30,

2005


  

December 31,

2004


First trust deeds

   $ 5,370,148    3,686,830

Second trust deeds

     586,463    197,362

Net deferred origination costs and other

     32,600    38,673
    

  
     $ 5,989,211    3,922,865
    

  

 

At June 30, 2005, the Company had mortgage loans held for sale of approximately $31.3 million on which the accrual of interest had been discontinued. If these mortgage loans had been current throughout their terms, interest income would have increased by approximately $1.2 million for the six months ended June 30, 2005.

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

3. Mortgage Loans Held for Investment

 

For the three and six months ended June 30, 2005, the Company securitized $5.9 billion and $8.9 billion in loans, respectively, through transactions structured as financings, resulting in an increase in its mortgage loans held for investment. As of June 30, 2005, the balance of mortgage loans held for investment included $25.7 million of mortgage loans held for investment that were not yet securitized. A summary of the components of mortgage loans held for investment at June 30, 2005 and December 31, 2004 is as follows (dollars in thousands):

 

    

June 30,

2005


   

December 31,

2004


 

Mortgage loans held for investment:

              

Unpaid principal balance of mortgage loans

   $ 18,475,484     13,169,595  

Allowance for loan losses

     (145,565 )   (90,227 )

Net deferred origination costs

     153,071     115,956  
    


 

     $ 18,482,990     13,195,324  
    


 

 

At June 30, 2005, the Company had mortgage loans held for investment of approximately $319.5 million on which the accrual of interest had been discontinued. If these mortgage loans had been current throughout their terms, interest income would have increased by approximately $13.6 million for the six months ended June 30, 2005.

 

The following table presents a summary of the activity for the allowance for losses on mortgage loans held for investment for the three and six months ended June 30, 2005 and 2004 (dollars in thousands):

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Beginning balance

   $ 117,495     45,596     90,227     26,251  

Additions

     36,875     17,112     67,113     36,981  

Charge-offs

     (8,805 )   (1,401 )   (11,775 )   (1,925 )
    


 

 

 

     $ 145,565     61,307     145,565     61,307  
    


 

 

 

 

4. Residual Interests in Securitizations

 

Residual interests in securitizations consisted of the following components at June 30, 2005 and December 31, 2004 (dollars in thousands):

 

    

June 30,

2005


   

December 31,

2004


 

Over-collateralization account

   $ 158,621     158,755  

Net interest receivable (NIR)

     (13,058 )   (10,734 )
    


 

     $ 145,563     148,021  
    


 

 

The net interest receivable, or NIR, balance above represents the discounted value of cash flows expected to be received from net interest spread, while the over-collateralization account represents the current, un-discounted balance of over-collateralization as of the period end. Residual interests in securitizations are recorded at estimated fair value, which is based on estimated discounted cash flows, resulting in the presentation above.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

The following table summarizes the activity in the over-collateralization, or OC, accounts for the six months ended June 30, 2005 and 2004 (dollars in thousands):

 

    

Six Months Ended

June 30,


 
     2005

    2004

 

Balance, beginning of period

   $ 158,755     169,905  

Initial deposits to OC accounts

     7,914     —    

Additional deposits to OC accounts

     1,305     10,871  

Release of cash from OC accounts

     (9,353 )   (8,167 )
    


 

Balance, end of period

   $ 158,621     172,609  
    


 

 

The following table summarizes activity in the NIR accounts for the six months ended June 30, 2005 and 2004 (dollars in thousands):

 

    

Six Months Ended

June 30,


 
     2005

    2004

 

Balance, beginning of period

   $ (10,734 )   9,593  

NIR gains

     (1,670 )   21,871  

Cash received from NIRs

     (4,162 )   (19,370 )

Accretion of NIRs

     7,927     9,358  

Fair value adjustment

     (4,419 )   (6,770 )
    


 

Balance, end of period

   $ (13,058 )   14,682  
    


 

 

During the six months ended June 30, 2005, the Company completed a $989.2 million securitization structured as a sale. During the six months ended June 30, 2004, the Company completed a $337.1 million securitization structured as a sale, related to its investment in Carrington Mortgage Credit Fund I, LP, (“Carrington”). 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.

 

5. Mortgage Servicing Assets

 

Mortgage servicing assets represent the carrying value of our mortgage loan servicing rights. The following table summarizes activity in the mortgage servicing assets for the six months ended June 30, 2005 and 2004 (dollars in thousands):

 

    

Six Months Ended

June 30,


 
     2005

    2004

 

Balance, beginning of period

   $ 8,249     1,900  

Additions

     35,893     —    

Amortization

     (3,747 )   (252 )
    


 

Balance, end of period

   $ 40,395     1,648  
    


 

 

The Company records mortgage servicing assets when it sells loans on a servicing-retained basis and when it sells loans through whole loan sales to an investor in the current period and sells the servicing rights to a third party in a subsequent period.

 

The addition of $35.9 million for the six months ended June 30, 2005 includes (i) $27.2 million of servicing rights retained by the Company in certain of its whole loan sales to Carrington and (ii) $8.7 million of servicing rights related to the securitization structured as a sale completed in June 2005. The $8.7 million of servicing rights associated with the securitization structured as a sale was subsequently sold to a third party in August 2005 for $8.7 million. As of June 30, 2005, the Company had also retained the right to service $17.1 billion of loans underlying its portfolio of mortgage loans held for investment.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

6. Goodwill

 

Goodwill is recorded in connection with the acquisition of new subsidiaries and is included in prepaid expenses and other assets. As of June 30, 2005 and December 31, 2004, the Company had goodwill of $15.5 million. No impairment was recognized during the six months ended June 30, 2005.

 

7. Credit Facilities and Other Short-Term Borrowings

 

Credit facilities and other short-term borrowings consist of the following at June 30, 2005 and December 31, 2004 (dollars in thousands):

 

    

June 30,

2005


  

December 31,

2004


A $2.0 billion asset-backed commercial paper facility for Von Karman Funding LLC, a wholly-owned subsidiary of New Century Mortgage, expiring in September 2006, secured by mortgage loans held for sale and cash generated through the sale of loans, bearing interest based on a margin over one-month LIBOR.

   $ —      —  

A $2.0 billion master repurchase agreement ($1 billion of which is uncommitted) between New Century Funding A, a Delaware business trust which is a wholly-owned subsidiary of New Century Mortgage, and Bank of America, N.A., expiring in August 2005, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR. The Company expects to either renew or extend this facility prior to its expiration.

     769,730    975,119

A $1.0 billion master repurchase agreement among New Century Credit, NC Residual II Corporation, a wholly-owned subsidiary of NC Capital (“NC Residual II”), New Century Mortgage, NC Capital and Barclays Bank PLC expiring in November 2005, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR. The Company expects to either renew or extend this facility prior to its expiration.

     609,719    43,917

An $800 million aggregation facility ($400 million of which is uncommitted) from Bear Stearns Mortgage Capital expiring in October 2005, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR. The Company expects to either renew or extend this facility prior to its expiration.

     764,471    428,397

A $700 million master repurchase agreement among New Century Credit, New Century Mortgage, NC Capital, NC Residual II, and IXIS Real Estate Capital Inc. expiring in September 2005, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR. The Company expects to either renew or extend this facility prior to its expiration.

     428,626    617,141

A $150 million master repurchase agreement between New Century Funding SB-1, a Delaware business trust and wholly-owned subsidiary of New Century Mortgage, and Citigroup Global Markets, successor to Salomon Brothers, expiring in September 2005, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR. The Company expects to either renew or extend this facility prior to its expiration.

     —      —  

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

    

June 30,

2005


    December 31,
2004


 

A $650 million repurchase agreement among New Century Credit, NC Capital and Citigroup Global Markets Reality Corp., successor to Salomon Brothers, expiring in September 2005, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR. We have the ability to increase the size of this facility to $800 million provided that the value of the loans outstanding at any one time under this facility and the $150 million facility set forth immediately above may not exceed $800 million in the aggregate. The Company expects to either renew or extend this facility prior to its expiration.

     668,459     260,025  

A $150 million master loan and security agreement among New Century Mortgage, NC Capital, New Century Financial and Citigroup Global Markets Realty Corp., successor to Salomon Brothers Realty Corp., expiring in December 2005, secured by delinquent loans and REO properties, bearing interest based on a margin over one-month LIBOR. The Company expects to either renew or extend this facility prior to its expiration.

     1,091     959  

A $250 million repurchase agreement between New Century Mortgage and Citigroup Global Markets, which expires in December 2005, secured by small balance commercial mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR.

     25,529     54,398  

A $500 million master loan and security agreement among New Century Credit, New Century Mortgage, NC Capital and Credit Suisse First Boston Mortgage Capital LLC expiring in November 2005, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR. The Company expects to either renew or extend this facility prior to its expiration.

     352,785     —    

A $2.0 billion master loan and security agreement among New Century Credit, New Century Mortgage, NC Capital, NC Residual II, Morgan Stanley Bank, Concord Minutemen Capital Company, LLC and Morgan Stanley Mortgage Capital Inc. expiring in February 2007, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR.

     705,874     959,822  

A $2.0 billion asset-backed note purchase and security agreement ($500 million, of which is uncommitted) between New Century Funding I, a special-purpose vehicle established as a Delaware statutory trust, which is a wholly-owned subsidiary of New Century Mortgage, and UBS Real Estate Securities Inc., expiring in June 2006, secured by mortgage loans held for sale, bearing interest based on a margin over one-month LIBOR.

     1,320,764     1,141,167  

Less: Credit facility amounts reclassified to financing on mortgage loans held for investment

     (19,841 )   (776,677 )
    


 

     $ 5,627,207     3,704,268  
    


 

 

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

The various credit facilities contain certain restrictive financial and other covenants that require the Company to, among other things, restrict dividends, maintain certain levels of net worth, liquidity, available borrowing capacity, and debt-to-net worth ratios and to comply with regulatory and investor requirements. The Company was in compliance with these covenants at June 30, 2005.

 

8. Financing on Mortgage Loans Held for Investment

 

When the Company sells loans through securitizations structured as financings, the related bonds are added to its balance sheet. As of June 30, 2005 and December 31, 2004, the financing on mortgage loans held for investment consisted of the following (dollars in thousands):

 

    

June 30,

2005


   

December 31,

2004


 

Securitized bonds

   $ 18,378,752     12,379,524  

Short-term financing on retained bonds

     9,945     23,616  

2003-NC5 NIM bond

     —       7,583  

2005-NC3 NIM bond

     8,272     —    

Debt issuance costs

     (73,265 )   (81,427 )

Credit facility amounts reclassified from warehouse credit facilities

     19,841     776,677  
    


 

Total financing on mortgage loans held for investment

   $ 18,343,545     13,105,973  
    


 

 

The Company’s maturity of financing on mortgage loans held for investment is based on certain prepayment assumptions. The Company estimates the average life to be between 1.9 and 4.0 years. The following table reflects the estimated maturity of the financing on mortgage loans held for investment as of June 30, 2005 (dollars in thousands):

 

Due in less than 1 year

   $ 4,850,728

Due in 2 years

     5,587,436

Due in 3 years

     2,410,775

Thereafter

     5,494,606
    

     $ 18,343,545
    

 

9. Convertible Senior Notes Private Offering

 

On July 8, 2003, New Century TRS closed a private offering of $175.0 million of convertible senior notes due July 3, 2008 pursuant to Rule 144A under the Securities Act of 1933. On July 14, 2003, the initial purchasers of the convertible senior notes exercised their option, in full, to acquire an additional $35.0 million principal amount of the convertible senior notes. The convertible senior notes bear interest at a rate of 3.50% per year, paid semi-annually, and, as of March 17, 2004, became convertible into New Century TRS common stock at a conversion price of $34.80 per share. The conversion price represents a 28.0% premium over the closing share price on July 8, 2003. Principal balance is not due until maturity. As a result of the Merger, the convertible senior notes became convertible into shares of New Century common stock. On February 14, 2005, New Century, New Century TRS and the trustee under the indenture governing the convertible senior notes entered into a second supplemental indenture pursuant to which New Century agreed to fully and unconditionally guarantee the due and punctual payment of the convertible senior notes.

 

On November 22, 2004, New Century TRS commenced an offer, upon the terms and subject to the conditions described in the prospectus related to the offer and the accompanying letter of transmittal, to convert all the outstanding convertible senior notes into shares of New Century common stock, cash, or a combination of both. The offer and withdrawal rights expired at midnight, New York City time, on December 23, 2004. On December 24, 2004, New Century TRS accepted for payment $204.5 million, or approximately 97.4%, of the $210.0 million aggregate principal amount of the convertible senior notes then outstanding, which constituted all of the convertible senior notes validly tendered and not withdrawn. In the aggregate, the holders who tendered their convertible senior notes for conversion in the offer received 6,236,431 shares of New Century common stock, which included 359,796 shares for additional consideration and an additional $3.4 million in cash for accrued interest through that date. On June 27, 2005, a holder of New Century TRS’

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

convertible senior notes proposed, and it agreed, to convert $500,000 principal amount of convertible senior notes into 15,014 shares of its common stock. In connection with the conversion, the Company made a cash payment to the holder of $51,104, which included a conversion incentive fee and accrued interest through that date.

 

As of June 30, 2005, the number of shares of the Company’s common stock into which the remaining convertible senior notes were convertible into was 150,143, subject to certain adjustments under the terms of the convertible senior notes. For example, the terms of the convertible senior notes allow for the bondholder’s conversion rate to adjust if the Company’s dividend rate increases generally above a dividend yield of 1.75%, subject to certain other factors. As of June 30, 2005, the maximum number of shares of the Company’s common stock into which the remaining untendered convertible senior notes were convertible into was 176,637, subject to certain adjustments under the terms of the convertible senior notes. On July 29, 2005, concurrent with the payment of a cash dividend of $1.60 per share, the number of shares into which the remaining convertible senior notes were convertible was adjusted to 154,679.

 

10. Series A Cumulative Redeemable Preferred Stock Offering

 

In June 2005, the Company sold 4,500,000 shares, which included 300,000 shares sold to the underwriters to cover overallotments, of its Series A Cumulative Redeemable Preferred Stock, raising $109.0 million in net proceeds. The shares have a liquidation value of $25.00 per share and pay an annual coupon of 9.125% and are not convertible into any other securities. The Company may, at its option, redeem the Series A Cumulative Redeemable Preferred Stock, in the aggregate or in part, at any time on or after June 21, 2010. As such, this stock is not considered mandatorily or contingently redeemable under the provisions of SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity and is therefore classified as a component of equity. Accrued preferred stock dividends were $285,000 as of June 30, 2005.

 

11. Interest Income

 

The following table presents the components of interest income for the three and six months ended June 30, 2005 and 2004 (dollars in thousands):

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   2004

   2005

   2004

Interest on mortgage loans held for investment

   $ 315,887    97,472    563,547    176,809

Interest on mortgage loans held for sale

     98,830    89,071    175,029    158,063

Residual interest income

     3,903    4,578    7,927    9,358

Other interest income

     2,241    14    5,429    33
    

  
  
  
     $ 420,861    191,135    751,932    344,263
    

  
  
  

 

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

12. Interest Expense

 

The following table presents the components of interest expense for the three and six months ended June 30, 2005 and 2004 (dollars in thousands):

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   2004

   2005

   2004

Interest on financing on mortgage loans held for investment

   $ 160,646    33,430    278,366    66,415

Interest on credit facilities and other short-term borrowings

     54,850    29,743    97,056    49,686

Interest on convertible senior notes

     60    2,126    123    4,250

Other interest expense

     2,999    2,007    5,091    2,919
    

  
  
  
     $ 218,555    67,306    380,636    123,270
    

  
  
  

 

13. Hedging Activities

 

In connection with the Company’s strategy to mitigate interest rate risk on its residual assets, mortgage loans held for sale and mortgage loans held for investment, the Company uses derivative financial instruments such as Euro Dollar futures and interest rate cap contracts. It is not the Company’s policy to use derivatives to speculate on interest rates. These derivative instruments have an active secondary market, and are intended to provide income and cash flow to offset potential reduced interest income and cash flow under certain interest rate environments, as well as to hedge the fair value of certain fixed-rate mortgage loans held for investment and certain mortgage loans held for sale. In accordance with SFAS 133, the derivative financial instruments and any related margin accounts are reported on the condensed consolidated balance sheets at their fair value.

 

In 2003, the Company began applying hedge accounting as defined by SFAS 133 for certain derivative financial instruments used to hedge cash flows related to its financing on mortgage loans held for investment. In June 2004, the Company began applying hedge accounting for certain derivative financial instruments to hedge the fair value of certain of its mortgage loans held for investment and certain of its mortgage loans held for sale. The Company designates certain derivative financial instruments, Euro Dollar futures and interest rate cap contracts, as hedge instruments under SFAS 133, and, at trade date, these instruments and their hedging relationship are identified, designated and documented.

 

The Company documents the relationships between hedging instruments and hedged items, as well as its risk management objectives and strategies for undertaking various hedge transactions. This process includes linking derivatives to specific assets and liabilities on the condensed consolidated balance sheet. The Company also assesses, both at the inception of the hedge and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in cash flows or fair value of the hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company will discontinue hedge accounting prospectively.

 

When hedge accounting is discontinued because the Company determines that the derivative no longer qualifies as an effective hedge, the derivative will continue to be recorded on the condensed consolidated balance sheet at its fair value. Any change in the fair value of a derivative no longer qualifying as an effective hedge is recognized in current period earnings. When a hedge is terminated, it is derecognized at the time of termination. For terminated hedges or hedges that no longer qualify as effective, the effective position previously recorded is amortized or accreted into earnings with the hedged item.

 

Cash Flow Hedge Instruments - For derivative financial instruments designated as cash flow hedge instruments, the Company evaluates the effectiveness of these hedges against the interest payments related to its financing on mortgage loans held for investment being hedged to ensure there remains a highly effective correlation in the hedge relationship. To hedge the adverse effect of interest rate changes on the cash flows as a result of changes in the benchmark LIBOR interest rate, which affect the interest payments related to its financing on mortgage loans held for investment (variable rate debt) being hedged, the Company uses derivatives classified as cash flow hedges under SFAS 133. Once the hedge relationship is established, for those derivative instruments designated as qualifying cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income during the current period, and reclassified into earnings in the period(s) during which the hedged transaction

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

affects earnings pursuant to SFAS 133. The ineffective portion and/or remaining gain or loss on the derivative instrument is recognized in earnings in the current period. During the three and six months ended June 30, 2005, the Company recognized a gain of $3.6 million from the ineffective portion of these hedges. For the three and six months ended June 30, 2004, the Company recorded a charge to earnings of approximately $1.2 million and $3.0 million, respectively, for the ineffective portion of these hedges.

 

As of June 30, 2005, the Company had open Euro Dollar futures contracts that were designated as hedging the variability in expected cash flows from the variable rate debt related to its financing on mortgage loans held for investment. The fair value of these contracts at June 30, 2005 was an $11.0 million asset and is included in prepaid expenses and other assets. The fair value of these contracts at June 30, 2004 was a $26.6 million asset, and is included in prepaid expenses and other assets. For the three and six months ended June 30, 2005, the Company recognized a gain of $13.9 million and $20.6 million, respectively, attributable to cash flow hedges, which has been recorded as a reduction of interest expense related to the Company’s financing on mortgage loans held for investment. Additionally, certain Euro Dollar futures contracts were terminated during the fourth quarter of 2004 in connection with the transfer of certain assets from New Century TRS to New Century. The fair value of the contracts at the termination date of ($30.9) million is being amortized from other comprehensive income over the original hedge period, as the hedged transaction affects future earnings. The amortization of $3.1 million and $6.1 million, respectively, for the three and six months ended June 30, 2005 have been recorded as an increase in interest expense related to the Company’s financing on mortgage loans held for investment. As of June 30, 2005, the related other comprehensive income balance was ($24.8) million.

 

Fair Value Hedge Instruments - For derivative financial instruments designated as fair value hedge instruments, the Company evaluates the effectiveness of these hedges against the fair value of the asset being hedged to ensure that there remains a highly effective correlation in the hedge relationship. To hedge the adverse effect of interest rate changes on the fair value of the hedged assets as a result of changes in the benchmark LIBOR interest rate, the Company uses derivatives classified as fair value hedges under SFAS 133. Once the hedge relationship is established, for those derivative instruments designated as qualifying fair value hedges, changes in the fair value of the derivative instruments and changes in the fair value of the hedged asset or liability attributable to the hedged risk are recorded in current earnings pursuant to SFAS 133. For the three months ended June 30, 2005, the Company recognized a loss of $3.8 million whereas for the six months ended June 30, 2005, the Company recognized a gain of $4.8 million, which was substantially offset by changes in the fair value of the hedged assets. The gain (loss) has been included as a component of gain on sale of mortgage loans

 

As of June 30, 2005, the Company had open Euro Dollar futures contracts that were designated as fair value hedges. The fair value of these contracts at June 30, 2005 was a $6.5 million liability and is included in accounts payable and accrued liabilities. The fair value of these contracts was substantially offset by changes in the fair value of the hedged assets.

 

Interest Rate Cap - Certain of the Company’s securitizations structured as financings are subject to interest rate cap contracts, or caplets, designated and documented as cash flow hedges, used to mitigate interest rate risk. The change in the fair value of these interest rate cap contracts is recorded in other comprehensive income each period. Amounts are reclassified out of other comprehensive income as the hedged transactions impact earnings. For the three and six months ended June 30, 2005, the Company recorded interest expense of $2.7 million and $5.0 million, respectively, related to the amortization of the caplets. The related net change to other comprehensive income due to the amortization and change in fair value of the caplets was $2.3 million. At June 30, 2004, such caplets were not designated as hedges. The fair value of these caplets was $2.2 million at June 30, 2005 and is included in prepaid expenses and other assets.

 

During the six months ended June 30, 2004, certain of the Company’s securitizations structured as financings were subject to interest rate cap contracts, not designated and documented as hedges, used to mitigate interest rate risk. The change in the fair value of these interest rate cap contracts is recorded through earnings each period, and is included as a component of interest expense. For the three months ended June 30, 2004, the Company recognized interest expense reduction of $1.8 million and for the six months ended June 30, 2004, the Company recognized interest expense of $338,000 related to the change in fair value of these cap contracts. The fair value of these cap contracts at June 30, 2004 was $3.2 million and is included in prepaid expenses and other assets. At June 30, 2005, all cap contracts were designated as hedges.

 

Non-designated Hedge Instruments - For derivative financial instruments not designated as hedge instruments, realized and unrealized changes in fair value are recognized in the period in which the changes occur.

 

The change in the fair value of Euro Dollar futures contracts, not designated and documented as hedges, used to mitigate interest rate risk in the Company’s residual assets is recorded through earnings each period, and is included as a component of gain on sale. During the three and six months ended June 30, 2005, the

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

Company recognized a gain of zero and $395,000, respectively, related to the change in fair value of these contracts. These contracts were settled at March 31, 2005, and as such had no fair value as of that date. For the three and six months ended June 30, 2004, the Company recognized a gain of $3.2 million and $1.0 million, respectively, related to the change in the fair value of these contracts. The fair value of these contracts at June 30, 2004 was a $236,000 asset, and is included in prepaid expenses and other assets.

 

14. Income Taxes

 

Commencing in 2004, New Century has operated so as to qualify as a REIT for federal income tax purposes and will file a separate federal income tax return that does not include the operations of the Company’s non-REIT, or TRS, companies. Provided at least 90% of the taxable income of the REIT is distributed to stockholders in the manner prescribed by the Code, no income taxes are due on the income distributed in the form of dividends by the REIT. Effective tax rates for all periods reported upon in 2005 will therefore differ substantially from rates in 2004 when most of the operations of the Company were taxable. The table below outlines the calculation of tax expense and a comparison of the components comprising the differences in the tax rate for the consolidated group for the three and six months ended 2005 and 2004 (dollars in thousands):

 

     Three Months Ended June 30,

    Six Months Ended June 30,

 
    

2005


    2004

   

2005


    2004

 
     REIT

    TRS

    Total

    Non-REIT

    REIT

    TRS

    Total

    Non-REIT

 

Earnings before income taxes

   $ 79,234     14,157     93,391     162,386     143,820     40,735     184,555     318,853  

Taxable REIT earnings (expense) in excess of GAAP Earnings

     41,763     (21,644 )   20,119     N/A     65,408     (36,677 )   28,731     N/A  
    


 

 

 

 

 

 

 

Taxable REIT and taxable TRS income

     120,997     (7,487 )   113,510     162,386     209,228     4,058     213,286     318,853  

Expected dividend paid deduction for REIT level companies

     (120,997 )   N/A     (120,997 )   N/A     (209,228 )   N/A     (209,228 )   N/A  
    


 

 

 

 

 

 

 

Taxable income after REIT dividend paid deduction

   $ —       (7,487 )   (7,487 )   162,386     —       4,058     4,058     318,853  
    


 

 

 

 

 

 

 

Income tax (expense) benefit by entity

     747     941     1,688     (60,009 )   —       (4,716 )   (4,716 )   (129,231 )

Add back earnings before income taxes

     79,234     14,157     93,391     162,386     143,820     40,735     184,555     318,853  
    


 

 

 

 

 

 

 

Net earnings by entity

   $ 79,981     15,098     95,079     102,377     143,820     36,019     179,839     189,622  
    


 

 

 

 

 

 

 

Combined tax rate

                 -1.81 %   36.95 %               2.56 %   40.53 %
                  

 

             

 

 

For 2005, the Company has available an additional “Dividend Paid Deduction” which was not required to be utilized in its 2004 tax year. After operating so as to qualify as a REIT in 2004, the Company’s first REIT dividend shareholder record date and payment date were both January 2005 events. By applying, via a tax election, only the portion of its January 2005 dividend representing taxable earnings on the 2004 tax return, the remaining dividend paid in January 2005 of approximately $27.0 million is deductible against the Company’s taxable REIT income in 2005, reducing the amount of distributions that otherwise would be required to avoid a tax liability on undistributed taxable income. Based upon this additional $27.0 million deduction and the Company’s dividend guidance for the current year, no accrual of taxes for taxable REIT income in excess of the dividends paid out to date are required for the six months ended June 30, 2005.

 

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

15. Earnings per Share

 

The following table illustrates the computation of basic and diluted earnings per share for the periods indicated (dollars in thousands, except per share amounts):

 

    

Three Months Ended

June 30,


  

Six Months Ended

June 30,


     2005

   2004

   2005

   2004

Basic:

                     

Net earnings

   $ 95,079    102,377    179,839    189,622

Less: Preferred stock dividends

     285    —      285    —  
    

  
  
  

Net earnings available to common stockholders

   $ 94,794    102,377    179,554    189,622
    

  
  
  

Weighted average number of common shares outstanding

     55,376    33,299    55,079    33,129
    

  
  
  

Earnings per share

   $ 1.71    3.07    3.26    5.72
    

  
  
  

Diluted:

                     

Net earnings available to common stockholders

   $ 94,794    102,377    179,554    189,622

Add: Interest and amortization of debt issuance costs on convertible senior notes, net of tax

     77    1,254    95    2,486
    

  
  
  

Diluted net earnings

   $ 94,871    103,631    179,649    192,108
    

  
  
  

Weighted average number of common shares outstanding

     55,376    33,299    55,079    33,129

Dilutive effect of convertible senior notes, stock options and restricted stock

     2,020    8,863    2,253    8,960
    

  
  
  
       57,396    42,162    57,332    42,089
    

  
  
  

Earnings per share

   $ 1.65    2.46    3.13    4.56
    

  
  
  

 

For the three and six months ended June 30, 2005, the Company has included the effect of approximately 165,000 shares of common stock issuable related to its convertible senior notes in the computation of diluted earnings per share. For the three and six months ended June 30, 2004, the Company has included the effect of approximately 6.0 million shares of common stock issuable under its convertible senior notes in the computation of diluted earnings per share. Diluted earnings have been adjusted to add the interest expense and amortization of debt issuance costs recorded related to the convertible senior notes, net of the applicable income tax effect.

 

For the three months ended June 30, 2005 and 2004, options to purchase 313,000 and 855,000 shares, respectively, of the Company’s common stock were excluded from the calculation of diluted earnings per share because their effect was anti-dilutive. For the six months ended June 30, 2005 and 2004, options to purchase 196,000 and 795,000 shares, respectively, of the Company’s common stock were excluded from the calculation of diluted earnings per share because their effect was anti-dilutive.

 

16. Consolidating Financial Information

 

On February 14, 2005, New Century and New Century TRS entered into a second supplemental indenture in connection with New Century’s agreement to guarantee the payment of New Century TRS’ obligations with respect to its 3.50% convertible senior notes due 2008 (see Note 9—Convertible Senior Notes Private Offering).

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Unaudited Condensed Consolidating Schedule - Balance Sheet

 

June 30, 2005

 

(Dollars in thousands)

 

The following is consolidating information as to the financial condition, results of operations and cash flows of New Century:

 

    

New Century

Financial

Corporation


   

New Century

Residual IV
Corporation


   

New Century

Credit

Corporation


   

New Century

TRS

Holdings, Inc.


    Eliminations

    Consolidated

 
Assets                                       

Cash and cash equivalents

   $ 407,069     —       1,000     161,084     —       569,153  

Restricted cash

     —       553,219     —       183,040     —       736,259  

Mortgage loans held for sale, net

     —       —       —       5,989,211     —       5,989,211  

Mortgage loans held for investment, net

     —       15,454,417     25,750     3,071,569     (68,746 )   18,482,990  

Residual interests in securitizations

     —       —       —       145,563     —       145,563  

Mortgage servicing assets

     —       —       —       40,395     —       40,395  

Accrued interest receivable

     —       86,401     232     21,717     —       108,350  

Income taxes, net

     —       —       —       93,122     —       93,122  

Office property and equipment, net

     —       —       —       72,774     —       72,774  

Prepaid expenses and other assets

     512     23,088     (3,054 )   140,722     32,895     194,163  

Due to (from) affiliates

     251,805     (214,614 )   46,007     (83,198 )   —       —    

Investment in subsidiary

     1,433,997     —       —       —       (1,433,997 )   —    
    


 

 

 

 

 

Total assets

   $ 2,093,383     15,902,511     69,935     9,835,999     (1,469,848 )   26,431,980  
    


 

 

 

 

 

Liabilities and Stockholders’ Equity                                       

Credit facilities on mortgage loans held for sale

   $ —       —       —       5,627,207     —       5,627,207  

Financing on mortgage loans held for investment, net

     —       15,274,603     19,841     3,049,101     —       18,343,545  

Accounts payable and accrued liabilities

     92,329     18,251     —       300,771     —       411,351  

Convertible senior notes, net

     —       —       —       4,919     —       4,919  

Notes payable

     —       —       —       43,904     —       43,904  
    


 

 

 

 

 

Total liabilities

     92,329     15,292,854     19,841     9,025,902     —       24,430,926  
    


 

 

 

 

 

Commitments and contingencies

                                      

Stockholders’ equity:

                                      

Preferred stock

     45     —       —       —       —       45  

Common stock

     562     —       —       —       —       562  

Additional paid-in capital

     1,236,226     450,152     3,000     —       (453,152 )   1,236,226  

Accumulated other comprehensive income (loss)

     (20,668 )   933     —       (21,601 )   20,668     (20,668 )

Retained earnings, restricted

     784,889     158,572     47,094     831,698     (1,037,364 )   784,889  
    


 

 

 

 

 

Total stockholders’ equity

     2,001,054     609,657     50,094     810,097     (1,469,848 )   2,001,054  
    


 

 

 

 

 

Total liabilities and stockholders’ equity

   $ 2,093,383     15,902,511     69,935     9,835,999     (1,469,848 )   26,431,980  
    


 

 

 

 

 

 

 

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NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Consolidating Schedule – Balance Sheet

 

December 31, 2004

 

(Dollars in thousands)

 

    

New Century

Financial

Corporation


   

New Century

Residual IV

Corporation


  

New Century

Credit

Corporation


  

New Century

TRS

Holdings, Inc.


    Eliminations

    Consolidated

 
Assets                                     

Cash and cash equivalents

   $ 742,239     —      1,000    99,615     —       842,854  

Restricted cash

     9,000     274,408    —      170,627     —       454,035  

Mortgage loans held for sale, net

     —       —      —      3,922,865     —       3,922,865  

Mortgage loans held for investment, net

     —       8,582,010    806,479    3,834,614     (27,779 )   13,195,324  

Residual interests in securitizations

     —       —      —      148,021     —       148,021  

Mortgage servicing assets

     —       —      —      8,249     —       8,249  

Accrued interest receivable

     —       43,374    1,328    21,506     —       66,208  

Income taxes, net

     —       —      —      180,840     —       180,840  

Office property and equipment, net

     —       —      —      47,266     —       47,266  

Prepaid expenses and other assets

     213     40,062    1,694    126,066     18,247     186,282  

Due to (from) affiliates

     (30,568 )   44,288    39,006    (52,726 )   —       —    

Investment in subsidiary

     1,240,315     —      —      —       (1,240,315 )   —    
    


 
  
  

 

 

Total assets

   $ 1,961,199     8,984,142    849,507    8,506,943     (1,249,847 )   19,051,944  
    


 
  
  

 

 

Liabilities and Stockholders’ Equity                                     

Credit facilities on mortgage loans held for sale

   $ —       —      —      3,704,268     —       3,704,268  

Financing on mortgage loans held for investment, net

     —       8,467,650    776,676    3,861,647     —       13,105,973  

Accounts payable and accrued liabilities

     82,634     8,277    59,853    169,344     —       320,108  

Convertible senior notes, net

     —       —      —      5,392     —       5,392  

Notes payable

     —       —      —      37,638     —       37,638  
    


 
  
  

 

 

Total liabilities

     82,634     8,475,927    836,529    7,778,289     —       17,173,379  

Commitments and contingencies

                                    

Stockholders’ equity:

                                    

Common stock

     547     —      —      —       —       547  

Additional paid-in capital

     1,101,091     450,152    3,000    —       (453,152 )   1,101,091  

Accumulated other comprehensive income (loss)

     (4,700 )   23,608    —      (28,307 )   4,699     (4,700 )

Retained earnings, restricted

     781,627     34,455    9,978    756,961     (801,394 )   781,627  
    


 
  
  

 

 

Total stockholders’ equity

     1,878,565     508,215    12,978    728,654     (1,249,847 )   1,878,565  
    


 
  
  

 

 

Total liabilities and stockholders’ equity

   $ 1,961,199     8,984,142    849,507    8,506,943     (1,249,847 )   19,051,944  
    


 
  
  

 

 

 

 

26


Table of Contents

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Unaudited Condensed Consolidating Schedule – Statements of Income

 

For the Three Months Ended

 

June 30, 2005 and 2004

 

(Dollars in thousands)

 

     June 30, 2005

    June 30, 2004

 
    

New Century

Financial

Corporation


   

New Century

Residual IV

Corporation


   

New Century

Credit

Corporation


   

New Century

TRS

Holdings, Inc.


    Eliminations

    Consolidated

   

New Century

TRS

Holdings, Inc.


 

Interest income

   $ 2,246     249,883     26,854     161,776     (19,898 )   420,861     191,135  

Interest expense

     (4,783 )   (103,094 )   (6,204 )   (104,474 )   —       (218,555 )   (67,306 )
    


 

 

 

 

 

 

Net interest income

     (2,537 )   146,789     20,650     57,302     (19,898 )   202,306     123,829  

Provision for losses on mortgage loans held for investment

     —       (36,550 )   —       (325 )   —       (36,875 )   (17,112 )
    


 

 

 

 

 

 

Net interest income after provision for losses

     (2,537 )   110,239     20,650     56,977     (19,898 )   165,431     106,717  

Other operating income:

                                            

Gain (loss) on sale of mortgage loans

     —       —       —       135,240     3,464     138,704     215,051  

Servicing fees received (paid)

     —       (15,991 )   (360 )   22,982     —       6,631     7,753  

Other income

     —       443     2,967     (12 )   —       3,398     829  

Equity in net earnings of subsidiary

     105,573     —       —       —       (105,573 )   —       —    
    


 

 

 

 

 

 

Total other operating income

     105,573     (15,548 )   2,607     158,210     (102,109 )   148,733     223,633  
    


 

 

 

 

 

 

Operating expenses:

                                            

Personnel

     4,565     —       —       143,496     —       148,061     109,000  

General and administrative

     3,255     —       —       39,069     —       42,324     34,551  

Advertising and promotion

     —       —       —       20,711     —       20,711     15,684  

Professional services

     137     —       —       9,540     —       9,677     8,729  
    


 

 

 

 

 

 

Total operating expenses

     7,957     —       —       212,816     —       220,773     167,964  
    


 

 

 

 

 

 

Earnings before income taxes

     95,079     94,691     23,257     2,371     (122,007 )   93,391     162,386  

Income taxes

     —       (747 )   —       (941 )   —       (1,688 )   60,009  
    


 

 

 

 

 

 

Net earnings

   $ 95,079     95,438     23,257     3,312     (122,007 )   95,079     102,377  
    


 

 

 

 

 

 

 

 

27


Table of Contents

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Unaudited Condensed Consolidating Schedule – Statements of Income

 

For the Six Months Ended

 

June 30, 2005 and 2004

 

(Dollars in thousands)

 

     June 30, 2005

    June 30, 2004

 
    

New Century

Financial

Corporation


   

New Century

Residual IV

Corporation


   

New Century

Credit

Corporation


   

New Century

TRS

Holdings, Inc.


    Eliminations

    Consolidated

   

New Century

TRS

Holdings, Inc.


 

Interest income

   $ 4,574     417,877     46,429     306,175     (23,123 )   751,932     344,263  

Interest expense

     (5,200 )   (168,685 )   (14,108 )   (192,643 )   —       (380,636 )   (123,270 )
    


 

 

 

 

 

 

Net interest income

     (626 )   249,192     32,321     113,532     (23,123 )   371,296     220,993  

Provision for losses on mortgage loans held for investment

     —       (65,701 )   —       (1,412 )   —       (67,113 )   (36,981 )
    


 

 

 

 

 

 

Net interest income after provision for losses

     (626 )   183,491     32,321     112,120     (23,123 )   304,183     184,012  

Other operating income:

                                            

Gain (loss) on sale of mortgage loans

     —       513     —       281,139     (3,196 )   278,456     417,027  

Servicing fees received (paid)

     —       (27,967 )   (496 )   41,816     —       13,353     13,649  

Other income

     —       887     5,292     1,092     —       7,271     829  

Equity in net earnings of subsidiary

     193,389     —       —       —       (193,389 )   —       —    
    


 

 

 

 

 

 

Total other operating income

     193,389     (26,567 )   4,796     324,047     (196,585 )   299,080     431,505  
    


 

 

 

 

 

 

Operating expenses:

                                            

Personnel

     6,209     —       —       270,374     —       276,583     189,966  

General and administrative

     6,453     —       —       77,646     —       84,099     64,383  

Advertising and promotion

     —       —       —       40,543     —       40,543     29,249  

Professional services

     262     —       —       17,221     —       17,483     13,066  
    


 

 

 

 

 

 

Total operating expenses

     12,924     —       —       405,784     —       418,708     296,664  
    


 

 

 

 

 

 

Earnings before income taxes

     179,839     156,924     37,117     30,383     (219,708 )   184,555     318,853  

Income taxes

     —       —       —       4,716     —       4,716     129,231  
    


 

 

 

 

 

 

Net earnings

   $ 179,839     156,924     37,117     25,667     (219,708 )   179,839     189,622  
    


 

 

 

 

 

 

 

 

28


Table of Contents

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

Unaudited Consolidating Statements of Cash Flows

 

Six Months Ended June 30, 2005 and 2004

 

(Dollars in thousands)

 

     June 30, 2005

    June 30, 2004

 
    

New Century

Financial

Corporation


   

New Century

Residual IV

Corporation


   

New Century

Credit

Corporation


   

New Century

TRS

Holdings, Inc.


    Eliminations

    Consolidated

    New Century
TRS
Holdings, Inc.


 

Cash flows from operating activities:

                                            

Net earnings

   $ 179,839     156,924     37,117     25,667     (219,708 )   179,839     189,622  

Adjustments to reconcile net earnings to net cash provided by operating activities:

                                            

Depreciation and amortization

     1,359     35,019     —       20,933     —       57,311     12,105  

Cash flows received from residual interests

     —       —       —       12,210     —       12,210     27,537  

Accretion of NIRs

     —       —       —       (7,927 )   —       (7,927 )   (9,358 )

NIR gains

     —       —       —       1,670     —       1,670     (21,871 )

Initial deposits to over-collateralization accounts

     —       —       —       (7,914 )   —       (7,914 )   (10,871 )

Retained bond

     —       —       —       —       —       —       (3,536 )

Servicing gains

     —       —       —       (35,893 )   —       (35,893 )   —    

Fair value adjustment of residual securities

     —       —       —       4,419     —       4,419     6,770  

Provision for losses on mortgage loans held for investment

     —       65,701     —       1,412     —       67,113     36,981  

Provision for repurchase losses

     —       —       —       6,072     —       6,072     3,184  

Mortgage loans originated or acquired for sale

     —       —       —       (15,587,599 )   —       (15,587,599 )   (17,234,447 )

Mortgage loan sales, net

     —       —       —       13,520,803     —       13,520,803     14,140,969  

Principal payments on mortgage loans held for sale

     —       —       —       115,017     —       115,017     55,709  

Increase in credit facilities on mortgage loans held for sale

     —       —       —       1,922,939     —       1,922,939     2,808,168  

Due to (from) affiliates

     (282,373 )   258,902     (7,002 )   30,473     —       —       —    

Tax benefit related to non-qualified stock options

     —       —       —       14,594     —       14,594     —    

Net change in other assets and liabilities

     4,236     (34,448 )   (54,009 )   113,634     (14,648 )   14,765     51,217  

Equity in undistributed earnings of subsidiaries

     (193,389 )   —       —       —       193,389     —       —    
    


 

 

 

 

 

 

Net cash provided by (used in) operating activities

     (290,328 )   482,098     (23,894 )   150,510     (40,967 )   277,419     52,179  
    


 

 

 

 

 

 

Cash flows from investing activities:

                                            

Mortgage loans originated or acquired for investment, net

     —       (9,037,680 )   784,406     37,991     40,967     (8,174,316 )   (3,457,776 )

Principal payments on mortgage loans held for investment

     —       2,034,024     (3,677 )   729,553     —       2,759,900     739,313  

Purchases of office property and equipment

     —       —       —       (35,618 )   —       (35,618 )   (12,594 )
    


 

 

 

 

 

 

Net cash provided by (used in) investing activities

     —       (7,003,656 )   780,729     731,926     40,967     (5,450,034 )   (2,731,057 )
    


 

 

 

 

 

 

Cash flows from financing activities:

                                            

Proceeds from issuance of financing on mortgage loans held for investment, net

     —       8,575,660     —       (1,204 )   —       8,574,456     5,017,915  

Repayments of financing on mortgage loans held for investment

     —       (1,775,291 )   —       (813,116 )   —       (2,588,407 )   (640,625 )

Decrease in credit facilities on mortgage loans held for investment

     —       —       (756,835 )   —       —       (756,835 )   (1,680,487 )

Proceeds from issuance of preferred stock

     108,956     —       —       —       —       108,956     —    

Proceeds from notes payable

     —       —       —       15,726     —       15,726     17,756  

Repayments of notes payable

     —       —       —       (9,460 )   —       (9,460 )   (6,248 )

Change in restricted cash

     9,000     (278,811 )   —       (12,413 )   —       (282,224 )   (205,486 )

Payment of dividends on common stock

     (168,938 )   —       —       —       —       (168,938 )   (12,132 )

Net proceeds from issuance of stock

     17,933     —       —       (500 )   —       17,433     4,527  

Purchase of treasury stock

     (11,793 )   —       —       —       —       (11,793 )   —    
    


 

 

 

 

 

 

Net cash provided by (used in) financing activities

     (44,842 )   6,521,558     (756,835 )   (820,967 )   —       4,898,914     2,495,220  
    


 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

     (335,170 )   —       —       61,469     —       (273,701 )   (183,658 )

Cash and cash equivalents, beginning of period

     742,239     —       1,000     99,615     —       842,854     278,598  
    


 

 

 

 

 

 

Cash and cash equivalents, end of period

   $ 407,069     —       1,000     161,084     —       569,153     94,940  
    


 

 

 

 

 

 

 

 

29


Table of Contents

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

17. Segment Reporting

 

The operating segments reported below are the segments of the Company for which separate financial information is available and for which revenues and operating income amounts are evaluated regularly by management in deciding how to allocate resources and in assessing performance.

 

The portfolio segment reflects the Company’s investment in its mortgage loan portfolio, which produces net interest income. The mortgage loan operations segment reflects purchases and originations of non-conforming residential mortgage loans through relationships with various mortgage companies, mortgage brokers, correspondent lenders, and directly to borrowers. The mortgage loan operations segment records (i) interest income, interest expense, provision for mortgage loans losses on the mortgage loans it holds prior to selling its loans to the portfolio segment or in the whole loan market, (ii) interest income, interest expense, provision for mortgage loan losses on mortgage loans it holds in its portfolio and (iii) gain on sale of mortgage loans. The servicing segment services loans, seeking to ensure that loans are repaid in accordance with their terms and earns a servicing fee based upon the dollar amount of the servicing portfolio.

 

For its portfolio segment, management evaluates mortgage assets at the segment level. As such, the quarter end balances of these assets are included herein.

 

For the three and six months ended June 30, 2005 and 2004 (dollars in thousands):

 

     Three Months Ended June 30, 2005

 
     Qualified REIT
Subsidiary


   

Taxable REIT

Subsidiary


      
     Portfolio

    Portfolio

    Mortgage Loan
Operations


    Servicing and
other


   Total

 

Interest income

   $ 250,766     60,705     109,390     —      420,861  

Interest expense

     (114,081 )   (46,565 )   (57,909 )   —      (218,555 )
    


 

 

 
  

Net interest income

     136,685     14,140     51,481     —      202,306  

Provision for losses on mortgage loans held for investment

     (36,550 )   (325 )   —       —      (36,875 )
    


 

 

 
  

Net interest income after provision for losses

     100,135     13,815     51,481     —      165,431  

Other operating income:

                               

Gain on sale of mortgage loans

     —       —       138,704     —      138,704  

Servicing & other

     (12,942 )   —       (5,270 )   28,241    10,029  
    


 

 

 
  

Total other operating income

     (12,942 )   —       133,434     28,241    148,733  
    


 

 

 
  

Operating expenses

     7,959     —       201,774     11,040    220,773  
    


 

 

 
  

Earnings before income taxes

   $ 79,234     13,815     (16,859 )   17,201    93,391  
    


 

 

 
  

Funding volume

   $ —       —       13,444,170     —      13,444,170  
    


 

 

 
  

Securitizations structured as financings

   $ 5,890,404     —       —       —      5,890,404  
    


 

 

 
  

Mortgage assets at June 30, 2005

   $ 15,411,421     3,071,569     5,989,211     —      24,472,201  
    


 

 

 
  

 

30


Table of Contents

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

     Three Months Ended June 30, 2004

 
    

Taxable REIT

Subsidiary


      
     Portfolio

    Mortgage Loan
Operations


    Servicing and
other


   Total

 

Interest income

   $ 102,050     89,085     —      191,135  

Interest expense

     (33,430 )   (33,876 )   —      (67,306 )
    


 

 
  

Net interest income

     68,620     55,209     —      123,829  

Provision for losses on mortgage loans held for investment

     (17,112 )   —       —      (17,112 )
    


 

 
  

Net interest income after provision for losses

     51,508     55,209     —      106,717  

Other operating income:

                         

Gain on sale of mortgage loans

     —       215,051     —      215,051  

Servicing & other

     —       (6,503 )   15,085    8,582  
    


 

 
  

Total other operating income

     —       208,548     15,085    223,633  
    


 

 
  

Operating expenses

     —       161,786     6,178    167,964  
    


 

 
  

Earnings before income taxes

   $ 51,508     101,971     8,907    162,386  
    


 

 
  

Funding volume

   $ —       12,255,867     —      12,255,867  
    


 

 
  

Securitizations structured as financings

   $ 3,457,776     —       —      3,457,776  
    


 

 
  

Mortgage assets at June 30, 2004

   $ 9,146,472     4,784,222     —      13,930,694  
    


 

 
  

 

31


Table of Contents

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

     Six Months Ended June 30, 2005

 
     Qualified REIT
Subsidiary


   

Taxable REIT

Subsidiary


      
     Portfolio

    Portfolio

    Mortgage Loan
Operations


    Servicing and
other


   Total

 

Interest income

   $ 432,210     125,717     194,005     —      751,932  

Interest expense

     (187,993 )   (90,373 )   (102,270 )   —      (380,636 )
    


 

 

 
  

Net interest income

     244,217     35,344     91,735     —      371,296  

Provision for losses on mortgage loans held for investment

     (65,701 )   (1,412 )   —       —      (67,113 )
    


 

 

 
  

Net interest income after provision for losses

     178,516     33,932     91,735     —      304,183  

Other operating income:

                               

Gain on sale of mortgage loans

     513     —       277,943     —      278,456  

Servicing & other

     (22,284 )   —       (10,619 )   53,527    20,624  
    


 

 

 
  

Total other operating income

     (21,771 )   —       267,324     53,527    299,080  
    


 

 

 
  

Operating expenses

     12,925     —       384,035     21,748    418,708  
    


 

 

 
  

Earnings before income taxes

   $ 143,820     33,932     (24,976 )   31,779    184,555  
    


 

 

 
  

Funding volume

   $ —       —       23,695,737     —      23,695,737  
    


 

 

 
  

Securitizations structured as financings

   $ 8,881,728     —       —       —      8,881,728  
    


 

 

 
  

Mortgage assets at June 30, 2005

   $ 15,411,421     3,071,569     5,989,211     —      24,472,201  
    


 

 

 
  

 

 

32


Table of Contents

NEW CENTURY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

(Unaudited)

 

June 30, 2005 and 2004

 

     Six Months Ended June 30, 2004

 
    

Taxable REIT

Subsidiary


      
     Portfolio

   

Mortgage Loan

Operations


    Servicing and
other


   Total

 

Interest income

   $ 186,167     158,096     —      344,263  

Interest expense

     (66,415 )   (56,855 )   —      (123,270 )
    


 

 
  

Net interest income

     119,752     101,241     —      220,993  

Provision for losses on mortgage loans held for investment

     (36,981 )   —       —      (36,981 )
    


 

 
  

Net interest income after provision for losses

     82,771     101,241     —      184,012  

Other operating income:

                         

Gain on sale of mortgage loans

     —       417,027     —      417,027  

Servicing & other

     —       (12,717 )   27,195    14,478  
    


 

 
  

Total other operating income

     —       404,310     27,195    431,505  
    


 

 
  

Operating expenses

     —       284,822     11,842    296,664  
    


 

 
  

Earnings before income taxes

   $ 82,771     220,729     15,353    318,853  
    


 

 
  

Funding volume

   $ —       20,692,223     —      20,692,223  
    


 

 
  

Securitizations structured as financings

   $ 3,457,776     —       —      3,457,776  
    


 

 
  

Mortgage assets at June 30, 2004

   $ 9,146,472     4,784,222     —      13,930,694  
    


 

 
  

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This Quarterly Report on Form 10-Q represents an update to the more detailed and comprehensive disclosures included in our Annual Report on Form 10-K for the year ended December 31, 2004. As such, a reading of the Annual Report on Form 10-K is necessary to an informed understanding of the following discussions.

 

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. As used herein, except where the context suggests otherwise, for time periods on and after October 1, 2004, the terms “the company,” “our,” “its,” “we,” “the group,” and “us” refer to New Century Financial Corporation and its consolidated subsidiaries and for the time periods before October 1, 2004, the terms “the company,” “our,” “its,” “we,” “the group,” and “us” mean New Century TRS Holdings, Inc. and its consolidated subsidiaries.

 

General

 

New Century Financial Corporation is a real estate investment trust, or REIT, that, through its taxable REIT subsidiaries, operates one of the nation’s largest subprime mortgage finance companies. We have been originating and purchasing subprime loans since 1996, and, in the fourth quarter of 2004, we began operating our business as a REIT. We will elect to be taxed as a REIT when we file our tax returns for 2004. In connection with our REIT conversion, we closed an offering of approximately $770.0 million of our common stock, net of underwriting and other expenses. The net proceeds from the offering have been used primarily to build a portfolio of mortgage assets. We expect that our portfolio of mortgage assets will provide a relatively stable source of revenues and will contribute a significant portion of our earnings in 2005.

 

We originate and purchase primarily first mortgage products nationwide. We focus on lending to individuals whose borrowing needs are generally not fulfilled by traditional financial institutions because they do not satisfy the credit, documentation or other underwriting standards prescribed by conventional mortgage lenders and loan buyers. 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 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 credit risks associated with this segment of the mortgage industry.

 

We have historically sold our loans through both whole loan sales and securitizations. Until 2003, we typically structured those securitizations as sales. Since 2003, we have retained a portion of our loan production for investment on our balance sheet through securitizations structured as financings rather than sales. For 2005, we expect to retain between 20% and 30% of our total loan production for investment on our balance sheet. However, a substantial majority of these investments occurred during the first six months of 2005 and the substantial majority of our whole loan sales will occur during the second half of 2005. Whole loan sales provide greater current period earnings relative to investments in securitizations, which recognize income over time. Given the anticipated timing of our investments in securitizations, we expect that our reported earnings in the second half of 2005 will exceed our reported earnings in the first half of 2005.

 

We converted to a REIT in 2004 because we believe that the REIT structure provides the most tax-efficient way to hold mortgage loans on our balance sheet. We expect that we will continue to increase the size of our on-balance sheet mortgage loan portfolio, producing more diverse revenues across a variety of interest rate environments. We intend to evaluate, from time to time, whether we should engage in various capital raising activities, which may include offerings of debt, preferred stock, common stock or equity-linked securities.

 

The Merger and Related Transactions

 

On April 5, 2004, the board of directors of New Century TRS Holdings, Inc., or New Century TRS, formerly known as New Century Financial Corporation, approved a plan to change its capital structure to enable it to qualify as a REIT for U.S. federal income tax purposes. The board of directors of New Century TRS based its decision to convert New Century TRS to a REIT on several factors, including the potential for increased stockholder return, tax efficiency and ability to achieve growth objectives. On April 19, 2004, the board of directors of New Century TRS approved certain legal and financial matters related to the proposed REIT conversion.

 

On April 12, 2004, New Century TRS formed New Century Financial Corporation, or New Century, a Maryland corporation formerly known as New Century REIT, Inc. On September 15, 2004, the stockholders of both New Century and New Century TRS approved and adopted the merger agreement that implemented the restructuring of New Century TRS in order for it to qualify as a REIT.

 

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Pursuant to the merger agreement, (i) a wholly-owned subsidiary of New Century merged with and into New Century TRS, with New Century TRS as the surviving corporation, (ii) each outstanding share of common stock of New Century TRS was converted into one share of New Century common stock, (iii) New Century TRS changed its name to “New Century TRS Holdings, Inc.” and became a wholly-owned subsidiary of New Century and (iv) New Century changed its name to “New Century Financial Corporation” and became the publicly-traded NYSE-listed parent company that succeeded to and continued to operate substantially all of the existing businesses of New Century TRS. The merger was consummated and became effective on October 1, 2004.

 

The board of directors, committees of the board of directors and management of New Century immediately after the consummation of the merger had the same membership as the board of directors, committees of the board of directors and management of New Century TRS immediately prior to the consummation of the merger.

 

As a result of the merger and the related capital-raising activities, we expect that a significant source of our revenue prospectively will be interest income generated from our portfolio of mortgage loans held by our REIT and our qualified REIT subsidiaries. We also expect to continue to generate revenue through our taxable REIT subsidiaries from the sale of loans, servicing income and loan origination fees. We expect the primary components of our expenses to be (i) interest expense on our credit facilities, securitizations, and other borrowings, (ii) general and administrative expenses, and (iii) payroll and related expenses arising from our origination and servicing businesses.

 

Executive Summary

 

In the fourth quarter of 2004, we began operating our business as a REIT and began deploying the $770.0 million of capital we raised to establish a portfolio of mortgage assets. One of our primary objectives for the first six months of 2005 was to continue to grow our REIT portfolio of mortgage loans. During the first six months of 2005, we completed $8.9 billion of securitizations structured as financings at the REIT, increasing the balance of the REIT mortgage loans held for investment portfolio to $15.3 billion at June 30, 2005. The combination of the REIT and TRS mortgage loan portfolios resulted in a total mortgage loans held for investment portfolio of $18.5 billion at June 30, 2005.

 

We expect that a majority of our income will come from the interest we earn on the mortgage assets we hold for investment. We will supplement that income with earnings from our taxable REIT subsidiaries, which will continue to originate, service and sell mortgage loans.

 

Overview

 

Currently, there are two key components to our business: (i) our mortgage loan portfolio held by our REIT, our qualified REIT subsidiaries and our taxable REIT subsidiaries, and (ii) our origination, sales activities, and servicing conducted through our taxable REIT subsidiaries.

 

REIT and TRS Mortgage Loan Portfolios

 

The largest component of our revenue is derived from the income we earn on our portfolio of mortgage loans held for investment, which totaled $18.5 billion at June 30, 2005.

 

During 2003, we shifted our strategy to address the cyclical nature of our earnings with the goal of generating a more stable long-term earnings stream. Our principal strategy to achieve this goal is to hold loans on our balance sheet. Because our credit facilities are short-term in nature and generally do not allow loans to be financed through the facility for longer than 180 days, a securitization structure offers the most attractive means to finance loans on our balance sheet. To support the goal of matching the timing of cash flows with the recognition of earnings on our loans, during 2003 we began to structure our securitizations as financings rather than sales. We make an initial cash investment so that the securitization trusts begin to return cash flow to us beginning in the first month following securitization. Therefore, we require cash and capital to make an initial investment, as well as to support the loans on our balance sheet. During 2003 and 2004, we retained between 20% to 25% of our loan production through securitizations. During the first six months of 2005, we retained approximately 37% of our loan production to support our balance sheet strategy to deploy the capital raised in 2004 by growing our portfolio of mortgage loans held for investment. For the year of 2005, we expect to retain between 20% and 30% of our total loan production.

 

Our portfolio of mortgage loans held for investment generally consists of a representative cross-section of our overall production volume. This portfolio earns net interest income over its life, which is generally three years, on a weighted-average basis. The net interest income we earn from our portfolio is influenced by a variety of factors, including the performance of the loans and the level and direction of interest rates.

 

We measure the performance of the loans by monitoring prepayment rates and credit losses. Faster prepayments reduce the weighted average life of the portfolio, reducing net interest income. Cumulative credit losses, which we generally assume to be approximately 3% of the original balance of the loans, also reduce net interest income.

 

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Generally, our loans have a fixed-rate for a period of time, while the underlying bonds that finance those loans are variable rate based on one-month LIBOR, resulting in interest rate risk. Our hedging strategies to mitigate this interest rate risk are designed to lock in our interest margin at the inception of each securitization.

 

Originations and Sales

 

The second major component of our business is our ability to originate and purchase mortgage loans at a reasonable cost and to sell a portion of those loans in the secondary mortgage market at prices that result in an attractive operating margin. We measure our operating margin as the sum of the price we receive for our loans, plus the net interest we earn for the period of time we hold the loans, less the cost to originate the loans. For the past several years, our secondary marketing strategy included a combination of both whole loan sales and securitizations of our loans.

 

Loan origination volumes in our industry have historically fluctuated from year to year and are affected by such external factors as home values, the level of interest rates and consumer debt, and the overall condition of the economy. In addition, the premiums we receive from the secondary market for our loans have also fluctuated and are influenced by each of these factors, but predominantly the interest rate environment. As a consequence, the business of originating and selling loans is cyclical.

 

The operating margin of our origination franchise has three components: (i) net interest income; (ii) gain on sale of mortgage loans; and (iii) loan origination or acquisition costs. We use the operating margin as our principal metric to measure the value of our origination franchise.

 

Net interest income on mortgage loans held for sale—We typically hold our mortgage loans held for sale for an average period of 30 to 45 days before they are sold in the secondary market or securitized. During that time, we earn the coupon rate of interest paid by the borrower and we pay interest to the lenders that provide our financing facilities. During 2004, the difference between these interest rates was approximately 4.7%. During the six months ended June 30, 2005, the margin decreased to 3.0% as short-term rates have increased more rapidly than our average coupon rates. We manage the timing of our sales to optimize the net interest income we earn on the loans, while preserving the ability to sell the loans at the maximum price.

 

Gain on sale of mortgage loans—Gain on sale of mortgage loans is affected by the condition of the secondary market for our loans. During the latter half of 2004 and the first six months of 2005, as interest rates began to rise, the underlying factors that affect secondary market pricing remained somewhat stable. However, as short-term rates rose faster than long-term rates (a flatter yield curve), the prices we received for our loans began to decline relative to historic levels. Further, due to competitive pressures we have not raised the interest rates we charge our borrowers consistently with increases in the overall interest rate environment, reducing gain on sale margins in the first six months of 2005 compared to the first six months of 2004. We expect the gain on sale of mortgage loans to remain at lower margins, similar to the margins during first six months of 2005. During the first six months of 2005, we completed a $989.2 million fixed-rate securitization structured as a sale which resulted from an opportunity to match fixed-rate assets with fixed-rate liabilities. We may continue to utilize securitizations structured as sales in the second half of 2005 in order to maximize the secondary market value of our production.

 

Loan origination or acquisition cost—We also measure and monitor the cost to originate our loans. We typically refer to this as our loan acquisition costs. Loan acquisition costs include the fees paid to wholesale brokers and correspondents, direct loan origination costs, including commissions and corporate overhead costs, less points and fees received from borrowers, divided by total production volume. Loan acquisition costs do not include profit-based compensation, servicing division overhead, parent company expenses and startup operations. During the year of 2004 and through the first quarter of 2005, our loan acquisition costs remained relatively stable and generally fluctuated inversely with our production volume. As a result of the competitive environment and its impact on the value of our loans, we began implementing cost-cutting measures designed to reduce our loan acquisition costs. The cost-cutting measures we implemented in the first quarter of 2005, which included changes in production costs, controlling growth in non-sales overhead and a greater focus on discretionary spending, as well as increased production during the three months ended June 30, 2005, have resulted in a significant reduction of our loan acquisition costs during the second quarter of 2005.

 

These two components of our business account for most of our operating revenues and expenses. Our origination platform provides the source of the loan volume to conduct both parts of our business.

 

Loan Originations and Purchases

 

As of June 30, 2005, our Wholesale Division operated through 27 regional operating centers. Our Wholesale Division originated or purchased $21.2 billion in loans during the six months ended June 30, 2005. As of June 30, 2005, our Retail Division originated loans through 76 sales offices, including our centralized telemarketing unit. Our Retail Division originated $2.5 billion in loans during the six months ended June 30, 2005.

 

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During the six months ended June 30, 2005, approximately $12.4 billion, or 52.5%, of our mortgage loan production consisted of cash-out refinancings, where the borrowers refinanced their existing mortgages and received cash representing a portion of the equity in their homes. For the same period, approximately $9.2 billion, or 38.9%, of our mortgage loan production consisted of home purchase finance loans. The remainder of our mortgage production, $2.0 billion, or 8.6%, consisted of transactions in which borrowers refinanced their existing mortgages to obtain a better interest rate, a lower payment or different loan maturity, or rate and term refinance transactions. For the six months ended June 30, 2004, total originations consisted of $12.9 billion, or 62.1%, of cash-out refinancings, $6.7 billion, or 32.4%, of home purchase financings, and $1.1 billion, or 5.5%, of rate and term refinance transactions. Market and economic conditions, as well as our focus on increasing our home purchase business, have resulted in the shift in mix between cash-out refinancings and our home purchase business. We believe that our current rate of business is sustainable and that our origination strategies and initiatives are consistent with that belief. If we are successful in maintaining this mix, we believe our exposure to interest rate cyclicality will be somewhat reduced.

 

We have experienced considerable growth of our interest-only product. During the six months ended June 30, 2005, originations of interest-only loans totaled $7.8 billion, or 33.0%, of total originations. Interest-only originations during the six months ended June 30, 2004 totaled $3.5 billion, or 16.9%, of total originations during the period. We believe our stricter underwriting guidelines and the stronger credit characteristics of these loans mitigate their perceived higher risk.

 

For the six months ended June 30, 2005, full documentation loans as a percentage of originations totaled $12.3 billion, or 52.1%, limited documentation loans totaled $923.0 million, or 3.9%, and stated documentation loans totaled $10.4 billion, or 44.0%. Full documentation loans generally require applicants to submit two written forms of verification of stable income for at least 12 months. Limited documentation loans generally require applicants to submit 12 consecutive monthly bank statements on their individual bank accounts. Stated income documentation loans are based upon stated monthly income if the applicant meets certain criteria. For the six months ended June 30, 2004, full documentation loans as a percentage of total originations totaled $10.9 billion, or 52.9%, limited documentation loans totaled $978.0 million, or 4.7%, and stated documentation loans totaled $8.8 billion, or 42.4%. Generally, economic and market conditions determine product mix, including product introductions and offerings by competitors. As these factors change, product mix, including required documentation, fluctuates as well. We designed our underwriting standards and quality assurance programs to insure that loan quality is consistent and meets our guidelines, even as the documentation type mix varies.

 

 

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The following table sets forth selected information relating to loan originations and purchases during the periods shown (dollars in thousands):

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 
     2005

    2004

    2005

    2004

 

Wholesale originations

   $ 12,131,216     11,086,242     21,204,705     18,781,248  

Retail originations

     1,312,954     1,169,625     2,491,032     1,910,975  
    


 

 

 

Total originations

     13,444,170     12,255,867     23,695,737     20,692,223  

Fixed-rate mortgages

     3,032,998     4,333,968     5,359,577     6,659,613  

Adjustable-rate mortgages:

                          

Traditional

     5,331,874     5,386,726     10,515,293     10,534,808  

Interest Only

     5,079,298     2,535,173     7,820,867     3,497,802  
    


 

 

 

Total originations

     13,444,170     12,255,867     23,695,737     20,692,223  

Purchases

     5,602,698     4,218,979     9,226,655     6,703,353  

Refinances:

                          

Cash-out refinances

     6,695,743     7,368,344     12,441,653     12,850,155  

Rate/term refinances

     1,145,729     668,544     2,027,429     1,138,715  
    


 

 

 

Total originations

     13,444,170     12,255,867     23,695,737     20,692,223  

Full documentation

     7,150,722     6,461,693     12,349,786     10,947,098  

Limited documentation

     353,661     546,921     922,591     978,213  

Stated documentation

     5,939,787     5,247,253     10,423,360     8,766,912  
    


 

 

 

Total originations

   $ 13,444,170     12,255,867     23,695,737     20,692,223  

Average principal balance of loans originated

   $ 180     175     180     172  

Weighted average FICO score of loans originated

     632     634     630     628  

Percent of loans secured by first mortgages

     93.8 %   96.2 %   94.5 %   96.5 %

Weighted average LTV ratio(1)

     81.5 %   80.7 %   81.3 %   81.1 %

Weighted average interest rates:

                          

Fixed-rate mortgages - initial rate

     7.8 %   6.9 %   7.7 %   7.0 %

Adjustable-rate mortgages - initial rate

     7.1 %   6.8 %   7.1 %   6.8 %

Adjustable-rate mortgages - margin over index

     5.7 %   5.5 %   5.7 %   5.5 %

Total originations

     7.2 %   6.8 %   7.2 %   6.9 %

Percentage of loans originated in top two credit grades

     90.3 %   87.3 %   89.0 %   86.0 %

Percentage of loans originated in bottom two credit grades

     2.1 %   2.7 %   2.5 %   3.0 %

(1) Weighted average LTV is the LTV of the first lien mortgages and combined LTV of the second lien mortgages.

 

Secondary Market Transactions

 

Historically, one of our major components of revenue has been the recognition of gain on sale of our loans through whole loan sales and, until 2003, securitizations structured as sales. In a whole loan sale, we recognize and receive a cash gain upon sale. In a securitization structured as a sale for financial reporting purposes, we typically recognize a gain on sale at the time the loans are sold, and receive cash flows over the actual life of the loans.

 

Since the first quarter of 2003, we have structured all but one of our securitizations as financings rather than sales. Such structures do not result in gain on sale at the time of the transaction, but rather yield interest income as the payments on the underlying mortgages are received. The following table sets forth secondary marketing transactions for the periods indicated (dollars in thousands):

 

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     Three Months Ended June 30,

    Six Months Ended June 30,

 
     2005

    2004

    2005

    2004

 
     Amount

   % of Sales

    Amount

   % of Sales

    Amount

   % of Sales

    Amount

   % of Sales

 

Premium whole loan sales

   $ 5,933,841    46.0 %   $ 6,403,993    62.5 %   $ 12,385,139    55.3 %   $ 13,713,146    78.0 %

Securitizations structured as sales (1)

     989,221    7.7 %     337,148    3.3 %     989,221    4.4 %     337,148    1.9 %
    

  

 

  

 

  

 

  

Total premium sales

     6,923,062    53.7 %     6,741,141    65.8 %     13,374,360    59.7 %     14,050,294    79.9 %

Discounted whole loan sales

     80,878    0.6 %     50,153    0.5 %     146,444    0.7 %     90,675    0.5 %
    

  

 

  

 

  

 

  

Total sales

     7,003,940    54.3 %     6,791,294    66.3 %     13,520,804    60.4 %     14,140,969    80.4 %

Securitizations structured as financings

     5,890,404    45.7 %     3,457,776    33.7 %     8,881,728    39.6 %     3,457,776    19.6 %
    

  

 

  

 

  

 

  

Total secondary market transactions

   $ 12,894,344    100.0 %   $ 10,249,070    100.0 %   $ 22,402,532    100.0 %   $ 17,598,745    100.0 %
    

  

 

  

 

  

 

  


(1) During the six months ended June 30, 2004 we completed a $337.1 million securitization structured as a sale, related to our investment in Carrington Mortgage Credit Fund I, LP.

 

Whole Loan Sales

 

During the three months ended June 30, 2005, whole loans sales and securitizations structured as sales accounted for $7.0 billion, or 54.3%, of our total secondary market transactions. The weighted average premiums received on whole loans sales was 2.28% of the original principal balance of the loans sold, including certain hedge gains and premiums received for servicing rights for the three months ended June 30, 2005. For the same period in 2004, whole loans sales and securitizations structured as sales accounted for $6.8 billion, or 66.3%, of our total secondary market transactions and the weighted average premiums received was 4.27%, including premiums received for servicing rights. During the six months ended June 30, 2005, whole loans sales and securitizations structured as sales accounted for $13.5 billion, or 60.4%, of our total secondary market transactions. The weighted average premiums received on whole loans sales was 2.63% of the original principal balance of the loans sold, including certain hedge gains and premiums received for servicing rights for the six months ended June 30, 2005. For the same period in 2004, whole loans sales and securitizations structured as sales accounted for $14.1 billion, or 80.4%, of our total secondary market transactions and the weighted average premiums received was 4.04%, including premiums received for servicing rights. No hedge gains related to whole loans sales were recognized in 2004. The underlying factors that affect secondary market pricing have remained somewhat stable. However, as short-term interest rates have risen faster than long-term interest rates (a flatter yield curve), the prices we received for our loans began to decline relative to historic levels. Further, we have not raised the interest rates we charge our borrowers consistent with increases in the overall interest rate environment, reducing gain on sale margins in the three and six months ended June 30, 2005 compared to the same periods in 2004.

 

Securitizations Structured as Financings

 

During the three months ended June 30, 2005, we completed two securitizations totaling $5.9 billion, and during the six months ended June 30, 2005, we completed three securitizations totaling $8.9 billion, which we structured as financings for accounting purposes under Statement of Financial Accounting Standards No. 140, or SFAS 140. The “portfolio-based” accounting treatment for securitizations structured as financings and recorded on-balance sheet is designed to more closely match the recognition of income with the receipt of cash payments. Because we do not record gain on sale revenue in the period in which the securitization structured as a financing occurs, the use of such portfolio-based accounting structures will result in lower income in the period in which the securitization occurs than would a traditional securitization structured as a sale. However, the recognition of income as interest payments are received on the underlying mortgage loans is expected to result in higher income recognition in future periods than would a securitization structured as a sale. During the six months ended June 30, 2004, we completed two securitizations totaling $3.5 billion, which we structured as financings. The increase in securitizations structured as financings in 2005 is the result of our strategy to retain more of our volume on our balance sheet in order to grow our REIT portfolio.

&