WMF GROUP LTD
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Filing Type: |
10-K |
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Filing Date: |
Mar 31 1999 |
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Ticker: |
WMFG |
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CIK |
1039206 |
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State: |
VA |
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Country: |
USA |
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Date Printed: |
Nov 20 2000 |
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE
FISCAL YEAR ENDED: DECEMBER 31, 1998
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15 (d) OF THE SECURITIES ACT OF
1934
For the
transition period from _________ to
_____________
Commission
File Number 000-22567
THE WMF
GROUP, LTD.
(Exact name
of registrant as specified in its charter)
Delaware
54-1647759
--------------------------------------------------------------------------------
(State or
other jurisdiction of (I.R.S. Employer
incorporation
or organization)
identification no.)
1593 Spring
Hill Road, Suite 400, Vienna, Virginia 22182
(Address of
principal executive offices) (Zip code)
Registrant's
telephone number, including are code (703) 610-1400
Securities
registered pursuant to Section 12 (b) of the Act:
Title of
Each Class Name of Each Exchange on Which
Registered
Common Stock,
$.01 par value The Nasdaq Stock Market
Securities registered pursuant to Section
12 (g) of the Act: NONE
Indicate by check mark
whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for
the past 90 days, Yes X No ____
Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form
10-K. _____
The aggregate market value
of the voting stock held by non-affiliates of the Registrant was approximately
$57.7 million based on the closing price of such shares on The Nasdaq Stock
Market as of March 29, 1999.
As of March 29, 1999 there
were 11,260,415 shares of common stock issued and
outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE:
THE PROXY STATEMENT FOR THE
1999 ANNUAL MEETING OF STOCKHOLDERS IS INCORPORATED BY REFERENCE INTO PART
III OF THIS REPORT.
1
The WMF GROUP,
LTD.
FORM 10-K
TABLE OF
CONTENTS
Item No.
Page
--------
----
PART I
1.
Business
3
2.
Properties 17
3.
Legal Proceedings 17
4.
Submission of Matters to a Vote
of Security Holders
18
PART II
5.
Market for Registrant's Common Equity and Related Stockholder
Matters 18
6.
Selected Financial Data 19
7.
Management's Discussion and Analysis of Financial Condition and
Results of Operations 21
7a.
Quantitative and Qualitative Disclosure about Market Risk 32
8.
Financial Statements and Supplementary Data 32
9.
Changes in and disagreements with Accountants on Accounting and
Financial Disclosure 32
PART III
10.
Directors and Executive Officers of the Registrant 32
11.
Executive Compensation 32
12.
Security Ownership of Certain Beneficial Owners and Management
32
13.
Certain Relationships and Related Transactions 32
PART IV
14.
Exhibits, Financial Statement Schedules, and Reports on Form 8-K 32
2
A Warning About
Forward Looking Statements
This report may contain
"forward-looking statements." Any statement in this report, other
than a statement of historical fact, may be a forward-looking statement.
You can generally identify forward-looking
statements by looking for words such as "may," "will,"
"expect," "intend," "estimate,"
"anticipate," "believe" or "continue." Variations
on those or similar words, or the negatives of such words, also may indicate
forward-looking statements.
Although the Company believes that the
expectations reflected in this report are reasonable, the Company cannot assure
you that its expectations will be correct. The Company has included a
discussion entitled "Risk Factors" in this report, disclosing
important factors that could cause its actual results to differ materially from
its expectations. If in the future you hear or read any forward-looking
statements concerning the Company, you should refer to these Risk Factors.
The forward-looking statements in this
report are accurate only as of its date.
If the Company's expectations change, or if new events, conditions or
circumstances arise, the Company is not required to, and may not, update or
revise any forward-looking statement in this report.
PART I
ITEM 1. BUSINESS
COMPANY
OVERVIEW
The WMF Group, Ltd. (the
"Company") is one of the largest commercial mortgage financial
services companies in the United States, as measured by servicing portfolio
size, according to a survey published by the Mortgage Bankers Association of
America (the "MBA"). As the nation's largest originator of Federal National
Mortgage Association ("Fannie Mae") and Federal Housing Authority
("FHA") insured multifamily and health care loans, the Company has
originated more than $9 billion in conventional and FHA-insured multifamily and
commercial loans since 1993, and has a servicing portfolio of approximately
$12.1 billion, at December 31, 1998. The company has 346 employees and operates
19 offices nationwide. The Company has three principal lines of business: (i)
mortgage banking, (ii) capital markets and (iii) advisory services.
The WMF Group, Ltd. is a Delaware
corporation formed in October 1992 under the name "WMF Holdings,
Inc." Originally, the Company was created to hold the operations of WMF
Huntoon, Paige Associates Limited ("WMF Huntoon Paige") and WMF
Washington Mortgage Corp. ("WMF Washington Mortgage"). WMF Huntoon
Paige and WMF Washington Mortgage are wholly-owned subsidiaries of the Company.
WMF Huntoon Paige has originated and
serviced multifamily and healthcare mortgages insured by FHA under various
owners and under various names since 1979. WMF Washington Mortgage acquired WMF
Huntoon Paige in 1991. WMF Washington Mortgage has originated and serviced
multifamily and commercial mortgages under various owners and under various
names since 1984.
On April 1, 1996, NHP Incorporated
("NHP") purchased the Company and named it "NHP Financial
Services, Inc." In early 1997, NHP was acquired by Apartment Investment
and Management Co. ("AIMCO"). As a condition of that purchase, AIMCO
required NHP to spin-off the Company. On December 8, 1997, the Company became
an independent, publicly traded company. The Company's primary shareholders are
Demeter Holdings Corporation ("Demeter"), Phemus Corporation
("Phemus") and Capricorn Investors II, L.P. ("Capricorn").
Demeter and Phemus are affiliates of Harvard Private Capital Holdings, Inc.
("Harvard").
3
INDUSTRY
OVERVIEW
The Company believes that the financing of
commercial and multifamily real estate offers significant growth opportunities.
Commercial and multifamily real estate encompasses a wide spectrum of assets
including multifamily, office, industrial, retail and hospitality. These assets
are financed by an estimated $1.3 trillion of outstanding commercial real
estate debt. During the past ten years, total commercial mortgage originations
have averaged approximately $210 billion annually, of which approximately 75
percent to 80 percent consist of non-multifamily assets. The Company
anticipates that on a stabilized basis, the commercial real estate market will
require debt financing for existing properties of approximately $120 to $140
billion annually, plus additional amounts for new construction.
Mortgage banking involves the origination
and servicing of mortgage loans. Commercial mortgage banks have arranged a
significant portion of the debt financing for commercial real estate.
Historically, commercial mortgage banks originated and serviced loans for life
insurance companies in specified geographic regions. In addition to providing
loans to life insurance companies, some commercial mortgage banks acted as
originators for Government Sponsored Entities ("GSEs") such as Fannie
Mae and Federal Home Loan Mortgage Corporation ("Freddie Mac"), and
also acted as brokers for other lenders. As a result, a fragmented industry has
developed which is comprised of small local and regional firms.
However, since the early 1990s the
commercial mortgage banking industry has experienced significant change, in
part due to the growth in commercial mortgage securitization, the expanded involvement
of GSEs, increased borrower sophistication and advances in information
technology. Many of the existing firms lack the capital and financial
sophistication to compete effectively in today's rapidly changing market.
Accordingly, the Company believes the commercial mortgage industry is going
through a period of consolidation similar to that experienced in the
residential mortgage industry. Although consolidation provides significant
growth opportunities for the Company, certain risks are also involved. See
"Risk Factors -- The Company May Be Unable to Complete Acquisitions or
Enter into New Business Lines."
STRATEGIC
OBJECTIVES
Because of its geographic scope, multiple
investor relationships, underwriting expertise, operating systems and product
development capabilities, the Company believes that it is well-positioned to
compete effectively in the commercial real estate financing industry.
Technological demands, large and sophisticated infrastructure for real estate
underwriting and risk evaluation, and rapid market changes increasingly
characterize this industry. The Company believes that these developments will
lead to the creation of large and sophisticated mortgage finance enterprises
offering a wide spectrum of commercial finance products. The Company seeks to
use its existing infrastructure and market position to increase market share of
its established businesses and to expand into related businesses.
The Company seeks to increase reported
earnings and cash flow through (i) acquisitions, (ii) internal growth, (iii)
design and delivery of new mortgage products, including structured loan
products and participating loan products, (iv) expansion into related
businesses, such managing commercial mortgage investment funds, and (v)
diversification of fee income sources.
Acquisitions. The Company has pursued a strategy of
acquiring (1) multifamily and commercial mortgage businesses that either serve
key real estate markets in the United States or provide specialized services
that enhance its product line, and (2) additional servicing portfolios. In the
past, the Company has sought to acquire companies with active and productive
loan origination staffs, significant market share and servicing portfolios of
$250 million or more and expects to continue to do so in the future, to the
extent adequate capital and attractive opportunities are available.
Since 1996, the Company has
made six acquisitions (the "Acquistions"):
. During 1996, the Company increased its portfolio
of serviced mortgages by
40.9 percent from $4.4 billion to $6.2
billion, primarily as a result of
two acquisitions. On May 13, 1996, WMF
Huntoon Paige purchased a portion of
the loan production pipeline and servicing,
as well as certain other
assets, of American Capital Resources
Investment Corp. ("ACR") for
approximately $4.2 million, plus potential
future payments based on
realization of loans closed from the
pipeline through August 1997. The
acquired pipeline and loan production offices
originated approximately $138
million in multifamily and healthcare loans
for WMF Huntoon Paige in 1996.
4
. On December 31, 1996, WMF Washington
Mortgage acquired all of the common
stock of Detroit-based Proctor &
Associates of Michigan ("Proctor"), the
37th largest commercial mortgage banking
firm in the United States based on
a survey by the MBA. WMF Washington
Mortgage paid approximately $3.7
million in cash to acquire Proctor. The
acquisition brought to the Company
a $1.1 billion loan servicing portfolio of
multifamily, retail and office
building mortgages, as well as 17 active
correspondent relationships with
life insurance companies.
. On April 15, 1997, WMF Washington Mortgage
purchased substantially all of
the mortgage banking assets and liabilities
of Askew Investment Company
("Askew") in Dallas, Texas for
$5.6 million, excluding transaction costs
(82 percent of which was paid at closing
and the remaining 18 percent of
which will be paid in the form of earnouts
upon the attainment of certain
performance objectives over a 36-month
period). Askew is a multifamily and
commercial mortgage bank with correspondent
relationships with 14 insurance
companies, which originated $375 million of
mortgages in 1996. The
acquisition increased the Company's
mortgage servicing portfolio by $425
million and gave the Company access to the
traditional insurance company
whole-loan buyers in the markets served by
Askew. The purchase also
provided the Company with a new source of
loans it intended for
securitization through the Company's
capital market relationships.
. On November 5, 1997, WMF Washington Mortgage
purchased 100 percent of the
outstanding stock of The Robert C. Wilson
Company and its Arizona
subsidiary (collectively, "Robert C.
Wilson") for a purchase price of
approximately $4.0 million in cash (80
percent of which was paid at closing
and the remaining 20 percent of which will
be paid in the form of earnouts
upon the attainment of certain performance
objectives over a 42-month
period). In addition to its mortgage and
equity origination and servicing
activities, Robert C. Wilson provides
commercial office leasing and real
estate sales. Robert C. Wilson has
correspondent relationships with 24
insurance companies and originated
approximately $475 million of mortgages
in 1997. The acquisition increased the
Company's servicing portfolio by
$554 million.
. On December 23, 1997, WMF Washington
Mortgage purchased substantially all
of the mortgage banking assets of New York
Urban West, Inc. ("New York
Urban") for a purchase price of
approximately $4.9 million in cash (84
percent of which was paid at closing and
the remaining 16 percent of which
will be paid in the form of earnouts upon
the attainment of certain
performance objectives over a 42-month
period). An approved HUD mortgagee,
New York Urban originated $225 million of
mortgages in 1997 and had
correspondent relationships with several
life insurance companies. The
acquisition increased the Company's
servicing portfolio by $1.3 billion.
. On March 27, 1998, the Company created WMF
Carbon Mesa Advisors, Inc. ("WMF
Carbon Mesa"), which purchased all of the
assets of Carbon Mesa Advisors,
Inc. and Strategic Real Estate Partners for
a combination of cash and
common stock. WMF Carbon Mesa develops new
loan products, manages
commercial mortgage investment funds,
provides special asset management
services and originates commercial
mortgages.
The Company also grows its
servicing portfolio through the acquisition of servicing rights. Since 1992,
the Company has acquired servicing rights on approximately $1.3 billion of
mortgages in over 44 transactions.
The Company routinely reviews and conducts
investigations of potential acquisitions of multifamily and commercial mortgage
businesses. As of March 30, 1999, the Company does not have any agreements or
letters of intent with respect to pending acquisitions. However, if the Company
has access to sufficient capital, the Company may enter into discussions with
one or more potential acquisition targets in the commercial mortgage financial
services business. The Company cannot assure you that such discussions will
result in future acquisitions, or that if those acquisitions are completed,
they will be successful.
Internal Growth. The Company has grown through internal
expansion. This growth has occurred though a combination of opening of new
offices, hiring new loan officers, implementing loan officer training programs,
and creating a national sales force capable of originating loans for multiple
of investor sources. Prospectively, the Company seeks to grow via continued
expansion of its national origination system, further streamlining of its
servicing operations, and the realization of other operating efficiencies.
- In addition to expanding its origination
system through acquisitions, the
Company opened four new loan origination
offices and hired 16 new loan
officers in 1998. Through training and other management initiatives, the
Company has developed a national sales
force, capable of selling all loan
products offered by the Company.
- The Company implemented a cost-reduction
program, which is expected to
result in savings of at least $7.5 million
annually
5
from previously anticipated levels. See
"Major Developments in 1998 - Cost-
Saving Measures".
As a result of acquisitions and internal
growth, the Company has increased loan originations by approximately 62 percent
annually, from approximately $240 million in 1992 to approximately $4.3 billion
in 1998. The Company's servicing portfolio has increased by approximately 26
percent annually, from approximately $3.0 billion in 1992 to $12.1 billion as
of December 31, 1998.
Design and delivery of new
mortgage products. Since 1992, the
Company has been involved in developing more than eight new products, including
one of the first whole-loan conduits (Common Sense/SM/), a revolving credit
facility for real estate investment trusts, a bridge loan program for
mark-to-market properties and a forward commitment program for tax-credit new
construction. Using these products, the
Company has originated loans totaling over $1.7 billion from 1992 to 1998.
The Company has also enhanced its interim
financing product, has added a number of loan products to sell to life
insurance companies, has created a small loan program, and has developed a
securitized loan product with a major Wall Street conduit for commercial
lending. The Company intends to enhance its ability to develop new financing
products in response to changing market conditions, including continued
development of bridge loan products, as well as the addition of high-yield,
mezzanine and participating loan products.
The Company cannot assure you that it will be successful in developing
any particular new product or, if a product is developed, that it will be
profitable for the Company.
Expansion into related
businesses. The Company seeks to build
upon its experience in evaluating real estate to expand its services and
develop related products. The Company has used its expertise to provide due diligence
services for institutional clients, to enter the advisory services/funds
management business and to expand its presence in the commercial
mortgage-backed securities market. Other possible businesses may include asset
management, commercial leasing and management and the purchase and retention of
commercial mortgage- backed securities. Expansion may occur through a
combination of acquisitions, strategic alliances and internal business
development. There can be no assurance that the Company will seek to undertake
any specific line of business, or that, if it undertakes a particular line of
business, that the business will be successful.
Fee Diversification. The Company intends to manage the risks of
the commercial real estate financing industry by (i) focusing its activities on
earning service and origination fees rather than earning interest on retained
mortgage assets, (ii) developing strategic relationships with multiple
investors, (iii) lending to a variety of commercial asset classes and (iv)
operating on a national basis.
. Fee-based Earnings. In 1998, approximately 96.8% of the Company's
revenue was
generated from origination, servicing and other related fees. Of
this amount, fees and other revenue
related to servicing and funds management agreements accounted for approximately 44% of Company fee revenue. In
addition to providing a stable source
of earnings, this approach requires significantly less capital than the retention of mortgage assets. While it
may make minority investments in funds
it manages, the Company does not intend to take significant principal risk positions.
. Multiple Investors. In
the past, changes in the financial markets and
investor requirements have contributed to the volatility of the
commercial mortgage financial
markets. The Company seeks to manage this risk by developing strategic relationships with a variety of investor
sources, including commercial banks,
GSEs, investment banks and insurance companies. The Company believes this strategy enabled it to originate $1.1
billion of multifamily and commercial
mortgages in the fourth quarter of 1998 despite the limited liquidity in the conduit market.
. Multiple Asset Classes. The Company has lent to a wide variety of
commercial
asset classes, including multifamily, retail, office and
hospitality. The Company believes
that business and financing cycles vary among asset classes. By lending to multiple asset classes, the
Company can reduce risk and improve
operating efficiency by redeploying its origination activities as
market conditions change.
. National Presence. The
Company has 19 loan origination offices located
throughout the country and has originated loans in every state
and the District of Columbia. This national
presence provides another source of
diversification, helping to mitigate the risk posed by changes in
regional business conditions.
See "Risk Factors" for a detailed discussion of the
risks that may affect the Company.
6
MAJOR DEVELOPMENTS
IN 1998
1998 Losses. During the year ended December 31, 1998, the
Company incurred a net loss of $33.3 million, or $6.38 per share. Almost all of
these losses were incurred at the Company's wholly owned subsidiary WMF Capital
Corp. ("Capital Corp.") and resulted from volatility in commercial
mortgage-backed securities markets and interest rates on U.S. Treasury
securities. Despite the losses, the Company's mortgage banking segment remained
profitable during the year, and the Company as a whole experienced increased
revenue during 1998.
Losses and Restructuring at
Capital Corp. Most of the Company's
losses during 1998 resulted from short-sale transaction losses related to
Capital Corp.'s inventory of mortgage loans. During the first three quarters of
1998, Capital Corp. originated $969 million in mortgage loans. To protect
itself against interest rate fluctuations prior to the sale or securitization
of its loans, Capital Corp. entered into arrangements for the short sale of
U.S. Treasury securities. Because of interest rate volatility during that
period, the Company was required to fund losses related to changes in the value
of its short-sale positions. To reduce its exposure to margin calls, Capital
Corp. sold $691 million in loans and closed the related U.S. Treasury short
positions at a loss in the third quarter of 1998.
During December of 1998, Capital Corp.
sold the remainder of its loan
inventory and closed the related short-sale positions without incurring
additional losses. As part of these
sales, the Company and Commercial Mortgage Investment Trust, Inc.
("COMIT") purchased $2.4 million and $7.6 million, respectively, of
subordinated interests in a pool of $63.5 million of these loans. COMIT is a
real estate investment trust ("REIT") that is owned by Harvard,
Capricorn and the Company. WMF Carbon Mesa manages COMIT. See "The
Company's Lines of Business - Advisory Services (WMF Carbon Mesa)" for
more information on WMF Carbon Mesa.
As a result of the losses incurred, Capital
Corp. was unable to satisfy certain loan commitments. Capital Corp. has settled one claim related to these obligations
but Capital Corp. may not be able to settle similar claims in the future. See "Risk Factors -- Unsatisfied Loan
Obligations May Cause Additional Losses."
The Company does not intend to contribute additional capital to Capital
Corp. or to take principal risk positions at Capital Corp.
Cost-Saving Measures. In response to its 1998 losses, the Company
implemented a cost-reduction program, reducing its workforce by 15 percent and
decreasing general and administrative expenses. The Company expects that the cost- reduction program will result
in annual savings of at least $7.5 million from previously anticipated levels,
beginning in 1999.
Issuance and Repayment of
Subordinated Notes. On September 4, 1998, the Company entered into a Credit
Agreement with COMIT. Under the Credit Agreement, Harvard and Capricorn
contributed a total of $20 million to COMIT, and the Company then sold $20
million of its subordinated notes to COMIT. The Company also issued warrants to
COMIT entitling it to purchase 1,200,000 shares of common stock at $11.25 per
share. COMIT later assigned 960,000 of the warrants to Harvard and 240,000 of
the warrants to Capricorn. As part of the Recapitalization Plan, described
below, Harvard and Capricorn surrendered those warrants. The Company repaid
$16.6 million of the subordinated notes on December 31, 1998. On March 12,
1999, the Company repaid the remaining principal and interest due under the
subordinated notes, and the notes were canceled.
Recapitalization Plan. To provide for its working and other capital
needs after the losses at Capital Corp., the Company entered into the
Recapitalization Plan. The Recapitalization Plan had two parts and raised a
total of approximately $27.5 million of new equity:
. Sale of $16.6 Million of Capital Stock to Demeter, Phemus and
Capricorn
On December 31, 1998, Demeter, Phemus and Capricorn acquired
3,635,972 shares of the Company's
Class A Non-Voting Convertible Preferred Stock (the "Class A Stock") for total cash proceeds of
approximately $16.6 million. On January
14, 1999, each share of Class A Stock was converted into one share of
common stock. As a result of these transactions,
Demeter acquired 2,757,633 shares of
the Company's common stock, Phemus acquired 151,145 shares of common stock, and Capricorn acquired 727,194
shares of common stock.
As part of the Class A Stock transaction, Harvard and Capricorn canceled
the warrants to purchase 1,200,000
shares of common stock issued to COMIT in
connection with the subordinated notes. In addition, Demeter, Phemus and Capricorn entered into a Standby Purchase
Agreement to purchase up to 664,028
shares of common stock not otherwise purchased in the rights
offering described below, for a total
purchase price of $3,320,140. The Company
applied the proceeds of the sale of Class A Stock to repay part of
the subordinated notes held by COMIT.
7
Because of their
participation in this transaction, Demeter, Phemus and Capricorn agreed not to exercise, transfer
or acquire any rights during the
rights offering.
. $10.9 Million Public Rights Offering/Private Placement
The Company issued all of its shareholders of record as of
February 1, 1999, 1.072 transferable
rights for each share of common stock held by them on that date. Each right entitled its holder to
purchase one share of common stock
for $5.00. The rights expired on March 8, 1999.
Through the rights offering, the Company sold a total of
1,482,271 shares of common stock for
total proceeds of approximately $7.4 million. On March 19, 1999, Demeter, Phemus and Capricorn
completed the purchase of a total of
664,028 shares of the Company's common stock pursuant to the Standby
Purchase Agreement, for total
proceeds to the Company of approximately $3.3 million. Also, Capricorn has agreed to purchase an
additional 34,520 shares at $5.375
per share, for proceeds to the Company of $185,545. The Company expects that this sale to Capricorn will
close shortly.
The Company applied the proceeds from the rights offering first
to repay the remaining subordinated
notes held by COMIT. The Recapitalization Plan resulted in the effective conversion of the Company's $20
million of subordinated notes into
common stock and raised approximately $7.5 million of additional common equity, which was used to repay borrowings
under the Company's revolving line of
credit and for working capital.
Expansion into Funds
Management. Though the acquisition of Carbon Mesa Advisors, Inc. and Strategic
Real Estate Partners in March 1998, the Company started its advisory services
segment, which manages commercial mortgage investment funds, provides special
asset management services and develops new loan products. In June, the Company,
with Harvard and Capricorn, formed a commercial mortgage REIT to invest in
bridge, mezzanine, and structured loans originated by the Company. The REIT is
managed by WMF Carbon Mesa and is expected to fund up to $345 million of
commercial and multifamily mortgages through June 1999.
THE
COMPANY'S LINES OF BUSINESS
MORTGAGE ORIGINATION
Mortgage origination involves the making
of loans to borrowers who use real estate property as collateral. The Company's
staff of 59 loan originators targets a wide variety of borrowers, including
developers, local entrepreneurial owners, large portfolio owners and public
companies such as REITs.
Currently, the Company originates
mortgages through two channels -- retail and correspondent. For the retail
operation, the Company has loan originators in 19 offices located throughout
the country. Those individuals directly solicit owners of real estate, as well
as local multifamily and commercial mortgage brokers. The Company believes that
having a local presence within a market significantly adds to its understanding
of the local economic, demographic and real estate trends, thus allowing it to
serve borrowers and investors better. A local presence also helps develop
borrower relationships and identify new customers.
In those markets where the Company does
not have a retail presence, it acts through "correspondent
relationships" with local mortgage brokers. In this relationship, a local
commercial mortgage broker identifies potential borrowers and refers them to
the Company for their loans. Currently, the Company originates loans through
correspondents throughout the United States. In 1998, the Company obtained 25.9
percent of its $4.3 billion of loan originations through correspondents.
The Company's relationship with
correspondents differs between multifamily and commercial lending and FHA
lending. For multifamily and commercial lending, the Company enters into an
agreement with each correspondent which generally provides that (1) the
borrower will pay the correspondent, usually based on a percentage of the loan,
(2) in some instances, the Company will have a right of first refusal to
finance properties meeting the criteria of its loan programs and investors and
(3) the correspondent will be eligible for incentive fees based on the
servicing fees received by the Company from the originated loans. Generally
either party to a multifamily and commercial correspondent agreement may
terminate the relationship without cause upon prior written notice. The multifamily and commercial correspondent
agreements usually do not place geographic restrictions on either the Company
or the correspondent.
With respect to FHA lending,
correspondents generally enter into agreements with the Company for each
individual
8
transaction and the terms
of the agreements vary from transaction to transaction. These agreements define
the compensation, roles, representations and warranties for the correspondent
and the Company.
After it identifies a potential borrower,
the Company determines which of its mortgage products best meets the borrower's
needs. Then the Company works with the borrower and a mortgage investor to
prepare a loan application. When the borrower completes the application, the
Company's underwriters conduct due diligence. In the case of FHA loans, the FHA
conducts due diligence. See "-- Mortgage Underwriting" below. The
loan is evaluated, and if appropriate, submitted to a loan committee consisting
of senior officers of the Company.
If the Company or the FHA approves the
loan, the Company issues a commitment to the borrower. Normally, the Company
simultaneously commits to sell the loan to an appropriate investor. This
simultaneous commitment from both a borrower and a mortgage investor enables
the Company to eliminate its exposure to interest rate changes for each
transaction. Typical investors include insurance companies, banks, credit
corporations, GSEs (such as Fannie Mae) and other institutional investors.
Typically the Company funds a loan 15 to 30 days after the loan commitment. At
that time, the Company funds the loan using its warehouse lines of credit and
the borrower pays the Company an origination fee, typically one percent of the
principal amount of the loan.
Within 10 to 45 days after funding the
loan, the Company completes the sale of the loan to an investor. In connection with such sales, the Company
sometimes retains certain liabilities. See "Risk Factors -- The Company is
Liable for Certain Representation and Warranties Concerning Mortgage
Loans" and "Risk Factors -- The Company May Incur Losses on Mortgage
Loans Under the DUS Program." After selling a mortgage loan, the Company
typically retains the right to service the loan. See "-- Mortgage
Servicing" below.
As of December 31, 1998, the Company held
33 mortgage loans for sale with an aggregate principal balance of $34.2
million. After December 31, 1998, the Company sold these loans. As of December
31, 1997, the Company held 32 mortgage loans for sale with an aggregate
principal balance of $49.4. After that date, the Company sold these loans. As
of December 31, 1998, the Company's subsidiary, Capital Corp., had $65.8
million of forward commitments to lend that were not matched with investor
commitments. Those commitments are subject to market risk until such time as a
permanent investor is identified. See "Risk Factors - The Company May
Incur Losses Related To Loan Commitments For Which It Does Not Have A Purchaser
And Has Not Entered Into Hedge Arrangements" below.
The Company provides a diverse range of
products to borrowers through three business units: Conventional Multifamily,
FHA Multifamily and Healthcare, and Commercial/Life Insurance Company. The
following table sets forth information regarding loan origination volume by
business unit for each of the last three years.
9
LOAN
ORIGINATION VOLUME BY BUSINESS UNIT
(DOLLARS IN
MILLIONS)
1998 1997 1996
-------- -------- --------
CONVENTIONAL MULTIFAMILY $1,263.5 $ 742.0
$ 505.4
FHA MULTIFAMILY AND HEALTHCARE 451.3 489.7 505.6
COMMERCIAL/LIFE INSURANCE/ (1)/ 2,633.9 1,075.2 117.5
-------- -------- --------
TOTAL $4,348.7 $2,306.9
$1,128.5
======== ======== ========
/(1)/ Includes Capital
Corp. and other conduit originations.
Conventional Multifamily
(Fannie Mae). This business unit
finances multifamily properties that are not supported by governmental
insurance or guaranties. The Company sells such loans to a variety of mortgage
investors, including Fannie Mae. Through WMF Washington Mortgage, one of the
Company's most active conventional products is Fannie Mae's Delegated
Underwriting and Servicing Program ("DUS Program"). Currently, there
are only 26 companies approved to participate in this program. The Company,
through WMF Washington Mortgage, originated approximately $660 million and $240
million of DUS Program loans in 1998 and 1997, respectively.
Under the DUS Program, Fannie Mae allows
WMF Washington Mortgage to approve, close and service loans on multifamily
mortgages that meet predetermined criteria. Fannie Mae commits to purchase
these loans after they close. As part of the program, Fannie Mae requires that
participating companies share in the risk of loss on the loan. See "Risk
Factors -- The Company May Incur Losses on Mortgage Loans Under the DUS Program."
In return for sharing the risk of loss, the Company receives a servicing fee
that is significantly higher than its typical fee. The Company underwrites each
loan to manage its loss exposure and enhance its return on servicing. See
"-- Mortgage Underwriting" below.
In addition to its participation in the DUS
Program, the Company, through WMF Washington Mortgage, is a Fannie Mae Prior
Approval Lender and is one of the designated post-closing review lenders for
the Fannie Mae Aggregation Facility. These programs allow WMF Washington
Mortgage to sell certain loans to Fannie Mae that would not otherwise qualify
for the DUS Program. Unlike DUS, however, neither of these programs requires
that the Company share in the risk of loss.
FHA Multifamily and
Healthcare. The Company, through WMF
Huntoon Paige, is the largest provider of FHA-insured multifamily and
healthcare financing in the country. The Company originates and services both
construction and permanent loans. For the twelve months ended September 30,
1998, WMF Huntoon Paige originated approximately 12.0 percent of all FHA
multifamily and healthcare insured debt financing, more than any other FHA
mortgagee.
The Company operates FHA lending through a
separate subsidiary because typical property characteristics, borrower
requirements, licensing and approval processes differ significantly between FHA
and conventional multifamily financing. The Company, through WMF Huntoon Paige,
is an FHA-approved mortgagee and, as such, must comply with the applicable requirements
of the National Housing Act ("Housing Act") and the regulations and
policies of the FHA that are promulgated pursuant to the Housing Act. See
"Risk Factors-The Company May Be Unable To Continue To Comply With
Government Regulations and Programs," below.
Commercial/Life Insurance
Company Loans. With its acquisitions in
1996 and 1997, the Company substantially increased its presence in the market
for commercial, non-multifamily financing. The Company originates loans secured
by a variety of properties, including office buildings, retail centers, hotels,
warehouses and nursing homes. Through relationships with regional mortgage
banks, insurance companies have been particularly active investors in this
segment. The Company, through its acquisitions, has established relationships
with a number of insurance companies, including: John Hancock, UNUM, Canada
Life, CIGNA, American General, Nationwide, Berkshire Life, Government Personnel
Mutual and Century Life.
In addition to originating commercial and
multifamily loans placed with insurance companies, the Company has established
origination relationships with commercial mortgage conduits operated by major
financial institutions, including Greenwich Capital Markets and NationsBank,
N.A. In 1998, the Company originated
loans totaling approximately $1.5 billion through commercial mortgage conduits.
The Company will typically process conduit eligible loans through WMF Funding,
a division of WMF
10
Washington Mortgage (see
"-Capital Markets (WMF Funding)" below).
MORTGAGE UNDERWRITING. The Company's originators work with
underwriters who perform due diligence on all loans prior to commitment and
approval. The Company's underwriters assess
each proposed loan including a review of (1) borrower financial position and
credit history, (2) past operating performance of the underlying collateral,
(3) potential changes in project economics and (4) appraisal, environmental and
engineering studies completed by a pre-approved list of third-party
consultants. Additionally, underwriters
inspect the property, review tenant and lease files, survey comparable markets,
and analyze area economic and demographic trends. A loan committee consisting of the Company's senior officers
reviews and approves each proposed loan.
The Company applies its own underwriting
guidelines, as well as those provided by investors. Among other things, the Company considers debt service coverage
and loan-to-value ratios, property financial and operating performance, quality
of property management, borrower credit history and tenant profile. The
standards vary from investor to investor and may include a subjective element
based on an assessment of the total credit risk. The standards generally do not
involve mechanical application of a set formula. The Company revises its
underwriting criteria based on its experience and as market conditions and
investor requirements change.
Due in part to its underwriting procedures,
in 1998 the Company achieved a loan delinquency rate (i.e., loans delinquent
over 60 days) equal to only .14 percent of its entire conventional multifamily
and commercial portfolios based on unpaid principal balance. In connection with
the Fannie Mae DUS Program, the Company has originated over 358 DUS loans since
1990 with original principal balances in excess of $1.9 billion. The Company
has experienced one loss of $0.3 million on a DUS Program loan. Another lender
originated that loan, and the Company acquired the risk-sharing obligation as
part of its DUS approval in 1990.
The Company uses the underwriting criteria
established by the FHA to recommend loans for FHA insurance. The Company must
provide the FHA with certain information. The FHA then examines the loans and
decides whether to provide insurance.
MORTGAGE SERVICING
As a mortgage servicer, the Company
performs both primary and master servicing functions. Primary servicing
involves the collection of mortgage payments, maintenance of escrow accounts
for the payment of taxes and insurance premiums, remittance of payments of
principal and interest, reporting to investors on financial and property issues
and general loan administration. The primary servicer must inspect properties,
determine the adequacy of insurance coverage, monitor delinquent accounts and,
in cases of extreme delinquency, institute forbearance arrangements or
foreclosure proceedings on behalf of investors.
Master servicers administer and report on
securitized pools of mortgage- backed securities. Normally, the mortgages in
the pool are serviced by individual primary servicers. Master servicing
agreements typically require the primary servicer to retain responsibility for
administering the mortgage loans, and the master servicer supervises the
primary servicers by monitoring their compliance with the servicing contract.
The master servicer consolidates all accounting and reporting to the issuer of
the securities.
The Company has contracts to service loans
with mortgage owners and originators of mortgage-backed securities. The
contracts are generally for a term equal to the term of the serviced mortgage
or the mortgage-backed security and are terminable for cause. Contracts with
insurance companies who own mortgages are usually terminable on 30 days' notice
by the owner, in many instances without cause. In some circumstances, the
insurance company must pay a termination fee if it terminates a servicing
contract without cause. Under these agreements, the Company receives an annual
fee for primary servicing. The fee typically ranges from five basis points to
40 basis points of the unpaid principal balance of the loans underlying the
securities. Fees for master servicing typically range from one to ten basis
points.
As of December 31, 1998, the Company acted
as the primary servicer for approximately $10.6 billion of loans and as the
master servicer for an additional $1.6 billion of loans. These loans were
obtained through the Company's origination network and through the purchase of
servicing rights. A breakdown of the servicing portfolio is shown below.
11
SERVICING
PORTFOLIO BY PRODUCT TYPE
$ IN
MILLIONS
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
---- ---- ----
CONVENTIONAL MULTIFAMILY $ 2,583 $ 1,544 $1,644
FHA AND GINNIE MAE 3,905 4,201 3,076
COMMERCIAL 4,069
4,173 1,267
MASTER SERVICING 1,585 952 214
------- ------- ------
TOTAL $12,142
$10,870 $6,201
======= ======= ======
The Company principally services loans in
its offices in Vienna, Virginia; Edison, New Jersey; and Houston, Texas. It
employs approximately 70 people in these servicing facilities. As of December
31, 1998, the Company serviced 3,154 loans. As part of its servicing functions
on these loans, the Company managed escrow accounts totaling approximately $350
million and processed approximately $83.0 million in principal and interest
payments each month. The Company continuously reviews its servicing operations
and seeks to implement improvements in its systems and business processes.
CAPITAL MARKETS (WMF
FUNDING)
To capitalize on its national loan
origination system and conduit loan processing system, as well as to reduce the
capital requirements and principal risks associated with operating a conduit,
the Company created WMF Funding, a division of WMF Washington Mortgage, in
December 1998. The Company has entered into a strategic relationship with
Greenwich Capital Markets ("Greenwich") pursuant to which WMF Funding
will originate loans for sale to Greenwich. Greenwich is expected to pool these
loans with other loans and then sell interests in, or "securitize,"
the pool. The Company will service the loans it originates and receive a
portion of the profits, if any, from any securitization of those loans.
Prior to September 1998, the Company had
operated an independent commercial mortgage conduit through its subsidiary Capital
Corp. The operations of Capital Corp. have been curtailed since it suffered
substantial losses in the second and third quarters of 1998 and the Company has
determined not to make further investments in Capital Corp. However, the
Company cannot assure you that it will not be required to do so.
ADVISORY SERVICES (WMF
CARBON MESA)
The Company's advisory services segment,
WMF Carbon Mesa, was formed in March 1998, when the Company acquired all of the
assets of Carbon Mesa Advisors, Inc. and Strategic Real Estate Partners. Based
in Los Angeles, WMF Carbon Mesa manages a private commercial mortgage fund,
provides a variety of advisory services to institutional investors and
originated over $400 million in loans and investments in 1997. WMF Carbon Mesa
employs 16 people.
WMF Carbon Mesa develops new loan products,
manages commercial mortgage investment funds, provides special asset management
servicing and originates commercial mortgages. In June 1998, WMF Carbon Mesa
entered into an agreement to manage COMIT. COMIT invests in multifamily and
commercial mortgages, primarily those originated by the Company that are not
sold in securitizations or to other institutional investors. These types of
multifamily and commercial loans include bridge, mezzanine and structured
transactions.
Financial information for each of the
Company's operating segments is included in Note 15 of the Company's
Consolidated Financial Statements.
EMPLOYEES
At December 31, 1998, the Company employed
346 persons. Most of these people work in professional, administrative and
technical positions and no employee is represented by a labor union or subject
to a collective bargaining agreement. The Company believes that its employee
relations are generally good.
12
RISK FACTORS
UNSATISFIED CONTRACTUAL
COMMITMENTS MAY CAUSE ADDITIONAL LOSSES - As a result of the losses described
above (See "Major Developments in 1998 - 1998 Losses") and to reduce
its exposure to additional losses, the Company has decided that it will no
longer contribute capital to Capital Corp. This determination, combined with
changes in market conditions, resulted in Capital Corp.'s being unable to
fulfill its obligations under at least one loan commitment. The Company has
settled all claims related to that loan commitment, but the Company cannot
assure you that it will not incur significant losses in the future related to
the Company's inability to meet other contractual commitments of Capital Corp.
LOSSES RELATED TO LOANS
HELD FOR SALE FOR WHICH THE COMPANY DOES NOT HAVE INVESTOR COMMITMENTS COULD
AFFECT THE COMPANY'S RESULTS OF OPERATIONS -Generally the Company sells loans
to third-party mortgage investors at predetermined prices before the Company
funds or purchases the loan. However, sometimes the Company originates or
purchases a mortgage loan before an investor has agreed to purchase it from the
Company. During the period between the Company's origination or purchase of a
loan and the sale of the loan to an investor (called the "holding period"),
the Company must bear the interest rate risk and credit risk associated with
that loan. If the holding period is long, the Company's risks are higher.
Adverse changes in interest rates, the market for these mortgage loans or the
value of assets securing the mortgages could impair the Company's ability to
sell loans, increasing the Company's holding period and potential losses. If
the Company is unable to sell its loans for a long period of time, the
Company's business and results of operations could be materially adversely
affected.
THE COMPANY MAY INCUR
LOSSES RELATED TO LOAN COMMITMENTS FOR WHICH IT DOES NOT HAVE A PURCHASER AND HAS
NOT ENTERED INTO HEDGE ARRANGEMENTS - Capital Corp. has entered into forward
commitments to lend money on certain terms and conditions which subject the
Company to interest rate and market risks until the Company sells the loans. As
of December 31, 1998, Capital Corp. had commitments outstanding to extend
credit to borrowers of $65.8 million. No investor has committed to purchase
these loans, and Capital Corp. has not entered into arrangements to manage the
interest rate and market risk associated with those loans. If interest rates
increase or the demand for such loans declines before Capital Corp. is able to
sell these loans, Capital Corp. may incur significant losses. The Company is
currently seeking investors for the loans, but the Company cannot assure you
that Capital Corp. will not incur significant losses before such an investor is
found or that it will locate an investor at all.
COMPANY'S LOSS OF DEFERRED
TAX ASSETS COULD ADVERSELY AFFECT SHAREHOLDER EQUITY- As of December 31, 1998,
the Company had $17.3 million in deferred tax assets related to the Company's
losses during 1998. The Company has recognized the tax benefit of those
operating losses as deferred tax assets and believes that it is more likely
than not that the Company will have sufficient taxable income to realize the
tax benefits of those losses during the next 20 years. However, in the event of
a change of control of the Company or Capital Corp. or certain other material
changes in the Company's business, the Company would have to establish a
valuation allowance against the deferred tax asset. An increase in the
valuation allowance relating to the deferred tax asset could adversely affect
operating results and shareholder equity.
THE COMPANY MAY BE UNABLE
TO COMPLETE ACQUISITIONS OR ENTER INTO NEW BUSINESS LINES - The Company plans
to expand its business both internally and through acquisitions of other
commercial mortgage financial service companies. The Company cannot assure you
that it will be able to support its continued growth. The Company also cannot
assure you that it will be able to identify, finance and purchase additional
acquisition candidates, or that future acquisitions, if completed, will be
successful.
When the Company acquires new businesses
with different markets, customers, financial products, systems and management,
the Company may have difficulty integrating those business into its existing
operations. This integration process
may cause unforeseen difficulties and may require a large portion of
management's attention and the Company's resources. These difficulties may be
particularly acute as the Company expands into business lines outside of its
traditional multifamily business.
The Company originally focused on
originating and servicing mortgages on multifamily properties, such as
apartment buildings and condominiums. Since 1996, the Company has expanded its
origination and servicing of mortgages on other commercial properties, such as
office buildings, hotels, and retail stores. The Company plans to continue to
expand its business in both the multifamily and commercial mortgage areas. See
"Business - Strategic Objectives."
To support, manage and control continued
growth, the Company must be able to hire, train, retain, supervise and manage
its workforce. The Company must also develop the skills necessary to compete
successfully in its new business lines. In particular, the
13
success of certain
acquisitions may depend on the Company's ability to retain key employees of the
acquired business.
THE COMPANY MAY INCUR
LOSSES ON MORTGAGE LOANS UNDER THE DUS PROGRAM - WMF Washington Mortgage is an
approved lender under the Fannie Mae DUS Program. Under this program, WMF
Washington Mortgage originates, places and services multifamily loans for
Fannie Mae without having to obtain Fannie Mae's prior approval for each loan.
The DUS Program requires WMF Washington
Mortgage to pay a portion of any losses on mortgages that it originates under
the program. These losses may cost WMF Washington Mortgage up to 20 percent of
the original principal balance of the loan. Additionally, if borrowers default
under loans in the DUS Program, the value of WMF Washington Mortgage's
servicing rights for those loans could materially decrease. See "The
Company's Operations May Decline As a Result of Impairment of Mortgage
Servicing Rights"
To remain in the DUS Program, WMF
Washington Mortgage must maintain a letter of credit or cash sufficient to
cover its estimated portion of any losses. As of December 31, 1998, the unpaid
principal balance of WMF Washington Mortgage loans in the DUS Program totaled
$1.5 billion and WMF Washington Mortgage had a $6.3 million reserve for
probable loan losses under the DUS Program. WMF Washington Mortgage also had a
$5.2 million letter of credit to pay for losses under the program. While the
Company believes that these reserves are sufficient, actual losses under the
DUS Program could exceed these reserves and hurt the Company's performance. If
the Company incurs and is required to fund additional losses, results of
operations may be adversely affected.
THE COMPANY IS LIABLE FOR
CERTAIN REPRESENTATIONS AND WARRANTIES CONCERNING MORTGAGE LOANS - When the
Company originates mortgage loans and then sells them to investors, the Company
must make certain representations and warranties concerning those mortgages.
These representations and warranties cover such matters as title to mortgaged
property, lien priority, environmental reviews and certain other matters. When
making these representations and warranties, the Company relies in part on
similar representations and warranties made by the borrower or others.
If the representations made by a borrower
or others are false, the Company will have a claim against the borrower or
other party. The Company's ability to recover its damages, however, depends on
the financial condition of the party that made the false representation. In
addition, the Company makes some representations and warranties even though it
does not receive similar representations and warranties from borrowers or
others. If those representations are later found to be false, the Company would
have to pay for any losses and would not have a claim against another party.
The Company cannot assure you that it will not experience a material loss as a
result of its representations and warranties.
THE COMPANY MAY INCUR
LOSSES AS A RESULT OF CHANGES IN GENERAL ECONOMIC CONDITIONS - The following
general economic conditions could have an adverse effect on the Company's
business:
. periods of general, regional or industry-related economic
slowdown or recession,
. declining demand for real estate or
. changes in interest rate levels.
An economic slowdown will generally reduce
the Company's origination and sales of mortgages, which generated approximately
56.0 percent of the Company's revenue during 1998. In addition, periods of
economic slowdown or recession may increase the risk that borrowers will
default on multifamily and commercial mortgage loans, and those defaults may
have an adverse effect on the Company's financial condition. When the owner of
a mortgage forecloses on a property, the Company's servicing fees may be
reduced or eliminated and the Company may experiences additional losses.
Periods of economic slowdown or recession
may be accompanied by decreased demand for multifamily or commercial
properties. Decreased demand may result in declining values for the properties
securing outstanding loans, and decreased property values weaken the Company's
collateral coverage and increase the possibility of losses in the event of default.
If more properties are for sale during recessionary periods, the Company may
receive lower prices when it sells foreclosed properties, or it may have to
delay such sales. The Company cannot assure you that it will be able to sell
foreclosed properties in the multifamily or commercial markets. Any material
deterioration of such markets could reduce the Company's proceeds from
foreclosure sales.
THE COMPANY EARNINGS MAY BE
AFFECTED BY CHANGES IN INTEREST RATES - The Company believes that interest rate
changes can affect its operating results in a variety of ways, including
impacts on
14
origination fees, servicing
fees, placement fee income and gains on loan sales, as well as its own cost of
financing. Generally, interest rate increases reduce the level of economic and
real estate activity, thereby decreasing the demand for mortgage financing,
which in turn may negatively affect the Company's ability to earn origination
fees and generate gains on loan sales. In addition to possibly depressing loan
origination levels, gains on loan sales may be further restricted because the
value of fixed income securities, such as many real estate mortgages, tend to
decline as interest rates increase. Finally, interest rate increases raise the
cost of debt financing, particularly if the Company finances its operations
with variable rate debt.
Interest rate increases, however,
positively affect Company earnings from loan servicing activities. A reduction
in real estate activity may reduce the risk of borrower prepayments,
potentially increasing the level of servicing fees and the value of the
Company's servicing portfolio. Additionally, placement fee income earned by the
Company may benefit from increased interest rate levels.
Declines in interest rates should generally
have a corresponding favorable impact on Company earnings from originating,
loan sales and financing activities and a negative impact on servicing and
placement fee income. Changes in the relationship between short-term and
long-term interest rates may also affect the Company's results of operations.
The Company earns net interest income, typically based upon long-term rates
earned on loans held between loan closing and mortgage investor funding. Net
interest income increases when long-term rates increase relative to short-term
rates and decreases when short-term rates increase relative to long-term rates.
Although the Company believes that the
interest rate environment generally has the foregoing effects, there is no
consistent correlation between interest rate levels and either the Company's
revenues or its overall profitability. In part, this lack of correlation
reflects the refinancing of existing permanent and construction mortgages at
their maturities which may occur regardless of the interest rate environment.
Additionally, approximately 56 percent of the Company's revenues are derived
from originating and approximately 44 percent of the Company's revenues are
derived from servicing activities, and interest rates have different impacts on
each, as described above.
See Item 7A, Quantitative and Qualitative
Disclosures about Market Risk, for
additional information about the Company's exposure to interest rate risk.
THE COMPANY'S OPERATIONS
MAY DECLINE AS A RESULT OF IMPAIRMENT OF MORTGAGE SERVICING RIGHTS - Under
generally accepted accounting principles ("GAAP"), the Company must
treat its servicing rights as an asset. Servicing rights are recorded as an
asset on the Company's balance sheet at either the purchase price paid for the
servicing rights or the relative fair value of the servicing rights at the time
the Company sells a loan and retains the servicing associated with that loan.
The Company also must amortize the value of the servicing rights over their
estimated lives.
If the value of the servicing rights, as
shown on the Company's balance sheet, exceeds their fair value, then the rights
are impaired. The fair value of the servicing rights may be affected by, and
impairment may result from, factors such as:
. changes in mortgage prepayments, which tend to increase as long-
term interest rates decline, and
tend to decrease as such
interest rates rise;
. prepayment penalty terms, including lockout and yield maintenance
requirements;
. higher than expected rate of loan defaults;
. lower than expected short-term interest rates;
. factors which impact the net cash flow generated from the
servicing rights, such as the
cost of servicing such loans; and
. the underlying loans' average custodial balances (the amount
deposited by borrowers for
taxes, deposits and replacement
reserves).
To the extent that the Company's servicing
rights are impaired, the Company's operating results may be adversely affected.
Although the Company has not recorded any impairment in the Consolidated
Financial Statements presented herein, it may record impairment at any time in
the future. The Company cannot assure you that it has accurately estimated the
factors that could cause impairment of the servicing, or that the Company's
mortgage servicing rights can be sold at their value, if at all.
THE COMPANY MAY INCUR
LOSSES UPON TERMINATION OF CERTAIN SERVICING CONTRACTS -As of December 31,
1998, the Company had contracts to service mortgages with a total principal
balance of $12.1 billion. Approximately 24 percent of those contracts are
terminable upon 30 days' notice by the owner of the serviced mortgage. Most of
the contracts with these termination provisions are for the servicing of
mortgages held by insurance companies. As the Company increases its servicing
of mortgages held by insurance companies, the percentage of servicing contracts
with such termination provisions may also increase.
15
The rest of the Company's servicing
contracts are for a term equal to the life of the mortgage. The holder of the mortgage may terminate the
contract only for cause, after paying the Company a termination fee, or after
prepayment or other early termination of the mortgage.
If a significant number of the Company's
mortgage servicing contracts were terminated and the Company were unable to
replace them with new servicing contracts, the Company's operations would be
adversely affected.
THE COMPANY MAY BE UNABLE
TO CONTINUE TO COMPLY WITH GOVERNMENT REGULATIONS AND PROGRAMS -
The Company's operations are regulated by:
. federal, state and local government authorities, including the
FHA and the Government National
Mortgage Association ("Ginnie
Mae");
. various federal, state and local laws and judicial and
administrative decisions; and
. regulations of GSEs (such as Fannie Mae) that purchase mortgages
originated and/or serviced by
the Company.
Among other things, these laws, regulations
and decisions:
. require the Company to maintain a minimum net worth, minimum
lines of credit, minimum liquid
reserves and minimum errors and
omissions and fidelity
insurance;
. require the employment of trained personnel competent to perform
their assigned responsibilities;
. require periodic financial reports;
. require a quality control plan for the underwriting, origination
and servicing of loans;
. restrict loan originations, credit activities, maximum interest
rates, and finance and other
charges;
. regulate disclosures to customers, the terms of secured
transactions and personnel
qualifications; and
. require certain collection, repossession and claims-handling
procedures and other trade
practices.
Although the Company believes that it
complies in all material respects with applicable laws and regulations and with
the requirements of mortgage purchasers, the Company cannot assure you that it
will be able to continue to comply if more restrictive laws, rules, regulations
or requirements are adopted in the future. If the Company fails to comply with
all applicable requirements, the Company could lose the opportunity to
originate, sell or service mortgages in certain jurisdictions, or to originate
mortgages on behalf of, sell mortgages to or service mortgages held by certain
institutions. If that occurs, the Company's financial results could be
adversely affected.
The FHA insured approximately 10.4 percent
of loans originated by the Company during the year ended December 31, 1998 and
approximately 44.9 percent of loans serviced by the Company as of December 31,
1998. If the laws or regulations governing FHA programs change, the
availability of FHA-insured loans could decrease, and the Company's ability to
originate or service those mortgages could be affected. Any such change could
have a material adverse effect on the Company and its results of operations.
THE COMPANY MAY INCUR
LOSSES RELATED TO THE YEAR 2000 CONVERSION - The Year 2000 Problem refers to
errors that may occur when computers use two digits rather than four to define
the applicable year. Software and
hardware may recognize a date using "00" as the year 1900, rather
than the year 2000. If a computer does
not recognize a date on or after January 1, 2000, the error could, among other
things, prevent the Company from processing transactions, sending invoices or
engaging in other normal business activities.
Although the Company's Year 2000 program
(see "Management's Discussion and Analysis Of Financial Condition and
Results of Operations - Year 2000") is intended to minimize the adverse
effects of the Year 2000 Problem on the Company's business and operations, the
actual effects of the Year 2000 Problem and the success or failure of the Company's
efforts described below cannot be known until after January 1, 2000. If the
Company, its major vendors, service providers or major customers fail to
address adequately the Year 2000 Problem in a timely manner, the Company's
business, results of operations and financial condition could be adversely
affected.
THE COMPANY MAY NOT BE ABLE
TO COMPETE WITH OTHER MORTGAGE BANKING BUSINESSES - The Company's competition
varies by geographic market. Generally, competition is fragmented with very few
national competitors and many local and regional competitors.
16
In addition, the Company's
business is characterized by low barriers to entry, and new competitors have
recently been successful in raising the capital necessary to enter the
business. Moreover, certain of the Company's competitors are larger and have
greater financial resources than the Company, including the commercial mortgage
banking arms of General Motors, General Electric, Mellon Bank, Banc One and
First Union. The Company competes largely on the basis of its experience in
purchasing and servicing and on its ability to respond promptly to changing
market conditions. Although management believes that the Company is well
positioned to continue to compete effectively in the multifamily and commercial
mortgage banking businesses, there can be no assurance that it will do so or
that the Company will not encounter further increased competition in the future
which could limit its ability to maintain or increase its market share.
ITEM 2. PROPERTIES
The following table
summarizes information about the Company's primary leased office space:
--------------------------------------------------------------------------------------------------------------------------
Location of the Approximate square feet Lease Expiration Business Segment
office Occupied Date Occupying Space
--------------------------------------------------------------------------------------------------------------------------
Vienna, VA 52,000 sf December 31, 2000 Mortgage Banking, Headquarters
--------------------------------------------------------------------------------------------------------------------------
Edison, NJ 15,200 sf April, 28, 2000 Mortgage Banking
--------------------------------------------------------------------------------------------------------------------------
Houston, TX 10,200 sf January 28, 2001 Mortgage Banking
--------------------------------------------------------------------------------------------------------------------------
Los Angeles, CA 17,700 sf January 30, 2007 Advisory Services,
Mortgage Banking
--------------------------------------------------------------------------------------------------------------------------
Charlotte, NC 16,500 sf February 14, 2003 Capital Markets, Mortgage Banking
--------------------------------------------------------------------------------------------------------------------------
New York, NY 13,600 sf October 20, 2008 Mortgage Banking
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The Company's headquarters are currently
located in Vienna, Virginia. In addition to the offices listed above, the
Company has thirteen corporate offices located around the country, including
Phoenix, AZ; Detroit, MI; Dallas, TX; Denver, CO; and Atlanta, GA.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time
in legal proceedings arising in the ordinary course of business. In connection
with the Company's loan servicing activities, the Company is indemnified to
varying degrees by the party on whose behalf the Company is acting. The Company
also maintains insurance that management believes is adequate for the Company's
operations. Except as described below, none of the legal proceedings in which
the Company is currently involved, either individually or in the aggregate (and
after consideration of available indemnities and insurance), is expected to
have a material adverse effect on the Company's business or financial
condition; however, any claims asserted in the future may result in legal
expenses or liabilities which could have a material adverse effect on the
Company's business or financial condition.
Two lawsuits have been filed against
Capital Corp. alleging, among other things, breach of contract by Capital Corp.
due to its failure to fund certain loan commitments issued by it. The Company
is also named as a defendant in one of the lawsuits. An adverse judgement in
these matters against Capital Corp. would be material to Capital Corp., and if
against the Company, could be material to the Company. Capital Corp. is
attempting to resolve the matters by settlement and compromise but no
assurances can be given that such attempts will be successful. The Company does
not anticipate a material adverse judgement against it in the case where it is
named as a defendant.
ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the
Company's security holders during the fourth quarter of the year ended December
31, 1998.
PART II
ITEM 5.MARKET FOR
REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
17
The Company's common stock began trading on
December 8, 1997 and trades on The Nasdaq Stock Market under the symbol
"WMFG".
The following table sets forth the high and
low per-share closing prices for the Company's common stock for each quarterly
period since its initial public offering:
CALENDAR YEAR HIGH LOW
------------- ---- ---
1997
----
Fourth Quarter (from December 9,
1997) $14 $12 1/8
1998
----
First Quarter 32 1/2 11 1/8
Second Quarter 28 1/4 19 5/8
Third Quarter 29
5
Fourth Quarter 8 1/4 3 3/8
1999
----
First Quarter (through March 29,
1999) 6 1/2 4 3/4
On March 29, 1999, the Company had
approximately 244 stockholders of record.
The Company does not anticipate declaring
and paying cash dividends on the Company's common stock in the foreseeable
future. The decision whether to apply any legally available funds to the
payment of dividends on the Company common stock will be made by the Board of
Directors of the Company from time to time in the exercise of its business
judgment, taking into account the Company's financial condition, results of
operations, existing and proposed commitments for use of the Company's funds
and other relevant factors.
The Company's ability to pay dividends may
be restricted from time to time by financial covenants in its credit agreements
or in arrangements with or regulations of government sponsored entities.
On December 30, 1998, the Company issued a
total of 250,000 warrants as part of a settlement agreement between the Company
and one of its borrowers. As adjusted, the warrants permit the borrower to
purchase 100,000 shares of the Company's common stock at $5.90 per share and
150,000 shares of the Company's common stock at $9.70 per share. The exercise
price of the warrants may be further adjusted upon the occurrence of certain
dilutive events. Also as part of the settlement, the Company issued 50,000
shares of its common stock to be held in escrow to secure Capital Corp.'s
obligations under the settlement agreement. These transactions were exempt from
registration pursuant to Section 4(2) of the Securities Act of 1933, as amended
(the "Securities Act"), because they did not involve any public
offering.
On December 31, 1998, the Company sold a
total of 3,635,972 shares of Class A Stock to Demeter, Phemus and Capricorn for
total proceeds of approximately $16.6 million. The shares of Class A Stock were
subsequently converted to an equal number of shares of common stock. The
Company used the proceeds from the sale of Class A Stock to partially repay the
subordinated notes held by COMIT. The sale of the Class A Stock was exempt from
registration pursuant to Section 4(2) of the Securities Act, because the sale
did not involve any public offering.
ITEM 6. SELECTED FINANCIAL
DATA
The following table sets forth selected
financial and operating data of the Company as of and for each of the years
ended December 31, 1998, 1997, 1995. Also set forth is data as of and for the
three-month period ended March 31, 1996 and as of and for the nine-month period
ended December 31, 1996. The data for the three-month period ended March 31,
1996 and the nine-month period ended December 31, 1996 are presented separately
as a result of the acquisition of the Company, which was formerly known as WMF Holdings
Ltd., by NHP effective April 1, 1996 (the "NHP Acquisition"). The
table also sets forth pro forma income statement data for the year ended
December 31, 1996 giving effect to the NHP Acquisition as though it occurred
January 1, 1996. The selected financial data of the Company as of and for each
of the above mentioned periods were derived from the Company's consolidated
18
financial statements
contained elsewhere herein. The pro forma data (which are unaudited) are
derived from the footnote 19 of the Company's consolidated financial statements
contained in this document. The pro forma results are not necessarily
indicative of operating results that would have been achieved had the NHP
Acquisition actually occurred on January 1, 1996. Additionally, the pro forma
operating results are not intended to be a projection of results of future
operations. The selected financial and operating data should be read in
conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the financial statements, pro
forma financial statements and related notes included elsewhere herein.
19
SELECTED
CONSOLIDATED FINANCIAL DATA
(DOLLARS IN
THOUSANDS, EXCEPT PER SHARE DATA)
WMF Holdings
Ltd. and
The Company Subsidiaries
------------------------------- --------------------------
For the period For the period
Pro
Forma April 1 to January 1 to Year Ended
December 31, December 31, March 31, December 31,
1998 1997 1996 (1) 1996
1996 1995
---------------------------------------------------------------------------------------------
(Unaudited)
INCOME STATEMENT DATA
Revenues $
72,541 $ 44,645 $ 30,301 $23,473 $
6,828 $ 21,999
Expenses
105,863 42,203 29,416 22,318
6,523 21,222
Net income (loss) (33,322) 2,442 885
1,155 305 777
Net income (loss) per
share-Basic (2) (6.38) 0.57 0.21
0.27 0.07 0.16
Weighted average
shares
outstanding-Basic (2) 5,224 4,272 4,217
4,217 4,217 4,717
Net income (loss) per
share-Diluted(2) (6.38) 0.55 0.21
0.27 0.07 0.16
Weighted average shares
outstanding-
Diluted(2) 5,224 4,452 4,217
4,217 4,217 4,717
DECEMBER 31, DECEMBER 31,
DECEMBER 31, MARCH 31, DECEMBER 31,
1998 1997 1996 1996 1995
---- ----
---- ---- ----
BALANCE SHEET DATA
Mortgage loans held for
sale $ 34,217 $ 49,431 $40,263 $23,116 $
32,462
Servicing rights 26,243 26,796 22,460 8,477
8,466
Total assets 144,527 119,331 88,097 48,976
57,176
Total debt (3) 79,151 59,904 46,136 34,108
43,304
Shareholders' equity 27,378 38,825 22,528 4,324
4,018
OTHER DATA
Cash Flows from
Operating
activities (4) $ 14,086 $ (1,099) $ 1,275 $(8,708) $ 9,983
$(21,897)
Investing
activities (4) (54,759) (21,463) (9,824)
(9,276) (548) (2,343)
Financing
activities (4) 41,122 26,529 7,833
17,029 (9,196) 26,833
EBITDA (4)
(41,168) 11,439 8,256 6,502
1,754 4,743
_____________
(1) Adjusted to reflect
results of operations for the twelve months ended
December 31, 1996, as if the NHP Acquisition
had occurred January 1, 1996.
Adjustments include all income amounts for
the three months ended March
31,1996 and additional amortization of
$575,648.
(2) Gives retroactive
effect to a 789.94 per share stock split effective October
3, 1997.
(3) Includes $5,000,000 of
notes to the Company's former shareholder as of March
31, 1996 and December 31, 1995, which were repaid
in conjunction with the
NHP Acquisition.
(4) Operating, investing
and financing cash flow represents the amount of cash
generated from operating, investing and
financing activities, respectively,
as determined using GAAP.
(5) EBITDA is a non-GAAP
presentation of the Company's performance and consists
of income (loss) from operation before
non-warehouse interest expense,
income taxes, depreciation and amortization.
EBITDA is included because it
is used in the industry as a measure of a
company's operating performance
and provides information in addition to that
supplied by GAAP-based data
regarding the ability of the Company's
business to generate cash, but should
not be constructed as an alternative either
(i) to income (loss) from
operations (determined in accordance with
GAAP) as measure of profitability
or (ii) to cash flows from operating
activities (determined in accordance
with GAAP). EBITDA does not take into
account the Company's debt service
requirements and other commitments and,
accordingly, is not necessarily
indicative of amounts that may be available
for discretionary uses and
EBITDA as measured by the Company may not be
comparable to EBITDA as
measured by other companies.
20
ITEM 7. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
On April 1, 1996, NHP acquired all the
outstanding capital stock of the Company for consideration of approximately $21
million, in the form of $16.8 million in cash and 210,000 shares of NHP Common
Stock. (For periods prior to NHP's acquisition of the Company, the Company is
referred to as "WMF Holding."). As a result of the NHP Acquisition,
all assets and liabilities acquired were recorded at their fair value which
resulted in an increase of the recorded value of the Company's servicing rights
of $10.7 million and goodwill of $5.1 million.
The following discussion and analysis
presents the significant changes in financial condition and results of
operations of the Company for the years ended December 31, 1998, 1997 and 1996.
The results of operations of acquired businesses are included in the Company's
consolidated financial statements from the date of acquisition. This discussion
should be read in conjunction with the Company's consolidated financial
statements and notes thereto included elsewhere herein. For the purpose of
comparing the year ended December 31, 1997 to the year ended December 31, 1996,
the three months ended March 31, 1996 has been combined with the nine months
ended December 31, 1996. As a result of the NHP Acquisition, the year ended
December 31, 1997 includes $575,000 of additional amortization expense as
compared to the year ended December 31, 1996. For purposes of comparing the
year ended December 31, 1997 and 1996, no other income statement amounts have
been impacted by the NHP Acquisition.
Although it incurred significant
losses in 1998, since 1996, the Company has experienced significant growth in
its revenues, annual production volume and servicing volume. The Company seeks
to continue to expand its business through (i) acquisitions, (ii) internal
growth, (iii) design and delivery of new mortgage products, (iv) expansion into
related businesses, and (v) diversification of fee income sources. On a
going-forward basis, to the extent that the Company is successful in completing
acquisitions, the Company will experience increased expenses associated with
the amortization of goodwill and acquired mortgage servicing rights and, if the
acquisitions are financed by additional indebtedness, an increase in interest
expense. Through its acquisitions, the Company's primary focus is to increase
its mortgage origination capabilities and servicing portfolio as well as to
expand into related businesses. Accordingly, such acquisitions may result in a
short-term decrease in income from operations during the period from
acquisition through a period necessary to integrate the acquired companies.
RESULTS OF OPERATIONS -
SUMMARY
The Company's primary business activities
are commercial and multifamily loan servicing, loan origination and sales of
the loans to investors in the secondary market. With the formation of Capital
Corp. and the acquisition of Carbon Mesa in the first quarter of 1998, the
Company operated a commercial mortgage conduit, manages commercial mortgage
investment funds and provides special asset management services. The Company
manages its operations through three business segments: mortgage banking,
capital markets, and advisory services. Revenues from mortgage banking
activities are earned from the origination of commercial and multifamily real
estate mortgage loans and the servicing of such loans. Sources of mortgage
banking revenue include loan servicing fees, gains on sale of mortgage loans
(including related gains on originated servicing rights), interest income on
loans prior to sale, "placement fees" (revenue earned relating to
utilization of escrow funds) and origination fee income. In capital markets,
the principal sources of revenue include gain on the sale of mortgage loans,
gains on the sale of servicing and interest income on loans prior to
securitization. Structuring fee income, management fees and origination fees
represent the major sources of income for the advisory services segment.
The Company's revenue is significantly
influenced by the timing of origination and sales of mortgage loans and is
somewhat sensitive to economic factors such as the general level of interest
rates and demand for commercial and multifamily real estate. As a result,
future revenues may fluctuate due to changes in these factors. Therefore, the
Company's historical results may not be indicative of future periods.
21
The following table sets
forth information derived from the Company's consolidated statements of
operations and reconciles the summary segment financial information to the
consolidated statements of operations for each of the periods presented:
Segment Financial Information and Reconciliation to Consolidated
Statements
Statements of
Operations
(in thousands)
Year Ended Year Ended Year Ended
December 31, December
31, December 31,
1998 1997 1996
-----------------------------------------------
Revenue
(Proforma)
-------
Mortgage Banking (1) $ 67,567 $44,645
$30,301
Capital Markets 3,484 - -
Advisory Services 1,490 - -
----------------------------------------------
Total
72,541 44,645 30,301
Consolidated
Statement
72,541 44,645 30,301
Expenses
(2)
------------
Mortgage
Banking (1)
59,169 39,116 27,154
Capital
Markets 60,379 -
-
Advisory
Services
2,114 - -
Non-operating
interest
3,267 758 278
----------------------------------------------
Total
124,929 39,874 27,432
Consolidated
Statement
124,929 39,874 27,432
Pretax
income (loss)
(52,388) 4,771 2,869
Provision
(benefit) for taxes
(19,066) 2,329 1,984
----------------------------------------------
Net
income (loss)
($33,322) $ 2,442 $
885
==============================================
Mortgage
Banking EBITDA (1)
16,074 11,439 $ 8,256
Capital
Markets EBITDA
(56,766) - -
Advisory
Services EBITDA
(476) - -
----------------------------------------------
Total
($41,168) $11,439 $ 8,256
Consolidated
EBITDA
($41,168) $11,439 $ 8,256
(1) Mortgage banking operations includes
corporate administrative expenses. (2)
The company recognized reorganization and recapitalization expenses of
approximately $2.0 million with
approximately $1.7 million reported in
mortgage banking and $341,000 reported in
capital markets.
22
The following table sets
forth information derived from the Company's consolidated balance sheet for
each of the periods presented and a reconciliation to the Company's
consolidated balance sheet:
December 31,
December 31, December 31,
1998 1997 1996
----------------------------------------------
Assets
------
Mortgage Banking
(1) $131,264 $119,331 $88,097
Capital Markets 8,558
- -
Advisory Services 4,705 - -
----------------------------------------------
Total 144,527 119,331
88,097
Consolidated
Statement $144,527 $119,331 $88,097
(1) Mortgage banking operations includes
corporate administration.
YEAR ENDED DECEMBER 31,
1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
Net income (loss) was ($33.3) million for
the year ended December 31, 1998, a decrease of $35.7 million from $2.4 million
for the same period in 1997. The
decline in net income was due primarily to U.S. Treasury short sale transaction
losses of $36.7 million and losses of $10.5 million on loan sales at Capital
Corp. The losses were partially offset
by higher gains on loan sales, servicing revenue and placement fee income in
the mortgage banking segment and structuring fee income in the advisory
services segment. Net income includes a
tax benefit of $19.1 million for the year ended December 31, 1998.
The Company's earnings (losses) before
non-operating interest expense, income taxes, depreciation and amortization
(EBITDA) for the year ended December 31, 1998 was ($41.2) million, a decrease
of $52.6 million from $11.4 million for the same period in 1997. The decrease
in EBITDA for the year ended December 31, 1998 as compared to 1997 is due
primarily to U.S. Treasury short sale transaction losses and losses on loans
sales at Capital Corp., as discussed above.
Higher servicing fee and placement fee income in the mortgage banking
segment helped to offset the loss in EBITDA, as the Company's servicing
portfolio balance at December 31, 1998 was $12.1 billion, up from $10.9 billion
as of December 31, 1997.
EBITDA is widely used in the industry as a
measure of a company's operating performance, but should not be considered as
an alternative either (i) to income from continuing operations (determined in
accordance with GAAP) as a measure of profitability or (ii) to cash flows from
operating activities (determined in accordance with GAAP). EBITDA does not take into account the
Company's debt service requirements and other commitments and, accordingly, is
not necessarily indicative of amounts that are available for discretionary
uses.
The Company's consolidated tax benefit for
the year ended December 31, 1998 was $19.1 million, compared to a tax expense
of $2.3 million for the same period in 1997. The tax provision change is the
result of the Company recognizing a deferred tax asset related to the losses
incurred at Capital Corp. during the year ended December 31, 1998. Differences
between the effective income tax rate and the federal and state income tax
rates are due primarily to the amortization of goodwill, a portion of which is
not deductible for income tax purposes. The Company has concluded that it is
more likely than not to have sufficient taxable income, either through continuing
operations or asset dispositions during the carry forward period, to realize
the tax benefit of $19.1 million.