-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QlqhZkUJ7rHGGOEVIJGD7qCfgP3fiId8Jd4N3r4PWOXuFKn2pcoTdHmMu3m2JIOV eWPfM9HefO3+cUFIUV9Tww== 0000950144-96-006854.txt : 19961007 0000950144-96-006854.hdr.sgml : 19961007 ACCESSION NUMBER: 0000950144-96-006854 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 19961004 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: MEGO MORTGAGE CORP CENTRAL INDEX KEY: 0001023334 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS BUSINESS CREDIT INSTITUTION [6159] IRS NUMBER: 880286042 STATE OF INCORPORATION: DE FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: S-1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-13421 FILM NUMBER: 96639158 BUSINESS ADDRESS: STREET 1: 1000 PARKWOOD CIRCLE STREET 2: SUITE 500 CITY: ATLANTA STATE: GA ZIP: 30339 BUSINESS PHONE: 7027373700 MAIL ADDRESS: STREET 1: 4310 PARADISE RD CITY: LAS VEGAS STATE: NV ZIP: 89109 S-1 1 MEGO MORTGAGE CORP FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 4, 1996 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 MEGO MORTGAGE CORPORATION (Name of Registrant as Specified in its Charter) --------------------- DELAWARE 6162 88-0286042 (State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer incorporation or organization) Classification Code Number) Identification No.)
--------------------- 1000 PARKWOOD CIRCLE, SUITE 500 ATLANTA, GEORGIA 30339 (770) 952-6700 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) --------------------- JAMES L. BELTER EXECUTIVE VICE PRESIDENT MEGO MORTGAGE CORPORATION 1000 PARKWOOD CIRCLE, SUITE 500 ATLANTA, GEORGIA 30339 (770) 952-6700 (Name, address, including zip code, and telephone number, including area code, of agent for service) COPY OF COMMUNICATIONS TO: GARY EPSTEIN, ESQ. STEVEN R. FINLEY, ESQ. FERN S. WATTS, ESQ. GIBSON, DUNN & CRUTCHER LLP GREENBERG, TRAURIG, HOFFMAN, 200 PARK AVENUE LIPOFF, ROSEN & QUENTEL, P.A. NEW YORK, NEW YORK 10166 1221 BRICKELL AVENUE (212) 351-4000 MIAMI, FLORIDA 33131 (FACSIMILE) (212) 351-4035 (305) 579-0500 (FACSIMILE) (305) 579-0717
--------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box: / / If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. / / --------------------- CALCULATION OF REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------- PROPOSED MAXIMUM PROPOSED MAXIMUM TITLE OF EACH CLASS OF SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE AMOUNT OF REGISTERED REGISTERED PER UNIT(1) OFFERING PRICE REGISTRATION FEE - ---------------------------------------------------------------------------------------------------------- % Senior Subordinated Notes due 2001..................... $40,000,000 100% $40,000,000 $12,122 - ---------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457 under the Securities Act of 1933. Exclusive of accrued interest, if any. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 MEGO MORTGAGE CORPORATION (CROSS REFERENCE SHEET PURSUANT TO ITEM 501 OF REGULATION S-K)
ITEM NUMBER AND CAPTION HEADING IN PROSPECTUS - ------------------------------------------------- ------------------------------------------- 1. Forepart of the Registration Statement and Outside Front Cover Page of Prospectus... Outside Front Cover Page 2. Inside Front and Outside Back Cover Pages of Prospectus............................ Inside Front and Outside Back Cover Pages 3. Summary Information and Risk Factors....... Prospectus Summary; Risk Factors 4. Use of Proceeds............................ Use of Proceeds 5. Determination of Offering Price............ Cover Page; Underwriting 6. Dilution................................... * 7. Selling Security Holders................... * 8. Plan of Distribution....................... Cover Page; Underwriting 9. Description of Securities to be Registered............................... Prospectus Summary; Description of the Notes 10. Interests of Named Experts and Counsel..... * 11. Information With Respect to the Registrant............................... Prospectus Summary; Risk Factors; Capitalization; Selected Financial Data; Management's Discussion and Analysis of Financial Condition and Results of Operations; Business; Management; Principal Stockholders; Certain Transactions; Description of the Notes; Financial Statements 12. Disclosure of Commission Position on Indemnification for Securities Act Liabilities.............................. *
- --------------- * Omitted because response is negative or inapplicable. 3 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED OCTOBER 4, 1996 PROSPECTUS $40,000,000 MEGO MORTGAGE CORPORATION % SENIOR SUBORDINATED NOTES DUE 2001 Mego Mortgage Corporation (the "Company") is offering hereby (the "Offering") $40.0 million principal amount of its % Senior Subordinated Notes due 2001 (the "Notes"). Interest on the Notes will be payable semiannually on and of each year, commencing , 1997. The Notes are not redeemable at any time prior to , 1999, except that, until , 1998, the Company may redeem, at its option, up to 35% of the original principal of the Notes at the redemption price set forth herein plus accrued interest to the date of redemption with the net proceeds of one or more Public Equity Offerings (as defined herein), if at least 65% of the original principal amount of the Notes remain outstanding after such redemption. On or after , 1999, the Notes are redeemable at the option of the Company in whole or in part, at the redemption prices set forth herein plus accrued interest to the date of redemption. Upon the occurrence of a Change of Control (as defined herein), holders of the Notes will have the right to require the Company to repurchase their Notes, in whole or in part, at a purchase price equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest, if any, to the repurchase date. The Notes will be general unsecured obligations of the Company, subordinated in right of payment to all Senior Indebtedness (as defined herein) of the Company. In addition, the obligations of the Company under the Notes will be jointly and severally guaranteed (Subsidiary Guarantees, as defined herein) on an unsecured, subordinated basis by each of the Company's future Restricted Subsidiaries, other than Special Purpose Subsidiaries (each as defined herein). The Subsidiary Guarantees will be subordinated in right of payment to all Senior Indebtedness of the Subsidiary Guarantors. As of May 31, 1996, after giving pro forma effect to the offering of the Notes, the outstanding Senior Indebtedness of the Company, on a consolidated basis, would have been approximately $ million. There is no established trading market for the Notes and the Company does not intend to apply for a listing of the Notes on any national securities exchange. See "Description of the Notes." Concurrently with the Offering by the Company, the Company is offering 2,000,000 shares of common stock, par value $0.01 per share (the "Common Stock"), of the Company (the "Common Stock Offering"). The sale of the Notes being offered hereby is contingent upon the completion of the Common Stock Offering. THE NOTES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 9 HEREOF FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED CAREFULLY BY PROSPECTIVE PURCHASERS OF THE NOTES OFFERED HEREBY. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------ THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR ENDORSED THE MERITS OF THIS OFFERING. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
- ------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------ PRICE TO UNDERWRITING PROCEEDS TO PUBLIC(1) DISCOUNT(2) COMPANY(3) - ------------------------------------------------------------------------------------------------------ Per Note............................ % % % Total............................... $ $ $ - ------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------
(1) Plus accrued interest, if any, from the date of issuance. (2) The Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriting." (3) Before deducting expenses payable by the Company estimated at $ . ------------------------ The Notes are offered by the Underwriters, subject to receipt and acceptance by the Underwriters, approval of certain legal matters by counsel for the Underwriters and certain other conditions. The Underwriters reserve the right to withdraw, cancel or modify such offers and to reject orders in whole or in part. It is expected that delivery of the Notes will be made through the facilities of The Depository Trust Company on or about , 1996. ------------------------ FRIEDMAN, BILLINGS, RAMSEY & CO., INC. OPPENHEIMER & CO., INC. The date of this Prospectus is , 1996 4 [MAP OF LOCATIONS TO BE INSERTED] IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE NOTES AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. 2 5 PROSPECTUS SUMMARY The following summary is qualified in its entirety by reference to the more detailed information and financial statements, including the notes thereto, appearing elsewhere in this Prospectus. Each prospective investor is urged to read this Prospectus in its entirety. Unless otherwise indicated, all information in this Prospectus gives effect to a 1,600-for-1 stock split effected in October 1996. THE COMPANY Mego Mortgage Corporation (the "Company") is a specialized consumer finance company that originates, purchases, sells and services consumer loans consisting primarily of home improvement loans secured by liens on the improved property. Through its network of independent correspondent lenders ("Correspondents") and home improvement construction contractors ("Dealers"), the Company initially originated only home improvement loans insured under the Title I credit insurance program ("Title I Loans") of the Federal Housing Administration (the "FHA"). The Title I program provides for insurance of 90% of the principal balance of the loan, and certain other costs. The Company began offering conventional uninsured home improvement loans and debt consolidation loans ("Conventional Loans") through its Correspondents in May 1996 and such loans have become a significant portion of its current loan originations. The Company's borrowers are individuals who own their home and have verifiable income but may have limited access to traditional financing sources due to insufficient home equity, limited credit history or high ratios of debt service to income. These borrowers require or seek a high degree of personalized service and prompt response to their loan applications. As a result, the Company's borrowers generally are not averse to paying higher interest rates that the Company charges for its loan programs as compared to the interest rates charged by banks and other traditional financial institutions. The Company has developed a proprietary credit index profile that includes as a significant component the credit evaluation score methodology developed by Fair, Isaac and Company to classify borrowers on the basis of likely future performance. The other components of the Company's scoring system include debt to income ratio, employment history and residence stability. The Company charges varying rates of interest based upon the borrower's credit profile and income. For the year ended August 31, 1996, the loans originated by the Company had a weighted average interest rate of 14.0%. The Company's loan originations increased to $139.3 million during the year ended August 31, 1996 from $87.8 million during the year ended August 31, 1995 and $8.1 million during the six months in which it originated loans in the year ended August 31, 1994. The Company's revenues increased to $13.6 million for the year ended August 31, 1995 from $751,000 for the year ended August 31, 1994. For the nine months ended May 31, 1996, the Company had revenues of $17.4 million compared to $6.8 million for the nine months ended May 31, 1995. For the nine months ended May 31, 1996, the Company had net income of $4.6 million compared to $1.2 million for the nine months ended May 31, 1995. The Company sells substantially all the loans it originates through either whole loan sales to third party institutional purchasers or securitizations at a yield below the stated interest rate on the loans, retaining the right to service the loans and receive any amounts in excess of the yield to the purchasers. The Company completed its first two securitizations of Title I Loans in March and August 1996 totalling $133.1 million and expects to sell a substantial portion of its loan production through securitizations in the future. At May 31, 1996, the Company serviced $166.3 million of loans it had sold. The Company's strategic plan is to continue to expand its lending operations while maintaining its credit quality. The Company's strategies include: (i) offering new loan products; (ii) expanding its network of Correspondents and Dealers; (iii) entering new geographic markets; (iv) realizing operational efficiencies through economies of scale; and (v) using securitizations to sell higher volumes of loans on more favorable terms. At May 31, 1996, the Company had developed a network of approximately 265 active Correspondents and approximately 445 active Dealers. The Company's Correspondents generally offer a wide variety of loans and its Dealers typically offer home improvement loans in conjunction with debt consolidation. By offering a more diversified product line, including Conventional Loans, and maintaining its high level of service, the 3 6 Company has increased the loan production from its existing network of Correspondents. The Company also intends to increase its number of active Correspondents and Dealers by greater penetration of existing markets, because of its broader product line, and through expansion into new geographic markets. The Company anticipates that as it expands its lending operations it will realize economies of scale, thereby reducing its average loan origination costs and enhancing its profitability. In addition, the Company intends to continue to sell its loan production through securitizations as opportunities arise. Through access to securitization, the Company believes that it has the ability to sell higher volumes of loans on more favorable terms than through whole loan sales. The Company was incorporated under the laws of the State of Delaware in 1992. The Company's principal executive offices are located at 1000 Parkwood Circle, Suite 500, Atlanta, Georgia 30339, and its telephone number is (770) 952-6700. CONCURRENT OFFERING OF COMMON STOCK Concurrently with the Offering, the Company is offering 2,000,000 shares of Common Stock (plus up to an additional 300,000 shares to cover over-allotments, if any) by a separate prospectus in the Common Stock Offering. The consummation of the Offering and the Common Stock Offering are conditioned upon each other. In connection with the Common Stock Offering, the Company has applied for quotation of the Common Stock on The Nasdaq National Market under the symbol "MMGC." RELATIONSHIP WITH MEGO FINANCIAL Mego Financial Corp. ("Mego Financial"), a publicly traded company, currently owns 100% of the outstanding Common Stock. Upon completion of the Common Stock Offering, Mego Financial will own approximately 83.3% of the outstanding Common Stock (approximately 81.3% if the underwriters of the Common Stock Offering exercise their over-allotment option in full). As a result of its ownership interest, upon completion of the Common Stock Offering, Mego Financial will have voting control on all matters submitted to stockholders of the Company, including the election of directors and the approval of extraordinary corporate transactions. See "Principal Stockholders." In order to fund the Company's past operations and growth, and in conjunction with filing consolidated tax returns, the Company incurred debt to Mego Financial ("Intercompany Debt"). The amount of Intercompany Debt was $8.5 million at August 31, 1995 and $12.0 million at May 31, 1996. The Company intends to use a portion of the aggregate net proceeds from the Offering and the Common Stock Offering to repay Intercompany Debt. It is not anticipated that Mego Financial will continue to provide funds to the Company or guarantee the Company's indebtedness following consummation of the Offering. The Company also has agreements with its affiliate, Preferred Equities Corporation ("PEC"), for the provision of management services and loan servicing and an agreement with Mego Financial and its direct and indirect subsidiaries for tax sharing. See "Use of Proceeds" and "Certain Transactions." 4 7 THE OFFERING Amount offered...................... $40.0 million aggregate principal amount. Maturity date....................... , 2001. Interest payment dates.............. and of each year, commencing , 1997. Subsidiary Guarantees............... The obligations of the Company under the Notes will be jointly and severally guaranteed by each of the future Restricted Subsidiaries, other than Special Purpose Subsidiaries. See "Description of the Notes -- Subsidiary Guarantees." Optional redemption................. The Notes are not redeemable by the Company prior to , 1999, except that, until , 1998, the Company may redeem, at its option, up to 35% of the original principal amount of the Notes at the redemption price set forth herein plus accrued interest to the date of redemption with the net proceeds of one or more Public Equity Offerings if at least 65% of the original principal amount of the Notes remains outstanding after such redemption. On or after , 1999, the Notes will be redeemable at the option of the Company in whole or in part, at the redemption prices set forth herein, plus accrued interest to the date of redemption. See "Description of the Notes -- Optional Redemption." Mandatory redemption................ None. Ranking............................. The Notes will be general unsecured obligations of the Company, subordinated in right of payment to all existing and future Senior Indebtedness of the Company and will be senior in right of payment to all Indebtedness (as defined herein) of the Company that by its terms is expressly subordinated in right of payment to the Notes. Each Subsidiary Guarantee will be a general unsecured obligation of the Subsidiary Guarantor, subordinated in right of payment to all Senior Indebtedness of such Subsidiary Guarantor and will be senior in right of payment to all Indebtedness of such Subsidiary Guarantor that by its terms is expressly subordinated in right of payment to the Subsidiary Guarantee. As of May 31, 1996, after giving pro forma effect to the issuance of the Notes, the outstanding Senior Indebtedness of the Company, on a consolidated basis, would have been approximately $ million. Change of Control................... Upon a Change of Control, holders of the Notes will have the option to require the Company to repurchase up to all outstanding Notes of the holders requiring such repurchase at 101% of their principal amount, plus accrued interest to the date of repurchase. There can be no assurance that the Company will have 5 8 the funds available to repurchase the Notes in the event of a Change of Control. Certain covenants................... The Indenture (as defined herein) pursuant to which the Notes will be issued will contain certain covenants that, among other things, limit the ability of the Company and its subsidiaries to incur certain indebtedness, pay dividends and make other distributions, engage in transactions with affiliates, sell assets (including stock of subsidiaries), issue subsidiary preferred stock, create certain liens, engage in mergers or consolidations and enter into any arrangement that would impose certain restrictions on the ability of subsidiaries to make dividend and other payments to the Company. See "Description of the Notes -- Certain Covenants." Amendment or waiver of Indenture provisions.......................... Certain provisions of the Indenture, including those related to Change of Control, may be amended or waived with the consent of the holders of at least the majority in principal amount of then outstanding Notes. Use of proceeds..................... The Company intends to use the aggregate net proceeds from the Offering and the Common Stock Offering to provide capital to originate and securitize loans and to repay Intercompany Debt. See "Use of Proceeds." 6 9 SUMMARY FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) The summary financial information set forth below should be read in conjunction with the financial statements, related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Prospectus.
YEAR ENDED AUGUST NINE MONTHS 31, ENDED MAY 31, ----------------- ---------------- 1994(1) 1995 1995 1996 ------- ------- ------ ------- STATEMENT OF OPERATIONS DATA: Revenues: Gain on sale of loans.................................... $ 579 $12,233 $6,098 $11,621 Net unrealized gain on mortgage related securities(2).... -- -- -- 2,182 Interest income, net..................................... 172 473 313 538 Loan servicing income.................................... -- 873 418 3,049 ------- ------- ------- ------- Total revenues............................................. 751 13,579 6,829 17,390 Total costs and expenses................................... 2,262 7,660 4,975 9,927 ------- ------- ------- ------- Income (loss) before income taxes(3)....................... (1,511) 5,919 1,854 7,463 Income taxes(3)............................................ -- 2,277 651 2,833 ------- ------- ------- ------- Net income (loss).......................................... $(1,511) $ 3,642 $1,203 $ 4,630 ======= ======= ======= ======= Net income (loss) per share................................ $ (0.15) $ 0.36 $ 0.12 $ 0.46 ======= ======= ======= =======
AS OF AUGUST 31, AS OF MAY 31, 1996 ----------------- ------------------------ 1994(1) 1995 ACTUAL AS ADJUSTED(4) ------- ------- ------- -------------- BALANCE SHEET DATA: Loans held for sale, net.............................. $1,463 $ 3,676 $ 4,671 $ 4,671 Excess servicing rights............................... 904 14,483 12,796 12,796 Mortgage related securities(2)........................ -- -- 15,144 15,144 Total assets.......................................... 5,122 24,081 40,499 Total liabilities..................................... 983 13,300 25,088 Total stockholder's equity............................ 4,139 10,781 15,411
YEAR ENDED AUGUST NINE MONTHS 31, ENDED MAY 31, ----------------- ------------------ 1994(1) 1995 1995 1996 ------- ------- ------- -------- OPERATING DATA: Loans originated...................................... $8,133 $87,751 $52,521 $ 89,391 Weighted average interest rate on loans originated.... 14.18 % 14.55% 14.47% 14.23% Servicing portfolio (period end): Company-owned loans................................. $1,471 $ 3,720 $ 6,250 $ 4,763 Sold loans.......................................... 6,555 88,566 52,400 166,285 ------- ------- -------- Total....................................... $8,026 $92,286 $58,650 $171,048 ======= ======= ======== Delinquency period(5): 31-60 days past due................................. 2.06 % 2.57% 1.27% 2.41% 61-90 days past due................................. 0.48 0.73 0.39 0.78 91 days and over past due........................... 0.26 0.99 0.68 4.34(6) 91 days and over past due, net of claims filed(7)... 0.26 0.99 0.68 2.38 Claims filed with HUD(8).............................. -- -- -- 1.96 Amount of FHA insurance available (period end)........ $ 831 $ 9,552 $ 6,029 $ 18,084(9) Amount of FHA insurance available as a percentage of loans serviced (period end)......................... 10.36 % 10.35% 10.28% 10.57%(9) Ratio of earnings to fixed charges(10)................ N/A 7.69x 5.27x 10.23x
7 10 - --------------- (1) The Company commenced originating loans in March 1994. (2) Mortgage related securities consist of certificates representing interests retained by the Company in securitization transactions. (3) The results of operations of the Company are included in the consolidated Federal income tax returns filed by Mego Financial, the Company's sole stockholder. Mego Financial allocates income taxes to the Company calculated on a separate return basis. See "Certain Transactions." (4) As adjusted to give effect to (i) the sale of the Notes offered hereby (after deducting underwriting discounts and estimated expenses of the Offering), (ii) the sale of the shares of Common Stock pursuant to the Common Stock Offering (at an assumed initial public offering price of $ per share and after deducting underwriting discounts and estimated expenses of the Common Stock Offering) and (iii) the application of the estimated net proceeds from the Offering and the Common Stock Offering as described under "Use of Proceeds." (5) Represents the dollar amount of delinquent loans as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (6) During the nine month period ended May 31, 1996, the processing and payment of claims filed with HUD was delayed. See "Business -- Loan Servicing." (7) Represents the dollar amount of delinquent loans net of delinquent Title I Loans for which claims have been filed with HUD and payment is pending as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (8) Represents the dollar amount of delinquent Title I Loans for which claims have been filed with HUD and payment is pending as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (9) If all claims filed with HUD had been processed and paid as of period end, the amount of FHA insurance available would have been reduced to $15,063,000, which as a percentage of loans serviced would have been 8.98%. (10) Earnings include pretax income, the portion of rents representative of the interest factor and interest on debt. Fixed charges include interest on indebtedness (including the Notes), prepaid commitment fees and the portion of rents representative of the interest factor. 8 11 RISK FACTORS Investment in the Notes offered hereby involves a high degree of risk, including the risks described below. Each prospective investor should carefully consider the following risk factors inherent in and affecting the business of the Company and this offering before making an investment decision. This Prospectus contains forward-looking statements within the meaning of Section 27A of the Securities Act. Discussions containing such forward-looking statements may be found in the material set forth under "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business," as well as in the Prospectus generally. Actual events or results may differ as a result of various factors, including, without limitation, the risk factors set forth below and the matters set forth in the Prospectus generally. SUBORDINATION AND LEVERAGE The Notes (including the Subsidiary Guarantees) will be subordinated in right of payment to all existing and future Senior Indebtedness, including all warehouse indebtedness and all other indebtedness for borrowed money. The Company currently has significant outstanding indebtedness and subsequent to the Offering, the Company will be significantly leveraged. As of May 31, 1996, after giving effect to the Offering, the Company would have had outstanding indebtedness of approximately $ million, of which approximately $ million would have been Senior Indebtedness to which the Notes are subordinated. See "Capitalization." In addition, subject to the limitations set forth in the Indenture, the Company and its future Subsidiaries (as defined herein) may incur substantial amounts of additional indebtedness, much of which is expected to constitute Senior Indebtedness. By reason of the subordination of the Notes, in the event of insolvency, bankruptcy, liquidation, reorganization, dissolution or winding up of the business of the Company or any Subsidiary Guarantor (as defined herein) or upon default in payment with respect to or acceleration of any Senior Indebtedness of the Company or any Subsidiary Guarantor or an event of default with respect to certain Senior Indebtedness continuing for up to 179 days, the assets of the Company or the Subsidiary Guarantor would be available to pay the amounts due on the Notes only after such Senior Indebtedness had been paid in full. The Company is a party to certain warehouse facilities for the financing of its loan originations, which facilities are secured by the loans financed thereby. The Company also has certain additional secured credit facilities and, subject to the limitations set forth in the Indenture, may have additional amounts of secured indebtedness in the future. The Notes (including the Subsidiary Guarantees) are effectively subordinated to all such secured obligations to the extent of the collateral, irrespective of whether payments on the Notes (including the Subsidiary Guarantees) are otherwise permitted to be made under the subordination provisions in the Indenture prior to payment of such other indebtedness in full. Upon certain events of default under such facilities, the lenders could elect to declare all amounts outstanding, together with accrued and unpaid interest thereon, to be immediately due and payable. If the Company were unable to repay those amounts, the lenders could proceed against the collateral granted them to secure that indebtedness. If any of such indebtedness were to be accelerated, there can be no assurance that the assets of the Company would be sufficient to repay in full that indebtedness and the other indebtedness of the Company, including the Notes. The Company's ability to make payments of principal and interest on, or to refinance its indebtedness (including the Notes) depends on its future operating performance, which to a certain extent is subject to economic, financial, competitive and other factors beyond its control. The degree to which the Company is leveraged could have important consequences to the holders of the Notes, including (i) the Company's vulnerability to adverse general economic and industry conditions, (ii) the Company's ability to obtain additional financing for future working capital expenditures (including loan originations), general corporate purposes or other purposes, and (iii) the dedication of a substantial portion of the Company's cash flow from operations to the payment of principal and interest on indebtedness, thereby reducing the funds available for operations and future business opportunities. CONSEQUENCES OF CHANGE OF CONTROL Upon the occurrence of a Change of Control, the holders of the Notes would be entitled to require the Company to repurchase up to all outstanding Notes of the holders requiring such repurchase at a purchase 9 12 price equal to 101% of the principal amount of such Notes plus accrued and unpaid interest thereon to the date of repurchase. Failure by the Company to make such a repurchase would result in a default under the Indenture. In addition, the future indebtedness of the Company and the Subsidiaries may contain prohibitions on the occurrence of certain events that would constitute a Change of Control or require such indebtedness to be repurchased upon a Change of Control. Moreover, the exercise by the holders of the Notes of their right to require the Company to repurchase the Notes could cause a default under such indebtedness due to the financial effect of such repurchase on the Company or otherwise, even if the Change of Control itself does not cause a default. In the event of a Change of Control, there can be no assurance that the Company would have sufficient assets to repurchase the Notes and to satisfy its other obligations under the Notes and any such other indebtedness or be permitted to make such repurchase in compliance with the subordination provisions in the Indenture. See "Description of the Notes -- Change of Control." LIQUIDITY -- DEPENDENCE ON SECURITIZATION TRANSACTIONS The values of and markets for the sale of the Company's loans are dependent upon a number of factors, including general economic conditions, interest rates and government regulations. Adverse changes in those factors may affect the Company's ability to originate or sell loans in the secondary market for acceptable prices within reasonable time frames. The ability of the Company to sell loans in the secondary market is essential for continuation of the Company's loan origination activities. A reduction in the size of the secondary market for home improvement loans would adversely affect the Company's ability to sell its loans in the secondary market with a consequent adverse impact on the Company's profitability and future originations. The Company entered into its first two securitization transactions, which involve the pooling and sale of loans, in March 1996 and August 1996 and intends to continue to sell loans through securitization transactions from time to time as opportunities arise. There can be no assurance that the Company will be able to securitize its loan production efficiently. Securitization transactions may be affected by a number of factors, some of which are beyond the Company's control, including, among other things, conditions in the securities markets in general, conditions in the asset-backed securitization market and the conformity of loan pools to rating agency requirements and, to the extent that monoline insurance is used, the requirements of such insurers. Adverse changes in the securitization market could impair the Company's ability to originate and sell loans through securitizations on a favorable or timely basis. Any such impairment could have a material adverse effect upon the Company's results of operations and financial condition. Furthermore, the Company's quarterly operating results can fluctuate significantly as a result of the timing and level of securitizations. LIQUIDITY -- CASH FLOW As a result of its increased volume of loan originations, the Company has operated since March 1994, and expects to continue to operate for the foreseeable future, on a negative cash flow basis. During the nine months ended May 31, 1996, the Company operated on a negative cash flow basis using $8.0 million in operations that was funded primarily from borrowings, due primarily to an increase in loans originated and the Company's sale of loans. In connection with whole loan sales and securitizations, the Company recognizes a gain on sale of the loans upon the closing of the transaction and the delivery of the loans, but does not receive the cash representing such gain until it receives the excess servicing spread, which is payable over the actual life of the loans sold. The Company incurs significant expenses in connection with securitizations and incurs tax liabilities as a result of the gain on sale. The Company must maintain external sources of cash to fund its operations and pay its taxes and therefore must maintain warehouse lines of credit and other external funding sources. If the capital sources of the Company were to decrease, the rate of growth of the Company would be negatively affected. See "-- Dependence on Mego Financial and PEC." The documents governing the Company's securitizations require the Company to build over-collateralization levels through retention within each securitization trust of excess servicing distributions and application thereof to reduce the principal balances of the senior interests issued by the related trust or cover interest shortfalls. This retention causes the aggregate principal amount of the loans in the related pool to exceed the aggregate principal balance of the outstanding investor certificates. Such over-collateralization amounts serve as credit enhancement for the related trust and therefore are available to absorb losses realized on loans held by such trust. The Company continues to be subject to the risks of default and foreclosure following the sale of 10 13 loans through securitizations to the extent excess servicing distributions are required to be retained or applied to reduce principal from time to time. Such retained amounts are predetermined by the entity issuing the guarantee of the related senior interests and are a condition to obtaining insurance and an AAA/Aaa rating thereon. In addition, such retention delays cash distributions that otherwise would flow to the Company through its retained interest, thereby adversely affecting the flow of cash to the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." After giving pro forma effect to the Offering and the Common Stock Offering, the Company would have had net income of $ million for the nine months ended May 31, 1996 and its ratio of earnings to fixed charges would have been . However, this ratio is not necessarily indicative of the adequacy of the Company's cash flow from operating activities to cover fixed charges because net income consists largely of non-cash items. There can be no assurance that cash from operations will be sufficient to enable it to make required interest payments on its debt obligations and other required payments, and the Company may encounter liquidity problems which could affect its ability to meet such obligations while attempting to withstand competitive pressures. INTEREST RATE RISKS Changes in interest rates affect the Company's business in a variety of ways, including decreased demand for loans during periods of higher interest rates, fluctuations in profits derived from the difference between short-term and long-term interest rates and increases in prepayment rates during periods of lower interest rates. The profits realized by the Company from home improvement loans are, in part, a function of the difference between fixed long-term interest rates, at which the Company originates its home improvement loans, and adjustable short-term interest rates, at which the Company finances such loans until the closing of the sale of such loans. Generally, short-term rates are lower than long-term rates and the Company benefits from the positive interest rate differentials during the time the loans are held by the Company pending the closing of the sale of such loans. During the period from 1994 through the present, the interest rate differential was high and this fact contributed significantly to the Company's net interest income. The interest rate differential may not continue at such favorable levels in the future. Changes in interest rates during the period between the time an interest rate is established on a loan and the time such loan is sold affect the revenues realized by the Company from loans. In connection with the origination of loans, the Company issues loan commitments for periods of up to 45 days in the case of Correspondents and 90 days in the case of Dealers. Furthermore, the period of time between the closing on a loan and the sale of such loan generally ranges from 10 to 90 days. Increases in interest rates during these periods will result in lower gains (or even losses) on sales of loans than would be recorded if interest rates had remained stable or had declined. Changes in interest rates after the sale of loans also affect the profits realized by the Company with respect to loan sale transactions in which the yield to the purchaser is based on an adjustable rate. During the year ended August 31, 1995 and the nine months ended May 31, 1996, the Company sold loans under an agreement which provides for the yield to the purchaser to be adjusted monthly to a rate equal to 200 basis points over the one-month London Interbank Offered Rate ("LIBOR"). An increase in LIBOR would result in a decrease in the Company's future income from such sold loans resulting in a charge to earnings in the period of adjustment. Although through May 31, 1996 the Company has not suffered losses in connection with the sale of Title I Loans or Conventional Loans as a result of interest rate changes, there can be no assurance that such losses will not occur in the future. To date, the Company has not hedged its interest rate risk, although it may do so in the future. To the extent that the Company engages in hedging transactions, there can be no assurance that it will be successful in mitigating the adverse impact of changes in interest rates. Interest rate levels also affect the Company's excess servicing spread. The Company generally retains the servicing rights to the loans it sells. The yield to the purchaser is generally lower than the average stated interest rates on the loans, as a result of which the Company earns an excess servicing spread on the loans it sells. Increases in interest rates or competitive pressures may result in reduced servicing spreads, thereby reducing or eliminating the gains recognized by the Company upon the sale of loans in the future. 11 14 CAPITALIZED EXCESS SERVICING RIGHTS AND VALUATION OF MORTGAGE RELATED SECURITIES At May 31, 1996, the Company's balance sheet reflected excess servicing rights of $12.8 million, mortgage related securities of $15.1 million and mortgage servicing rights of $2.7 million. The Company derives a significant portion of its income by realizing gains upon the sale of loans due to the excess servicing rights associated with such loans recorded at the time of sale and the capitalization of mortgage servicing rights recorded at origination. Excess servicing rights as capitalized on the Company's balance sheet represent the excess of the interest rate payable by an obligor on a loan over the interest rate passed through to the purchaser acquiring an interest in such loan, less the Company's normal servicing fee and other applicable recurring fees. The Company records gains on sale of loans through securitizations and whole loan sales based in part on the estimated fair value of the mortgage related securities (residual and interest only securities) retained by the Company and on the estimated fair value of retained mortgage servicing rights related to such loans. When loans are sold, the Company recognizes as current revenue the present value of the excess servicing rights expected to be realized over the anticipated average life of loans sold less future estimated credit losses relating to the loans sold. Mortgage related securities consist of certificates representing the excess of the interest rate payable by an obligor on a sold loan over the yield on pass-through certificates sold pursuant to a securitization transaction, after payment of servicing and other fees. The capitalized excess servicing rights, and capitalized mortgage servicing rights and valuation of mortgage related securities are computed using prepayment, default and interest rate assumptions that the Company believes are reasonable. The amount of revenue recognized upon the sale of loans will vary depending on the assumptions utilized. The weighted average discount rate used to determine the present value of the balance of capitalized excess servicing rights and capitalized mortgage servicing rights reflected on the Company's balance sheet at August 31, 1995 and May 31, 1996 was approximately 12%. Capitalized excess servicing rights are amortized over the lesser of the estimated or actual remaining life of the underlying loans as an offset against the excess servicing rights component of servicing income actually received in connection with such loans. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Although the Company believes that it has made reasonable estimates of the fair value of the mortgage related securities, the excess servicing rights and mortgage servicing rights likely to be realized, the rate of prepayment and the amount of defaults utilized by the Company are estimates and actual experience may vary from its estimates. The gain recognized by the Company upon the sale of loans will have been overstated if prepayments or defaults are greater than anticipated. Higher levels of future prepayments could result in excess servicing rights and mortgage servicing rights amortization expense exceeding realized excess servicing rights and mortgage servicing rights, thereby adversely affecting the Company's servicing income and resulting in a charge to earnings in the period of adjustment. Similarly, if delinquencies or liquidations were to be greater than initially assumed, excess servicing rights and mortgage servicing rights amortization would occur more quickly than originally anticipated, which would have an adverse effect on servicing income in the period of such adjustment. The Company periodically reviews its prepayment assumptions in relation to current rates of prepayment and, if necessary, reduces the remaining asset to the net present value of the estimated remaining future excess servicing rights. Rapid increases in interest rates or competitive pressures may result in a reduction of excess servicing income recognized by the Company upon the sale of loans in the future, thereby reducing the gains recognized by the Company upon such sales. Higher levels of prepayments than initially assumed would result in a charge to earnings in the period of adjustment. Increases in interest rates or higher than anticipated rates of loan prepayments or credit losses on the underlying loans of the Company's mortgage related securities or similar securities may require the Company to write down the value of such mortgage related securities and result in a material adverse impact on the Company's results of operations and financial condition. The Company is not aware of an active market for the mortgage related securities, excess servicing rights or mortgage servicing rights. No assurance can be given that the mortgage related securities, capitalized excess servicing rights or mortgage servicing rights could in fact be sold at their carrying value, if at all. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 12 15 In order to provide availability under its warehouse line of credit, during the year ended August 31, 1995 and the nine months ended May 31, 1996, the Company sold an aggregate of approximately $138.5 million of loans under an agreement which provides for the yield to the purchaser to be adjusted monthly to a rate equal to 200 basis points over LIBOR. The Company is not obligated to reacquire and the purchaser is not obligated to resell such loans. In March 1996 and August 1996, in order to fix the yield on such loans, the Company reacquired $77.8 million and $36.2 million, respectively, of such loans and included the loans in pools of loans sold in its first two securitization transactions. As a result of the reacquisitions and subsequent sales in the securitization transactions, the gains on sale and excess servicing rights recognized upon the initial sales of the loans in such periods were recalculated without any material adverse effect on the Company's earnings. The Company anticipates that in the future it may sell and then reacquire loans to be resold pursuant to securitizations, which will result in recalculation of the initial gain on sale and excess servicing rights. Any such recalculation in such periods could have a material adverse effect on the Company's earnings in the period of recalculation. CONTINGENT RISKS Loan delinquencies and other loan defaults by obligors expose the Company to risks of loss and reduced net earnings. The loan delinquency and default risks to which the Company's business is subject become more acute in an economic slowdown or recession. During such periods, loan delinquencies and other defaults generally increase. In addition, significant declines in market values of the properties that secure loans serviced by the Company reduce homeowners' equity in their homes and their borrowing power, thereby increasing the likelihood of delinquencies and defaults. Because most of the Company's borrowers generally lack significant equity in their homes, the likelihood of default may be further increased. This lack of equity also increases the risk that, upon the occurrence of a customer default, the Company would be unlikely to recover more than the amount insured. Although the Company sells substantially all loans which it originates on a limited recourse basis, the Company retains some degree of risk on substantially all loans sold. In connection with whole loan sales, the excess servicing payable to the Company is subordinated to the payment of scheduled principal and interest due to the purchasers of such loans. The Company is required under the loan sale documentation to establish reserves which are typically based on a percentage of the principal balances of such loans and funded from the excess servicing spread received by the Company. If a reserve falls below the required level, the Company is obligated under the loan sale documentation to restore the reserve from the servicing spread received by the Company, thereby reducing the stream of revenue from the servicing spread. Although the Company believes it maintains adequate reserves for potential losses from delinquencies and defaults, there can be no assurance that such levels of reserves will be adequate in the future. In addition, documents governing the Company's securitizations and whole loan sales require the Company to commit to reacquire or replace loans that do not conform to the representations and warranties made by the Company at the time of sale. When borrowers are delinquent in making monthly payments on loans included in a securitization trust, the Company is required to advance interest payments with respect to such delinquent loans to the extent that the Company deems such advances ultimately recoverable. These advances require funding by the Company but have priority of repayment from the succeeding month's collections. During the period of time that loans are held pending sale, the Company is subject to the various business risks associated with the lending business, including the risk of borrower default, the risk of foreclosure and the risk that a rapid increase in interest rates would result in a decline in the value of loans to potential purchasers. To date, a significant portion of the loans originated by the Company qualify under Title I of the National Housing Act pursuant to which 90% of the principal balances of such loans are insured by the FHA; however, the Company bears the risk of delinquencies and defaults with respect to the uninsured portion of such loans. Moreover, even as to the insured portion, the amount of reimbursement to which the Company is entitled pursuant to Title I is limited to the amount of insurance coverage in its reserve account established by the FHA. The amount of insurance coverage in a lender's reserve account is equal to 10% of the original principal amount of all Title I Loans originated and reported for insurance coverage by the lender less the amount of all insurance claims approved for payment in connection with losses on such loans and less amounts transferred in 13 16 connection with sales of loans. The Company also would sustain a loss on loans if defaults occur that are not cured and proceeds from FHA insurance or the foreclosure on and disposition of property securing a defaulted loan are less than the amounts due on the loan plus carrying and other costs. Furthermore, Title I sets forth requirements to be satisfied by the lender in connection with the origination of Title I Loans and the submission of claims for insurance. The exhaustion of the reserves or the Company's failure to comply with Title I requirements could result in denial of payment by FHA. The Company began originating Conventional Loans in May 1996 and expects that such loans will become a significant portion of its loan portfolio. During the period of time that such loans are held for sale, the Company bears the risk of delinquencies and defaults with respect to the entire principal amount of and interest on such loans and the risk that the realizable value of the property securing such loans will not be sufficient to repay the borrower's obligations to the Company. Significant defaults under these loans could have a material adverse effect on the Company's results of operations and financial condition. In the ordinary course of its business, the Company is subject to claims made against it by borrowers and private investors arising from, among other things, losses that are claimed to have been incurred as a result of alleged breaches of fiduciary obligations, misrepresentations, errors and omissions of employees, officers and agents of the Company (including its appraisers), incomplete documentation and failures by the Company to comply with various laws and regulations applicable to its business. The Company believes that liability with respect to any currently asserted claims or legal actions is not likely to be material to the Company's results of operations 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 results of operations and financial condition. RISKS RELATING TO GROWTH STRATEGY The Company's strategic plan contemplates the continued expansion of its mortgage lending operations. The Company's ability to continue implementing its expansion strategy depends on its ability to increase the volume of loans it originates while maintaining credit quality and managing its resulting growth. The Company's ability to increase its volume of loans will depend on, among other factors, its ability to (i) obtain and maintain increasingly larger lines of credit, (ii) securitize pools of loans for sale, (iii) offer attractive products to prospective borrowers, (iv) attract and retain qualified underwriting, servicing and other personnel, (v) market its loan products successfully and (vi) establish and maintain relationships with Correspondents and Dealers in states in which the Company is currently active and in additional states. The Company's ability to manage growth as it pursues its expansion strategy will be dependent upon, among other things, its ability to (i) maintain appropriate procedures, policies and systems to ensure that the Company's loan portfolio does not have an unacceptable level of credit risk and loss, (ii) satisfy its need for additional financing on reasonable terms, (iii) manage the costs associated with expanding its infrastructure and (iv) continue operating in competitive, economic, regulatory and judicial environments that are conducive to the Company's business activities. As part of its expansion strategy, the Company has begun to offer a more diversified product line, including Conventional Loans which expose the Company to greater risks than Title I Loans. There can be no assurance that the Company will be able to continue to grow successfully. DEPENDENCE ON CREDIT ENHANCEMENT In order to gain access to the securitization market, the Company has relied on credit enhancements provided by a monoline insurance carrier to guarantee outstanding senior interests in the related securitization trusts to enable it to obtain an AAA/Aaa rating for such interests. The Company has not attempted to structure a mortgage loan pool for sale through a securitization based solely on the internal credit characteristics of the pool or the Company's credit. In the absence of such credit enhancements, the Company would be unable to market its loans through securitizations at reasonable rates. Any substantial reductions in the size or availability of the securitization market for the Company's loans, or the unwillingness of insurance companies to insure the senior interests in the Company's loan pools, could have a material adverse effect on the Company's results of operations and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." 14 17 DEPENDENCE ON FINANCING; NEED FOR ADDITIONAL FINANCING The Company's business operations require continued access to adequate credit facilities. The Company is dependent on the availability of credit facilities for the origination of loans prior to their sale. The Company has a financing arrangement for the financing of Title I and Conventional Loan originations prior to the sale of such loans, which provides for a warehouse line of credit of up to $20.0 million which expires in August 1997. At May 31, 1996, an aggregate of $3.0 million was outstanding under such line of credit and $17.0 million was available for borrowing. In addition, at May 31, 1996, the Company had a $5.0 million demand note facility, of which $5.0 million was outstanding on that date. As of June 28, 1996, this facility was replaced by a $10.0 million facility for the financing of excess servicing rights and mortgage related securities. In September 1996, the Company entered into a repurchase agreement with a financial institution pursuant to which it pledged the interest only certificates from its two 1996 securitizations in exchange for a $3.0 million advance. The Company also received a commitment from the same financial institution for the purchase of $2.0 billion of loans over a five-year period, as well as a commitment for up to $11.0 million, reduced by any amounts advanced under the repurchase agreement, for the financing of the interest only and residual certificates from future securitizations. In the event that the proceeds received by the Company from the Offering and the Common Stock Offering together with cash flow from operations and its existing credit facilities prove to be insufficient to meet the Company's capital requirements, the Company may be required to seek additional financing. There can be no assurance that such financing will be available on favorable terms, or at all. To the extent that the Company were not successful in maintaining or replacing existing financing or obtaining additional financing, or selling its loans or receivables, it would have to curtail its activities, which would have a material adverse effect on the Company. INCOME TAXES For Federal income tax purposes the Company reports its income in a consolidated return filed by Mego Financial. As part of a tax sharing arrangement, the Company records a liability to Mego Financial for Federal income taxes calculated at the Federal statutory rate (currently 34%) applied to the Company's financial statement income before giving consideration to income tax expense. The Company also provides for state income taxes at the rate of 6% of income before income taxes. CONCENTRATION OF OPERATIONS IN CALIFORNIA Approximately 38.3% of the dollar volume of the Company's servicing portfolio at, and approximately 27.9% of the dollar volume of loans originated by the Company during the nine months ended, May 31, 1996 were secured by properties located in California. Although the Company is expanding its network nationally, significant portions of the Company's servicing portfolio and loan originations are likely to remain concentrated in California for the foreseeable future. Consequently, the Company's results of operations and financial condition are dependent upon general trends in the California economy and its residential real estate market. The California economy has experienced a slowdown or recession over the last several years that has been accompanied by a sustained decline in the California real estate market. Residential real estate market declines may adversely affect the value of the properties securing loans to the extent that the principal balances of such loans, together with any primary financing on the mortgaged properties, will equal or exceed the value of the mortgaged properties. In addition, California historically has been vulnerable to certain natural disaster risks, such as earthquakes and erosion-caused mudslides, which are not typically covered by the standard hazard insurance policies maintained by borrowers. Uninsured disasters may adversely impact borrowers' ability to repay loans made by the Company. The existence of adverse economic conditions or the occurrence of such natural disasters in California could have a material adverse effect on the Company's results of operations and financial condition. LEGISLATIVE AND REGULATORY RISKS Members of Congress and government officials from time to time have suggested the elimination of the mortgage interest deduction for federal income tax purposes, either entirely or in part, based on borrower income, type of loan or principal amount. Because many of the Company's loans are made to borrowers for the 15 18 purpose of consolidating consumer debt or financing other consumer needs, the competitive advantages of tax deductible interest, when compared with alternative sources of financing, could be eliminated or seriously impaired by such government action. Accordingly, the reduction or elimination of these tax benefits would have a material adverse effect on the demand for loans of the kind offered by the Company. The Company's business is subject to extensive regulation, supervision and licensing by federal, state and local governmental authorities and is subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations. The Company's consumer lending activities are subject to the Federal Truth-in-Lending Act and Regulation Z (including the Home Ownership and Equity Protection Act of 1994), the Federal Equal Credit Opportunity Act and Regulation B, as amended ("ECOA"), the Fair Credit Reporting Act of 1970, as amended, the Federal Real Estate Settlement Procedures Act ("RESPA") and Regulation X, the Home Mortgage Disclosure Act and the Federal Debt Collection Practices Act, as well as other federal and state statutes and regulations of, and examinations by, the Department of Housing and Urban Development ("HUD") and state regulatory authorities with respect to originating, processing, underwriting, selling, securitizing and servicing loans. These rules and regulations, among other things, impose licensing obligations on the Company, establish eligibility criteria for mortgage loans, prohibit discrimination, provide for inspections and appraisals of properties, require credit reports on loan applicants, regulate assessment, collection, foreclosure and claims handling, investment and interest payments on escrow balances and payment features, mandate certain disclosures and notices to borrowers and, in some cases, fix maximum interest rates, fees and mortgage loan amounts. Failure to comply with these requirements can lead to loss of approved status, termination or suspension of servicing contracts without compensation to the servicer, demands for indemnification or mortgage loan repurchases, certain rights of rescission for mortgage loans, class action lawsuits and administrative enforcement actions. Although the Company believes that it has systems and procedures to facilitate compliance with these requirements and believes that it is in compliance in all material respects with applicable local, state and federal laws, rules and regulations, there can be no assurance that more restrictive laws, rules and regulations will not be adopted in the future that could make compliance more difficult or expensive. See "Business -- Government Regulation." To date, a substantial portion of the loans originated by the Company have been Title I Loans. Accordingly, a substantial part of the Company's business is dependent on the continuation of the Title I Loan program, which is federally funded. In August 1995, bills were introduced in both houses of the United States Congress that would, among other things, abolish HUD, of which the FHA is a part, reduce federal spending for housing and community development activities and eliminate the Title I Loan program. Other changes to HUD have been proposed, which, if adopted, could affect the operation of the Title I Loan program. Discontinuation of or a significant reduction in the Title I Loan program or the Company's authority to originate loans under the Title I Loan program could have a material adverse effect on the Company's results of operations and financial condition. FRAUDULENT CONVEYANCES AND PREFERENTIAL TRANSFERS The ability of the holders of the Notes or the Trustee (as defined herein) to enforce the Subsidiary Guarantees may be limited by certain fraudulent conveyance and similar laws. Various fraudulent conveyance and similar laws have been enacted for the protection of creditors and may be utilized by a court of competent jurisdiction to avoid the Subsidiary Guarantees or to subordinate the obligations of the Company under the Notes or the obligations of any Subsidiary Guarantor under its Subsidiary Guarantee to obligations (including trade payables) that do not otherwise constitute Senior Indebtedness. The requirements for establishing a fraudulent conveyance vary depending on the law of the jurisdiction which is being applied. Generally, if in a bankruptcy, reorganization, rehabilitation or similar proceeding in respect of the Company or a Subsidiary Guarantor, or in a lawsuit by or on behalf of creditors against the Company or a Subsidiary Guarantor, a court were to find that (i) the Company or a Subsidiary Guarantor, as the case may be, incurred indebtedness in connection with the Notes (including the Subsidiary Guarantees) with the intent of hindering, delaying or defrauding current or future creditors of the Company or the Subsidiary Guarantor, as the case may be, or (ii) the Company or a Subsidiary Guarantor, as the case may be, received less than reasonably equivalent 16 19 value or fair consideration for incurring such indebtedness, as the case may be, and either (a) was insolvent at the time of the incurrence of such indebtedness, (b) was rendered insolvent by reason of incurring such indebtedness, (c) was at such time engaged or about to engage in a business or transaction for which its assets constituted unreasonably small capital or (d) intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they matured, such court could, with respect to the Company or the Subsidiary Guarantor, as the case may be, declare void in whole or in part the obligations of the Company or such Subsidiary Guarantor in connection with the Notes (including the Subsidiary Guarantees) and/or subordinate claims with respect to the Notes to all other debts of the Company or the Subsidiary Guarantors, as applicable. If the obligations of the Company or the Subsidiary Guarantors were subordinated, there can be no assurance that after payment of the other debts of the Company or the Subsidiary Guarantors, there would be sufficient assets to pay such subordinated claims with respect to the Notes and the Subsidiary Guarantees. Generally, for purposes of the foregoing, an entity will be considered insolvent if the sum of its respective debts is greater than the fair saleable value of all of its property at a fair valuation or if the present fair saleable value of its assets is less than the amount that will be required to pay its probable liability on its existing debts, as they become absolute and mature. Additionally, under federal bankruptcy or applicable state insolvency law, if certain bankruptcy or insolvency proceedings were initiated by or against the Company or any Subsidiary Guarantor within 90 days after any payment by the Company or such Subsidiary Guarantor with respect to the Notes or a Subsidiary Guarantee, respectively, or if the Company or such Subsidiary Guarantor anticipated becoming insolvent at the time of such payment, all or a portion of such payment could be avoided as a preferential transfer and the recipient of such payment could be required to return such payment. PERMISSIBLE OPERATION THROUGH SUBSIDIARIES Although the Company currently has no Subsidiaries, it is permitted to conduct future operations through Subsidiaries. If it forms or acquires Subsidiaries in the future, the Company may be required to rely, at least in part, upon payment from its Subsidiaries to generate the funds necessary to meet its obligations, including the payment of interest on and principal of the Notes. The ability of the Subsidiaries to make such payments will be subject to, among other things, applicable state laws, and may be subject to certain net worth maintenance requirements under warehouse credit facilities of subsidiaries that are permitted under the Indenture. See "Description of the Notes -- Certain Covenants -- Limitation on Restrictions of Distributions from Restricted Subsidiaries." Claims of creditors of the Company's Subsidiaries will generally have priority as to the assets of such Subsidiaries over the claims of the Company. Although the Subsidiary Guarantees provide the Note holders with a direct claim against the assets of the Subsidiary Guarantors, enforcement of the Subsidiary Guarantees against any Subsidiary Guarantors would be subject to certain "suretyship" defenses available to guarantors generally, and such enforcement would also be subject to certain defenses available to the Subsidiary Guarantors in certain circumstances. See " --Fraudulent Conveyances and Preferential Transfers." Although the Indenture contains waivers of most "suretyship" defenses, certain of those waivers may not be enforced by a court in a particular case. To the extent that the Subsidiary Guarantees are not enforceable, the Notes would be effectively subordinated to all liabilities of the Company's Subsidiaries, including trade payables of such Subsidiaries, whether or not such liabilities otherwise constitute Senior Indebtedness under the Indenture. See " -- Subordination and Leverage," above. DEPENDENCE ON EXECUTIVE OFFICERS Certain of the Company's loan agreements and loan sale agreements with financial institutions contain provisions to the effect that if more than a specified number of certain of the senior executive officers of the Company do not continue to hold such positions or control the Company, whether due to death, disability or otherwise, the lenders or purchasers have the right to declare the loans or agreements in default. In such event, there is no assurance that the lenders or purchasers will consider replacement executive officers acceptable to them and not declare such instruments in default. 17 20 DEPENDENCE ON MEGO FINANCIAL AND PEC The Company has been dependent on Mego Financial to provide, among other things, (i) funds for operations without interest and (ii) guarantees of the Company's financing arrangements. The Company anticipates that no further financing or guarantees will be made by Mego Financial following the completion of the Offering. There can be no assurance that the absence of such financing or guarantees will not have a material adverse effect on the Company, particularly as the Company seeks to grow. In addition, the Company has been dependent on its affiliate, PEC, to provide management services, routine loan collection services and management information systems, including services of certain of its executive officers. There can be no assurance that PEC will continue to provide such services. The loss of such services could have a material adverse effect on the Company if suitable replacements are not made. COMPETITION The consumer finance industry is highly competitive. Competitors in the consumer finance business include mortgage banking companies, commercial banks, credit unions, thrift institutions, credit card issuers and finance companies. Certain of the Company's competitors are substantially larger, have greater name recognition and have more capital and other resources than the Company. Competition in the home improvement and debt consolidation loan business can take many forms including convenience in obtaining a loan, customer service, marketing and distribution channels and interest rates. In addition, the current level of gains realized by the Company and its existing competitors on the sale of loans could attract additional competitors to this market with the possible effect of lower gains on loan sales resulting from increased loan origination competition. The Company depends largely on its Correspondents and Dealers for its originations of loans. The Company's competitors also seek to establish relationships with the Company's Correspondents and Dealers, none of whom is required to deal exclusively with the Company. The Company's future results may become more exposed to fluctuations in the volume and cost of its loans resulting from competition from other purchasers of such loans, market conditions and other factors. CONTROL BY MAJORITY STOCKHOLDER Upon completion of the Common Stock Offering, the Company's current sole stockholder, Mego Financial, will beneficially own approximately 83.3% of the outstanding shares of Common Stock (approximately 81.3% if the underwriters of the Common Stock Offering exercise their over-allotment option in full) and will therefore be able to elect the entire Board of Directors and control all matters submitted to stockholders for a vote, all fundamental corporate matters, including the selection of management and key personnel, whether the Company engages in any mergers, acquisitions or other business combinations or whether Mego Financial, at some time in the future, divests all or any portion of its interest in the Company by means of a distribution to its stockholders or otherwise. The Common Stock Offering has been structured in such a way as to facilitate the ability of Mego Financial, should it so determine in the future, to effect a subsequent tax free distribution of all or a portion of Mego Financial's shares in the Company to its shareholders, although there is no assurance that any such distribution will occur. The Company has been advised that Mego Financial may seek a ruling from the Internal Revenue Service, as is customary, that such a distribution would be tax free. There is no assurance that it will obtain such a ruling. Pursuant to the Amended and Restated Certificate of Incorporation of the Company (the "Certificate of Incorporation") and an agreement between Mego Financial and the Company, no additional shares of Common Stock may be issued by the Company that would reduce Mego Financial's interest below 80% without Mego Financial's written approval, so long as Mego Financial owns at least 80% of the issued and outstanding Common Stock of the Company (the "Eighty Percent Period"). In addition, although the Certificate of Incorporation provides for the issuance of one or more series of preferred stock from time to time, during the Eighty Percent Period no shares of any other class of capital stock may be issued without Mego Financial's written approval during such period, nor may the Company invest in or form any corporation without such approval. Amendments to the Company's bylaws and changes to the Board are also subject to such approval during the Eighty Percent 18 21 Period. Any decision as to whether any transactions of the type mentioned above ultimately occur will be solely within the discretion of Mego Financial. See "Principal Stockholders." PORTION OF PROCEEDS TO BENEFIT MAJORITY STOCKHOLDER The Company intends to use a portion of the aggregate net proceeds of the Offering and the Common Stock Offering to repay Intercompany Debt owed to Mego Financial. See "Use of Proceeds." ABSENCE OF PUBLIC MARKET FOR THE NOTES Prior to the Offering, there has been no public market for the Notes. There can be no assurance that an active trading market for the Notes will develop or that, if developed, it will be sustained after the Offering or that it will be possible to resell the Notes at or above the initial public offering price. The market price of the Notes could be subject to significant fluctuations in response to the Company's operating results and other factors. In addition, the market in recent years has experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of companies. Such fluctuations, and general economic and market conditions, may adversely affect the market price of the Notes. The Notes will not be listed on any securities exchange or quoted on The Nasdaq National Market. See "Selected Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Underwriting." FACTORS INHIBITING TAKEOVER As Mego Financial will continue to own in excess of 80% of the Common Stock after the Common Stock Offering, no takeover would be successful without its consent. Changes in the management or ownership of Mego Financial or a reduction in the number of shares owned by Mego Financial, however, could have an effect on the likelihood of a takeover. However, the Certificate of Incorporation provides that no additional shares of Common Stock may be issued that would reduce Mego Financial's interest below 80% without its written approval during the Eighty Percent Period. In addition, although the Certificate of Incorporation provides for the issuance of one or more series of preferred stock from time to time, during the Eighty Percent Period no shares of any other class of capital stock may be issued without Mego Financial's written approval. Even in the event that at some later date Mego Financial's percentage ownership in the Company is significantly reduced, certain provisions of the Company's Certificate of Incorporation and Amended and Restated Bylaws (the "Bylaws") may be deemed to have anti-takeover effects and may delay, defer or prevent a takeover attempt that a stockholder might consider in its best interest. The Company's Certificate of Incorporation authorizes the Board to determine the rights, preferences, privileges and restrictions of unissued series of preferred stock and to fix the number of shares of any series of preferred stock and the designation of any such series, without any vote or action by the Company's stockholders. Thus, the Board may authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of the Common Stock. In addition, the issuance of preferred stock may have the effect of delaying, deferring or preventing a change of control of the Company, since the terms of the preferred stock that might be issued could potentially prohibit the Company's consummation of any merger, reorganization, sale of substantially all of its assets, liquidation or other extraordinary corporate transaction without the approval of the holders of the outstanding shares of the preferred stock. Other provisions of the Company's Certificate of Incorporation and Bylaws (i) provide that special meetings of the stockholders may be called only by the Board of Directors or upon the written demand of the holders of not less than 30% of the votes entitled to be cast at a special meeting and (ii) establish certain advance notice procedures for nomination of candidates for election as directors by stockholders and for stockholder proposals to be considered at annual stockholders' meetings. Mego Financial could also vote to amend the Company's Certificate of Incorporation or Bylaws without the vote of any other holders of the Common Stock. Upon the occurrence of a Change of Control, the holders of the Notes will be entitled to require the Company to repurchase up to all outstanding Notes of the holders requiring such repurchase. This provision would further inhibit any takeover of the Company. See "Description of the Notes -- Change of Control." 19 22 USE OF PROCEEDS The net proceeds to the Company from the sale of the Notes offered hereby, after deducting underwriting discounts and estimated expenses of the Offering, are estimated to be approximately $ million. The net proceeds to the Company from the Common Stock Offering, based upon an assumed initial public offering price of $ per share and after deducting underwriting discounts and estimated expenses of the Common Stock Offering, are estimated to be approximately $ million ($ million if the underwriters of the Common Stock Offering exercise their over-allotment option in full). The Company currently intends to use approximately $ of the aggregate net proceeds received by the Company from the Offering and the Common Stock Offering to repay Intercompany Debt which does not bear interest and is due on demand. The remaining net proceeds will be used to provide capital to originate and securitize loans. Pending such use, the net proceeds received by the Company will be invested in high quality, short term interest-bearing investment and deposit accounts and may be used to temporarily reduce the amounts outstanding under the Company's lines of credit, which currently bear interest at rates ranging from 1.0% to 2.0% over the prime rate. 20 23 CAPITALIZATION The following table sets forth the capitalization of the Company at May 31, 1996, and as adjusted as of such date to give effect to (i) the sale of the Notes offered hereby (after deducting underwriting discounts and estimated expenses of the Offering), (ii) the sale of the 2,000,000 shares of Common Stock pursuant to the Common Stock Offering (at an assumed initial public offering price of $ per share and after deducting underwriting discounts and estimated expenses of the Common Stock Offering) and (iii) the application of the net proceeds from the Offering and the Common Stock Offering as described under "Use of Proceeds." This table should be read in conjunction with the financial statements, the related notes and the other financial information appearing elsewhere in this Prospectus.
MAY 31, 1996 ------------------- AS ACTUAL ADJUSTED ------- ------- (IN THOUSANDS) Debt: Warehouse line of credit............................................... $ 3,012 $ 3,012 Demand note............................................................ 5,000 5,000 Other notes and contracts payable...................................... 860 860 % Senior Subordinated Notes due 2001................................. -- 40,000 Intercompany Debt...................................................... 11,963 -- ------- ------- Total debt..................................................... $20,835 $48,872 ======= ======= Stockholder's equity: Preferred stock, $.01 par value; 5,000,000 shares authorized; no shares issued and outstanding.............................................. -- -- Common stock, $.01 par value; 50,000,000 shares authorized; 10,000,000 shares issued and outstanding, actual and 12,000,000 shares issued and outstanding, as adjusted(1)..................................... 5,000 Additional paid-in capital............................................. 3,650 Retained earnings...................................................... 6,761 6,761 ------- ------- Total stockholder's equity............................................. 15,411 ------- ------- Total capitalization........................................... $36,246 $ ======= =======
- --------------- (1) Does not include 900,000 shares of Common Stock reserved for issuance upon the exercise of stock options available to be granted under the Company's Stock Option Plan or 300,000 shares of Common Stock issuable pursuant to the underwriters' over-allotment option in the Common Stock Offering. See "Management -- Stock Option Plan" and "Underwriting." 21 24 SELECTED FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) The selected Statement of Operations Data and Balance Sheet Data set forth below have been derived from the financial statements of the Company. The financial statements as of August 31, 1994 and 1995 and for each of the two years in the period ended August 31, 1995 have been audited by Deloitte & Touche LLP, independent auditors, and are included elsewhere in this Prospectus. The selected data as of May 31, 1996 and for the nine month periods ended May 31, 1995 and 1996 are derived from the unaudited financial statements of the Company, which, in the opinion of management, include all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of the information set forth therein. The selected financial information set forth below should be read in conjunction with the financial statements, the related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Prospectus. The results of operations for the nine months ended May 31, 1996 may not be indicative of results of operations to be expected for the full year.
YEAR ENDED AUGUST NINE MONTHS 31, ENDED MAY 31, ----------------- ---------------- 1994(1) 1995 1995 1996 ------- ------- ------ ------- STATEMENT OF OPERATIONS DATA: Revenues: Gain on sale of loans.................................... $ 579 $12,233 $6,098 $11,621 Net unrealized gain on mortgage related securities(2).... -- -- -- 2,182 Interest income, net..................................... 172 473 313 538 Loan servicing income.................................... -- 873 418 3,049 ------- ------- ------- ------- Total revenues................................... 751 13,579 6,829 17,390 ------- ------- ------- ------- Costs and expenses: Other interest........................................... 22 187 58 120 Provision for credit losses.............................. 96 864 558 815 Depreciation and amortization............................ 136 403 260 641 Commissions and selling.................................. 13 552 339 1,560 General and administrative: Payroll and benefits.................................. 975 3,611 2,442 3,550 Professional services................................. -- 409 244 716 Services by affiliate................................. 442 690 503 503 FHA insurance......................................... 11 231 110 390 Other................................................. 567 713 461 1,632 ------- ------- ------- ------- Total costs and expenses......................... 2,262 7,660 4,975 9,927 ------- ------- ------- ------- Income (loss) before income taxes(3)....................... (1,511) 5,919 1,854 7,463 Income taxes(3)............................................ -- 2,277 651 2,833 Net income (loss).......................................... $(1,511) $ 3,642 $1,203 $ 4,630 ======= ======= ======= ======= Net income (loss) per share................................ $ (0.15) $ 0.36 $ 0.12 $ 0.46 ======= ======= ======= =======
AS OF AUGUST 31, AS OF MAY 31, 1996 ---------------- ------------------------ 1994(1) 1995 ACTUAL AS ADJUSTED(4) ------ ------- ------- -------------- BALANCE SHEET DATA: Loans held for sale, net.............................. $1,463 $ 3,676 $ 4,671 $ 4,671 Excess servicing rights............................... 904 14,483 12,796 12,796 Mortgage related securities(2)........................ -- -- 15,144 15,144 Total assets.......................................... 5,122 24,081 40,499 Total liabilities..................................... 983 13,300 25,088 Total stockholder's equity............................ 4,139 10,781 15,411
22 25
YEAR ENDED AUGUST NINE MONTHS ENDED 31, MAY 31, ------------------ ----------------------- 1994(1) 1995 1995 1996 ------ ------- ------- ----------- OPERATING DATA: Loans originated.................................. $8,133 $87,751 $52,521 $ 89,391 Weighted average interest rate on loans originated...................................... 14.18% 14.55% 14.47% 14.23% Servicing portfolio (period end): Company-owned loans............................. 1,471 3,720 6,250 4,763 Sold loans...................................... 6,555 88,566 52,400 166,285 ------ ------- ------- Total................................... $8,026 $92,286 $58,650 $ 171,048 ====== ======= ======= Delinquency period(5): 31-60 days past due............................. 2.06% 2.57% 1.27% 2.41% 61-90 days past due............................. 0.48 0.73 0.39 0.78 91 days and over past due....................... 0.26 0.99 0.68 4.34(6) 91 days and over past due, net of claims filed(7)..................................... 0.26 0.99 0.68 2.38 Claims filed with HUD(8).......................... -- -- -- 1.96 Amount of FHA insurance available (period end).... $ 831 $ 9,552 $ 6,029 $ 18,084(9) Amount of FHA insurance available as a percentage of loans serviced (period end).................. 10.36% 10.35% 10.28% 10.57%(9) Ratio of earnings to fixed charges(10)............ N/A 7.69x 5.27x 10.23x
- --------------- (1) The Company commenced originating loans in March 1994. (2) Mortgage related securities consist of certificates representing interests retained by the Company in securitization transactions. (3) The results of operations of the Company are included in the consolidated Federal income tax returns filed by Mego Financial, the Company's sole stockholder. Mego Financial allocates income taxes to the Company calculated on a separate return basis. See "Certain Transactions." (4) As adjusted to give effect to (i) the sale of the Notes offered hereby (after deducting underwriting discounts and estimated expenses of the Offering), (ii) the sale of the 2,000,000 shares of Common Stock pursuant to the Common Stock Offering (at an assumed initial public offering price of $ per share and after deducting underwriting discounts and estimated expenses of the Common Stock Offering) and (iii) the application of the estimated net proceeds from the Offering and the Common Stock Offering as described under "Use of Proceeds." (5) Represents the dollar amount of delinquent loans as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (6) During the nine month period ended May 31, 1996, the processing and payment of claims filed with HUD was delayed. See "Business -- Loan Servicing." (7) Represents the dollar amount of delinquent loans net of delinquent Title I Loans for which claims have been filed with HUD and payment is pending as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (8) Represents the dollar amount of delinquent Title I Loans for which claims have been filed with HUD and payment is pending as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (9) If all claims filed with HUD had been processed and paid as of period end, the amount of FHA insurance available would have been reduced to $15,063,000, which as a percentage of loans serviced would have been 8.98%. (10) Earnings include pretax income, the portion of rents representative of the interest factor and interest on debt. Fixed charges include interest on indebtedness (including the Notes), prepaid commitment fees and the portion of rents representative of the interest factor. 23 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Financial Statements, including the notes thereto, contained elsewhere in this Prospectus. GENERAL The Company began originating loans on March 1, 1994 and, accordingly, the Company's results of operations for the year ended August 31, 1995 include a full year's operations, while results for the year ended August 31, 1994 include only six months of loan originations. The Company recognizes revenue from the gain on sale of loans, interest income and servicing income. Interest income, net, represents the interest received on loans in the Company's portfolio prior to their sale, net of interest paid under its credit agreements. The Company continues to service all loans sold to date. Net loan servicing income represents servicing fee income and other ancillary fees received for servicing loans less the amortization of capitalized mortgage servicing rights. Mortgage servicing rights are amortized over the estimated net future servicing fee income. The Company sells its loans through whole loan sales to third party purchasers, retaining the right to service the loans and to receive any amounts in excess of the guaranteed yield to the purchasers. In addition, the Company has commenced the sale of loans through securitizations. Most of the regular interests of the related securitizations are sold, with the interest only and residual class securities retained by the Company. Gain on sale of loans includes the gain on sale of mortgage backed securities and the gain on sale of loans. The gain on sale of mortgage backed securities is determined by an allocation of the cost of the securities based on the relative fair value of the securities sold and the securities retained. The Company generally retains an interest only strip security and the residual interest security. The fair value of the interest only strip and residual interest security is the present value of the estimated cash flow to be received after considering the effects of estimated prepayments and credit losses. The net unrealized gain on mortgage related securities represents the difference between the allocated cost basis of the securities and the estimated fair value. As the holder of the residual securities, the Company is entitled to receive certain excess cash flows. These excess cash flows are calculated as the difference between (a) principal and interest paid by borrowers and (b) the sum of (i) pass-through interest and principal to be paid to the holders of the regular securities and interest only securities, (ii) trustee fees, (iii) third-party credit enhancement fees, (iv) servicing fees and (v) estimated loan pool losses. The Company's right to receive this excess cash flow is subject to the satisfaction of certain reserve requirements which are specific to each securitization and are used as a means of credit enhancement. The Company carries interest only and residual securities at fair value. As such, the carrying value of these securities is affected by changes in market interest rates and prepayment and loss experiences of these and similar securities. The Company estimates the fair value of the interest only and residual securities utilizing prepayment and credit loss assumptions the Company believes to be appropriate for each particular securitization. To the Company's knowledge, there is no active market for the sale of these interest only and residual securities. The range of values attributable to the factors used in determining fair value is broad. Accordingly, the Company's estimate of fair value is subjective. The present value of expected net cash flows from the sale of loans is recorded at the time of sale as excess servicing rights and mortgage related securities. Excess servicing rights are amortized as a charge to income, as payments are received on the retained interest differential over the estimated life of the underlying loans. The expected cash flows used to determine the excess servicing rights asset and mortgage related securities have been reduced for potential losses under recourse provisions of the sales agreements. The allowance for losses on loans sold with recourse represents the Company's estimate of losses to be incurred in connection with the recourse provisions of the sales agreements. To determine the fair value of the mortgage servicing rights, the Company projects net cash flows 24 27 expected to be received over the life of the loans. Such projections assume certain servicing costs, prepayment rates and credit losses. These assumptions are similar to those used by the Company to value the residual securities. As of May 31, 1996, mortgage servicing rights totaled $2.7 million. There can be no assurance that the Company's estimates used to determine the fair value of mortgage servicing rights will remain appropriate for the life of the loans. If actual loan prepayments or credit losses exceed the Company's estimates, the carrying value for the Company's mortgage servicing rights may have to be written down through a charge against earnings. The Company will not write up such assets to reflect slower than expected prepayments, although slower prepayments may increase future earnings as the Company will receive cash flows in excess of those anticipated. Fluctuations in interest rates may also result in a write-down of the Company's mortgage servicing rights in subsequent periods. The Company discounts cash flows on its loan sales at the rate it believes an independent third-party purchaser would require as a rate of return. The cash flows were discounted to present value using discount rates which averaged 12.0% for the years ended August 31, 1994 and 1995 and the nine months ended May 31, 1995 and 1996. The Company has developed its assumptions based on experience with its own portfolio, available market data and ongoing consultation with its financial advisors. Total costs and expenses consist primarily of general and administrative expenses, depreciation and amortization, and interest expense on borrowings to finance loan originations. Mego Financial provides the services of certain of its executive officers to the Company. General and administrative expenses include the portion of the salaries of such executive officers allocated to and paid by the Company. See "Certain Transactions." RESULTS OF OPERATIONS Nine Months Ended May 31, 1996 Compared to Nine Months Ended May 31, 1995 The Company originated $89.0 million of Title I Loans during the nine months ended May 31, 1996 compared to $52.5 million of Title I Loans during the nine months ended May 31, 1995, an increase of 69.5%. The increase is a result of the overall growth in the Company's business, including an increase in the number of active Correspondents and Dealers and an increase in the number of states served. At May 31, 1996, the Company had approximately 265 active Correspondents and 445 active Dealers in 36 states, compared to approximately 120 active Correspondents and 125 active Dealers in 31 states at May 31, 1995. The Company originated $385,000 of Conventional Loans during the nine months ended May 31, 1996 and did not originate Conventional Loans during the nine months ended May 31, 1995. The following table sets forth certain data regarding loans originated by the Company during the nine months ended May 31, 1995 and 1996.
NINE MONTHS ENDED MAY 31, ----------------------------------------------- 1995 1996 --------------------- --------------------- Principal amount of loans: Correspondents: Title I..................................... $40,405,634 76.9% $57,625,881 64.5% Conventional................................ -- -- 384,900 0.4 ----------- ----- ----------- ----- Total Correspondent.................... 40,405,634 76.9% 58,010,781 64.9% ----------- ----- ----------- ----- Dealers........................................ 12,115,753 23.1 31,379,719 35.1 ----------- ----- ----------- ----- Total.................................. $52,521,387 100.0% $89,390,500 100.0% =========== ===== =========== =====
25 28
NINE MONTHS ENDED MAY 31, 1995 1996 ----------- ----------- Number of loans: Correspondents: Title I..................................... 2,171 62.5% 3,130 53.2% Conventional................................ -- -- 13 0.2 ----------- ----- ----------- ----- Total Correspondent.................... 2,171 62.5 3,143 53.4 ----------- ----- ----------- ----- Dealers........................................ 1,302 37.5 2,742 46.6 ----------- ----- ----------- ----- Total.................................. 3,473 100.0% 5,885 100.0% =========== ===== =========== =====
The Company sold $88.0 million of Title I Loans and $50,000 of Conventional Loans during the nine months ended May 31, 1996, recognizing a gain on sale of loans of $11.6 million and a net unrealized gain on mortgage related securities of $2.2 million. The Company sold $47.4 million of Title I Loans during the nine months ended May 31, 1995 recognizing a gain on sale of loans of $6.1 million and no net unrealized gain on mortgage related securities because there were no securitization transactions in such period. The increase in gain on sale of loans was primarily a result of increased volume of loans sold. As a percentage of loans sold, gain on sale of loans was 13.2% during the nine months ended May 31, 1996 compared to 12.8% during the nine months ended May 31, 1995. The weighted average gross excess spreads on sold loans was 5.7% and 6.7% for the nine months ended May 31, 1995 and 1996, respectively. A weighted average discount rate of 12% per year was used in the determination of the gain on sale for both periods. Interest income, net of interest expense increased 71.9% to $538,000 during the nine months ended May 31, 1996 from $313,000 during the nine months ended May 31, 1995. The increase was primarily the result of the increase in the size of the portfolio of loans held for sale. Net loan servicing income increased 617.7% to $3.0 million during the nine months ended May 31, 1996 from $418,000 during the nine months ended May 31, 1995. The increase was primarily the result of the increase in the amount of loans sold with the servicing rights retained by the Company, which increased to $166.3 million at May 31, 1996 from $54.1 million at May 31, 1995. Total revenues increased 155.9% to $17.4 million for the nine months ended May 31, 1996 from $6.8 million for the nine months ended May 31, 1995. The increase was primarily the result of the increased volume of loans originated and the sale of such loans. Total costs and expenses increased 98.0% to $9.9 million for the nine months ended May 31, 1996 from $5.0 million for the nine months ended May 31, 1995. General and administrative expenses increased 78.9% to $6.8 million from $3.8 million primarily as a result of increased payroll related to the hiring of additional loan quality control and other personnel in contemplation of the expansion of the Company's business and costs related to the opening of additional offices. The Company has paid its affiliate, PEC, servicing fees in an amount equal to 50 basis points of the principal balance of loans serviced per year. In addition, the Company has paid management fees to PEC in an amount equal to the direct and indirect expenses of PEC for the services rendered by PEC's employees to the Company, including an allocable portion of the salaries and expenses of such employees based upon the percentage of time such employees spend performing services for the Company. Included in general and administrative expenses were servicing fees paid to PEC in the amount of $87,000 and $479,000 for the nine months ended May 31, 1995 and 1996, respectively, and management fees paid to PEC in the amount of $503,000 and $503,000 for the nine months ended May 31, 1995 and 1996, respectively. The provision for credit losses increased 46.1% to $815,000 from $558,000. At May 31, 1996, the Company had established a provision for credit losses equal to 1.0% of loans sold. Other interest increased 106.9% to $120,000 from $58,000 representing interest on capitalized lease obligations. Depreciation and amortization expense increased 146.5% to $641,000 from $260,000 as a result of the purchase of additional equipment, the expansion of the Company's facilities and additional development costs. Income before income taxes increased 294.7% to $7.5 million for the nine months ended May 31, 1996 from $1.9 million for the nine months ended May 31, 1995. 26 29 Income taxes increased 330.1% to $2.8 million for the nine months ended May 31, 1996 from $651,000 for the nine months ended May 31, 1995. As a result of the foregoing, net income increased 283.3% to $4.6 million for the nine months ended May 31, 1996 from $1.2 million for the nine months ended May 31, 1995. Fiscal 1995 Compared to Fiscal 1994 The Company commenced originating loans in March 1994. The Company originated $87.8 million of loans during fiscal 1995 compared to $8.1 million of loans during fiscal 1994, an increase of 984.0%. The increase was a result of the overall growth in Company's business. At August 31, 1995, the Company had approximately 150 active Correspondents and 170 active Dealers in 34 states, compared to approximately 14 active Correspondents and 30 active Dealers in 14 states at August 31, 1994. The following table sets forth certain data regarding Title I Loans originated by the Company during the years ended August 31, 1994 and 1995.
YEAR ENDED AUGUST 31, ------------------------------------------ 1994 1995 ------------------ ------------------- Principal amount of loans: Correspondents...................................... $5,238,311 64.4% $63,792,680 72.7% Dealers............................................. 1,488,529 18.3 23,957,829 27.3 Bulk purchase....................................... 1,406,000 17.3 -- -- ---------- ----- ----------- ----- Total....................................... $8,132,840 100.0% $87,750,509 100.0% ========== ===== =========== ===== Number of loans: Correspondents...................................... 338 47.4% 3,437 59.1% Dealers............................................. 165 23.1 2,375 40.9 Bulk purchase....................................... 210 29.5 -- -- ---------- ----- ----------- ----- Total....................................... 713 100.0% 5,812 100.0% ========== ===== =========== =====
The Company sold $85.7 million of loans during fiscal 1995, recognizing a gain on sale of loans of $12.2 million. The Company sold $6.6 million of loans during fiscal 1994 recognizing a gain on sale of loans of $579,000. As a percentage of loans sold, gain on sale of loans was 14.2% during fiscal 1995 compared to 8.8% during fiscal 1994. The increase in gain on sale was primarily a result of increased volume of loans sold and a wider differential between the stated interest rate on the loans and the yield to purchasers. The weighted average gross excess spread on sold loans was 5.6% and 6.1% for fiscal 1994 and 1995, respectively. The weighted average discount rate used in the determination of the gain on sale for both periods was 12%. Interest income, net of interest expense increased 175.0% to $473,000 during fiscal 1995 from $172,000 during fiscal 1994. The increase was primarily the result of the increase in the size of the portfolio of loans held for sale. Net loan servicing income was $873,000 during fiscal 1995. This income was the result of the sale of Title I Loans, with the right to service the loans being retained by the Company. The Company had no loan servicing income in fiscal 1994 because the Company did not sell any loans until August 31, 1994. Total revenues increased 1,710.9% to $13.6 million for fiscal 1995 from $751,000 for fiscal 1994. The increase was primarily the result of the increased volume of loans originated and the sale of such loans. Total costs and expenses increased 234.8% to $7.7 million for fiscal 1995 from $2.3 million for fiscal 1994. General and administrative expenses increased 185.0% to $5.7 million from $2.0 million primarily as a result of increased payroll related to the hiring of additional personnel in contemplation of the expansion and projected growth of the Company's business and costs related to the opening of additional offices. Included in general and administrative expenses were servicing fees paid to PEC in the amount of $11,000 and $174,000 for fiscal 1994 and 1995, respectively, and management fees paid to PEC in the amount of $442,000 and $690,000 for fiscal 1994 and 1995, respectively. The provision for credit losses increased 800.0% to $864,000 27 30 from $96,000. At August 31, 1995, the Company had established a provision for credit losses equal to 1.0% of Title I Loans sold. Other interest increased 222.4% to $187,000 from $58,000 consisting of interest on capitalized lease obligations. Depreciation and amortization expense increased 146.5% to $641,000 from $260,000 as a result of the purchase of additional equipment, the expansion of the Company's facilities and additional development costs. Income (loss) before income taxes increased to income of $5.9 million for fiscal 1995 from a loss of $1.5 million for its six months of operations in fiscal 1994. Effective September 1, 1994, the Company adopted SFAS No. 122 which requires that a mortgage banking enterprise recognize as separate assets the rights to service mortgage loans for others, regardless of how those servicing rights are acquired. The effect of adopting SFAS No. 122 on the Company's financial statements was to increase income before income taxes by $1.1 million for fiscal 1995. As a result of the foregoing, net income (loss) increased to net income of $3.6 million for fiscal 1995 from a net loss of $1.5 million for fiscal 1994. FINANCIAL CONDITION May 31, 1996 Compared to August 31, 1995 Cash increased 11.8% to $841,000 at May 31, 1996 from $752,000 at August 31, 1995 primarily as a result of increased borrowings. Loans held for sale, net increased 27.0% to $4.7 million at May 31, 1996 from $3.7 million at August 31, 1995 primarily as a result of increased loan originations and the timing of loan sales in the first nine months of fiscal 1996. Mortgage related securities were $15.1 million at May 31, 1996 as a result of the Company's first securitization transaction in March 1996 and consist of an interest only security of $3.0 million and a residual interest security of $12.1 million. There was no corresponding asset at August 31, 1995. Excess servicing rights decreased 11.7% to $12.8 million at May 31, 1996 from $14.5 million at August 31, 1995. Excess servicing rights are calculated using prepayment, default and interest rate assumptions that the Company believes market participants would use for similar rights. The Company believes that the excess servicing rights recognized at the time of sale do not exceed the amount that would be received if such rights were sold at fair market value in the marketplace. The decrease in excess servicing rights was primarily a result of loans sold with excess servicing rights recognized which were reacquired and included in the March 1996 securitization as well as normal amortization of such excess servicing rights. The excess cash flow which had been recognized as excess servicing rights is included in the valuation of the residual securities. Mortgage servicing rights increased 145.5% to $2.7 million at May 31, 1996 from $1.1 million at August 31, 1995 as a result of additional sales of mortgage originations and the resulting increase in sold loans serviced from $88.6 million to $166.3 million. Notes and contracts payable increased 493.3% to $8.9 million at May 31, 1996 from $1.5 million at August 31, 1995, due to increased borrowings. Accounts payable and accrued liabilities increased 22.7% to $2.7 million at May 31, 1996 from $2.2 million at August 31, 1995, primarily as a result of increases in accrued payroll, interest and other unpaid operational costs. Allowances for credit losses and for loans sold with recourse decreased 16.2% to $838,000 at May 31, 1996 from $1.0 million at August 31, 1995. The decrease was a result of loans sold with recourse which were reacquired and included in the March 1996 securitization. The estimated credit losses are included in the valuation of the residual securities. Stockholder's equity increased 42.6% to $15.4 million at May 31, 1996 from $10.8 million at August 31, 1995 as a result of net income of $4.6 million during the first nine months of fiscal 1996. 28 31 LIQUIDITY AND CAPITAL RESOURCES The Company had cash of $841,000 at May 31, 1996 compared to cash of $752,000 at August 31, 1995. The Company's cash requirements arise from loan originations, payments of operating and interest expenses and deposits to reserve accounts related to loan sale transactions. Loan originations are initially funded principally through the Company's $20.0 million warehouse line of credit pending the sale of loans in the secondary market. Substantially all of the loans originated by the Company are sold. Net cash used in the Company's operating activities for the year ended August 31, 1995 and the nine months ended May 31, 1996 was approximately $10.3 million and $8.0 million, respectively. This use was funded primarily from the reinvestment of proceeds from the sale of loans in the secondary market totaling approximately $85.2 million and $88.1 million for the year ended August 31, 1995 and the nine months ended May 31, 1996, respectively. The loan sale transactions required the subordination of certain cash flows payable to the Company to the payment of scheduled principal and interest due to the loan purchasers. In connection with certain of such sale transactions, a portion of amounts payable to the Company from the excess interest spread is required to be maintained in a reserve account to the extent of the subordination requirements. The subordination requirements generally provide that the excess interest spread is payable to the reserve account until a specified percentage of the principal balances of the sold loans is accumulated therein. Excess interest spread payable to the Company is subject to being utilized first to replenish cash paid from the reserve account to fund shortfalls in collections of interest from borrowers who default on the payments on the loans until the Company's deposits into the reserve account equal the specified percentage. The excess interest required to be deposited and maintained in the respective reserve accounts is not available to support the cash flow requirements of the Company. At May 31, 1996, amounts on deposit in such reserve accounts totaled $2.4 million. Adequate credit facilities and other sources of funding, including the ability of the Company to sell loans in the secondary market, are essential for the continuation of the Company's loan origination operations. At May 31, 1996, the Company had a $20.0 million warehouse line of credit (the "Warehouse Line") for the financing of loan originations which expires in August 1997. At May 31, 1996, $3.0 million was outstanding under the Warehouse Line and $17.0 million was available. The Warehouse Line bears interest at the prime rate plus 1.0% per year and is secured by loans prior to sale. The agreement with the lender requires the Company to maintain a minimum tangible net worth of $12.5 million, and a minimum level of profitability of at least $500,000 per rolling six month period. In addition, at May 31, 1996, the Company had a $5.0 million demand note facility from the same lender, with respect to which $5.0 million was outstanding on that date. This note was secured by a pledge of the Company's excess servicing rights and the interest only and residual class certificates ("Certificates") relating to securitizations carried as "Mortgage related securities" on the Company's balance sheets, payable to the Company pursuant to its securitization agreements. As of June 28, 1996, this note was replaced by a $10.0 million revolving credit loan from the same lender (the "Revolving Loan"), with the same security. The Revolving Loan has an 18-month revolving credit period followed by a 30-month amortization period, and requires the Company to maintain a minimum tangible net worth of $12.5 million and a minimum level of profitability of at least $500,000 per rolling six month period. Borrowings under the Revolving Loan cannot exceed the lesser of (i) 40% of the Company's excess servicing rights and Certificates or (ii) six times the aggregate of the excess servicing rights and Certificate payments actually received by the Company over the most recent three-month period. While the Company believes that it will be able to maintain its existing credit facilities and obtain replacement financing as its credit arrangements mature and additional financing, if necessary, there can be no assurance that such financing will be available on favorable terms, or at all. From time to time, the Company has sold loans through whole loan sales. In August 1994, the Company entered into an agreement with a bank pursuant to which an aggregate of $38.3 million in principal amount of loans had been sold at December 31, 1995, for an amount equal to their remaining principal balance and accrued interest. Pursuant to the agreement, the purchaser is entitled to receive interest at a rate equal to the sum of 187.5 basis points and the yield paid on four-year Federal Government Treasury obligations at the time of the sale. The Company retained the right to service the loans and the right to receive the difference (the 29 32 "Excess Interest") between the sold loans' stated interest rate and the yield to the purchaser. The Company is required to maintain a reserve account equal to 1.0% of the declining principal balance of the loans sold pursuant to the agreement funded from the Excess Interest received by the Company less its servicing fee to fund shortfalls in collections from borrowers who default in the payment of principal or interest. In April 1995, the Company entered into a continuing agreement with a financial institution pursuant to which an aggregate of approximately $138.5 million in principal amount of loans had been sold at May 31, 1996 for an amount equal to their remaining principal balances. Pursuant to the agreement, the purchaser is entitled to receive interest at a variable rate equal to the sum of 200 basis points and the one-month LIBOR rate as in effect from time to time. The Company retained the right to service the loans and the right to receive the Excess Interest. The Company is required to maintain a reserve account equal to 2.5% of the proceeds received by the Company from the sale of loans pursuant to the agreement plus the Excess Interest received by the Company less its servicing fee to fund shortfalls in collections from borrowers who default in the payment of principal or interest. In May 1995 and June 1995, the Company reacquired an aggregate of approximately $25.0 million of such Title I Loans for an amount equal to their remaining principal balance, which were sold to a financial institution. In March 1996 and August 1996, the Company reacquired an additional $77.8 million and $36.2 million, respectively, of the Title I Loans in connection with its first two securitization transactions. In May 1995, the Company entered into an agreement with a bank pursuant to which an aggregate of $25.0 million in principal amount of loans had been sold at June 30, 1995 for an amount equal to their remaining principal balance. Pursuant to the agreement, the purchaser is entitled to receive interest at a rate equal to the sum of 190 basis points and the yield paid on four-year Federal Government Treasury obligations at the time of the sale. The Company retained the right to service the loans and the right to receive the Excess Interest. The agreement requires the Company to maintain a reserve account equal to 1.0% of the declining principal balance of the loans sold pursuant to the agreement funded from the Excess Interest received by the Company less its servicing fee to fund shortfalls in collections from borrowers who default in the payment of principal or interest. In September 1996, the Company entered into a repurchase agreement with a financial institution pursuant to which the Company pledged the interest only certificates from its two 1996 securitizations in exchange for a $3.0 million advance. The Company also received a commitment from the same financial institution, providing for the purchase of up to $2.0 billion of loans over a five-year period. In consideration of the purchase commitment, Mego Financial will issue to the financial institution five-year warrants to purchase 1,000,000 shares of Mego Financial's common stock at an exercise price of $7.125 per share. The value of the warrants will be charged to the Company as the commitment for the purchase of loans is utilized. The financial institution has also agreed to provide the Company a separate one-year facility of up to $11.0 million, less any amounts advanced under the repurchase agreement, for the financing of the interest only and residual certificates from future securitizations. In furtherance of the Company's strategy to sell loans through securitizations, in March 1996 and August 1996, the Company completed its first two securitizations pursuant to which it sold pools of $84.2 million and $48.9 million, respectively, of Title I Loans. The Company previously reacquired at par $77.8 million and $36.2 million of such loans, respectively. Pursuant to these securitizations, pass-through certificates evidencing interests in the pools of loans were sold in a public offering. The Company continues to subservice the sold loans and is entitled to receive from payments in respect of interest on the sold loans a servicing fee equal to 1.25% of the balance of each loan with respect to the March transaction and 1.0% with respect to the August transaction. In addition, with respect to both transactions, the Company received certificates (carried as "Mortgage related securities" on the Company's balance sheet), representing the interest differential, after payment of servicing and other fees, between the interest paid by the obligors of the sold loans and the yield on the sold certificates. The Company may be required to repurchase loans that do not conform to the representations and warranties made by the Company in the securitization agreements. During the nine months ended May 31, 1996 and the year ended August 31, 1995, the Company used cash of $8.0 million and $10.3 million, respectively, in operating activities. During the nine months ended 30 33 May 31, 1996 and the year ended August 31, 1995, the Company provided cash of $8.6 million and $10.5 million, respectively, in financing activities. During the nine months ended May 31, 1996 and the year ended August 31, 1995, the Company used cash of $488,000 and $274,000, respectively, in investing activities, which was substantially expended for office equipment and furnishings and data processing equipment. The Company believes that funds from operations and financing activities, borrowings under its existing credit facilities and the net proceeds from the Offering and the Common Stock Offering will be sufficient to satisfy its contemplated cash requirements for at least 12 months following the consummation of the Offering. EFFECTS OF CHANGING PRICES AND INFLATION The Company's operations are sensitive to increases in interest rates and to inflation. Increased borrowing costs resulting from increases in interest rates may not be immediately recoverable from prospective purchasers. The Company's loans consist primarily of fixed-rate long term installment contracts that do not increase or decrease as a result of changes in interest rates charged to the Company. In addition, delinquency and cancellation rates may be affected by changes in the national economy. RECENT ACCOUNTING PRONOUNCEMENTS At August 31, 1995, effective September 1, 1994, the Company adopted SFAS No. 122, which requires that a mortgage banking enterprise recognize as separate assets the rights to service mortgage loans for others, regardless of how those servicing rights are acquired. The effect of adopting SFAS No. 122 on the Company's financial statements was to increase income before income taxes by $1.1 million for the year ended August 31, 1995. The fair value of capitalized mortgage servicing rights was estimated by taking the present value of expected net cash flows from mortgage servicing using assumptions the Company believes market participants would use in their estimates of future servicing income and expense, including assumptions about prepayment, default and interest rates. Capitalized mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. The estimate of fair value was based on a 100 basis points per year servicing fee, reduced by estimated costs of servicing, and using a discount rate of 12% in 1995. The Company has developed its assumptions based on experience with its own portfolio, available market data and ongoing consultation with its investment bankers. The Financial Accounting Standards Board (the "FASB") has issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS No. 121"). SFAS No. 121 requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS No. 121 is effective for fiscal years beginning after December 15, 1995. The Company has not determined the effect upon adoption on its results of operation or financial condition. The FASB has issued Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), which establishes financial accounting and reporting standards for stock-based employee compensation plans and for transactions in which an entity issues its equity instruments to acquire goods or services from nonemployees. SFAS No. 123 is generally effective for fiscal years beginning after December 15, 1995. The Company intends to provide the pro forma and other additional disclosures about stock-based employee compensation plans in its 1997 financial statements as required by SFAS No. 123. The FASB has issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 125"). SFAS No. 125 provides new accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. SFAS No. 125 also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings and requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value. SFAS No. 125 also requires that servicing assets be measured by allocating the carrying amount between the assets sold and retained interests based on their relative fair values at the date of transfer. Additionally, SFAS No. 125 requires that the servicing assets and liabilities be subsequently measured by (i) amortization in proportion to and over the period of estimated net servicing income and (ii) assessment for asset impairment or increased obligation based on their fair 31 34 values. The Company has not adopted SFAS No. 125 for the current period, but must adopt the new requirements effective January 1, 1997. The Company has not yet determined the effect of SFAS No. 125 on its results of operations or financial condition in the period of adoption. SEASONALITY Home improvement loan volume tracks the seasonality of home improvement contract work. Volume tends to build during the spring and early summer months, particularly with regard to pool installations. A decline is typically experienced in late summer and early fall until temperatures begin to drop. This change in seasons precipitates the need for new siding, window and insulation contracts. Peak volume is experienced in November and early December and declines dramatically from the holiday season through the winter months. Debt consolidation and home equity loan volume are not impacted by seasonal climate changes and, with the exclusion of the holiday season, tend to be stable throughout the year. 32 35 BUSINESS GENERAL The Company is a specialized consumer finance company that originates, purchases, sells and services consumer loans consisting primarily of home improvement loans secured by liens on the improved property. Through its network of Correspondents and Dealers, the Company initially originated only Title I Loans. The Title I program provides for insurance of 90% of the principal balance of the loan, and certain other costs. The Company began offering Conventional Loans through its Correspondents in May 1996 and such loans have become a significant portion of its current loan originations. The Company's borrowers are individuals who own their home and have appropriate verifiable income but may have limited access to traditional financing sources due to insufficient home equity, limited credit history or high ratios of debt service to income. These borrowers require or seek a high degree of personalized service and prompt response to their loan applications. As a result, the Company's borrowers generally are not averse to paying higher interest rates that the Company charges for its loan programs as compared to the interest rates charged by banks and other traditional financial institutions. The Company has developed a proprietary credit index profile that includes as a significant component the credit evaluation score methodology developed by Fair, Isaac and Company to classify borrowers on the basis of likely future performance. The other components of the Company's scoring system include debt to income ratio, employment history and residence stability. The Company charges varying rates of interest based upon the borrower's credit profile and income. For the year ended August 31, 1996, the loans originated by the Company had a weighted average interest rate of 14.0%. The Company's loan originations increased to $139.3 million during the fiscal year ended August 31, 1996 from $87.8 million during the fiscal year ended August 31, 1995 and $8.1 million during the six months in which it originated loans in the fiscal year ended August 31, 1994. The Company's revenues increased to $13.6 million for the fiscal year ended August 31, 1995 from $751,000 for the fiscal year ended August 31, 1994. For the nine months ended May 31, 1996, the Company had revenues of $17.4 million compared to $6.8 million for the nine months ended May 31, 1995. For the nine months ended May 31, 1996, the Company had net income of $4.6 million compared to $1.2 million for the nine months ended May 31, 1995. The Company sells substantially all the loans it originates through either whole loan sales to third party institutional purchasers or securitizations at a yield below the stated interest rate on the loans, retaining the right to service the loans and receive any amounts in excess of the guaranteed yield to the purchasers. The Company completed its first two securitizations of Title I Loans in March and August 1996 totalling $133.1 million and expects to sell a substantial portion of its loan production through securitizations in the future. At May 31, 1996, the Company serviced $166.3 million of loans it had sold. HOME IMPROVEMENT LOAN INDUSTRY According to data released by the Commerce Department's Bureau of the Census, expenditures for home improvement and repairs of residential properties have exceeded $100.0 billion per year since 1992 with 1995 expenditures estimated at $112.6 billion. The Company targets the estimated $40.0 billion of those expenditures which are for owner-occupied single-family properties where improvements are performed by professional remodelers. As the costs of home improvements escalate, home owners are seeking financing as a means to improve their property and maintain and enhance its value. The National Association of Home Builders Economics Forecast in 1995 estimates that home improvement expenditures will exceed $200.0 billion by the year 2003. Two types of home improvement financing are available to borrowers, the Title I program administered by the FHA, which is authorized to partially insure qualified lending institutions against losses, and uninsured loans where the lender relies more heavily on the borrower's creditworthiness, debt capacity and the underlying collateral. Both types of loans are generally secured with a real estate mortgage lien on the property improved. The conventional home improvement financing market continues to grow, as many homeowners have limited access to traditional financing sources due to insufficient home equity, limited credit history or high 33 36 ratios of debt service to income. Conventional loan proceeds can be used for a variety of improvements such as large remodeling projects, both interior and exterior, kitchen and bath remodeling, room additions and in-ground swimming pools. Borrowers also have the opportunity to consolidate a portion of their outstanding debt in order to reduce their monthly debt service. According to the FHA, the amount of single family Title I Loans originated has grown from $375.0 million during 1988 to $1.3 billion during 1995. Based on FHA data, the Company estimates that it had an 8.6% market share of the property improvement Title I loan market in calendar 1995. Out of approximately 3,100 lenders participating in the program in 1995, according to FHA data, the Company was the third largest originator of property improvement Title I Loans. Under Title I, the payment of approximately 90% of the principal balance of a loan is insured by the United States of America in the event of a payment default. The Title I program generally limits the maximum amount of the loan to $25,000 and restricts the type of eligible improvements and the use of the loan proceeds. Under Title I, only property improvement loans to finance the alteration, repair or improvement of existing single family, multifamily and non-residential structures are allowed. The FHA does not review individual loans at the time of approval. In the case of a Title I Loan less than $7,500, no equity is required in the property to be improved and the loan may be unsecured. BUSINESS STRATEGY The Company's strategic plan is to continue to expand its lending operations while maintaining its credit quality. The Company's strategies include: (i) offering new loan products ; (ii) expanding its existing network of Correspondents and Dealers ; (iii) entering new geographic markets; (iv) realizing operational efficiencies through economies of scale; and (v) using securitizations to sell higher volumes of loans on more favorable terms. At May 31, 1996, the Company had developed a nationwide network of approximately 265 active Correspondents and approximately 445 active Dealers. The Company's Correspondents generally offer a wide variety of loans and its Dealers typically offer home improvement loans in conjunction with debt consolidation. By offering a more diversified product line, including Conventional Loans, and maintaining its high level of service, the Company has increased the loan production from its existing network of Correspondents. The Company anticipates that as it expands its lending operations it will realize economies of scale thereby reducing its average loan origination costs and enhancing its profitability. In addition, the Company intends to continue to sell its loan production through securitizations as opportunities arise. Through access to securitization, the Company believes that it has the ability to sell higher volumes of loans on more favorable terms than in whole loan sales. Product Extension and Expansion The Company intends to continue to review its loan programs and introduce new loan products to meet the needs of its customers. The Company will also evaluate products or programs that it believes are complementary to its current products for the purpose of enhancing revenue by leveraging and enhancing the Company's value to its existing network of Correspondents and Dealers. The Company believes that its introduction of new loan products will enhance its relationship with its Dealers and Correspondents and enable it to become a single source for their various financing needs. Expansion of Correspondent Operations The Company seeks to increase originations of loans from select Correspondents. The Company has expanded its product line to include Conventional Loans to meet the needs of its existing network of Correspondents. Prior to May 1996, the Company originated only Title I Loans. This limited its ability to attract the more sophisticated Correspondent that offered a multitude of loan products and, accordingly, limited the Company's market penetration. The Company began offering Conventional Loans to existing select Correspondents in May 1996. In order to maintain the Company's customer service excellence, the Company has gradually increased the number of Correspondents to which it has offered Conventional Loans. Since the Company commenced offering Conventional Loans, the loan production of the Company's Correspondent division has significantly increased. The Company believes that it is well positioned to expand this segment without any material increase in concentration or quality risks. 34 37 Expansion of Dealer Operations The Company seeks to expand its Dealer network and maximize loan originations from its existing network by offering a variety of innovative products and providing consistent and prompt service at competitive prices. The Company will provide conventional products as well as its existing Title I product to its Dealers in order to meet the needs of the diverse borrower market. The Company targets Dealers that typically offer financing to their customers and attempts to retain and grow these relationships by providing superior customer service, personalized attention and prompt approvals and fundings. The Company has been unable to fully meet the needs of its Dealers because of Title I program limits on the amount and types of improvements which may be financed. The Company intends to meet the needs of its Dealers with new Conventional Loan programs. These programs allow for more expensive project financing such as in-ground swimming pools and substantial remodeling as well as financing for creditworthy borrowers with limited equity who are in need of debt consolidation and borrowers with marginal creditworthiness and substantial equity in their property. With this strategy, the Company believes it can achieve further market penetration of its existing Dealer network and gain new Dealers and market share in areas in which the Title I product is less successful because of its restrictions. Nationwide Geographic Expansion The Company intends to continue to expand its Correspondent and Dealer network on a nationwide basis and to enhance its value to its existing network. The Company's strategy involves (i) focusing on geographic areas that the Company currently underserves and (ii) tailoring the Company's loan programs to better serve its existing markets and loan sources. Maximization of Flexibility in Loan Sales The Company employs a two-pronged strategy of disposing of its loan originations primarily through securitizations and, to a lesser extent, through whole loan sales. By employing this dual strategy, the Company has the flexibility to better manage its cash flow, diversify its exposure to the potential volatility of the capital markets and maximize the revenues associated with the gain on sale of loans given market conditions existing at the time of disposition. The Company has recently been approved by FNMA as a seller/servicer of Title I Loans, as a result of which the Company is eligible to sell such loans to FNMA on a servicing retained basis. LOAN PRODUCTS The Company originates Title I and Conventional Loans. Both types of loans are typically secured by a first or junior lien on the borrower's principal residence, although the Company occasionally originates and purchases unsecured loans with borrowers that have an excellent credit history. Borrowers use loan proceeds for a wide variety of home improvement projects, such as exterior/interior remodeling, structural additions, roofing and plumbing, as well as luxury items such as in-ground swimming pools, and for debt consolidation. The Company lends to borrowers of varying degrees of creditworthiness. See "Loan Processing and Underwriting." Conventional Loans A Conventional Loan is a non-insured home improvement or home equity loan typically undertaken to pay for a home improvement project, home improvement and debt consolidation combination or a debt consolidation. Substantially all of the Conventional Loans originated by the Company are secured by a first or junior mortgage lien on the borrower's principal residence. Underwriting for Conventional Loans varies according to the Company's evaluation of the borrower's credit risk and income stability as well as the underlying collateral. The Company will rely on the underlying collateral and equity in the property for borrowers judged to be greater credit risks. The Company targets the higher credit quality segment of borrowers. The Company has begun originating Conventional Loans through its Correspondent Division and plans to begin offering such loan products to its Dealer Division. 35 38 Title I Loan Program The National Housing Act of 1934 (the "Housing Act"), Sections 1 and 2(a), authorized the creation of the FHA and the Title I credit insurance program ("Title I"). Under the Housing Act, the FHA is authorized to insure qualified lending institutions against losses on certain types of loans, including loans to finance the alteration, repair or improvement of existing single family, multi-family and nonresidential real property structures. Under Title I, the payment of approximately 90% of the principal balance of a loan and certain other amounts is insured by the United States of America in the event of a payment default. Title I and the regulations promulgated thereunder establish criteria regarding (i) who may originate, acquire, service and sell Title I Loans, (ii) Title I Loan eligibility of improvements and borrowers, (iii) the principal amounts and terms of and security for Title I Loans, (iv) the use and disbursement of loan proceeds, (v) verification of completion of improvements, (vi) the servicing of Title I Loans in default and (vii) the processing of claims for Title I insurance. The principal amount of a secured Title I Loan may not exceed $25,000, in the case of a loan for the improvement of a single family structure, and $60,000, in the case of a loan for the improvement of a multi-family structure. Loans up to a maximum of $7,500 in principal amount may qualify as unsecured Title I Loans. Title I Loans are required to bear fixed rates of interest and, with limited exceptions, be fully amortizing with equal weekly, bi-weekly, semi-monthly or monthly installment payments. Title I Loan terms may not be less than six months nor more than 240 months in the case of secured Title I Loans or 120 months in the case of unsecured Title I Loans. Subject to other federal and state regulations, the lender may establish the interest rate to be charged in its discretion. Title I generally provides for two types of Title I Loans, direct loans ("Direct Title I Loans") and dealer loans ("Dealer Title I Loans"). Direct Title I Loans are made directly by a lender to the borrower and there is no participation in the loan process by the contractor, if any, performing the improvements. In the case of Dealer Title I Loans, the Dealer, a contractor performing the improvements, assists the borrower in obtaining the loan, contracts with the borrower to perform the improvements, executes a retail installment contract with the borrower and, upon completion of the improvements, assigns the retail installment contract to the Title I lender. Each Dealer must be approved by the Title I lender in accordance with HUD requirements. Direct Title I Loans are closed by the lender in its own name with the proceeds being disbursed directly to the borrower prior to completion of the improvements. The borrower is generally required to complete the improvements financed by a Direct Title I Loan within six months of receiving the proceeds. In the case of Dealer Title I Loans, the lender is required to obtain a completion certificate from the borrower certifying that the improvements have been completed prior to disbursing the proceeds to the Dealer. The FHA charges a lender an annual fee equal to 50 basis points of the original principal balance of a loan for the life of the loan. A Title I lender or Title I sponsored lender is permitted to require the borrower to pay the insurance premium with respect to the loan. In general, the borrowers pay the insurance premiums with respect to Title I Loans originated through the Company's Correspondents but not with respect to Title I Loans originated through the Company's Dealers. Title I provides for the establishment of an insurance coverage reserve account for each lender. The amount of insurance coverage in a lender's reserve account is equal to 10% of the original principal amount of all Title I Loans originated or purchased and reported for insurance coverage by the lender less the amount of all insurance claims approved for payment. The amount of reimbursement to which a lender is entitled is limited to the amount of insurance coverage in the lender's reserve account. LENDING OPERATIONS The Company has two principal divisions for the origination of loans, the Correspondent Division and the Dealer Division. The Correspondent Division represents the Company's largest source of loan originations. Through its Correspondent Division, the Company originates loans through a nationwide network of Correspondents including financial intermediaries, mortgage companies, commercial banks and savings and 36 39 loan institutions. The Company typically originates loans from Correspondents on an individual loan basis, pursuant to which each loan is pre-approved by the Company and is purchased immediately after the closing. The Correspondent Division conducts operations from its headquarters in Atlanta, Georgia, with a vice president of operations responsible for underwriting and processing and five account executives supervised by the Vice President-National Marketing responsible for developing and maintaining relationships with Correspondents. At May 31, 1996, the Company had a network of approximately 265 active Correspondents. In addition to purchasing individual Direct Title I Loans and Conventional Loans, from time to time the Correspondent Division purchases portfolios of loans from Correspondents. In March 1994, the Company purchased a portfolio of Direct Title I Loans originated by another financial institution, which consisted of 210 loans with an aggregate remaining principal balance of $1.4 million, an average balance of $6,695, a weighted average interest rate of 15.46% and a weighted average remaining term of 101 months. The Dealer Division originates Dealer Title I Loans through a network of Dealers, consisting of home improvement construction contractors approved by the Company, by acquiring individual retail installment contracts ("Installment Contracts") from Dealers. An Installment Contract is an agreement between the Dealer and the borrower pursuant to which the Dealer performs the improvements to the property and the borrower agrees to pay in installments the price of the improvements. Before entering into an Installment Contract with a borrower, the Dealer assists the borrower in submitting a loan application to the Company. If the loan application is approved, the Dealer enters into an Installment Contract with the borrower, the Dealer assigns the Installment Contract to the Company upon completion of the home improvements and the Company, upon receipt of the requisite loan documentation (described below) and completion of a satisfactory telephonic interview with the borrower, pays the Dealer pursuant to the terms of the Installment Contract. The Dealer Division maintains 12 branch offices located in Montvale, New Jersey, Kansas City, Missouri, Las Vegas, Nevada, Austin, Texas, Oklahoma City, Oklahoma, Seattle, Washington, Waterford, Michigan, Columbus, Ohio, Elmhurst, Illinois, Philadelphia, Pennsylvania, Denver, Colorado and Woodbridge, Virginia through which it conducts its marketing to Dealers in the state in which the branch is located as well as certain contiguous states. The Dealer Division is operated with a vice president of operations responsible for loan processing and underwriting, two regional managers, and 12 field representatives supervised by the Vice President-National Marketing who are responsible for marketing to Dealers. At May 31, 1996, the Company had a network of approximately 445 active Dealers doing business in 23 states. The Company intends to commence offering Conventional Loans through its Dealer Division. Correspondents and Dealers qualify to participate in the Company's programs only after a review by the Company's management of their reputations and expertise, including a review of references and financial statements, as well as a personal visit by one or more representatives of the Company. Title I requires the Company to reapprove its Dealers annually and to monitor the performance of those Correspondents that are sponsored by the Company. The Company's compliance function is performed by a director of compliance and loan administration, whose staff performs periodic reviews of portfolio loans and Correspondent and Dealer performance and may recommend to senior management the suspension of a Correspondent or a Dealer. The Company believes that its system of acquiring loans through a network of Correspondents and Dealers and processing such loans through a centralized loan processing facility has (i) assisted the Company in minimizing its level of capital investment and fixed overhead costs and (ii) assisted the Company in realizing certain economies of scale associated with evaluating and acquiring loans. The Company does not believe that the loss of any particular Correspondent or Dealer would have a material adverse effect upon the Company. See "Loan Processing and Underwriting." The Company originates and acquires a limited variety of loan products, including: (i) fixed rate, secured Title I Loans, secured by single family residences, with terms and principal amounts ranging from 60 to 240 months and approximately $3,000 to $25,000, respectively; and (ii) fixed rate, unsecured Title I Loans with terms and principal amounts ranging from 36 to 120 months and approximately $2,500 to $7,500, respectively. As part of the Company's strategic plan, the Company has commenced originating non-FHA insured Conventional Loans utilizing its established network of Correspondents. 37 40 The following table sets forth certain data regarding loan applications processed and loans originated by the Company during the periods indicated.
YEAR ENDED AUGUST 31, NINE MONTHS ENDED MAY 31, ----------------------------------------- ------------------------------------------ 1994 1995 1995 1996 ------------------ ------------------- ------------------- ------------------- Total Loan Applications: Number processed.................... 3,512 27,608 17,053 28,699 Number approved..................... 1,984 15,956 9,722 14,100 Approval ratio...................... 56.5% 57.8% 57.0% 49.1% Loan Originations: Principal balance of loans: Correspondents: Title I........................... $5,238,311 64.4% $63,792,680 72.7% $40,405,634 76.9% $57,625,881 64.5% Conventional...................... -- -- -- -- -- -- 384,900 0.4 ---------- ----- ----------- ----- ----------- ----- ----------- ----- Total Correspondents.......... 5,238,311 64.4 63,792,680 72.7 40,405,634 76.9 58,010,781 64.9 ---------- ----- ----------- ----- ----------- ----- ----------- ----- Dealers............................. 1,488,529 18.3 23,957,829 27.3 12,115,753 23.1 31,379,719 35.1 Bulk purchase....................... 1,406,000 17.3 -- -- -- -- -- -- ---------- ----- ----------- ----- ----------- ----- ----------- ----- Total......................... $8,132,840 100.0% $87,750,509 100.0% $52,521,387 100.0% $89,390,500 100.0% ========== ===== =========== ===== =========== ===== =========== ===== Number of Loans: Correspondents: Title I........................... 338 47.4% 3,437 59.1% 2,171 62.5% 3,130 53.2% Conventional...................... -- -- -- -- -- -- 13 0.2 ---------- ----- ----------- ----- ----------- ----- ----------- ----- Total Correspondents.......... 338 47.4 3,437 59.1 2,171 62.5 3,143 53.4 ---------- ----- ----------- ----- ----------- ----- ----------- ----- Dealers............................. 165 23.1 2,375 40.9 1,302 37.5 2,742 46.6 Bulk purchase....................... 210 29.5 -- -- -- -- -- -- ---------- ----- ----------- ----- ----------- ----- ----------- ----- Total......................... 713 100.0% 5,812 100.0% 3,473 100.0% 5,885 100.0% ========== ===== =========== ===== =========== ===== =========== ===== Average principal balance of loans............................. $ 11,407 $ 15,096 $ 15,123 $ 15,180 Weighted average interest rate on loans originated.................. 14.18% 14.55% 14.47% 14.23% Weighted average term of loans originated (months)............... 175 188 185 194
LOAN PROCESSING AND UNDERWRITING The Company's loan application and approval process generally is conducted over the telephone with applications usually received at the Company's centralized processing facility from Correspondents and Dealers by facsimile transmission. Upon receipt of an application, the information is entered into the Company's system and processing begins. All loan applications are individually analyzed by employees of the Company at its loan processing headquarters in Atlanta, Georgia. The Company has developed a proprietary credit index profile ("CIP") as a statistical credit based tool to predict likely future performance of a borrower. A significant component of this customized system is the credit evaluation score methodology developed by Fair, Isaac and Company ("FICO"), a consulting firm specializing in creating default predictive models through a high number of variable components. The other components of the CIP include debt to income analysis, employment stability, self employment criteria, residence stability and occupancy status of the subject property. By utilizing both scoring models in tandem, all applicants are considered on the basis of their ability to repay the loan obligation while allowing the Company to maintain its risk based pricing for each loan. Based upon FICO score default predictors and the Company's internal CIP score, loans are classified by the Company into gradations of descending credit risks and quality, from "A" credits to "D" credits, with subratings within those categories. Quality is a function of both the borrowers creditworthiness, and the extent of the value of the collateral, which is typically a second lien on the borrower's primary residence. "A+" credits generally have a FICO score greater than 680. An applicant with a FICO score of less than 620 would be rated a "C" credit unless the loan-to-value ratio was 75% or less which would raise the credit risk to the Company to a "B" or better depending on the borrower's debt service capability. Depending on loan size, 38 41 typical loan-to-value ratios for "A" and "B" credits range from 90% to 125%, while loan-to-value ratios for "C" and "D" credits range from 60% up to 90% with extraordinary compensating factors. The Company's underwriters review the applicant's credit history, based on the information contained in the application as well as reports available from credit reporting bureaus and the Company's CIP score, to determine the applicant's acceptability under the Company's underwriting guidelines. Based on the underwriter's approval authority level, certain exceptions to the guidelines may be made when there are compensating factors subject to approval from a corporate officer. The underwriter's decision is communicated to the Correspondent or Dealer and, if approved, fully explains the proposed loan terms. The Company endeavors to respond to the Correspondent or Dealer on the same day the application is received. The Company issues a commitment to purchase a pre-approved loan upon the receipt of a fully completed loan package. Commitments indicate loan amounts, fees, funding conditions, approval expiration dates and interest rates. Loan commitments are generally issued for periods of up to 45 days in the case of Correspondents and 90 days in the case of Dealers. Prior to disbursement of funds, all loans are carefully reviewed by funding auditors to ensure that all documentation is complete, all contingencies specified in the approval have been met and the loan is closed in accordance with Company and regulatory procedures. Conventional Loans The Company has implemented policies for its Conventional Loan program that are designed to minimize losses by adhering to high credit quality standards or requiring adequate loan-to-value levels. The Company will only make Conventional Loans to borrowers with an "A" or "B" credit grade using the CIP. Through August 31, 1996, the Company's portfolio of Conventional Loans originated through its Correspondent Division had been evaluated as an "A" credit risk and had a weighted average (i) FICO score of 661, (ii) gross debt to income ratio of 38%, (iii) interest rate of 14.04% and (iv) loan-to-value ratio of 110%, as well as an average loan amount of $28,569. Substantially all of the Conventional Loans originated to date by the Company are secured by first or second mortgage liens on single family, owner occupied properties. Terms of Conventional Loans made by the Company, as well as the maximum loan-to-value ratios and debt service to income coverage (calculated by dividing fixed monthly debt payments by gross monthly income), vary depending upon the Company's evaluation of the borrower's creditworthiness. Borrowers with lower creditworthiness generally pay higher interest rates and loan origination fees. As part of the underwriting process for Conventional Loans, the Company generally requires an appraisal of the collateral property as a condition to the commitment to purchase. The Company requires independent appraisers to be state licensed and certified. The Company requires that all appraisals be completed within the Uniform Standards of Professional Appraisal Practice as adopted by the Appraisal Standards Board of the Appraisal Foundation. Prior to originating a loan, the Company audits the appraisal for accuracy and to insure that the appraiser used sufficient care in analyzing data to avoid errors that would significantly affect the appraiser's opinion and conclusion. This audit includes a review of economic demand, physical adaptability of the real estate, neighborhood trends and the highest and best use of the real estate. In the event the audit reveals any discrepancies as to the method and technique that are necessary to produce a credible appraisal, the Company will perform additional property data research or may request a second appraisal to be performed by an independent appraiser selected by the Company in order to substantiate further the value of the subject property. The Company also requires a title report on all subject properties securing its loans to verify property ownership, lien position and the possibility of outstanding tax liens or judgments. In the case of larger loan amounts or first liens, the Company requires a full title insurance policy in compliance with the American Land Title Association. Title I Loans The Title I Loans originated by the Company are executed on forms meeting FHA requirements as well as federal and state regulations. Loan applications and Installment Contracts are submitted to the Company's 39 42 processing headquarters for credit verification. The information provided in loan applications is first verified by, among other things, (i) written confirmations of the applicant's income and, if necessary, bank deposits, (ii) a formal credit bureau report on the applicant from a credit reporting agency, (iii) a title report, (iv) if necessary, a real estate appraisal and (v) if necessary, evidence of flood insurance. Appraisals for Title I Loans, when necessary, are generally prepared by pre-approved independent appraisers that meet the Company's standards for experience, education and reputation. Loan applications are also reviewed to ascertain whether or not they satisfy the Company's underwriting criteria, including loan-to-value ratios (if non-owner occupied), borrower income qualifications, employment stability, purchaser requirements and necessary insurance and property appraisal requirements. The Company will make Title I Loans to borrowers with an "A" to "C" credit grade based on CIP score and lien position. Since the implementation of the CIP scoring system in February 1996, through August 31, 1996, the Company's portfolio of Title I Loans originated through its Correspondent and Dealer Divisions had been evaluated as a "C+" and "B" credit risk, respectively, and had a weighted average FICO score of 637 and 645, respectively. The Company's underwriting guidelines for Title I Loans meet FHA's underwriting criteria. Completed loan packages are sent to the Company's Underwriting Department for predisbursement auditing and funding. Subject to underwriting approval of an application forwarded to the Company by a Dealer, the Company issues a commitment to purchase an Installment Contract from a Dealer upon the Company's receipt of a fully completed loan package and notice from the borrower of satisfactory work completion. Subject to underwriting approval of an application forwarded to the Company by a Correspondent, the Company issues a commitment to purchase a Title I Loan upon the Company's receipt of a fully completed and closed loan package. The Company's underwriting personnel review completed loan applications to verify compliance with the Company's underwriting standards, FHA requirements and federal and state regulations. In the case of Title I Loans being acquired from Dealers, the Company conducts a prefunding telephonic interview with the property owner to determine that the improvements have been completed in accordance with the terms of the Installment Contract and to the owner's satisfaction. The Company utilizes a nationwide network of independent inspectors to perform on-site inspections of improvements within the timeframes specified by the Title I program. Since the Company does not currently originate any Title I Loans with an original principal balance in excess of $25,000, the FHA does not individually review the Title I Loans originated by the Company. QUALITY CONTROL The Company employs various quality control personnel and procedures in order to insure that loan origination standards are adhered to and regulatory compliance is maintained while substantial growth is experienced in the servicing portfolio. In accordance with Company policy, the Quality Control Department reviews a statistical sample of loans closed each month. This review is generally completed within 60 days of funding and circulated to appropriate department heads and senior management. Finalized reports are maintained in the Company's files for a period of two years from completion. Typical review procedures include reverification of employment and income, re-appraisal of the subject property, obtaining separate credit reports and recalculation of debt-to-income ratios. The statistical sample is intended to cover 10% of all new loan originations with particular emphasis on new Correspondents and Dealers. Emphasis will also be placed on those loan sources where higher levels of delinquency are experienced, physical inspections reveal a higher level of non-compliance, or payment defaults occur within the first six months of funding. On occasion, the Quality Control Department may review all loans generated from a particular loan source in the event an initial review determines a higher than normal number of exceptions. The account selection of the Quality Control Department is also designed to include a statistical sample of loans by each underwriter and each funding auditor and thereby provide management with information as to any aberration from Company policies and procedures in the loan origination process. 40 43 Under the direction of the Vice President of Credit Quality and Regulatory Compliance, a variety of review functions are accomplished. On a daily basis, a sample of recently approved loans are reviewed to insure compliance with underwriting standards. Particular attention is focused on those underwriters who have developed a higher than normal level of exceptions. In addition to this review, the Company has developed a staff of post-disbursement review auditors which reviews 100% of recently funded accounts, typically within two weeks of funding. All credit reports are analyzed, debt-to-income ratios recalculated, contingencies monitored and loan documents inspected. Exception reports are forwarded to the respective Vice Presidents of Production as well as senior management. The Company also employs a Physical Inspection Group that is responsible for monitoring the inspection of all homes which are the subject of home improvement loans. Non-compliance is tracked by loan source and serves as another method of evaluating a loan source relationship. The Company has expended substantial amounts in developing its Quality Control and Compliance Department. The Company recognizes the need to monitor its operations continually as it experiences substantial growth. Feedback from these departments provides senior management with the information necessary to take corrective action when appropriate, including the revision and expansion of its operating policies and procedures. LOAN PRODUCTION TECHNOLOGY SYSTEMS The Company utilizes a sophisticated computerized loan origination tracking system that allows it to monitor the performance of Dealers and Correspondents and supports the marketing efforts of the Dealer and Correspondent Divisions by tracking the marketing activities of field sales personnel. The system automates various other functions such as Home Mortgage Disclosure Act and HUD reporting requirements and routine tasks such as decline letters and the flood certification process. The system also affords management access to a wide range of decision support information such as data on the approval pipeline, loan delinquencies by source, and the activities and performance of underwriters and funders. The Company uses intercompany electronic mail, as well as an electronic-mail link with its affiliate, PEC, to facilitate communications and has an electronic link to PEC that allows for the automated transfer of accounts to PEC's servicing system. The Company is enhancing this system to provide for the automation of the loan origination process as well as loan file indexing and routing. These enhancements will include electronic routing of loan application facsimile transmissions, automated credit report inquiries and consumer credit scoring along with on-screen underwriting and approval functions. Where feasible the system will interface with comparable systems of the Company's Dealers and Correspondents. The Company expects that these enhancements will (i) increase loan production efficiencies by minimizing manual processing of loan documentation, (ii) enhance the quality of loan processing by use of uniform electronic images of loan files and (iii) facilitate loan administration and collections by providing easier access to loan account information. The implementation of these enhancements is expected to be substantially completed prior to December 1996. LOAN SERVICING The Company's strategy has been to retain the servicing rights associated with the loans it originates. The Company's loan servicing activities include responding to borrower inquiries, processing and administering loan payments, reporting and remitting principal and interest to the whole loan purchasers who own interests in the loans and to the trustee and others with respect to securitizations, collecting delinquent loan payments, processing Title I insurance claims, conducting foreclosure proceedings and disposing of foreclosed properties and otherwise administering the loans. The Company's various loan sale and securitization agreements allocate a portion of the difference between the stated interest rate and the interest rate passed through to purchasers of its loans to servicing revenue. Servicing fees are collected by the Company out of monthly loan payments. Other sources of loan servicing revenues include late charges and miscellaneous fees. The Company uses a sophisticated computer based mortgage servicing system that it believes enables it to provide effective and efficient administering of Conventional and Title I Loans. The servicing system is an on-line real time system developed and maintained by the Company's affiliate, PEC. It provides payment processing and cashiering functions, automated payoff statements, on-line collections, statement and notice mailing along 41 44 with a full range of investor reporting requirements. The Company has entered into a subservicing agreement with PEC for the use of the system and continuous support. The monthly investor reporting package includes a trial balance, accrued interest report, remittance report and delinquency reports. Formal written procedures have been established for payment processing, new loan set-up, customer service, tax and insurance monitoring. The Company is a HUD approved lender and a FNMA approved seller/servicer. As such, it is subject to a thorough due diligence review of its policies, procedures, and business, and is qualified to underwrite, sell and service Title I Loans on behalf of the FHA and FNMA. The Company's loan collection functions are organized into two areas of operation: routine collections and management of nonperforming loans. Routine collection personnel are responsible for collecting loan payments that are less than 60 days contractually past due and providing prompt and accurate responses to all customer inquiries and complaints. These personnel report directly to the Company's Vice President of Loan Administration. Borrowers are contacted on the due date for each of the first six payments in order to encourage continued prompt payment. Generally, after six months of seasoning, collection activity will commence if a loan payment has not been made within five days of the due date. Borrowers usually will be contacted by telephone at least once every five days and also by written correspondence before the loan becomes 60 days delinquent. With respect to loan payments that are less than 60 days late, routine collections personnel utilize a system of mailed notices and telephonic conferences for reminding borrowers of late payments and encouraging borrowers to bring their accounts current. Installment payment invoices and return envelopes are mailed to each borrower on a monthly basis. The Company has bilingual customer service personnel available. Once a loan becomes 30 days past due, a collection supervisor generally analyzes the account to determine the appropriate course of remedial action. On or about the 45th day of delinquency, the supervisor determines if the property needs immediate inspection to determine if it is occupied or vacant. Depending upon the circumstances surrounding the delinquent account, a temporary suspension of payments or a repayment plan to return the account to current status may be authorized by the Vice President of Loan Administration. In any event, it is the Company's policy to work with the delinquent customer to resolve the past due balance before Title I claim processing or legal action is initiated. Nonperforming loan management personnel are responsible for collecting severely delinquent loan payments (over 60 days late), filing Title I insurance claims or initiating legal action for foreclosure and recovery. Operating from the Company's headquarters in Atlanta, Georgia, collection personnel are responsible for collecting delinquent loan payments and seeking to mitigate losses by providing various alternatives to further actions, including modifications, special refinancing and indulgence plans. Title I insurance claim personnel are responsible for managing Title I insurance claims, utilizing a claim management system designed to track insurance claims for Title I Loans so that all required conditions precedent to claim perfection are met. In the case of Conventional Loans, a foreclosure coordinator will review all previous collection activity, evaluate the lien and equity position and obtain any additional information as necessary. The ultimate decision to foreclose, after all necessary information is obtained, is made by an officer of the Company. Foreclosure regulations and practices and the rights of the owner in default vary from state to state, but generally procedures may be initiated if: (i) the loan is 90 days or more delinquent; (ii) a notice of default on a senior lien is received; or (iii) the Company discovers circumstances indicating potential loss exposure. Net loan servicing income was $873,000 and $3.0 million for the year ended August 31, 1995 and the nine month period ended May 31, 1996, respectively, constituting 6.4% and 17.2%, respectively, of the Company's total revenues in such periods. As of May 31, 1996, the Company had increased the size of the loan portfolio it services to approximately $171.0 million from approximately $92.3 million as of August 31, 1995, an increase of approximately 85.3%. The Company's loan servicing portfolio is subject to reduction by normal amortization, prepayment of outstanding loans and defaults. 42 45 The following table sets forth certain information regarding the Company's loan servicing for the periods indicated:
YEAR ENDED AUGUST 31, NINE MONTHS ---------------- ENDED 1994(1) 1995 MAY 31, 1996 ------ ------- ------------ (IN THOUSANDS) Servicing portfolio at beginning of period.............. $ -- $ 8,026 $ 92,286 Additions to servicing portfolio........................ 8,317 87,757 89,391 Reductions in servicing portfolio(2).................... 291 3,491 10,629 Servicing portfolio (period end): Company-owned loans................................... 1,471 3,720 4,763 Sold loans............................................ 6,555 88,566 166,285 ------ ------- -------- Total......................................... $8,026 $92,286 $171,048 ====== ======= ========
- --------------- (1) The Company commenced originating loans in March 1994. (2) Reductions result from scheduled payments, prepayments and write-offs during the period. The following table sets forth the delinquency and Title I insurance claims experience of loans serviced by the Company as of the dates indicated:
AUGUST 31, AUGUST 31, MAY 31, 1994(1) 1995 1996 ---------- ---------- -------- (DOLLARS IN THOUSANDS) Delinquency period(2) 31-60 days past due................................... 2.06% 2.57% 2.41% 61-90 days past due................................... 0.48 0.73 0.78 91 days and over past due............................. 0.26 0.99 4.34(3) 91 days and over past due, net of claims filed(4)..... 0.26 0.99 2.38 Claims filed with HUD(5)................................ -- -- 1.96% Number of Title I insurance claims...................... 1 5 219 Total servicing portfolio at end of period.............. $8,026 $ 92,286 $171,048 Amount of FHA insurance available....................... 831 9,552 18,084(6) Amount of FHA insurance available as a percentage of loans serviced........................................ 10.36% 10.35% 10.57%(6) Losses on liquidated loans(7)........................... $ -- $ -- $ 7.6
- --------------- (1) The Company commenced originating loans in March 1994. (2) Represents the dollar amount of delinquent loans as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (3) During the nine-month period ended May 31, 1996, the processing and payment of claims filed with HUD was delayed. (4) Represents the dollar amount of delinquent loans net of delinquent Title I Loans for which claims have been filed with HUD and payment is pending as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (5) Represents the dollar amount of delinquent Title I Loans for which claims have been filed with HUD and payment is pending as a percentage of total dollar amount of loans serviced by the Company (including loans owned by the Company) as of the date indicated. (6) If all claims with HUD had been processed as of period end, the amount of FHA insurance available would have been reduced to $15,063,000, which as a percentage of loans serviced would have been 8.98%. (7) A loss is recognized upon receipt of payment of a claim or final rejection thereof. Claims paid in a period may relate to a claim filed in an earlier period. Since the Company commenced its Title I lending operations in March 1994, there has been no final rejection of a claim by the FHA. Aggregate losses on liquidated Title I Loans related to 29 of the 225 Title I insurance claims made by the Company since commencing operations through May 31, 1996. Losses on liquidated loans will increase as the balance of 43 46 the claims are processed by HUD. The Company has received an average payment from HUD equal to 90% of the outstanding principal balance of such Title I Loans, plus appropriate interest and costs. The Company has received an average amount equal to 96.68% of the outstanding principal balance of Title I Loans for which claims have been made, each payment including certain interest and costs. The processing and payment of claims filed with HUD have been delayed for a number of reasons including (i) furloughs experienced by HUD personnel in December 1995 and January 1996, (ii) the growth in the volume of Title I Loans originated from approximately $750 million in 1994 to $1.3 billion in 1995 without a corresponding increase in HUD personnel to service claims and (iii) the transition of processing operations to regional centers during the second and third quarters of 1996. It is expected that once appropriate staffing and training have been completed at HUD regional centers, the timeframe for payment of HUD claims will be significantly shortened. Sale of Loans The Company customarily sells the loans it originates to third party purchasers or, in the case of a third party purchaser not eligible to own a Title I Loan, sells Title I Loan participation certificates backed by Title I Loans. Whether the Company sells a loan or a loan participation, the Company typically retains the right to service the loans for a servicing fee. The Company typically sells loans for an amount approximating the then remaining principal balance. The purchasers are entitled to receive interest at yields below the stated interest rates of the loans. In connection with such sales, the Company is typically required to deposit into a reserve account the excess servicing spread received by it, less its servicing fee, up to a specified percentage of the principal balance of the loans, to fund shortfalls in collections that may result from borrower defaults. The following table sets forth certain data regarding Title I Loans sold by the Company during the periods indicated:
YEAR ENDED AUGUST 31, NINE MONTHS ------------------ ENDED 1994(1) 1995 MAY 31, 1996 ------ ------- ------------ Principal amount of loans sold to third party purchasers........................................ $6,555 $85,363 $ 88,073 Gain on sales of loans to third party purchasers.... 579 12,233 11,621 Net unrealized gain on mortgage related securities........................................ -- -- 2,182 Weighted average stated interest rate on loans sold to third party purchasers......................... 14.15% 14.53% 14.26% Weighted average pass-through interest rate on loans sold to third party purchasers.................... 8.53 8.42 7.56 Weighted average excess spread retained on loans sold.............................................. 5.62 6.11 6.70
-------------------- (1) The Company commenced originating loans in March 1994. At August 31, 1995 and May 31, 1996, the Company's balance sheet reflected excess servicing rights of approximately $14.5 million and $12.8 million, respectively. The Company also retains mortgage related securities through securitization transactions. At May 31, 1996, the Company's balance sheet reflected $15.1 million of mortgage related securities. The Company derives a significant portion of its income by realizing gains upon the sale of loans and loan participations due to the excess servicing rights associated with such loans. Excess servicing rights represent the excess of the interest rate payable by a borrower on a loan over the interest rate passed through to the purchaser of an interest in the loan, less the Company's normal servicing fee and other applicable recurring fees. Mortgage related securities consist of certificates representing the excess of the interest rate payable by an obligor on a sold loan over the yield on pass through certificates sold pursuant to a securitization transaction, after payment of servicing and other fees. When loans are sold, the Company recognizes as current revenue the present value of the excess servicing rights expected to be realized over the anticipated average life of the loans sold less future estimated credit losses relating to the loans sold. The capitalized excess servicing rights and valuation of mortgage related securities are computed using prepayment, default and interest rate assumptions that the Company believes are reasonable based on experience with its own portfolio, available market data and ongoing consultation with industry participants. The amount 44 47 of revenue recognized by the Company upon the sale of loans or loan participations will vary depending on the assumptions utilized. The weighted average discount rate used to determine the present value of the balance of capitalized excess servicing rights reflected on the Company's balance sheet at August 31, 1995 and May 31, 1996 was approximately 12.0%. Capitalized excess servicing rights are amortized over the lesser of the estimated or actual remaining life of the underlying loans as an offset against the excess servicing rights component of servicing income actually received in connection with such loans. Although the Company believes that it has made reasonable estimates of the excess servicing rights likely to be realized, the rate of prepayment and the amount of defaults utilized by the Company are estimates and experience may vary from its estimates. The gain recognized by the Company upon the sale of loans will have been overstated if prepayments or defaults are greater than anticipated. Higher levels of future prepayments would result in capitalized excess servicing rights amortization expense exceeding realized excess servicing rights, thereby adversely affecting the Company's servicing income and resulting in a charge to earnings in the period of adjustment. Similarly, if delinquencies or liquidations were to be greater than was initially assumed, capitalized excess servicing rights amortization would occur more quickly than originally anticipated, which would have an adverse effect on servicing income in the period of such adjustment. The Company periodically reviews its prepayment assumptions in relation to current rates of prepayment and, if necessary, reduces the remaining asset to the net present value of the estimated remaining future excess servicing income. Rapid increases in interest rates or competitive pressures may result in a reduction of future excess servicing income, thereby reducing the gains recognized by the Company upon the sale of loans or loan participations in the future. At August 31, 1995 and May 31, 1996, the Company's balance sheet reflected mortgage servicing rights of approximately $1.1 million and $2.7 million, respectively. The fair value of capitalized mortgage servicing rights was estimated by taking the present value of expected net cash flows from mortgage servicing using assumptions the Company believes market participants would use in their estimates of future servicing income and expense, including assumptions about prepayment, default and interest rates. Capitalized mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. The estimate of fair value was based on a range of 100 to 125 basis points per year servicing fee, reduced by estimated costs of servicing, and using a discount rate of 12% in the year ended August 31, 1995 and the nine months ended May 31, 1996. The Company has developed its assumptions based on experience with its own portfolio, available market data and ongoing consultation with industry participants. In furtherance of the Company's strategy to sell loans through securitizations, in March 1996 and August 1996, the Company completed its first two securitizations pursuant to which it sold pools of $84.2 million and $48.9 million, respectively, of Title I Loans. The Company previously reacquired at par $77.8 million and $36.2 million of such loans, respectively. Pursuant to these securitizations, pass-through certificates evidencing interests in the pools of loans were sold in a public offering. The Company continues to subservice the sold loans and is entitled to receive from payments in respect of interest on the sold loans a servicing fee equal to 1.25% of the balance of each loan with respect to the March transaction and 1.0% with respect to the August transaction. In addition, with respect to both transactions, the Company received certificates (carried as "Mortgage related securities" on the Company's balance sheet), representing the interest differential, after payment of servicing and other fees, between the interest paid by the obligors of the sold loans and the yield on the sold certificates. The Company may be required to repurchase loans that do not conform to the representations and warranties made by the Company in the securitization agreements. The Company typically earns net interest income during the "warehouse" period between the closing or assignment of a loan and its delivery to a purchaser. On loans held for sale, the Company earns interest at long-term rates, financed by lines of credit which bear interest at short-term interest rates. Normally, short-term interest rates are lower than long-term interest rates and the Company earns a positive spread on its loans held for sale. The average warehouse period for a loan ranges from six to 90 days, and the balance of loans in warehouse was approximately $1.5 million and $3.1 million as of August 31, 1995 and May 31, 1996, respectively. The Company's interest income, net of interest expense was $473,000 and $538,000 for the year ended August 31, 1995 and the nine months ended May 31, 1996, respectively. 45 48 SEASONALITY Home improvement loan volume tracks the seasonality of home improvement contract work. Volume tends to build during the spring and early summer months, particularly with regard to pool installations. A decline is typically experienced in late summer and early fall until temperatures begin to drop. This change in seasons precipitates the need for new siding, window and insulation contracts. Peak volume is experienced in November and early December and declines dramatically from the holiday season through the winter months. Debt consolidation and home equity loan volume are not impacted by seasonal climate changes and, with the exclusion of the holiday season, tend to be stable throughout the year. COMPETITION The consumer finance industry is highly competitive. Competitors in the home improvement and debt consolidation loan business include mortgage banking companies, commercial banks, credit unions, thrift institutions, credit card issuers and finance companies. Certain of the Company's competitors are substantially larger and have more capital and other resources than the Company. The Company faces substantial competition within both the home improvement and debt consolidation loan industry. The home improvement and debt consolidation loan industry is dominated by widely diversified mortgage banking companies, commercial banks, savings and loan institutions, credit card companies, financial service affiliates of Dealers and unregulated financial service companies, many of which have substantially greater personnel and financial resources than those of the Company. At present, these types of competitors dominate the home improvement and debt consolidation loan industry; however, no one lender or group of lenders dominates the industry. The Company believes that Greentree Financial Corp., The Money Store, First Plus Financial Inc., Associates First Capital Corporation and Empire Funding Corp. are some of the its largest direct competitors. The Company competes principally by providing prompt, professional service to its Correspondents and Dealers and, depending on circumstances, by providing competitive lending rates. Competition can take many forms including convenience in obtaining a loan, customer service, marketing and distribution channels, amount and term of the loan, and interest rates. In addition, the current level of gains realized by the Company and its existing competitors on the sale of loans could attract additional competitors into this market with the possible effect of lowering gains on future loan sales owing to increased loan origination competition. GOVERNMENT REGULATION The Company's consumer lending activities are subject to the Federal Truth-in-Lending Act and Regulation Z (including the Home Ownership and Equity Protection Act of 1994), ECOA, the Fair Credit Reporting Act of 1970, as amended, RESPA and Regulation X, the Home Mortgage Disclosure Act, the Federal Debt Collection Practices Act and the Housing Act, as well as other federal and state statutes and regulations affecting the Company's activities. Failure to comply with these requirements can lead to loss of approved status, termination or suspension of servicing contracts without compensation to the servicer, demands for indemnifications or mortgage loan repurchases, certain rights of rescission for mortgage loans, class action lawsuits and administrative enforcements actions. The Company presently is subject to the rules and regulations of, and examinations by, HUD, FHA and other federal and state regulatory authorities with respect to originating, underwriting, funding, acquiring, selling and servicing consumer and mortgage loans. In addition, there are other federal and state statutes and regulations affecting such activities. These rules and regulations, among other things, impose licensing obligations on the Company, establish eligibility criteria for loans, prohibit discrimination, provide for inspection and appraisals of properties, require credit reports on prospective borrowers, regulate payment features and, in some cases, fix maximum interest rates, fees and loan amounts. The Company is required to submit annual audited financial statements to various governmental regulatory agencies that require the maintenance of specified net worth levels. The Company's affairs are also subject to examination, at all times, by the Federal Housing Commissioner to assure compliance with FHA regulations, policies and procedures. For more information regarding regulation of the Company under Title I, see "Title I Loan Program." 46 49 The Company is a HUD approved Title I mortgage lender and is subject to the supervision of HUD. The Company is also a FNMA approved seller/servicer and is subject to the supervision of FNMA. In addition, the Company's operations are subject to supervision by state authorities (typically state banking or consumer credit authorities), many of which generally require that the Company be licensed to conduct its business. This normally requires state examinations and reporting requirements on an annual basis. The Federal Consumer Credit Protection Act ("FCCPA") requires a written statement showing an annual percentage rate of finance charges and requires that other information be presented to debtors when consumer credit contracts are executed. The Fair Credit Reporting Act requires certain disclosures to applicants concerning information that is used as a basis for denial of credit. ECOA prohibits discrimination against applicants with respect to any aspect of a credit transaction on the basis of sex, marital status, race, color, religion, national origin, age, derivation of income from public assistance program, or the good faith exercise of a right under the FCCPA. The interest rates which the Company may charge on its loans are subject to state usury laws, which specify the maximum rate which may be charged to consumers. In addition, both federal and state truth-in-lending regulations require that the Company disclose to its customers prior to execution of the loans, all material terms and conditions of the financing, including the payment schedule and total obligation under the loans. The Company believes that it is in compliance in all material respects with such regulations. EMPLOYEES As of May 31, 1996, the Company had 153 employees, including seven executive officers, 67 managerial and staff professional personnel, 19 marketing and sales specialists and 60 general administrative and support personnel and loan processors. None of the Company's employees is represented by a collective bargaining unit. The Company believes that its relations with its employees are satisfactory. PROPERTIES In order to accommodate the Company's growth, a lease of new corporate headquarters was executed in April 1996 for 45,950 square feet at 1000 Parkwood Circle, Atlanta, Georgia. This lease is for an initial six year term expiring August 2002 with a conditional option to extend the term to August 2007. After an initial partial rent abatement period of six months, monthly rentals will be $73,711 plus a pro rata share of any operating expense increase. This lease rate will escalate 2% per year throughout the term of the lease. The Company also leases 10,478 square feet of office space at its prior headquarters location in Atlanta, Georgia, at a rental of $13,193 per month, pursuant to a lease that expires in March 1999. The Company intends to sublease this office space for the remaining term of its lease. The Company also leases office space on short-term or month-to-month leases in Kansas City, Missouri, Austin, Texas, Montvale, New Jersey, Oklahoma City, Oklahoma, Seattle, Washington, Waterford, Michigan, Columbus, Ohio, Elmhurst, Illinois, Philadelphia, Pennsylvania, Denver, Colorado and Woodbridge, Virginia. LEGAL PROCEEDINGS In the ordinary course of its business, the Company is, from time to time, named in lawsuits. The Company believes that it has meritorious defenses to these lawsuits and that resolution of these matters will not have a material adverse effect on the business or financial condition of the Company. 47 50 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth certain information with respect to the directors and executive officers of the Company.
NAME AGE POSITION - ------------------------------------------- --- ------------------------------------------- Jerome J. Cohen............................ 68 Chairman of the Board and Chief Executive Officer Jeffrey S. Moore........................... 38 President, Chief Operating Officer and Director James L. Belter............................ 49 Executive Vice President and Chief Financial Officer Michael G. Ebinger......................... 40 Vice President, National Marketing Robert Nederlander......................... 63 Director Herbert B. Hirsch.......................... 60 Director Don A. Mayerson............................ 69 Director
Jerome J. Cohen has been Chairman of the Board and Chief Executive Officer of the Company since April 1995. Mr. Cohen has been the President and a Director of Mego Financial since January 1988. Since April 1992, Mr. Cohen has been a Director of Atlantic Gulf Communities Inc., formerly known as General Development Corporation, a publicly held company engaged in land development, land sales and utility operations in Florida and Tennessee. Mr. Cohen does not currently serve on a full time basis in his capacities with the Company. Jeffrey S. Moore has been the President of the Company since April 1995 and Chief Operating Officer since December 1993. In addition, Mr. Moore has served as a director of the Company since June 1992. Prior to being elected President, Mr. Moore served as an Executive Vice President of the Company from June 1992 to March 1995. Mr. Moore was the founder and from August 1984 until March 1992, served as President, Chief Executive Officer and a director of Empire Funding Corp., a privately-held, nationwide consumer finance company specializing in originating, purchasing, selling and servicing FHA Title I and other home improvement mortgage loans. Mr. Moore serves as a director of the Title One Home Improvement Lenders Association and is a member of its Legislative and Regulatory Affairs Committee. James L. Belter has been Executive Vice President of the Company since April 1995 and Chief Financial Officer since September 1996. Prior to joining the Company, from May 1989 to September 1993, Mr. Belter served as the President, Chief Operating Officer and a director of Del-Val Capital Corporation, a commercial finance company. From April 1985 to April 1989, Mr. Belter served as Executive Vice President of Security Capital Credit Corporation, a commercial finance company, where he was responsible for the formation of the company's installment receivable lending division. From November 1976 to April 1985, Mr. Belter served as a corporate Vice President of Barclays Business Credit, Inc. where he managed a unit specializing in financing portfolios of consumer contracts including residential second mortgages, home improvement contracts, timeshare and land sales. Michael G. Ebinger has served as Vice President of National Marketing since June 1995. From January 1995 to June 1995, Mr. Ebinger served as Director of National Accounts of the Correspondent Division. From 1989 to 1994, Mr. Ebinger served as Director of National Accounts for the home improvement division of Greentree Financial Corporation, where he developed and managed the national account program which created a network of over 1,000 home improvement contractors. From 1987 to 1989, he served as West Coast Regional Manager for VIPCO, a division of Crane Plastics, a manufacturer of replacement vinyl siding. From 1986 to 1987, he served as National Accounts Manager for Security Pacific Financial Services Corporation in its Manufacturer Funding Division and was responsible for the marketing of its indirect home improvement loan programs to home improvement contractors. Robert Nederlander has been a Director of the Company since September 1996. Mr. Nederlander has been the Chairman of the Board and Chief Executive Officer of Mego Financial since January 1988. 48 51 Mr. Nederlander is a member of the Company's Audit Committee. Since July 1995, Mr. Nederlander has served on the Board of Directors of Hospitality Franchise Systems, Inc. Mr. Nederlander has been President of Nederlander Organization, Inc., a company principally engaged in the theatrical business, since 1981. Since May 1989, Mr. Nederlander served as the Chairman of the Board and Chief Executive Officer of Allis-Chalmers Corporation, a publicly held company engaged in the machinery, equipment repair and women's shoulder pad business, and since November 1993, Mr. Nederlander has served as Vice Chairman of Allis-Chalmers Corporation. Between August 1990 and December 1991, Mr. Nederlander was the managing general partner of the New York Yankees Baseball Club. Since April 1988, Mr. Nederlander has been the Chairman of the Board of Riddell Sports, Inc., a publicly held company principally engaged in the manufacture of football helmets and other athletic protective equipment and the licensing of trademarks. Herbert B. Hirsch has been a Director of the Company since the Company's formation in June 1992. Mr. Hirsch has been the Senior Vice President, Chief Financial Officer, Treasurer and a Director of Mego Financial since January 1988. Mr. Hirsch served as Vice President and Treasurer of the Company from June 1992 to September 1996. Don A. Mayerson has been a Director of the Company since the Company's formation in June 1992. Mr. Mayerson has been the Secretary of Mego Financial since January 1988 and the Executive Vice President and General Counsel of Mego Financial since April 1988. Mr. Mayerson served as Vice President, General Counsel and Secretary of the Company from June 1992 to September 1996. The Company's officers are elected annually by the Board of Directors and serve at the discretion of the Board of Directors. The Company's directors hold office until the next annual meeting of stockholders and until their successors have been duly elected and qualified. The Company reimburses all directors for their expenses in connection with their activities as directors of the Company. Directors of the Company who are also employees of the Company do not receive additional compensation for their services as directors. Members of the Board of Directors of the Company who are not employees of the Company receive an annual fee of $20,000 for four Board meetings per year plus $2,500 for each additional meeting attended in person and $1,000 for each additional telephonic meeting attended. Directors are also reimbursed for their expenses incurred in attending meetings of the Board of Directors and its committees. KEY EMPLOYEES Robert Bellacosa -- Mr. Bellacosa, age 54, has served as Vice President of Financial Management since October 1993 and Secretary since September 1996. From May 1989 to October 1993, Mr. Bellacosa served as Senior Vice President of Accounting for Del-Val Capital Corp. From May 1985 to May 1989, he served as Vice President of Security Capital Credit Corp. where he was responsible for loan administration of commercial real estate and term receivable lending functions. From 1974 to 1985, he served as Vice President for Aetna Business Credit, Inc. which was purchased by Barclays American Business Credit, Inc. and was responsible for the management of loan administration for special term receivables. Jack Elrod -- Mr. Elrod, age 40, has served as Vice President of Loan Administration since May 1995. From March 1994 to May 1995, Mr. Elrod served as a Senior Underwriter for ITT Financial Corporation. From March 1993 to March 1994, he served as Branch Manager for Commercial Credit Corporation and from January 1977 to February 1993, he served as Assistant Vice President and District Manager of Household Finance Corporation. Samuel Schultz -- Mr. Schultz, age 47, has served as Vice President of Credit Quality since June 1996 and as Vice President of the Company's Dealer Division Operations from December 1993 until June 1996. Mr. Schultz was a consultant to the Company from June 1993 until December 1993. From September 1990 to June 1993, he served as Vice President of Underwriting for Empire Funding Corp., a nationwide consumer finance company specializing in the purchase of FHA Title I and other home improvement mortgage loans. From February 1988 to September 1990, he served as a Senior Manager for Avco Financial Services. From October 1985 to February 1988, he served as a Department Manager for Associates Financial Services Inc. Prior to 1985, and since 1971, Mr. Schultz's experience includes collections and originations of consumer finance loans for Postal Finance, Turner Mortgage and other consumer finance companies. 49 52 Jeffrey Rast -- Mr. Rast, age 46, has served as Vice President of Correspondent Division Operations since July 1994. From March 1989 to December 1993, Mr. Rast served as Senior Vice President and Regional Manager for Barclays American Financial Corp. From December 1987 to March 1989, he served as President and Chief Operating Officer of Bankwest Industrial Bank. From January 1981 to December 1987, he served as Vice President and Regional Manager of Manufacturers Hanover Financial Services. From January 1974 to December 1982, he served in various positions including District and Branch Manager for ITT Financial Services. Yancy Lockie -- Mr. Lockie, age 33, has served as Vice President of Dealer Division Operations since July 1996. From September 1993 to June 1996, Mr. Lockie served as Manager of Real Estate Underwriting for NationsCredit Financial Services and was responsible for underwriting of real estate and indirect home improvement loans for 245 branches and from December 1990 to August 1993, he served as Branch Manager for NationsCredit Financial Services. From 1987 to November 1990, he served as a Senior Assistant Manager and Senior Underwriter for Household Finance Corporation. John Kostelich -- Mr. Kostelich, age 33, has served as Vice President of Project Management since June 1996 and is responsible for developing and implementing the Company's policies and procedures for new and diversified loan products. From June 1995 to June 1996, Mr. Kostelich served as Director of Compliance for the Company. From 1985 to 1995, he served in various positions for ITT Consumer Financial Corporation, including Director of Quality Control and Correspondent Support Operations, Senior Compliance Officer, in which he managed special projects for the Chairman of the company, Regional Manager and Branch Manager. EXECUTIVE COMPENSATION The following table sets forth information concerning the annual and long-term compensation earned by the Company's chief executive officer and each of the three other executive officers whose annual salary and bonus during the fiscal years presented exceeded $100,000 (the "Named Executive Officers"). The Company did not grant any stock options to the Named Executive Officers during the fiscal year ended August 31, 1996. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION AWARDS ----------------------------------------------- ------------------------ OTHER NUMBER OF FISCAL ANNUAL OPTIONS ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1) GRANTED(2) COMPENSATION - ------------------------------ ------ -------- ------- --------------- --------- ------------ Jerome J. Cohen(3)............ 1994 $ 75,000 $ -- $ -- -- $ -- Chairman of the Board and 1995 64,388 -- -- -- -- Chief Executive Officer 1996 65,748 -- -- -- -- Jeffrey S. Moore.............. 1994 $126,771 $ -- $ 5,140 25,000 $ -- President and Chief 1995 200,003 -- 13,963 -- -- Operating Officer 1996 286,087 86,385 13,625 -- -- James L. Belter............... 1994 $ 98,079 $ -- $ -- 15,000 $ -- Executive Vice President and 1995 150,003 50,000 1,510 -- -- Chief Financial Officer 1996 159,080 50,000 4,330 -- -- Michael G. Ebinger............ 1994 $ -- $ -- $ -- -- $ -- Vice President 1995 55,320 -- 5,609 15,000 -- 1996 110,011 11,500 -- -- --
- --------------- (1) Other annual compensation consists of car allowances, contributions to 401(k) plans and moving expenses. (2) Represents options to purchase shares of Mego Financial's common stock paid as compensation for services rendered to the Company. (3) Mr. Cohen's compensation is included in the management fees paid to PEC. See "Certain Transactions." 50 53 EMPLOYMENT AGREEMENT The Company has entered into an employment agreement with Jeffrey S. Moore which expires on December 31, 1998 and which provides for an annual base salary of $200,000. In addition, Mr. Moore is to receive an incentive bonus each calendar year equal to 1.5% of the Company's after tax income, provided that certain scheduled sales goals are met, as well as deferred compensation of 1% of the gain on sale from sales of loans during such year, payable in 48 equal installments. In the event payments of the incentive bonus and deferred compensation due in any year exceed $500,000, then the excess over $500,000 is only payable with the approval of the Company's Board of Directors. COMPANY STOCK OPTION PLAN Under the Company's Stock Option Plan (the "Plan"), which will be effective upon the consummation of the Common Stock Offering, 900,000 shares of Common Stock will be reserved for issuance upon exercise of stock options. The options, even if vested, may not be exercised without the written approval of Mego Financial during the Eighty Percent Period. Such shares will be accompanied by stock appreciation rights which will become exercisable as determined by the Board, or a Committee thereof, only if Mego Financial does not give approval to the exercise of the option. The Plan is designed as a means to retain and motivate key employees and directors. The Company's Board of Directors, or a committee thereof, administers and interprets the Plan and is authorized to grant options thereunder to all eligible employees and directors of the Company, except that no incentive stock options (as defined in Section 422 of the Internal Revenue Code) may be granted to a director who is not also an employee of the Company or a subsidiary. The Plan will provide for the granting of both incentive stock options and nonqualified stock options. Options will be granted under the Plan on such terms and at such prices as determined by the Company's Board of Directors, or a committee thereof, except that the per share exercise price of incentive stock options cannot be less than the fair market value of the Common Stock on the date of grant. Each option is exercisable after the period or periods specified in the related option agreement, but no option may be exercisable after the expiration of ten years from the date of grant. Options granted to an individual who owns (or is deemed to own) at least 10% of the total combined voting power of all classes of stock of the Company must have an exercise price of at least 110% of the fair market value of the Common Stock on the date of grant and a term of no more than five years. The Plan also authorizes the Company to make or guarantee loans to optionees to enable them to exercise their options. Such loans must (i) provide for recourse to the optionee, (ii) bear interest at a rate no less than the prime rate of interest, and (iii) be secured by the shares of Common Stock purchased. The Board of Directors has the authority to amend or terminate the Plan, provided that no such action may impair the rights of the holder of any outstanding option without the written consent of such holder, and provided further that certain amendments of the Plan are subject to stockholder approval. Unless terminated sooner, the Plan will continue in effect until all options granted thereunder have expired or been exercised, provided that no options may be granted ten years after commencement of the Plan. The following table sets forth information with respect to options to be granted under the Plan upon consummation of the Common Stock Offering to (i) each Named Officer and (ii) each director and nominee for director. All of the options are nonstatutory, are being granted with an exercise price equal to the offering price, are subject to the consummation of the Common Stock Offering and are being granted in 1996.
NAME OF GRANTEE NUMBER OF SHARES - ----------------------------------------------------------------------------- ---------------- Robert Nederlander........................................................... Jerome J. Cohen.............................................................. Jeffrey S. Moore............................................................. James L. Belter.............................................................. Herbert B. Hirsch............................................................ Don A. Mayerson..............................................................
51 54 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Company does not currently have a Compensation Committee. Mr. Cohen participated in deliberations concerning compensation of executive officers during fiscal 1996. Mr. Cohen's compensation was determined by the Board of Directors of Mego Financial. BONUS PLAN The Company does not currently have a bonus plan but anticipates it may adopt a bonus plan pursuant to which an aggregate of not in excess of 2 1/2% of pretax income will be distributed to officers and key employees. PRINCIPAL STOCKHOLDERS Mego Financial currently owns 10,000,000 shares of Common Stock (after giving effect to the 1,600-for-one stock split), representing 100% of all the issued and outstanding Common Stock of the Company. After giving effect to the issuance of the Common Stock pursuant to the Common Stock Offering, Mego Financial will own approximately 83.3% of the issued and outstanding Common Stock of the Company (approximately 81.3% if the underwriters of the Common Stock Offering exercise their over-allotment option in full). The following table sets forth, as of the date of this Prospectus, information with respect to the beneficial ownership of the common stock of Mego Financial by (i) each person known by the Company to be the beneficial owner of more than 5% of the outstanding shares of common stock of Mego Financial, (ii) each director of the Company, (iii) each of the Named Executive Officers and (iv) all directors and executive officers of the Company as a group. Unless otherwise noted, the Company believes that all persons named in the table have sole voting and investment power with respect to all shares of common stock of Mego Financial beneficially owned by them.
PERCENTAGE OWNERSHIP ATTRIBUTABLE TO THE COMPANY --------------------------- BEFORE THE AFTER THE AMOUNT AND NATURE OF COMMON STOCK COMMON STOCK NAME AND ADDRESS OF BENEFICIAL OWNER(1) BENEFICIAL OWNERSHIP OFFERING OFFERING - ------------------------------------------------- -------------------- ------------ ------------ Robert Nederlander(2)............................ 2,126,697 11.6% 9.7% Eugene I. Schuster and Growth Realty Inc. ("GRI")(3)..................................... 1,933,634 10.5 8.7 Jerome J. Cohen(4)............................... 1,120,823 6.1 5.1 Jeffrey S. Moore(5).............................. 5,000 * * James L. Belter(6)............................... 3,000 * * Michael G. Ebinger(7)............................ 3,000 * * Herbert B. Hirsch(8)............................. 1,692,623 9.2 7.7 Don A. Mayerson(9)............................... 817,414 4.5 3.7 All executive officers and directors of the Company as a group (7 persons)(10)............. 5,768,557 30.1 25.1
- --------------- * Less than 1%. (1) A person is deemed to be the beneficial owner of securities that can be acquired by such person within 60 days from the date of this Prospectus upon the exercise of options and warrants. Each beneficial owner's percentage ownership is determined by assuming that options and warrants that are held by such person (but not those held by any other person) and that are exercisable within 60 days from the date of this Prospectus have been exercised. (2) 810 Seventh Avenue, 21st Floor, New York, New York 10019. Includes 14,000 shares issuable under an option granted pursuant to the Mego Financial Stock Option Plan, to the extent exercisable within the next 60 days, and 250,000 shares issuable upon the exercise of warrants held by an affiliate of Mr. Nederlander which are presently exercisable. 52 55 (3) 321 Fisher Building, Detroit, Michigan 48202. Consists of 1,683,634 shares held of record by GRI, a wholly-owned subsidiary of Venture Funding, Ltd. of which Mr. Schuster is a principal shareholder, Director and Chief Executive Officer, and 250,000 shares issuable upon the exercise of warrants held by an affiliate of Mr. Schuster which are presently exercisable. (4) 1125 N.E. 125th Street, Suite 206, North Miami, Florida 33161. Includes 14,000 shares issuable under an option granted pursuant to the Mego Financial Stock Option Plan, to the extent exercisable within the next 60 days, and 200,000 shares issuable upon the exercise of warrants held by Mr. Cohen which are presently exercisable. Excludes 103,503 shares owned by Mr. Cohen's spouse and 500,000 shares owned by a trust for the benefit of his children over which Mr. Cohen does not have any investment or voting power, as to which he disclaims beneficial ownership. (5) 1000 Parkwood Circle, Suite 500, Atlanta, Georgia 30339. Includes 5,000 shares issuable under an option granted pursuant to the Mego Financial Stock Option Plan, to the extent exercisable within the next 60 days. (6) 1000 Parkwood Circle, Suite 500, Atlanta, Georgia 30339. Includes 3,000 shares issuable under an option granted pursuant to the Mego Financial Stock Option Plan, to the extent exercisable within the next 60 days. (7) 1000 Parkwood Circle, Suite 500, Atlanta, Georgia 30339. Includes 3,000 shares issuable under an option granted pursuant to the Mego Financial Stock Option Plan, to the extent exercisable within the next 60 days. (8) 230 East Flamingo Road, Las Vegas, Nevada 89109. Includes 14,000 shares issuable under an option granted pursuant to the Mego Financial Stock Option Plan, to the extent exercisable within the next 60 days, and 200,000 shares issuable upon the exercise of warrants held by Mr. Hirsch which are presently exercisable. Excludes 10,000 shares held by the daughter of Mr. Hirsch as custodian for a minor child as to which he disclaims beneficial ownership, and 21,666 shares held by a family trust, as to which he disclaims beneficial ownership. (9) 1125 N.E. 125th Street, Suite 206, North Miami, Florida 33161. Includes 14,000 shares issuable under an option granted pursuant to the Mego Financial Stock Option Plan, to the extent exercisable within the next 60 days, and 100,000 shares issuable upon the exercise of warrants held by Mr. Mayerson which are presently exercisable. Excludes 56,667 shares owned by Mr. Mayerson's spouse, as to which he disclaims beneficial ownership. (10) See Notes (2)-(9). CERTAIN TRANSACTIONS TAX SHARING AND INDEMNITY AGREEMENT After the Offering, the results of operations of the Company will continue to be included in the tax returns filed by Mego Financial's affiliated or combined group for federal income tax purposes. The members of the group, including the Company, currently are parties to a tax allocation arrangement that allocates the liability for those taxes among them. Effective on consummation of the Offering, the Company, Mego Financial and the other members of the tax reporting group will enter into a tax allocation and indemnity agreement. Under that agreement, for periods ending after the Offering, the tax liabilities of each entity in the group will be allocated pursuant to a method that would impose on the Company liability for an amount that corresponds (with various modifications) to the liability that the Company would incur if it filed a separate tax return. In addition, the agreement provides that the Company and the other members of the group each will indemnify the other under certain circumstances. MANAGEMENT AGREEMENT WITH PEC The Company and PEC are parties to a management services agreement (the "Management Agreement") pursuant to which certain employees of PEC provide services to the Company on an as needed basis. The Management Agreement provides for the payment by the Company of a management fee to PEC in an amount equal to the direct and indirect expenses of PEC related to the services rendered by its employees to 53 56 the Company, including an allocable portion of the salaries and expenses of such employees based upon the percentage of time such employees spend performing services for the Company. For the years ended August 31, 1994, 1995 and 1996, $442,000, $690,000 and $671,000, respectively, of the salaries and expenses of certain employees of PEC were attributable to and paid by the Company in connection with services rendered by such employees to the Company. SERVICING AGREEMENT WITH PEC The Company has an arrangement with PEC pursuant to which it pays servicing fees of 50 basis points of the principal balance of loans serviced per year. For the years ended August 31, 1994, 1995 and 1996, the Company paid servicing fees to PEC of $11,000, $174,000 and $709,000, respectively. The Company anticipates that prior to consummation of the Offering it will enter into a servicing agreement with PEC providing for the payment of servicing fees of 50 basis points of the principal balance of loans serviced per year. GUARANTEES BY MEGO FINANCIAL Mego Financial has guaranteed the Company's obligations under the Warehouse Line, the Revolving Loan and the Company's new office lease. 54 57 DESCRIPTION OF THE NOTES GENERAL The Notes are to be issued under an Indenture, to be dated as of , 1996 (the "Indenture"), between the Company and American Stock Transfer & Trust Company, as Trustee (the "Trustee"). A copy of the form of the Indenture is filed as an exhibit to the Registration Statement of which this Prospectus is a part. The following summary of certain provisions of the Indenture does not purport to be complete and is subject to, and is qualified in its entirety by reference to, all the provisions of the Indenture, including the definitions of certain terms therein and those terms made a part thereof by the Trust Indenture Act of 1939, as amended. Principal of, premium, if any, and interest on the Notes will be payable, and the Notes may be exchanged or transferred, at the office or agency of the Company in the Borough of Manhattan, The City of New York (which initially shall be the corporate trust office of the Trustee, at 40 Wall Street, New York, New York 10005), except that, at the option of the Company, payment of interest may be made by check mailed to the address of the Holders as such address appears in the Note register. The Notes will be issued only in fully registered form, without coupons, in denominations of $1,000 and any integral multiple of $1,000. No service charge shall be made for any registration of transfer or exchange of Notes, but the Company may require payment of an amount sufficient to cover any transfer tax or other similar governmental charge payable in connection therewith. TERMS OF THE NOTES The Notes will be general unsecured obligations of the Company, subordinated in right of payment to all Senior Indebtedness of the Company, will be limited to $40,000,000 aggregate principal amount, and will mature on , 2001. The Notes will bear interest at the rate shown on the cover page hereof from , 1996, or from the most recent date to which interest has been paid or provided for, payable semiannually to Holders of record at the close of business on the or immediately preceding the interest payment date on and of each year, commencing , 1997. The Company will pay interest on overdue principal at 1% per year in excess of such rate and will pay interest on overdue installments of interest at such higher rate to the extent lawful. Interest on the Notes will be computed on the basis of a 360-day year of twelve 30-day months. SUBSIDIARY GUARANTEES The Notes will be unconditionally guaranteed (a "Subsidiary Guarantee") by all future Subsidiaries of the Company other than Special Purpose Subsidiaries (together, the "Subsidiary Guarantors", and each of them, a "Subsidiary Guarantor"), unless any such Subsidiary is designated an "Unrestricted Subsidiary" in accordance with the terms of the Indenture. Each Subsidiary Guarantor's obligations under its Subsidiary Guarantee will be unsecured obligations of such Subsidiary Guarantor, subordinated in right of payment to all Senior Indebtedness of such Subsidiary Guarantor, and will be joint and several with the obligations of each other Subsidiary Guarantor under its Subsidiary Guarantee of the Notes. In addition, the Indenture will provide that, in the event the Company designates a Restricted Subsidiary to be an Unrestricted Subsidiary, then such Restricted Subsidiary will be released and relieved of any obligations under its Subsidiary Guarantee; provided that such designation is conducted in accordance with the applicable provisions of the Indenture. See "-- Certain Covenants -- Restricted Payments", "-- Certain Definitions -- Unrestricted Subsidiary" and "-- Investments." The Indenture will include a covenant by the Company to cause each future Restricted Subsidiary (other than a Special Purpose Subsidiary) to execute a Subsidiary Guarantee. The obligations of each Subsidiary Guarantor under its Subsidiary Guarantee will be limited so as to reduce the risk that they would be found to constitute a fraudulent conveyance under applicable law. See "Risk Factors -- Fraudulent Conveyances and Preferential Transfers." 55 58 SUBORDINATION The Indebtedness represented by the Notes and the Subsidiary Guarantees will be subordinated in right of payment to all existing and future Senior Indebtedness of the Company and the Subsidiary Guarantors, respectively, including without limitation all obligations of the Company or any Subsidiary Guarantor under any Warehouse Facility, and will be senior in right of payment to all future Indebtedness of the Company and the Subsidiary Guarantors that by its terms is expressly subordinated in right of payment to the Notes or the Subsidiary Guarantees as described in the Indenture ("Junior Subordinated Obligations"). As of May 31, 1996, the Company had approximately $ million of Senior Indebtedness outstanding and had no Subsidiaries. See "Capitalization." Although the Indenture contains limitations on the amount of additional Indebtedness which the Company and the Restricted Subsidiaries may incur, the amount of such Indebtedness is likely to be substantial, and substantially all such Indebtedness may be Senior Indebtedness. See "-- Certain Covenants -- Limitations on Indebtedness." If any Senior Indebtedness is disallowed, avoided or subordinated pursuant to the provisions of Section 548 of the Bankruptcy Law or any applicable state fraudulent conveyance law, such Indebtedness nevertheless will constitute Senior Indebtedness for purposes of the Indenture. The Company may not pay the principal of, premium, if any, or interest on, the Notes or make any deposit pursuant to the provisions described under "Defeasance" and may not repurchase, redeem, defease or otherwise retire any Notes (collectively, "pay the Notes" or "make a payment with respect to the Notes") if (i) any Senior Indebtedness of the Company is not paid when due or (ii) any other default on any such Senior Indebtedness occurs and the maturity thereof has been accelerated in accordance with its terms, unless, in either case, (x) the default has been cured or waived and any such acceleration has been rescinded or (y) such Senior Indebtedness has been paid in full. During the continuance of any default (other than a default described in clause (i) or (ii) of the preceding sentence) with respect to any Designated Senior Indebtedness of the Company pursuant to which the maturity thereof may be accelerated immediately without further notice (except such notice as may be required to effect such acceleration) or the expiration of any applicable grace periods, the Company may not pay the Notes for a period (a "Payment Blockage Period") commencing upon the receipt by the Company and the Trustee of written notice of such default from the Representative of any Designated Senior Indebtedness specifying an election to effect a Payment Blockage Period (a "Blockage Notice") and ending 179 days thereafter (or earlier if such Payment Blockage Period is terminated (i) by written notice to the Trustee and the Company from the Person or Persons who gave such Blockage Notice, (ii) by repayment in full of such Designated Senior Indebtedness or (iii) because the default giving rise to such Blockage Notice is no longer continuing). Notwithstanding the provisions described in the immediately preceding sentence (but subject to the provisions contained in the next preceding sentence), unless the holders of such Designated Senior Indebtedness or the Representative of such holders shall have accelerated the maturity of such Designated Senior Indebtedness, the Company may resume payments on the Notes after such Payment Blockage Period. Not more than one Blockage Notice may be given in any consecutive 360-day period, irrespective of the number of defaults with respect to Designated Senior Indebtedness during such period. Upon any payment or distribution of the assets of the Company to creditors upon a total or partial liquidation or total or partial dissolution of the Company or in a bankruptcy, reorganization, insolvency, receivership or similar proceeding relating to the Company or its property (whether voluntary or involuntary), (i) the holders of Senior Indebtedness of the Company will be entitled to receive payment in full before the holders of the Notes are entitled to receive any payment, and (ii) until the Senior Indebtedness of the Company is paid in full, any payment to which the Holders of the Notes would be entitled but for this provision will be made to holders of Senior Indebtedness as their interests may appear, except that Holders may receive shares of stock or debt securities of the Company that are subordinated to Senior Indebtedness of the Company to at least the same extent as the Notes. No Subsidiary Guarantor may make any payment under its Subsidiary Guarantee with respect to any payment with respect to the Notes if (i) any Senior Indebtedness of any Subsidiary Guarantor is not paid when due or (ii) any other default on any such Senior Indebtedness occurs and the maturity thereof has been 56 59 accelerated in accordance with its terms, unless, in either case, (x) the default has been cured or waived and any such acceleration has been rescinded or (y) such Senior Indebtedness has been paid in full. During the continuance of any default (other than a default described in clause (i) or (ii) of the preceding sentence) with respect to any Designated Senior Indebtedness of any Subsidiary Guarantor pursuant to which the maturity thereof may be accelerated immediately without further notice (except such notice as may be required to effect such acceleration) or the expiration of any applicable grace periods, such Subsidiary Guarantor may not make any payment with respect to the Notes for a period (a "Subsidiary Guarantor Payment Blockage Period") commencing upon the receipt by the Subsidiary Guarantor and the Trustee of written notice of such default from the Representative of any Designated Senior Indebtedness of such Subsidiary Guarantor specifying an election to effect a Subsidiary Guarantor Payment Blockage Period (a "Subsidiary Guarantor Blockage Notice") and ending 179 days thereafter (or earlier if such Subsidiary Guarantor Payment Blockage Period is terminated (i) by written notice to the Trustee and the Subsidiary Guarantors from the Person or Persons who gave such Subsidiary Guarantor Blockage Notice, (ii) by repayment in full to such Designated Senior Indebtedness of such Subsidiary Guarantor or (iii) because the default giving rise to such Subsidiary Guarantors Blockage Notice is no longer continuing). Notwithstanding the provisions described in the immediately preceding sentence (but subject to the provisions contained in the next preceding sentence), unless the holders of such Senior Indebtedness of such Subsidiary Guarantor or the Representative of such holders shall have accelerated the maturity of such Designated Senior Indebtedness of such Subsidiary Guarantor, such Subsidiary Guarantor may resume payments under its Subsidiary Guarantee after such Subsidiary Guarantor Payment Blockage Period. Not more than one Subsidiary Guarantor Blockage Notice may be given with respect to the Subsidiary Guarantors in any consecutive 360-day period, irrespective of the number of defaults with respect to Designated Senior Indebtedness of the Subsidiary Guarantors during such period. Upon any payment or distribution of the assets of any Subsidiary Guarantor to creditors upon a total or partial liquidation or total or partial dissolution of the Subsidiary Guarantor or in a bankruptcy, reorganization, insolvency, receivership or similar proceeding relating to the Subsidiary Guarantor or its property (whether voluntary or involuntary), (i) the holders of Senior Indebtedness of such Subsidiary Guarantor will be entitled to receive payment in full before the holders of the Notes are entitled to receive any payment, and (ii) until the Senior Indebtedness of such Subsidiary Guarantor is paid in full, any payment to which the Holders of the Notes would be entitled but for this provision will be made to holders of Senior Indebtedness of such Subsidiary Guarantor as their interests may appear, except that Holders may receive shares of stock or debt securities that are subordinated to Senior Indebtedness of the Subsidiary Guarantor to at least the same extent as the Subsidiary Guarantees. In the event that, notwithstanding the foregoing, any payment or distribution of assets of the Company or any Subsidiary Guarantor shall be received by the Trustee or the Holders at a time when such payment or distribution is prohibited by the foregoing provisions, such payment or distribution shall be held in trust for the benefit of the holders of Senior Indebtedness of such Person, and shall be paid or delivered by the Trustee or such Holders, as the case may be, to the holders of such Senior Indebtedness remaining unpaid or unprovided for or to their Representative, ratably according to the aggregate amounts remaining unpaid on account of the Senior Indebtedness held or represented by each, for application to the payment of all Senior Indebtedness remaining unpaid, to the extent necessary to pay or to provide for the payment of all such Senior Indebtedness in full after giving effect to any concurrent payment or distribution to the holders of such Senior Indebtedness. If payment of the Notes is accelerated because of an Event of Default, the Company or the Trustee shall promptly notify the holders of Senior Indebtedness or any Representative thereof of the acceleration. If the Trustee provides such notice, the Trustee also will notify the Company of the acceleration. By reason of such subordination provisions contained in the Indenture, in the event of insolvency, holders of the Notes may recover less, ratably, than other creditors of the Company or the Subsidiary Guarantors, or may recover nothing. 57 60 OPTIONAL REDEMPTION The Notes will not be redeemable prior to , 1999, except as provided below. Thereafter, the Notes will be redeemable, at the Company's option, in whole or in part, at any time or from time to time, upon not less than 30 nor more than 60 calendar days' prior notice mailed by first-class mail to each Holder's registered address, at the following redemption prices (expressed in percentages of principal amount), plus accrued interest to the redemption date (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the 12-month period commencing on of the years set forth below:
REDEMPTION PERIOD PRICE -------------------------------------------------------------------------- ---------- 1999...................................................................... % 2000 and thereafter....................................................... %
In addition, at any time and from time to time prior to , 1998, the Company may redeem in the aggregate up to 35% of the original principal amount of the Notes with the proceeds of one or more Public Equity Offerings, at a redemption price (expressed as a percentage of principal amount) of % plus accrued interest to the redemption date (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date); provided, however, that the aggregate principal amount of the Notes that remain outstanding after each such redemption is at least equal to 65% of the original principal amount of the Notes. In the case of any partial redemption, selection of the Notes for redemption will be made by the Trustee on a pro rata basis, by lot or by such other method as the Trustee in its sole discretion shall deem to be fair and appropriate, although no Note of $1,000 in original principal amount or less shall be redeemed in part. If any Note is to be redeemed in part, the notice of redemption relating to such Note shall state the portion of the principal amount thereof to be redeemed. A new Note in principal amount equal to the unredeemed portion thereof will be issued in the name of the Holder thereof upon cancellation of the original Note. SINKING FUND There will be no mandatory sinking fund for the Notes. MANDATORY OFFERS TO PURCHASE THE NOTES The Indenture will require the Company to purchase all of the outstanding Notes tendered by the Holders upon the occurrence of a Change of Control and to offer to purchase a portion of the outstanding Notes under certain other circumstances. See "Change of Control" and "Certain Covenants -- Limitations on Asset Sales." CHANGE OF CONTROL Upon the occurrence of a Change of Control, each Holder will have the right to require that the Company repurchase such Holder's Notes at a purchase price in cash equal to 101% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date). A "Change of Control" will be deemed to have occurred: (i) upon any merger or consolidation of the Company with or into any person or any sale, transfer or other conveyance, whether direct or indirect, of all or substantially all of the assets of the Company, on a consolidated basis, in one transaction or a series of related transactions, if, in the case of any such merger or consolidation, the securities of the Company that are outstanding immediately prior to such transaction and which represent 100% of the aggregate voting power of the Voting Stock of the Company are changed into or exchanged for cash, securities or property, unless pursuant to such transaction such securities are changed into or exchanged for, in addition to any other consideration, securities of the 58 61 surviving corporation that represent, immediately after such transaction, at least a majority of the aggregate voting power of the Voting Stock of the surviving corporation, provided, however, that the sale by the Company or its Subsidiaries from time to time of Receivables in the ordinary course of business shall not be treated hereunder as a sale of all or substantially all the assets of the Company; (ii) when any "person" or "group" (as such terms are used for purposes of Sections 13(d) and 14(d) of the Exchange Act, whether or not applicable), other than any or all of the Excluded Persons, is or becomes the "beneficial owner" (as defined in Rules 13d-3 and 13d-5 under the Exchange Act, except that such person shall be deemed to have "beneficial ownership" of all shares that any such person has the right to acquire, whether such right is exercisable immediately or only after the passage of time), directly or indirectly, of more than 40% of the then outstanding shares of Voting Stock of the Company; or (iii) when, during any period of 24 consecutive months after the Issue Date, individuals who at the beginning of any such 24-month period constituted the Board of Directors of the Company (together with any new directors whose election by such Board or whose nomination for election by the stockholders of the Company was approved by a vote of a majority of the directors then still in office who were either directors at the beginning of such period or whose election or nomination for election was previously so approved), cease for any reason to constitute a majority of the Board of Directors of the Company then in office. Within 30 days following any Change of Control, the Company shall mail a notice to each Holder with a copy to the Trustee stating: (i) that a Change of Control has occurred and that such Holder has the right to require the Company to purchase such Holder's Notes at a purchase price in cash equal to 101% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase (subject to the right of Holders of record on the relevant record date to receive interest on the relevant interest payment date); (ii) the circumstances and relevant facts regarding such Change of Control (including, in the case of any merger, consolidation or sale of all or substantially all assets, information with respect to pro forma results of operations, cash flow and capitalization after giving effect to such Change of Control); (iii) the repurchase date (which shall be no earlier than 30 days nor later than 60 days from the date such notice is mailed); and (iv) the instructions determined by the Company, consistent with the covenant described hereunder, that a Holder must follow in order to have its Notes purchased. The Company will comply, to the extent applicable, with the requirements of Section 14(e) of the Exchange Act and any other applicable securities laws or regulations in connection with the repurchase of Notes pursuant to the covenant described hereunder. To the extent that the provisions of any securities laws or regulations conflict with the provisions of the covenant described hereunder, the Company will comply with the applicable securities laws and regulations and will not be deemed to have breached its obligations under the covenant described hereunder by virtue thereof. The phrase "all or substantially all" of the assets of the Company is likely to be interpreted by reference to applicable state law at the relevant time, and will be dependent on the facts and circumstances existing at such time. As a result, there may be a degree of uncertainty in ascertaining whether a sale or transfer of "all or substantially all" of the assets of the Company has occurred. However, a sale of Receivables in the ordinary course of business will not constitute a Change of Control, regardless of the magnitude of such sale. The Change of Control purchase feature is a result of negotiations between the Company and the Underwriters. Management has no present intention to engage in a transaction involving a Change of Control, although it is possible that the Company would decide to do so in the future. Subject to the limitations discussed below, the Company could enter into certain transactions, including acquisitions, refinancings or other recapitalizations, that would not constitute a Change of Control under the Indenture, but that could increase the amount of indebtedness outstanding at such time or otherwise affect the Company's capital structure or credit ratings. Restrictions on the ability of the Company and its Restricted Subsidiaries to Incur additional Indebtedness are contained in the covenants described under "-- Certain Covenants -- Limitation 59 62 on Indebtedness," "-- Certain Covenants -- Limitation on Liens" and "-- Certain Covenants -- Limitation on Preferred Stock of Subsidiaries." Such restrictions can be waived only with the consent of the Holders of a majority in principal amount of the Notes then outstanding. Except for the limitations contained in such covenants, however, the Indenture will not contain any covenant or provision that may afford Holders of the Notes protection in the event of a highly leveraged transaction, reorganization, restructuring, merger, spin-off or similar transaction that may adversely affect such Holders. Future indebtedness of the Company may contain prohibitions on the occurrence of certain events that would constitute a Change of Control or require such indebtedness to be repurchased or prepaid upon a Change of Control. Moreover, the exercise by the Holders of their right to require the Company to repurchase the Notes could cause a default under such indebtedness, even if the Change of Control itself does not, due to the financial effect of such repurchase on the Company. If a Change of Control should occur, the rights of the Holders to receive payment for their Notes would be subject to the prior rights of the holders of any Senior Indebtedness. See "Subordination." Finally, the Company's ability to pay cash to the Holders of Notes following the occurrence of a Change of Control may be limited by the Company's then existing financial resources. There can be no assurance that sufficient funds will be available when necessary to make any required repurchases. The provisions under the Indenture relating to the Company's obligation to make an offer to repurchase the Notes as a result of a Change of Control may be waived or modified with the written consent of the Holders of a majority in principal amount of the Notes. As a result, a Holder may not be able to avail itself of its right to require the Company to repurchase the Notes upon a Change of Control. SAME-DAY SETTLEMENT AND PAYMENT Settlement for the Notes will be made in immediately available funds. All payments of principal, premium, if any, and interest will be made by the Company in immediately available funds. The Notes will trade in the Same-Day Funds Settlement System of The Depository Trust Company ("DTC") until maturity, and secondary market trading activity for the Notes will therefore settle in immediately available funds. CERTAIN COVENANTS Set forth below are descriptions of certain covenants set forth in the Indenture. Limitation on Indebtedness. (a) The Company will not Incur, and the Company will not permit any Restricted Subsidiary to Incur, directly or indirectly, any Indebtedness or Disqualified Stock if, on the date of such Incurrence and after giving effect thereto, the Consolidated Leverage Ratio exceeds 2.0 to 1.0. (b) Notwithstanding the foregoing paragraph (a), the Company and its Restricted Subsidiaries may Incur the following Indebtedness: (1) Permitted Warehouse Indebtedness and Guarantees by the Company of any Permitted Warehouse Indebtedness of Restricted Subsidiaries, provided that (i) on the date of such Incurrence and giving effect to any such Incurrence, the aggregate principal amount of Permitted Warehouse Indebtedness permitted under this clause (1), together with the amount of all then outstanding Warehouse Indebtedness (other than Permitted Warehouse Indebtedness) of the Company and its Restricted Subsidiaries permitted under clause (a) above, shall not exceed 300% of Consolidated Net Worth at such time, and (ii) that to the extent any such Indebtedness ceases to constitute Permitted Warehouse Indebtedness of the Company or a Restricted Subsidiary, such event shall be deemed to constitute the Incurrence of such Indebtedness (and any such Guarantees, but without duplication) by the Company or such Subsidiary, as the case may be; (2) the Notes and the Subsidiary Guarantees; (3) Hedging Obligations directly related to: (i) Indebtedness permitted to be Incurred by the Company or the Restricted Subsidiaries pursuant to the Indenture; (ii) Receivables held by the Company or its Restricted Subsidiaries pending sale or that have been sold pursuant to a Warehouse Facility; or (iii) Receivables with respect to which the Company or any Restricted Subsidiary has an outstanding purchase or offer commitment, financing commitment or security interest; 60 63 (4) Indebtedness outstanding on the Issue Date (other than Indebtedness described in clause (1) of this paragraph (b)); (5) Indebtedness or Disqualified Stock issued to and held by the Company or a Wholly Owned Restricted Subsidiary; provided, however, that any subsequent issuance or transfer of any Capital Stock that results in any such Wholly Owned Restricted Subsidiary ceasing to be a Wholly Owned Restricted Subsidiary or any subsequent transfer of such Indebtedness or Disqualified Stock (other than to the Company or a Wholly Owned Restricted Subsidiary) will be deemed, in each case, to constitute the Incurrence of such Indebtedness or issuance of such Disqualified Stock by the issuer thereof; (6) Indebtedness or Disqualified Stock of a Restricted Subsidiary Incurred on or prior to the date on which such Subsidiary was acquired by the Company, other than Indebtedness or Disqualified Stock Incurred in connection with, or to provide all or any portion of the funds or credit support utilized to consummate, the transaction or series of related transactions pursuant to which such Subsidiary became a Subsidiary or was acquired by the Company; provided, however, that on the date of such acquisition and after giving effect thereto, the Company would have been able to Incur at least $1.00 of Indebtedness pursuant to paragraph (a) above; and (7) while no Default or Event of Default exists, Refinancing Indebtedness in respect of Indebtedness Incurred pursuant to paragraph (a) or clause (4) or (6) of this paragraph (b). (c) Notwithstanding the foregoing, (i) the Company and its Restricted Subsidiaries may not Incur any Indebtedness (other than the Notes and the Subsidiary Guarantees) if such Indebtedness is subordinate or junior in ranking in any respect to any Senior Indebtedness unless such Indebtedness is a Junior Subordinated Obligation, (ii) the Company and its Restricted Subsidiaries shall not Incur any Indebtedness if the proceeds thereof are used, directly or indirectly, to Refinance any Junior Subordinated Obligations unless such Indebtedness shall be subordinated to the Notes or the Subsidiary Guarantees, as applicable, to at least the same extent as such Junior Subordinated Obligations, and (iii) no Restricted Subsidiary that is not a Subsidiary Guarantor shall incur, directly or indirectly, any Indebtedness. Unsecured Indebtedness is not deemed to be subordinate or junior to secured Indebtedness merely because it is unsecured. (d) For purposes of determining compliance with the foregoing covenant: (i) in the event that an item of Indebtedness meets the criteria of more than one of the types of Indebtedness described above, the Company, in good faith, will classify such item of Indebtedness and be required to include the amount and type of such Indebtedness in one of the above clauses; and (ii) an item of Indebtedness may be divided and classified in more than one of the types of Indebtedness described above. Limitation on Preferred Stock of Restricted Subsidiaries. The Company will not permit any Restricted Subsidiary to Incur, directly or indirectly, any Preferred Stock except: (a) Preferred Stock issued to and held by the Company or a Wholly Owned Restricted Subsidiary; provided, however, that any subsequent issuance or transfer of any Capital Stock that results in any such Wholly Owned Restricted Subsidiary ceasing to be a Wholly Owned Restricted Subsidiary or any subsequent transfer of such Preferred Stock (other than to the Company or a Wholly Owned Restricted Subsidiary) will be deemed, in each case, to constitute the Incurrence of such Preferred Stock by the issuer thereof; and (b) Preferred Stock of a Restricted Subsidiary Incurred or issued and outstanding on or prior to the date on which such Restricted Subsidiary was acquired by the Company, other than Preferred Stock Incurred or issued in connection with, or to provide all or any portion of the funds or credit support utilized to consummate, the transaction or series of related transactions pursuant to which such Subsidiary became a Restricted Subsidiary or was acquired by the Company; provided, however, that on the date of such acquisition and after giving effect thereto, the Company would have been able to Incur at least $1.00 of Indebtedness pursuant to paragraph (a) of the covenant described under "Limitation on Indebtedness." 61 64 Limitation on Liens. The Company will not, and will not permit any Restricted Subsidiary, directly or indirectly, to Incur or permit to exist any Lien of any nature whatsoever on any of its properties (including Capital Stock of a Subsidiary), whether owned at the Issue Date or thereafter acquired, other than Permitted Liens, without effectively providing that the Notes shall be secured equally and ratably with (or prior to) the obligations so secured for so long as such obligations are so secured. Limitation on Restricted Payments. (a) The Company will not, and will not permit any Restricted Subsidiary, directly or indirectly, to make a Restricted Payment if at the time the Company or such Restricted Subsidiary makes such Restricted Payment: (i) a Default shall have occurred and be continuing (or would result therefrom); (ii) the Company is not able to Incur an additional $1.00 of Indebtedness pursuant to paragraph (a) of the covenant described under "Limitation on Indebtedness"; or (iii) the aggregate amount of such Restricted Payment and all other Restricted Payments since the Issue Date would exceed the sum of: (A) 33% of the Consolidated Adjusted Net Income accrued during the period (treated as one accounting period) from the beginning of the fiscal quarter during which the Issue Date occurs to the end of the most recent fiscal quarter prior to the date of such Restricted Payment for which financial statements are available (or, in case such Consolidated Net Income shall be a deficit, minus 100% of such deficit); and (B) the aggregate Net Cash Proceeds received by the Company from the issuance or sale after the Issue Date of (1) Capital Stock of the Company (other than Disqualified Stock) or (2) debt securities of the Company, but only if, when and to the extent such debt securities have been converted into any such Capital Stock (other than, in each case, an issuance or sale to a Subsidiary of the Company and other than an issuance or sale to an employee stock ownership plan or to a trust established by the Company or any of its Subsidiaries for the benefit of their employees). (b) While no Default or Event of Default exists, the provisions of the foregoing paragraph (a) shall not prohibit: (i) any purchase or redemption of Capital Stock or Junior Subordinated Obligations of the Company to the extent made by exchange for, or out of the proceeds of the substantially concurrent sale of, Capital Stock of the Company (other than Disqualified Stock and other than Capital Stock issued or sold to (A) a Subsidiary of the Company or (B) an employee stock ownership plan or to a trust established by the Company or any of its Subsidiaries for the benefit of their employees, except to the extent that the funds used by such plan or trust are attributable to employee contributions); provided, however, that (A) such purchase or redemption shall be excluded in the calculation of the amount of Restricted Payments and (B) the Net Cash Proceeds from such sale shall be excluded from the calculation of amounts under clause (iii)(B) of paragraph (a) above; (ii) any payment, purchase, repurchase, redemption, defeasance or other acquisition or retirement for value of Junior Subordinated Obligations made by exchange for, or out of the proceeds of the substantially concurrent sale of, Indebtedness of the Company that is permitted to be Incurred pursuant to the covenant described under "Limitation on Indebtedness"; provided, however, that, such purchase, repurchase, redemption, defeasance or other acquisition or retirement for value shall be excluded in the calculation of the amount of Restricted Payments; and (iii) dividends paid within 60 days after the date of declaration thereof if at such date of declaration such dividend would have complied with the covenant described hereunder; provided, however, that such dividend shall be included in the calculation of the amount of Restricted Payments. Limitation on Restrictions on Distributions from Restricted Subsidiaries. The Company will not, and will not permit any Restricted Subsidiary, directly or indirectly, to create or otherwise cause or permit to exist or become effective any consensual encumbrance or restriction on the ability of any Restricted Subsidiary (a) to pay dividends or make any other distributions on its Capital Stock to the Company or a Restricted Subsidiary or pay any Indebtedness owed to the Company or any Restricted Subsidiary, (b) to make any loans or advances to the Company or any Restricted Subsidiary or (c) to transfer any of its property or assets to the Company or any Restricted Subsidiary, except: (i) any encumbrance or restriction pursuant to an agreement in effect at the Issue Date and listed on a schedule to the Indenture; (ii) any encumbrance or restriction with respect to a Restricted Subsidiary pursuant to an agreement applicable to such Subsidiary prior to the date on which such Subsidiary was acquired by the Company (other than an agreement entered into in connection with, or in anticipation of, the transaction or series of related transactions pursuant to which such Subsidiary became a Subsidiary or was acquired by the Company) and outstanding on such date; (iii) any encumbrance 62 65 or restriction with respect to a Restricted Subsidiary pursuant to any other agreement contained in any amendment to an agreement referred to in clause (i) or (ii) of this covenant or this clause (iii); provided, however, that the encumbrances and restrictions with respect to such Restricted Subsidiary contained in any such agreement or amendment are no less favorable to the Holders than encumbrances and restrictions with respect to such Restricted Subsidiary contained in the agreements referred to in clause (i) or (ii) of the covenant described hereunder, as the case may be; (iv) any such encumbrance or restriction consisting of customary non-assignment provisions in leases governing leasehold interests to the extent such provisions restrict the transfer of the lease or the property leased thereunder; (v) in the case of clause (c) above, restrictions contained in security agreements or mortgages securing Indebtedness of a Restricted Subsidiary otherwise permissible under the Indenture to the extent such restrictions restrict the transfer of the property subject to such security agreements or mortgages; (vi) with respect to the ability of a Restricted Subsidiary to pay dividends or make any other distributions on its Capital Stock to the Company, any Permitted Warehouse Indebtedness Limitation; and (vii) any restriction with respect to a Restricted Subsidiary imposed pursuant to an agreement entered into for the sale or disposition of all or substantially all the Capital Stock or assets of such Restricted Subsidiary pending the closing of such sale or disposition. Limitation on Sales of Assets and Subsidiary Stock. (a) The Company will not, and will not permit any Restricted Subsidiary, directly or indirectly, to consummate any Asset Disposition unless: (i) the Company or such Restricted Subsidiary receives consideration at the time of such Asset Disposition at least equal to the fair market value (including as to the value of any non-cash consideration), as determined in good faith by the Board of Directors, of the shares and assets subject to such Asset Disposition and at least 85% of the consideration thereof received by the Company or such Restricted Subsidiary is in the form of cash or Temporary Cash Investments; (ii) an amount equal to 100% of the Net Available Cash from such Asset Disposition is applied by the Company (or such Restricted Subsidiary, as the case may be): (A) first, to the extent the Company or such Restricted Subsidiary elects either (x) to acquire Additional Assets or (y) to prepay, repay, redeem or purchase Senior Indebtedness of the Company or such Restricted Subsidiary, as the case may be (other than in either case Indebtedness owed to the Company or an Affiliate of the Company), in each case within 180 days from the later of the date of such Asset Disposition or the receipt of such Net Available Cash; (C) second, to the extent of the balance of such Net Available Cash after application in accordance with clause (A), to make an offer to the Holders of the Notes to purchase Notes pursuant to and subject to the conditions contained in the Indenture; and (D) third, to the extent of the balance of such Net Available Cash after application in accordance with clauses (A) and (B), to any application not prohibited by the Indenture; and (iii) at the time of such Asset Disposition no Default shall have occurred and be continuing (or would result therefrom). Pending application of Net Available Cash pursuant to this covenant, such Net Available Cash shall be invested in Temporary Cash Investments. For the purposes of this covenant, the following are deemed to be cash or cash equivalents: (x) the assumption of Indebtedness (other than Junior Subordinated Obligations) of the Company or any Restricted Subsidiary, and the release of the Company or such Subsidiary from all liability on such Indebtedness, in connection with such Asset Disposition and (y) securities received by the Company or any Restricted Subsidiary from the transferee that are promptly converted by the Company or such Subsidiary into cash or Temporary Cash Investments. (b) In the event of an Asset Disposition that requires an offer to purchase the Notes, the Company will be required to purchase Notes tendered pursuant to an offer by the Company for the Notes at a purchase price of 100% of their principal amount plus accrued but unpaid interest in accordance with the procedures (including prorating in the event of oversubscription) set forth in the Indenture. If the aggregate purchase price of Notes tendered pursuant to such offer is less than the Net Available Cash allotted to the purchase thereof, the Company will be permitted to apply the remaining Net Available Cash in accordance with clause (a)(ii)(D) above. The Company shall not be required to make such an offer to purchase Notes pursuant to 63 66 this covenant if the Net Available Cash available therefor is less than $1,000,000 (which lesser amount shall be carried forward for purposes of determining whether such an offer is required with respect to any subsequent Asset Disposition). (c) The Company will comply, to the extent applicable, with the requirements of Section 14(e) of the Exchange Act and any other securities laws or regulations in connection with the repurchase of Notes pursuant to the covenant described hereunder. To the extent that the provisions of any securities laws or regulations conflict with provisions of the covenant described hereunder, the Company will comply with the applicable securities laws and regulations and will not be deemed to have breached its obligations under this clause by virtue thereof. Limitation on Affiliate Transactions. The Company will not, and will not permit any Restricted Subsidiary to, enter into or permit to exist any transaction (including without limitation the making of any loan, advance, guarantee or capital contribution to or for the benefit of, the purchase, sale, lease or exchange of any property with, the entering into or amending of employee compensation arrangements with, or the rendering of any service with or for the benefit of, any Affiliate of the Company (an "Affiliate Transaction") unless the terms thereof: (i) are in the ordinary course of business and consistent with past practice; (ii) are fair to the Company or such Restricted Subsidiary and are no less favorable to the Company or such Restricted Subsidiary than those that could be obtained at the time of such transaction in arm's-length dealings with a Person who is not such an Affiliate; (iii) if such Affiliate Transaction involves an amount in excess of $500,000, (A) are set forth in writing and (B) have been approved by a majority of the members of the Board of Directors having no personal stake in such Affiliate Transaction; and (iv) if such Affiliate Transaction involves an amount in excess of $3,000,000, have been determined by a nationally recognized investment banking firm to be fair, from a financial standpoint, to the Company and its Restricted Subsidiaries. The provisions of the foregoing paragraph shall not apply to (a) transactions exclusively between or among the Company and any Wholly Owned Restricted Subsidiary or between or among Wholly Owned Restricted Subsidiaries, (b) any Restricted Payment permitted to be made under the covenant described under "-- Limitation on Restricted Payments," (c) any employment or related arrangement entered into by the Company or any Restricted Subsidiary in the ordinary course of business on terms customary in the consumer finance business, provided any such arrangement is approved by the disinterested members of the Board of Directors, (d) customary directors fees and indemnities, and (e) payments required by the Tax Sharing Agreement or any renewal thereof on substantially similar terms, provided, however, in the case of each of the foregoing clauses (a) through (d), that such transactions are not otherwise prohibited by the Indenture. The provisions of clause (iv) of the foregoing paragraph shall not apply to transactions between the Company and PEC pursuant to agreements in effect on the Issue Date and described under "Certain Transactions" and renewals thereof on substantially similar terms. Merger and Consolidation. The Company will not consolidate with or merge with or into, or convey, transfer or lease, in one transaction or a series of related transactions, all or substantially all its assets to, any Person, unless: (i) the resulting, surviving or transferee Person (the "Successor Company") shall be a Person organized and existing under the laws of the United States of America or any State thereof and the Successor Company (if not the Company) shall expressly assume, by an indenture supplemental thereto, executed and delivered to the Trustee, in form satisfactory to the Trustee, all of the Company's obligations under the Notes and the Indenture; (ii) immediately after giving effect to such transaction (and treating any Indebtedness that becomes an obligation of the Successor Company or any Restricted Subsidiary as a result of such transaction as having been Incurred by such Successor Company or such Restricted Subsidiary at the time of such transaction), no Default shall have occurred and be continuing; (iii) immediately after giving effect to such transaction, the Successor Company would be able to incur an additional $1.00 of Indebtedness pursuant to paragraph (a) of the covenant described under "Limitation on Indebtedness;" (iv) immediately after giving effect to such transaction, the Successor Company shall have Consolidated Net Worth in an amount that is not less than the Consolidated Net Worth of the Company prior to such transaction; and (v) the Company shall have delivered to the Trustee an Officers' Certificate and an Opinion of Counsel, each stating that such consolidation, merger or transfer and such supplemental indenture (if any) comply with the Indenture. 64 67 The Successor Company shall be the successor to the Company and shall succeed to, and be substituted for, and may exercise every right and power of, the Company under the Indenture, but the predecessor Company, in the case of a lease, shall not be released from the obligation to pay the principal of, premium, if any, and interest on the Notes. The Indenture will provide that no Restricted Subsidiary may consolidate with or merge with or into (whether or not such Restricted Subsidiary is the surviving Person) another Person, whether or not affiliated with such Restricted Subsidiary, unless (i) subject to the provisions of the following paragraph, the Person formed by or surviving any such consolidation or merger (if other than such Restricted Subsidiary) assumes all the obligations of such Restricted Subsidiary, pursuant to a supplemental indenture, in form and substance satisfactory to the Trustee, under the Indenture; (ii) immediately after giving effect to such transaction, no Default or Event of Default exists; (iii) such Restricted Subsidiary, or any Person formed by or surviving any such consolidation or merger, would have Consolidated Net Worth (immediately after giving effect to such transaction) equal to or greater than the Consolidated Net Worth of such Restricted Subsidiary immediately preceding the transaction; and (iv) the Restricted Subsidiary would be permitted, immediately after giving effect to such transaction, to Incur at least $1.00 of additional Indebtedness pursuant to paragraph (a) in the covenant described above under the caption "Certain Covenants -- Limitation on Indebtedness"; provided that the foregoing provisions will not restrict the ability of a Subsidiary to consolidate or merge with the Company or another Wholly Owned Restricted Subsidiary. The Indenture will provide that, in the event of a sale or other disposition of all of the assets of any Subsidiary (other than to or with the Company or a Wholly Owned Restricted Subsidiary), by way of merger, consolidation or otherwise, or a sale or other disposition of all of the Capital Stock of any Subsidiary (other than to the Company or a Wholly Owned Restricted Subsidiary), then such Restricted Subsidiary (in the event of a sale or other disposition, by way of such a merger, consolidation or otherwise, of all of the Capital Stock of such Subsidiary) or the corporation acquiring the property (in the event of a sale or other disposition of all of the assets of such Restricted Subsidiary) will be released and relieved of any obligations under its Subsidiary Guarantee; provided that the Net Cash Proceeds of such sale or other disposition are applied in accordance with the applicable provisions of the Indenture. Limitation on Investment Company Status. The Company shall not take, and shall not permit any Restricted Subsidiary to take, any action, or otherwise permit to exist any circumstance, that would require the Company or such Restricted Subsidiary to register as an "investment company" under the Investment Company Act of 1940, as amended. Line of Business. The Company will not, and will not permit any Subsidiary, to engage in any line of business that is not a Related Business. Payments for Consent. The Indenture will provide that neither the Company nor any Restricted Subsidiary will, directly or indirectly, pay or cause to be paid any consideration, whether by way of interest, fee or otherwise, to any Holder of any Notes for or as an inducement to any consent, waiver or amendment of any of the terms or provisions of the Indenture or the Notes unless such consideration is offered to be paid or agreed to be paid to all Holders of the Notes that consent, waive or agree to amend in the time frame set forth in the solicitation documents relating to such consent, waiver or agreement. SEC Reports. Notwithstanding that the Company may not be required to remain subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act, the Company shall file with the SEC and provide the Trustee and Holders with such annual reports, quarterly reports and such other information, documents and reports as are specified in Sections 13 and 15(d) of the Exchange Act and applicable to a U.S. corporation subject to such Sections, such information, documents and other reports to be so filed and provided at the times specified for the filing of such information, documents and reports under such Sections. DEFAULTS An Event of Default is defined in the Indenture as: (i) a default in the payment of interest on the Notes when due, continued for 30 days; (ii) a default in the payment of principal of and premium, if any, on any 65 68 Note when due at its Stated Maturity, upon optional redemption, upon required repurchase, upon declaration of acceleration or otherwise; (iii) the failure by the Company or any Subsidiary Guarantor to comply with any of its obligations in the covenants described under "Change of Control," "Subsidiary Guarantees" or under "Certain Covenants -- Merger and Consolidation," or "-- Limitation on Sales of Assets and Subsidiary Stock"; (iv) the failure by the Company or any Subsidiary Guarantor to comply with any of its obligations in the covenants described above under "Certain Covenants -- Limitation on Affiliate Transactions", "-- Limitation on Indebtedness," "-- Limitation on Preferred Stock of Restricted Subsidiaries," "-- Limitation on Liens," "-- Limitation on Restricted Payments," "-- Limitation on Restrictions of Distributions from Restricted Subsidiaries," "-- Limitation on Investment Company Status" or "-- SEC Reports" and 30 days or more shall have expired after a Senior Officer of the Company first becomes aware of such failure; (v) the failure by the Company or any Subsidiary Guarantor to comply for 30 days after notice with its other agreements contained in the Indenture; (vi) Indebtedness of the Company or any Subsidiary is not paid within any applicable grace period after final maturity or is accelerated by the holders thereof because of a default and the total amount of such Indebtedness unpaid or accelerated exceeds $2,000,000 (the "cross acceleration provision"); (vii) certain events of bankruptcy, insolvency or reorganization of the Company or a Subsidiary (the "bankruptcy provisions"); or (viii) any judgment or decree for the payment of money in excess of $1,000,000 is rendered against the Company or a Subsidiary, remains outstanding for a period of 60 days following such judgment and is not discharged, waived or stayed (the "judgment default provision"). However, a default under clause (v) will not constitute an Event of Default until the Trustee or the Holders of 25% in principal amount of the outstanding Notes notify the Company of the Default and the Company does not cure such Default within the time specified after receipt of such notice. If an Event of Default occurs and is continuing, the Trustee or the Holders of at least 25% in principal amount of the outstanding Notes may declare the principal of, premium, if any, and accrued but unpaid interest on all the Notes to be due and payable. Upon such a declaration, such principal, premium, if any, and interest shall be due and payable immediately. If an Event of Default relating to certain events of bankruptcy, insolvency or reorganization of the Company occurs and is continuing, the principal of, premium, if any, any accrued but unpaid interest on all the Notes will ipso facto become and be immediately due and payable without any declaration or other act on the part of the Trustee or any Holders of the Notes. Under certain circumstances, the Holders of a majority in principal amount of the outstanding Notes may rescind any such acceleration with respect to the Notes and its consequences. Subject to the provisions of the Indenture relating to the duties of the Trustee, in case an Event of Default occurs and is continuing, the Trustee will be under no obligation to exercise any of the rights or powers under the Indenture at the request or direction of any of the Holders of the Notes unless such Holders have offered to the Trustee reasonable indemnity or security against any loss, liability or expense. Except to enforce the right to receive payment of principal, premium, if any, or interest when due, no Holder may pursue any remedy with respect to the Indenture or the Notes unless (i) such Holder has previously given the Trustee notice that an Event of Default is continuing, (ii) Holders of at least 25% in principal amount of the outstanding Notes have requested the Trustee to pursue the remedy, (iii) such Holders have offered the Trustee reasonable security or indemnity against any loss, liability or expense, (iv) the Trustee has not complied with such request within 60 days after the receipt thereof and the offer of security or indemnity and (v) the Holders of a majority in principal amount of the outstanding Notes have not given the Trustee a direction inconsistent with such request within such 60-day period. Subject to certain restrictions, the Holders of a majority in principal amount of the outstanding Notes have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee or of exercising any trust or power conferred on the Trustee. The Trustee, however, may refuse to follow any direction that conflicts with law or the Indenture or that the trustee determines is unduly prejudicial to the rights of any other Holder or that would involve the Trustee in personal liability. The Indenture provides that if a Default occurs and is continuing and is known to the Trustee, the Trustee must mail to each Holder of the Notes notice of the Default within 60 days after it occurs. Except in the case of a Default in the payment of principal of, premium, if any, or interest on any Note, the Trustee may withhold notice if and so long as a committee of its trust officers determines that withholding notice is not 66 69 opposed to the interest of the Holders. In addition, the Company is required to deliver to the Trustee, within 120 days after the end of each fiscal year, a certificate indicating whether the signers thereof know of any Default that occurred during the previous year. The Company also is required to deliver to the Trustee, within 30 days after a Senior Officer of the Company or any Subsidiary becomes aware of the occurrence thereof, written notice of any event which would constitute certain Defaults, their status and what action the Company or such Subsidiary is taking or proposes to take in respect thereof. AMENDMENTS AND WAIVERS Subject to certain exceptions, the Indenture may be amended with the consent of the Holders of a majority in principal amount of the Notes then outstanding (including consents obtained in connection with a tender offer or exchange for the Notes) and any past Default or compliance with any provisions may be waived with the consent of the Holders of a majority in principal amount of the Notes then outstanding. However, without the consent of each Holder of an outstanding Note affected thereby, no amendment or waiver may, among other things, (i) reduce the amount of Notes whose Holders must consent to an amendment, (ii) reduce the rate of or extend the time for payment of interest on any Note, (iii) reduce the principal of or extend the Stated Maturity of any Note, (iv) reduce the premium payable upon the redemption or acceleration of any Note or change the time at which any Note may be redeemed as described under "Optional Redemption", (v) make any Note payable in money other than that stated in the Note, (vi) impair the right of any Holder to receive payment of principal of, premium, if any, and interest on such Holder's Notes on or after the due dates therefor or to institute suit for the enforcement of any payment on or with respect to such Holder's Notes, (vii) make any change to the provisions of the Indenture relating to subordination of the Notes, (viii) release any Guarantee of the Notes (except in connection with any such Subsidiary being designated an Unrestricted Subsidiary, to the extent permissible under the Indenture), or (ix) make any change in the amendment provisions which require each Holder's consent or in the waiver provisions. Without the consent of any Holder, the Company and Trustee may amend the Indenture to cure any ambiguity, omission, defect or inconsistency, to provide for the assumption by a successor corporation of the obligations of the Company under the Indenture, to provide for uncertificated Notes in addition to or in place of certificated Notes (provided that the uncertificated Notes are issued in registered form for purposes of Section 163(f) of the Code, or in a manner such that the uncertificated Notes are described in Section 163(f)(2)(B) of the Code), to add guarantees with respect to the Notes, to secure the Notes, to add to the covenants of the Company for the benefit of the Holders or to surrender any right or power conferred upon the Company, to make any change that does not adversely affect the rights of any Holder or to comply with any requirement of the SEC in connection with the qualification of the Indenture under the Trust Indenture Act. The consent of the Holders is not necessary under the Indenture to approve the particular form of any proposed amendment. It is sufficient if such consent approves the substance of the proposed amendment. After an amendment under the Indenture becomes effective, the Company will mail to Holders a notice briefly describing such amendment. However, the failure to give such notice to all Holders, or any defect therein, will not impair or affect the validity of the amendment. TRANSFER A Holder will be able to register the transfer of or exchange the Notes only in accordance with the provisions of the Indenture. The Company may require payment of a sum sufficient to cover any tax, assessment or other governmental charge payable in connection with certain registrations of transfers and exchanges. DEFEASANCE The Company at any time may terminate all its obligations under the Notes and the Indenture ("legal defeasance"), except for certain obligations, including those respecting the defeasance trust and obligations to 67 70 register the transfer or exchange of the Notes, to replace mutilated, destroyed, lost or stolen Notes and to maintain a registrar and paying agent in respect of the Notes. The Company at any time may terminate its obligations under "Change of Control" and under the covenants described under "Certain Covenants" (other than the covenant described under "-- Merger and Consolidation"), the operation of the cross acceleration provision, the bankruptcy provisions with respect to Subsidiaries and the judgment default provision described under "-- Defaults" and the limitations contained in clauses (iii) and (iv) under "Certain Covenants -- Merger and Consolidation" ("covenant defeasance"). The Company may exercise its legal defeasance option notwithstanding its prior exercise of its covenant defeasance option. If the Company exercises its legal defeasance option, payment of the Notes may not be accelerated because of an Event of Default with respect thereto (other than an Event of Default with respect to the obligations referred to in the first sentence of the immediately preceding paragraph). If the Company exercises its covenant defeasance option, payment of the Notes may not be accelerated because of an Event of Default under the provisions described in the last sentence of the foregoing paragraph. In order to exercise either defeasance option, the Company must irrevocably deposit in trust (the "defeasance trust") with the Trustee unencumbered money or U.S. Government Obligations for the payment of principal of, premium, if any, and interest on the Notes to redemption or maturity, as the case may be, and must comply with certain other conditions, including delivery to the Trustee of an Opinion of Counsel to the effect that Holders will not recognize income, gain or loss for federal income tax purposes as a result of such deposit and defeasance and will be subject to federal income tax on the same amount and in the same manner and at the same times as would have been the case if such deposit and defeasance had not occurred (and, in the case of legal defeasance only, such Opinion of Counsel must be based on a ruling of the Internal Revenue Service or other change in applicable federal income tax law). CONCERNING THE TRUSTEE American Stock Transfer & Trust Company is to be the Trustee under the Indenture and has been appointed by the Company as Registrar and Paying Agent with regard to the Notes. The Holders of a majority in principal amount of the outstanding Notes will have the right to direct the time, method and place of conducting any proceeding for exercising any remedy available to the Trustee, subject to certain exceptions. The Indenture provides that if an Event of Default occurs (and is not cured), the Trustee will be required, in the exercise of its power, to use the degree of care of a prudent man in the conduct of his own affairs. Subject to such provisions, the Trustee will be under no obligation to exercise any of its rights or powers under the Indenture at the request of any Holder, unless such Holder shall have offered to the Trustee security and indemnity satisfactory to it against any loss, liability or expense and then only to the extent required by the terms of the Indenture. GOVERNING LAW The Indenture provides that it and the Notes will be governed by, and construed in accordance with, the laws of the State of New York without giving effect to applicable principles of conflicts of law to the extent that the application of the law of another jurisdiction would be required thereby. BOOK-ENTRY, DELIVERY AND FORM The Notes will initially be issued in the form of one or more Global Notes (the "Global Note"). The Global Note will be deposited on the Issue Date with, or on behalf of, The Depository Trust Company (the "Depositary") and registered in the name of Cede & Co., as nominee of the Depositary (such nominee being referred to herein as the "Global Note Holder"). The Company has been advised by the Depositary that the Depositary is a limited-purpose trust company that was created to hold securities for its participating organizations (collectively, the "Participants" or the "Depositary's Participants") and to facilitate the clearance and settlement of transactions in such securities between Participants through electronic book-entry changes in accounts of its Participants. The Depositary's 68 71 Participants include securities brokers and dealers (including the Underwriters), banks and trust companies, clearing corporations and certain other organizations. Access to the Depositary's system is also available to other entities such as banks, brokers, dealers and trust companies (collectively, the "Indirect Participants" or the "Depositary's Indirect Participants") that clear through or maintain a custodial relationship with a Participant, either directly or indirectly. Persons who are not Participants may beneficially own securities held by or on behalf of the Depositary only through the Depositary's Participants or the Depositary's Indirect Participants. The Company expects that pursuant to procedures established by the Depositary (i) upon deposit of the Global Note, the Depositary will credit the accounts of Participants designated by the Underwriters with portions of the principal amount of the Global Note and (ii) ownership of the Notes evidenced by the Global Note will be shown on, and the transfer of ownership thereof will be effected only through, records maintained by the Depositary (with respect to the interests of the Depositary's Participants), the Depositary's Participants and the Depositary's Indirect Participants. Prospective purchasers are advised that the laws of some states require that certain persons take physical delivery in definitive form of securities that they own. Consequently, the ability to transfer Notes evidenced by the Global Note will be limited to such extent. So long as the Global Note Holder is the registered owner of any Notes, the Global Note Holder will be considered the sole Holder under the Indenture of any Notes evidenced by the Global Note for the purposes of receiving payment on the Notes, receiving notices, and for all other purposes under the Indenture and the Notes. Beneficial owners of Notes evidenced by the Global Note will not be considered the owners or Holders thereof under the Indenture for any purpose, including with respect to the giving of any directions, instructions or approvals to the Trustee thereunder. Neither the Company nor the Trustee will have any responsibility or liability for any aspect of the records of the Depositary or for maintaining, supervising or reviewing any records of the Depositary relating to the Notes. Accordingly, each person owning a beneficial interest in the Global Note must rely on the procedures of the Depositary, and, if such person is not a Participant, on the procedures of the Participant through which such person owns its interest, to exercise any rights of a holder under the Indenture. The Company understands that under existing industry practices, in the event that the Company requests any action of holders or that an owner of a beneficial interest in the Global Note desires to give or take any action which a holder is entitled to give or take under the Indenture, the Depositary would authorize the Participants holding the relevant beneficial interest to give or take such action and such Participants would authorize beneficial owners owning through such Participants to give or take such action or would otherwise act upon the instructions of beneficial owners owning through them. Payments in respect of the principal of, and premium, if any, and interest on any Notes registered in the name of the Global Note Holder on the applicable record date will be payable by the Trustee to or at the direction of the Global Note Holder in its capacity as the registered Holder under the Indenture. Under the terms of the Indenture, the Company and the Trustee may treat the persons in whose names Notes, including the Global Note, are registered as the owners thereof for the purpose of receiving such payments. Consequently, neither the Company nor the Trustee has or will have any responsibility or liability for the payment of such amounts to beneficial owners of the Notes. The Company believes, however, that it is currently the policy of the Depositary to immediately credit the accounts of the relevant Participants with such payments, in amounts proportionate to their respective holdings of beneficial interests in the relevant security as shown on the records of the Depositary. Payments by the Depositary's Participants and the Depositary's Indirect Participants to the beneficial owners of Notes will be governed by standing instructions and customary practice and will be the responsibility of the Depositary's Participants or the Depositary's Indirect Participants. If (i) the Company notifies the Trustee in writing that the Depositary is no longer willing or able to act as a depositary and the Company is unable to locate a qualified successor within 90 days, (ii) the Company, at its option, notifies the Trustee in writing that it elects to cause the issuance of Notes in certificated form, or (iii) there shall have occurred and be continuing a Default or an Event of Default with respect to any of the Notes represented by the Global Note, then, upon surrender by the Global Note Holder of its Global Note, Notes in certificated form will be issued to each person that the Global Note Holder and the Depositary identify as being the beneficial owner of the related Notes. 69 72 Neither the Company nor the Trustee will be liable for any delay by the Global Note Holder or the Depositary in identifying the beneficial owners of Notes and the Company and the Trustee may conclusively rely on, and will be protected in relying on, instructions from the Global Note Holder or the Depositary for all purposes. CERTAIN DEFINITIONS "Additional Assets" means: (i) any operating property or assets (including Receivables, but excluding Indebtedness and Capital Stock of the Person) used or useful in a Related Business; (ii) the Capital Stock of a Person that becomes a Restricted Subsidiary as a result of the acquisition of such Capital Stock by the Company or another Subsidiary; or (iii) Capital Stock constituting a minority interest in any Person that at such time is a Restricted Subsidiary; provided, however, that any such Restricted Subsidiary described in clause (ii) or (iii) is primarily engaged in a Related Business. "Affiliate" of any specified Person means any other Person, directly or indirectly, controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, "control" when used with respect to any Person means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; provided that a Person shall be deemed to have such power with respect to the Company if such Person is the beneficial owner of Capital Stock representing 10% or more of the total voting power of the Voting Stock (on a fully diluted basis) of the Company or of rights or warrants to purchase such Capital Stock (whether or not currently exercisable). The terms "controlling" and "controlled" have meanings correlative to the foregoing. "Asset Disposition" means (i) any sale, lease, transfer or other disposition (or series of related sales, leases, transfers or dispositions) by the Company or any Restricted Subsidiary, including any disposition by means of a merger, consolidation or similar transaction (each referred to for the purposes of the definition as a "disposition"), of: (a) any shares of Capital Stock of a Subsidiary (other than director's qualifying shares or shares required by applicable law to be held by a Person other than the Company or a Subsidiary); (b) all or substantially all the assets of any division or line of business of the Company or any Restricted Subsidiary; (c) any other assets of the Company or any Restricted Subsidiary with a book or fair market value, together with other assets disposed of in the same or related transactions, exceeding $500,000; or (d) any Excess Spread Receivables (other than, in the case of clauses (a), (b), (c) or (d) above, (1) a disposition of Receivables in the ordinary course of business, (2) a disposition by a Restricted Subsidiary to the Company or by the Company or a Subsidiary to a Wholly Owned Restricted Subsidiary or (3) any grant of a Permitted Lien) or (ii) the issuance of Capital Stock by any Restricted Subsidiary to any Person other than the Company or any Wholly Owned Restricted Subsidiary. "Average Life" means, as of the date of determination, with respect to any Indebtedness or Preferred Stock, the quotient obtained by dividing (i) the sum of the products of numbers of years from the date of determination to the dates of each successive scheduled principal payment of such Indebtedness or redemption or similar payment with respect to such Preferred Stock multiplied by the amount of such payment by (ii) the sum of all such payments. "Board of Directors" means the Board of Directors of the Company or any committee thereof duly authorized to act on behalf of such Board. "Business Day" means each day which is not a Legal Holiday. "Capital Lease Obligations" means an obligation that is required to be classified and accounted for as a capital lease for financial reporting purposes in accordance with GAAP. The amount of Indebtedness represented by such obligation shall be the capitalized amount of such obligation determined in accordance with GAAP, and the Stated Maturity thereof shall be the date of the last payment of rent or any other amount due under such lease prior to the first date upon which such lease may be terminated by the lessee without payment of a penalty. 70 73 "Capital Stock" of any Person means any and all shares, interests, rights to purchase, warrants, options, participations or other equivalents of or interests in (however designated) equity of such Person, including any Preferred Stock, but excluding any debt securities convertible into such equity. "Code" means the Internal Revenue Code of 1986, as amended. "Consolidated Leverage Ratio" as of any date of determination means the ratio of (i) the aggregate amount of all Indebtedness of the Company and its Restricted Subsidiaries, excluding (A) Permitted Warehouse Indebtedness and Guarantees thereof permitted to be Incurred pursuant to clause (b)(1) of the covenant described under "Certain Covenants -- Limitation on Indebtedness," (B) Hedging Obligations permitted to be Incurred pursuant to clause (b)(4) of the covenant described under "Certain Covenants -- Limitation on Indebtedness" and (C) Junior Subordinated Obligations of the Company to (ii) the Consolidated Net Worth of the Company. "Consolidated Adjusted Net Income" means, for any period, (a) Consolidated Net Income minus (b) gain on sale of loans and net unrealized gain on mortgage related securities, plus (c) provision for credit losses, amortization and depreciation (including amortization of excess servicing rights), in each case for such period and for the Company and its Restricted Subsidiaries. "Consolidated Net Income" means, for any period, the net income of the Company and its consolidated Subsidiaries for such period; provided, however, that there shall not be included in such Consolidated Net Income: (i) any net income of any person if such Person is not a Restricted Subsidiary, except that (A) subject to the exclusion contained in clause (iv) below, the Company's equity in the net income of any such Person for such period shall be included in such Consolidated Net Income up to the aggregate amount of cash actually distributed by such Person during such period to the Company or a Restricted Subsidiary as a dividend or other distribution (subject, in the case of a dividend or other distribution paid to a Restricted Subsidiary, to the limitations contained in clause (iii) below) and (B) the Company's equity in a net loss of any such Person for such period shall be included in determining such Consolidated Net Income; (ii) any net income (or loss) of any Person acquired by the Company or a Restricted Subsidiary in a pooling of interests transaction for any period prior to the date of such acquisition; (iii) any net income of any Restricted Subsidiary if such Restricted Subsidiary is subject to restrictions, directly or indirectly, on the payment of dividends or the making of distributions by such Restricted Subsidiary, directly or indirectly, to the Company, except that (A) subject to the exclusion contained in clause (iv) below, the Company's equity in the net income of any such Restricted Subsidiary for such period shall be included in such Consolidated Net Income to the extent that cash could have been distributed by such Restricted Subsidiary during such period to the Company or another Restricted Subsidiary as a dividend or other distribution (subject, in the case of a dividend or other distribution paid to another Restricted Subsidiary, to the limitation contained in this clause) and (B) the Company's equity in a net loss of any such Restricted Subsidiary for such period shall be included in determining such Consolidated Net Income; (iv) any gain (but not loss) realized upon the sale or other disposition of any assets of the Company or its consolidated Restricted Subsidiaries (including pursuant to any sale-and-leaseback arrangement) which is not sold or otherwise disposed of in the ordinary course of business and any gain (but not loss) realized upon the sale or other disposition of any Capital Stock of any Person; (v) extraordinary gains or losses; and (vi) the cumulative effect of a change in accounting principles. "Consolidated Net Worth" means the consolidated stockholders' equity of the Company and its Subsidiaries, as determined in accordance with GAAP, as of the end of the most recent fiscal quarter of the Company for which financial statements are available, less (i) all write-ups by the Company or any Restricted Subsidiary (other than write-ups resulting from foreign currency translations and write-ups of tangible assets of a going concern business made within 12 months after acquisition thereof), (ii) all Investments in unconsolidated Subsidiaries or Persons that are not Restricted Subsidiaries (except Temporary Cash Investments), (iii) all unamortized debt discount and expense and unamortized deferred charges of the Company and its Restricted Subsidiaries, in each case as of such date, and (iv) any amounts attributable to Disqualified Stock. "Currency Agreement" means, with respect to any Person, any foreign exchange contract, currency swap agreement or other similar agreement to which such Person is a party or a beneficiary. 71 74 "Default" means any event which is, or after notice or passage of time or both would be, an Event of Default. "Designated Senior Indebtedness" means, as of any date of determination, any Senior Indebtedness if the unpaid principal amount thereof, or the amount of Senior Indebtedness committed to be extended by the lender or lenders under the related credit facility, equals or exceeds $1,000,000 on such date. "Disqualified Stock" means, with respect to any Person, any Capital Stock that by its terms (or by the terms of any security in to which it is convertible or for which it is exchangeable) or upon the happening of any event (i) matures or is mandatorily redeemable pursuant to a sinking fund obligation or otherwise, (ii) is convertible or exchangeable for Indebtedness or Disqualified Stock or (iii) is redeemable at the option of the holders thereof, in each case in whole or in part on or prior to the first anniversary of the Stated Maturity of the Notes. "Eligible Excess Spread Receivables" means Excess Spread Receivables of the Company and its Restricted Subsidiaries, other than (i) any Excess Spread Receivables created as the result of the securitization or sale of other Excess Spread Receivables, and (ii) any Excess Spread Receivables attributable to any whole loan sale of Receivables, unless the Person or Persons holding such Receivables (a) is a GSE or (b) has then outstanding senior unsecured and unsupported long-term debt rated Baa2 or better by Moody's Investors Service, Inc. and BBB or better by Standard & Poor's Ratings Group. "Excess Spread" means (i) with respect to a "pool" of Receivables that has been sold to a trust or other Person in a securitization, the excess of (a) the weighted average coupon on each pool of Receivables sold over (b) the sum of the pass-through interest rate plus a normal servicing fee, a trustee fee, an insurance fee and an estimate of annual future credit losses related to such assets, in each case calculated in accordance with the GAAP, and (ii) with respect to Receivables that have been sold to a Person in a whole loan sale, the cash flow of the Company and its Restricted Subsidiaries from such Receivables, net of, to the extent applicable, a normal servicing fee, a trustee fee, an insurance fee and an estimate of annual future credit losses related to such assets, in each case calculated in accordance with GAAP. "Excess Spread Receivables" of a Person means the contractual or certificated right to Excess Spread capitalized on such Person's consolidated balance sheet (the amount of which shall be the present value of the Excess Spread, calculated in accordance with GAAP, net of any allowance for losses on loans sold with recourse or other liability allocable thereto, to the extent not otherwise reflected in such amount). Excess Spread Receivables (a) include mortgage backed securities attributable to Receivables sold by the Company or any Subsidiary, and (b) do not include any mortgage servicing rights. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Excluded Person" means (i) any Existing Holder, (ii) any corporation or limited liability company controlled by one or more Existing Holders, (iii) any partnership the general partners of which are or are corporations controlled by one or more Existing Holders and (iv) any trust of which any Existing Holder is the trustee and at least 80% of the beneficial interests in which are owned by such Existing Holder and the spouse or lineal descendants of such Existing Holder. For purposes of this definition, "control" means the beneficial ownership of at least 80% of the Voting Stock of a Person. "Existing Holders" means Robert Nederlander, Eugene I. Schuster, Jerome J. Cohen, Herbert B. Hirsch and Don A. Mayerson. "GAAP" means generally accepted accounting principles in the United States of America as in effect as of the Issue Date, including those set forth in (i) the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants, (ii) statements and pronouncements of the Financial Accounting Standards Board, (iii) such other statements by such other entity as approved by a significant segment of the accounting profession and (iv) the rules and regulations of the SEC governing the inclusion of financial statements (including pro forma financial statements) in periodic reports required to be filed pursuant to Section 13 of the Exchange Act, including opinions and pronouncements in 72 75 staff accounting bulletins and similar written statements from the accounting staff of the SEC and releases of the Emerging Issues Task Force. "GSE" means Federal National Mortgage Association or Federal Home Loan Mortgage Corporation. "Guarantee" means any obligation, contingent or otherwise, of any Person directly or indirectly guaranteeing any Indebtedness or other obligation of any Person and any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or other obligation of such Person (whether arising by virtue of partnership arrangements, or by agreements to keep-well, to purchase assets, goods, securities or services, to take-or-pay or to maintain financial statement conditions or otherwise) or (ii) entered into for the purpose of assuring in any other manner the obligee of such Indebtedness or other obligation of the payment thereof or to protect such obligee against loss in respect thereof (in whole or in part); provided, however, that the term "Guarantee" shall not include endorsements for collection or deposit in the ordinary course of business. The term "Guarantee" used as a verb has a corresponding meaning. The term "Guarantor" means any person Guaranteeing any obligation. "Hedging Obligations" of any Person means the obligations of such Person pursuant to any Interest Rate Agreement or Currency Agreement. "Holders" or "Noteholders" means the Person in whose name a Note is registered on the Registrar's books. "Incur" means issue, assume, Guarantee, incur or otherwise become liable for; provided, however, that any Indebtedness or Capital Stock of a Person existing at the time such Person becomes a Subsidiary (whether by merger, consolidation, acquisition or otherwise) shall be deemed to be Incurred by such Subsidiary at the time it becomes a Subsidiary. The term "Incurrence" when used as a noun shall have a correlative meaning. The accretion of principal of a non-interest bearing or other discount security shall be deemed the Incurrence of Indebtedness. "Indebtedness" means, with respect to any Person on any date of determination (without duplication): (i) the principal of and premium, if any, in respect of (A) indebtedness of such Person for money borrowed and (B) indebtedness evidenced by notes, debentures, bonds or other similar instruments for the payment of which such Person is responsible or liable; (ii) all Capital Lease Obligations of such Person; (iii) all obligations of such Person issued or assumed as the deferred purchase price of property, all conditional sale obligations of such Person and all obligations of such Person under any title retention agreement (including any such obligations under repurchase agreements, but excluding trade accounts payable and expense accruals arising in the ordinary course of business not overdue by more than 60 days); (iv) all obligations of such Person for the reimbursement of any obligor on any letter of credit, banker's acceptance or similar credit transaction; (v) the amount of all obligations of such Person with respect to the redemption, repayment or other repurchase of any Disqualified Stock (but excluding any accrued dividends) or, in the case of a Subsidiary of such Person, any Preferred Stock (but excluding any accrued dividends); (vi) Warehouse Indebtedness; (vii) in connection with each sale of any Excess Spread Receivables, the maximum aggregate claim (if any) that the purchaser thereof could have against such Person if the payments anticipated in connection with such Excess Spread Receivables are not collected; (viii) all obligations of the type referred to in clauses (i) through (vii) of other Persons and all dividends of other Persons for the payment of which, in either case, such Person is responsible or liable, directly or indirectly, as obligor, guarantor or otherwise, including by means of any Guarantee; (ix) all obligations of the type referred to in clauses (i) through (viii) of other Persons secured by any Lien on any property or asset of such Person (whether or not such obligation is assumed by such Person), the amount of such obligation being deemed to be the lesser of the value of such property or assets or the amount of the obligation so secured; and (x) to the extent not otherwise included in this definition, Hedging Obligations of such Person. Notwithstanding the foregoing, "Indebtedness" shall not include obligations under the Tax Sharing Agreement or any renewal or other modification thereof that complies with the covenant described under "Certain Covenants -- Limitation on Affiliate Transactions." Except in the case of Warehouse Indebtedness (the amount of which shall be determined in accordance with the definition thereof), the amount of Indebtedness of any Person at any date shall be the 73 76 outstanding balance at such date of all unconditional obligations as described above and the maximum liability, upon the occurrence of the contingency giving rise to the obligation, of any contingent obligations at such date. Notwithstanding the foregoing, any securities issued in a securitization by a special purpose owner trust or similar entity formed by or on behalf of a Person and to which Receivables have been sold or otherwise transferred by or on behalf of such Person or its Restricted Subsidiaries shall not be treated as Indebtedness of such Person or its Restricted Subsidiaries under the Indenture, regardless of whether such securities are treated as indebtedness for tax purposes, provided (1) neither the Company nor any of its Restricted Subsidiaries (other than Special Purpose Subsidiaries) (a) provides credit support of any kind (including any undertaking, agreement or instrument that would constitute Indebtedness), except for credit support in the form of "over-collateralization" of the senior certificates issued in, or subordination of or recourse to all or a portion of Excess Spread Receivables attributable to, such securitization, in each case to the extent reflected in the book value of such Excess Spread Receivables, or (b) is directly or indirectly liable (as a guarantor or otherwise), and (2) no default with respect to such securities (including any rights that the holders thereof may have to take enforcement action against an Unrestricted Subsidiary) would permit (upon notice, lapse of time or both) any holder of any other Indebtedness of the Company or any of its Restricted Subsidiaries to declare a default on such other Indebtedness or cause the payment thereof to be accelerated or payable prior to its stated maturity. "Interest-only Certificate" means a certificate issued in a securitization of a pool of Receivables which pays a fixed or floating interest rate on a notional principal amount. "Interest Rate Agreement" means any interest rate swap agreement, interest rate cap agreement, repurchase agreement, futures contract or other financial agreement or arrangement designed to protect the Company or any Restricted Subsidiary against fluctuations in interest rates. "Investment" in any Person means any direct or indirect advance, loan (other than advances to customers in the ordinary course of business, other than Receivables, that are recorded as trade accounts on the balance sheet of the lender) or other extensions of credit (including by way of Guarantee or similar arrangement) or capital contribution to (by means of any transfer of cash or other property to others or any payment for property or services for the account or use of others), or any purchase or acquisition of Capital Stock, Indebtedness (including Receivables) or other similar instruments issued by, such Person. For purposes of the definitions of "Unrestricted Subsidiary" and "Restricted Payment" and the covenant described under "Certain Covenants -- Limitation on Restricted Payments," (i) "Investment" shall include the greater of (A) the portion (proportionate to the Company's equity interest in such Subsidiary) of the fair market value of the net assets of any Subsidiary of the Company at the time that such Subsidiary is designated an Unrestricted Subsidiary and (B) the aggregate amount of Investments by the Company and its Restricted Subsidiaries in such Subsidiary at the time it is so designated; provided, however, that upon a redesignation of such Subsidiary as a Restricted Subsidiary, the Company shall be deemed to continue to have a permanent "Investment" in an Unrestricted Subsidiary equal to an amount (if positive) equal to (x) the Company's "Investment" in such Subsidiary at the time of such redesignation less (y) the portion (proportionate to the Company's equity interest in such Subsidiary) of the fair market value of the net assets of such Subsidiary at the time of such redesignation; and (ii) any property transferred to or from a Person shall be valued at its fair market value at the time of such transfer, in each case as determined in good faith by the Board of Directors. "Issue Date" means the date on which the Notes are originally issued. "Junior Subordinated Obligation" is defined under "Subordination." "Lien" means (i) any mortgage, pledge, security interest, encumbrance, lien or charge of any kind (including any conditional sale or other title retention agreement or lease in the nature thereof) and (ii) any claim (whether direct or indirect through subordination or other structural encumbrance) against any Excess Spread Receivables sold or otherwise transferred by such Person to a buyer, unless such Person is not liable for any losses thereon. "Net Available Cash" from an Asset Disposition means cash payments received therefrom (including any cash payment received by way of deferred payment of principal pursuant to a note or installment receivable or 74 77 otherwise, but only as and when received, but excluding any other consideration received in the form of assumption by the acquiring Person of Indebtedness or other obligations relating to such properties or assets or received in any other noncash form) in each case net of (i) all legal, title and recording tax expenses, commissions and other fees and expenses incurred, and all Federal, state, provincial, foreign and local taxes required to be accrued as a liability under GAAP, as a consequence of such Asset Disposition, (ii) all payments made on any Indebtedness which is secured by any assets subject to such Asset Disposition, in accordance with the terms of any Lien upon or other security agreement of any kind with respect to such assets, or which must by its terms, or in order to obtain a necessary consent to such Asset Disposition, or by applicable law be, repaid out of the proceeds from such Asset Disposition, and (iii) the deduction of appropriate amounts provided by the seller as a reserve, in accordance with GAAP, against any liabilities associated with the property or other assets disposed in such Asset Disposition and retained by the Company or any Restricted Subsidiary after such Asset Disposition. "Net Cash Proceeds," with respect to any issuance or sale of Capital Stock, means the cash proceeds of such issuance or sale net of attorneys' fees, accountants' fees, underwriters' or placement agents' fees, discounts or commissions and brokerage, consultant and other fees actually incurred in connection with such issuance or sale and net of taxes paid or payable as a result thereof. "Non-Recourse Debt" means indebtedness (i) as to which neither the Company nor any of its Restricted Subsidiaries (a) provides a Guarantee or other credit support of any kind (including any undertaking, agreement or instrument that would constitute Indebtedness), (b) is directly or indirectly liable (as the primary obligor or otherwise), or (c) constitutes the lender; and (ii) no default with respect to which (including any rights that the holders thereof may have to take enforcement action against an Unrestricted Subsidiary) would permit (upon notice, lapse of time or both) any holder of any other Indebtedness of the Company or any of its Restricted Subsidiaries (other than the Notes and the Subsidiary Guarantees) to declare a default on such other Indebtedness or cause the payment thereof to be accelerated or payable prior to its stated maturity. "Permitted Investment" means an Investment by the Company or any Restricted Subsidiary: (i) in a Wholly Owned Restricted Subsidiary or a Person that, upon the making of such Investment, will become a Wholly Owned Restricted Subsidiary; provided, however, that the primary business of such Wholly Owned Restricted Subsidiary is a Related Business; (ii) in another Person if as a result of such Investment such other Person is merged or consolidated with or into, or transfers or conveys all or substantially all its assets to, the Company or a Wholly Owned Restricted Subsidiary; provided, however, that such Person's primary business is a Related Business; (iii) while no Default or Event of Default exists, any Investment in Persons engaged in a Related Business, provided the aggregate amount of all Investments made by the Company and its Restricted Subsidiaries after the Issue Date that constitute Permitted Investments under this clause (iii)(and, without limitation, not including Permitted Investments under clause (i) above), on any date (the "date of determination"), may not exceed the sum of (a) $6,000,000, plus (b) the excess, if any, of (A) 25% of Consolidated Net Income during the period (treated as one accounting period) from the beginning of the first fiscal quarter commencing after the Issue Date to the end of the fiscal quarter ended most recently prior to the date of determination for which financial statements are available (or, in case such Consolidated Net Income shall be a deficit, zero), over (B) the aggregate amount of Restricted Payments made by the Company and its Restricted Subsidiaries after the Issue Date (other than a Restricted Payment permitted to be made pursuant to clause (i) or (ii) paragraph (b) of the covenant described above under "Certain Covenants -- Limitation on Restricted Payments"), (iv) in the form of Temporary Cash Investments; (v) in the form of receivables (other than Receivables) owing to the Company or any Restricted Subsidiary if created or acquired in the ordinary course of business and payable or dischargeable in accordance with customary trade terms; (vi) in the form of payroll, travel and similar advances to cover matters that are expected at the time of such advances ultimately to be treated as expenses for accounting purposes and that are made in the ordinary course of business; (vii) in the form of loans or advances to employees made in the ordinary course of business consistent with past practices of the Company or such Restricted Subsidiary in an aggregate amount not to exceed $250,000 outstanding at any time; (viii) in the form of stock, obligations or securities received in settlement of debts created in the ordinary course of business and owing to the Company or any Restricted 75 78 Subsidiary or in satisfaction of judgments; (ix) in any Person to the extent such Investment represents the non-cash portion of the consideration received for an Asset Disposition as permitted pursuant to the covenant described under "Certain Covenants -- Limitation on Sales of Assets and Subsidiary Stock", provided the amount thereof does not exceed 10% of Consolidated Net Worth; (x) in the form of Receivables of the Company or any Restricted Subsidiary; and (xi) in the form of Excess Spread Receivables, subordinated certificates or Interest-only Certificates arising from a securitization or sale of Receivables by the Company or any of its Wholly Owned Restricted Subsidiaries (including any securitization of a "pool" of receivables that, in addition to Receivables, also includes loans, leases or other receivables of Persons other than the Company or any Wholly Owned Restricted Subsidiary). "Permitted Liens" means, with respect to the Company and any Restricted Subsidiary: (i) pledges or deposits by such Person under worker's compensation laws, unemployment insurance laws or similar legislation, or good faith deposits in connection with bids, tenders, contracts (other than for the payment of Indebtedness) or leases to which such Person is a party, or deposits to secure public or statutory obligations of such Person or deposits of cash or United States government bonds to secure surety or appeal bonds to which such Person is a party, or deposits as security for contested taxes or for the payment of rent, in each case Incurred in the ordinary course of business; (ii) Liens imposed by law, such as carriers', warehousemen's and mechanics' Liens, in each case for amounts not yet due or being contested in good faith by appropriate proceedings or other Liens arising out of judgments or awards against such Person with respect to which such Person shall then be proceeding with an appeal or other proceedings for review; (iii) Liens for property taxes not yet subject to penalties for nonpayment or which are being contested in good faith and by appropriate proceedings; (iv) minor survey exceptions, minor encumbrances, easements or reservations of, or rights of others for, licenses, rights of way, sewers, electric lines, telegraph and telephone lines and other similar purposes, or zoning or other restrictions as to the use of real property, or leases, subleases or other Liens incidental to the conduct of the business of such Person or to the ownership of its properties which were not Incurred in connection with Indebtedness and which do not in the aggregate materially adversely affect the value of said properties or materially impair their use in the operation of the business of such Person; (v) Liens securing Indebtedness of such Person Incurred to finance the construction, purchase or lease of, or repairs, improvements or additions to, equipment (including vehicles) of such Person (but excluding Capital Stock of another Person); provided, however, that the Lien may not extend to any other property owned by such Person or any of its Subsidiaries at the time the Lien is Incurred, and the Indebtedness secured by the Lien may not be Incurred more than 180 days after the later of the acquisition, completion of construction, repair, improvement, addition or commencement of full operation of the property subject to the Lien; (vi) Liens on Receivables of the Company or a Restricted Subsidiary, as the case may be, to secure Indebtedness permitted under the provisions described in clause (b)(1) under "-- Certain Covenants -- Limitation on Indebtedness" or clause (a) under "-- Certain Covenants -- Limitation on Preferred Stock of Subsidiaries"; (vii) Liens on Excess Spread Receivables (or on the Capital Stock of any Person substantially all the assets of which are Excess Spread Receivables); provided, however, that no such Liens may encumber Eligible Excess Spread Receivables in an amount equal to the sum of (1) the Specified Percentage in effect at the creation of such Lien (the "determination date") of the unpaid principal amount as of the determination date of the Notes and all other unsecured Indebtedness of the Company and its Restricted Subsidiaries that does not constitute Junior Subordinated Obligations (collectively, the "Specified Unsecured Indebtedness"; the amount under this subclause (1) being the "Base Set Aside"), plus (2) 25% of the excess, if any, of (x) the total amount of Eligible Excess Spread Receivables shown on the balance sheet of the Company and its Restricted Subsidiaries, determined on a consolidated basis in accordance with GAAP, as of the determination date, over (y) the Base Set Aside, provided that the sum of the Base Set Aside plus the amount in this clause (2) (the "Excess Set Aside") shall not exceed 200% of Specified Unsecured Indebtedness, plus (3) 10% of the excess, if any, of (x) the amount under the foregoing subclause (2)(x), over (y) the sum of the Base Set Aside plus the Excess Set Aside; (viii) Liens existing on the Issue Date and listed on a schedule to the Indenture; (ix) Liens on property or shares of Capital Stock of another Person at the time such other Person becomes a Restricted Subsidiary of such Person; provided, however, that (A) such Liens are not created, incurred or assumed in connection with, or in contemplation of, such other Person becoming a Subsidiary or being designated a Restricted Subsidiary and (B) such Liens may not extend to any other 76 79 property owned by such Person or any of its Restricted Subsidiaries; (x) Liens on property at the time such Person or any of its Restricted Subsidiaries acquires the property, including any acquisition by means of a merger or consolidation with or into such Person or a Restricted Subsidiary of such Person; provided, however, that (A) such Liens are not created, incurred or assumed in connection with, or in contemplation of, such acquisition and (B) such Liens may not extend to any other property owned by such Person or any of its Restricted Subsidiaries; (xi) Liens securing Indebtedness or other obligations of a Restricted Subsidiary of such Person owing to such Person or a Wholly Owned Restricted Subsidiary of such Person; (xii) Liens (other than on any Excess Spread Receivables) securing Hedging Obligations of the Company or such Restricted Subsidiary so long as such Hedging Obligations relate to Indebtedness that is, and is permitted under the Indenture to be, secured by a Lien on the same property securing such Hedging Obligations; (xiii) Liens to secure any Refinancing (or successive Refinancings) as a whole, or in part, of any Indebtedness of the Company or such Restricted Subsidiary secured by any Lien referred to in the foregoing clauses (v), (viii) and (ix); provided, however, that (A) such new Lien shall be limited to all or part of the same property that secured the original Lien (plus improvements to or on such property), (B) the Indebtedness secured by such Lien at such time is not increased to any amount greater than the sum of (1) the outstanding principal amount or, if greater, committed amount of the Indebtedness described under clause (v), (viii) or (ix), as the case may be, at the time the original Lien became a Permitted Lien and (2) an amount necessary to pay any fees and expenses, including premiums, related to such refinancing, refunding, extension renewal or replacement and (C) the Average Life of such Indebtedness is not decreased, and (xiv) any Lien in the form of "over-collateralization" of the senior certificates issued in, or subordination of or recourse to all or a portion of Excess Spread Receivables of the Company or any Subsidiary attributable to a securitization of Receivables, in each case to the extent reflected in the book value of such Excess Spread Receivables, which Lien is in favor of the holders of other interests in the trust relating to such securitization, provided, however, that notwithstanding any of the foregoing clauses, no Lien on Eligible Excess Spread Receivables, other than a Lien permissible under the foregoing clauses (vii) and (xiv), shall be a Permitted Lien. Notwithstanding the foregoing, "Permitted Liens" will not include any Lien described in clause (v), (ix) or (x) above to the extent such Lien applies to any Additional Assets acquired directly or indirectly from Net Available Cash pursuant to the covenant described under "Certain Covenants -- Limitation on Sale of Assets and Subsidiary Stock." Without limitation, for purposes of clause (vii) of this definition, the Incurrence of any Indebtedness (or an increase in the amount of any Indebtedness) secured by a Lien on Excess Spread Receivables shall be considered the incurrence of a new Lien on such Excess Spread Receivables, irrespective of whether a Lien securing other Indebtedness (or a lesser amount of Indebtedness) already exists on such assets at the time of such Incurrence. "Permitted Warehouse Indebtedness" means Warehouse Indebtedness in connection with a Warehouse Facility; provided, however, that (i) the assets being financed are eligible to be recorded as held for sale on the consolidated balance sheet of the Company and its Restricted Subsidiaries in accordance with GAAP, (ii) Warehouse Indebtedness constitutes Permitted Warehouse Indebtedness only (a) if, in the case of Warehouse Indebtedness under a Purchase Facility, recourse with respect to the obligations of the Company and its Restricted Subsidiaries under such Warehouse Facility is limited to the Receivables financed thereby or (b) in the case of any other Warehouse Indebtedness, to the extent of the lesser of (A) the amount advanced by the lender with respect to the Receivables financed under the Warehouse Facility, and (B) the principal amount of such Receivables, and (iii) any such Indebtedness has not been outstanding in excess of 360 days. "Permitted Warehouse Indebtedness Limitation" means, with respect to any Warehouse Indebtedness of any Restricted Subsidiary, any covenant in the credit documents under which such Warehouse Indebtedness is incurred to maintain the consolidated net worth of such Restricted Subsidiary at a specified dollar amount, provided that such covenant does not require such consolidated net worth to be maintained at a level in excess of 85% of the consolidated net worth of such Restricted Subsidiary at the time such credit documents are entered into, amended or renewed. For purposes of this definition, "consolidated net worth" shall be determined in accordance with GAAP. 77 80 "Person" means any individual, corporation, partnership, joint venture, association, joint-stock company, limited liability company, trust, unincorporated organization, government or any agency or political subdivision thereof or any other entity. "Preferred Stock" as applied to the Capital Stock of any Person, means Capital Stock of any class or classes (however designated) which is preferred as to the payment of dividends, or as to the distribution of assets upon any voluntary or involuntary liquidation or dissolution of such Person, over shares of Capital Stock of any other class of such corporation. "Principal" of a Note means the principal of the Note payable on the Note which is due or overdue or is to become due at the relevant time. "Public Equity Offering" means an underwritten primary public offering of Common Stock of the Company pursuant to an effective registration statement under the Securities Act. "Purchase Facility" means any Warehouse Facility pursuant to which the Company or a Restricted Subsidiary sells Receivables to a financial institution or other Person and retains a right of first refusal (or a right with similar effect) upon the subsequent resale of such Receivables by such financial institution. "Receivables" means loans, leases and receivables purchased or originated by the Company or any Restricted Subsidiary in the ordinary course of business; provided, however, that for purposes of determining the amount of a Receivable at any time, such amount shall be determined in accordance with GAAP, consistently applied, as of the most recent practicable date. "Refinance" means, in respect of any Indebtedness, to refinance, extend, renew, refund, repay, prepay, redeem, defease or retire, or to issue other Indebtedness in exchange or replacement for, such indebtedness. "Refinanced" and "Refinancing" shall have correlative meanings. "Refinancing Indebtedness" means Indebtedness that Refinances any Indebtedness of the Company or any Restricted Subsidiary existing on the Issue Date or Incurred in compliance with the Indenture, including Indebtedness that Refinances Refinancing Indebtedness; provided, however, that (i) such Refinancing Indebtedness has a Stated Maturity no earlier than the Stated Maturity of the Indebtedness being Refinanced, (ii) such Refinancing Indebtedness has an Average Life at the time such Refinancing Indebtedness is Incurred that is equal to or greater than the Average Life of the Indebtedness being Refinanced, (iii) such Refinancing Indebtedness has an aggregate principal amount (or, if Incurred with original issue discount, an aggregate issue price) that is equal to or less than the aggregate principal amount (or, if Incurred with original issue discount, the aggregate accreted value) then outstanding or committed (plus fees and expenses, including any premium and defeasance costs) under the Indebtedness being Refinanced, and (iv) in the case of Refinancing Indebtedness that Refinances any Junior Subordinated Obligations, such Refinancing Indebtedness constitutes a Junior Subordinated Obligation; provided further, however, that Refinancing Indebtedness shall not include (x) Indebtedness of a Subsidiary that Refinances Indebtedness of the Company or another Subsidiary or (y) Indebtedness of the Company or a Subsidiary that Refinances Indebtedness of an Unrestricted Subsidiary. "Related Business" means any consumer lending business or any financial service business directly relating to such business. "Representative" means, with respect to any Senior Indebtedness, any holder thereof or any agent, trustee or other representative for any such holder. "Restricted Payment" with respect to any Person means: (i) the declaration or payment of any dividends or any other distributions of any sort in respect of its Capital Stock (including any payment in connection with any merger or consolidation involving such Person) or similar payment to the direct or indirect holders of its Capital Stock (other than (A) dividends or distributions payable solely in its Capital Stock (other than Disqualified Stock), and (B) dividends or distributions payable solely to the Company or a Wholly Owned Restricted Subsidiary; (ii) the purchase, redemption or other acquisition or retirement for value of any Capital Stock of the Company held by any Person or of any Capital Stock of a Restricted Subsidiary held by any Affiliate of the Company (other than a Wholly Owned Restricted Subsidiary), including the exercise of any 78 81 option to exchange any Capital Stock (other than into Capital Stock of the Company that is not Disqualified Stock); (iii) the payment, purchase, repurchase, redemption, defeasance or other acquisition or retirement for value, prior to scheduled maturity, scheduled repayment or scheduled sinking fund payment of any Junior Subordinated Obligations of the Company or any Restricted Subsidiary; or (iv) the making of any Investment (other than a Permitted Investment) in any Person. Notwithstanding the foregoing, solely for purposes of calculating the aggregate amount of "other Restricted Payments since the Issue Date," as used in clause (iii) of paragraph (a) of the covenant described under "-- Certain Covenants -- Limitation on Restricted Payments," any Investment that constitutes a Permitted Investment under clause (iii) of the definition of "Permitted Investment" shall be considered a Restricted Payment (but such a Permitted Investment shall not be considered a Restricted Payment for any other purpose). "Restricted Subsidiary" means any Subsidiary of the Company that is not an Unrestricted Subsidiary. "SEC" means the Securities and Exchange Commission. "Senior Indebtedness" means principal of and interest (including interest accruing on or after the filing of any petition in bankruptcy or for reorganization relating to the Company or a Subsidiary, as applicable, to the extent postpetition interest is allowed in such proceeding) and premium, if any, on (a) any Indebtedness of the Company or any Restricted Subsidiary of the type referred to in clause (i), (ii), (iii), (iv) or (vi) of the definition of "Indebtedness," or (b) all Guarantees by the Company or any Restricted Subsidiary with respect to Indebtedness referred to in the foregoing clause (a), unless the instrument under which such Indebtedness is incurred expressly provides that it is pari passu with or subordinated in right of payment to the Notes (in the case of Indebtedness being Incurred by the Company) or the Subsidiary Guarantee of such Restricted Subsidiary (in the case of Indebtedness being Incurred by any Restricted Subsidiary). Notwithstanding the foregoing, Senior Indebtedness shall not include (a) any liability for federal, state, local, foreign or other taxes, (b) any Indebtedness of the Company or any Restricted Subsidiary to any Affiliates (including obligations under the Tax Sharing Agreement, as amended from time to time), (c) any trade accounts payable and expense accruals, (d) any Indebtedness that is Incurred in violation of the Indenture, and (e) Indebtedness owed for compensation or for services rendered. "Special Purpose Subsidiary" means a Restricted Subsidiary formed in connection with a securitization of Receivables (i) all the Capital Stock of which (other than directors' qualifying shares and shares held by other Persons to the extent such shares are required by applicable law to be held by a Person other than the Company or a Restricted Subsidiary) is owned by the Company or one or more Restricted Subsidiaries, (ii) that has no assets other than Excess Spread Receivables created in such securitization, (iii) that conducts no business other than holding such Excess Spread Receivables, and (iv) that has no Indebtedness (other than short-term Indebtedness to the Company or any Wholly Owned Restricted Subsidiary attributable to the purchase by such Restricted Subsidiary from the Company or such Wholly Owned Restricted Subsidiary of such Receivables, which Indebtedness is paid in full upon closing of such securitization). "Specified Percentage" means (i) at any time prior to the date that is 6 months after the Issue Date, 0%, (ii) subject to clause (i), at any time prior to the date that is 12 months after the Issue Date, 20%, (iii) subject to clauses (i) and (ii), at any time prior to the date that is 18 months after the Issue Date, 40%, (iv) subject to clauses (i), (ii) and (iii), at any time prior to the date that is 24 months after the Issue Date, 90%, and (v) at any other time, 125%. "Stated Maturity" means, with respect to any security, the date specified in such security as the fixed date on which the final payment of principal of such security is due and payable, including pursuant to any mandatory redemption provision (but excluding any provision providing for the repurchase of such security at the option of the holder thereof upon the happening of any contingency unless such contingency has occurred). "Subsidiary" means, in respect of any Person, any corporation, association, partnership or other business entity of which more than 50% of the total voting power of shares of Capital Stock or other interests (including partnership interests) entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof is at the time owned or controlled, directly or indirectly, by (i) such 79 82 Person, (ii) such Person and one or more Wholly Owned Subsidiaries of such Person or (iii) one or more Wholly Owned Subsidiaries of such Person. Unless otherwise specified, "Subsidiary" means a Subsidiary of the Company. "Tax Sharing Agreement" means the agreement, dated as of , 1996, by and among Mego Financial, the Company and certain affiliates of Mego Financial, without regard to any amendments, supplements or other modifications thereof after the Issue Date. "Temporary Cash Investments" means any of the following: (i) any investment in direct obligations of the United States of America or any agency thereof or obligations guaranteed as to principal and interest by the United States of America or any agency thereof and maturing within 180 days after acquisition thereof; (ii) investments in demand deposit accounts or time deposit accounts, certificates of deposit and money market deposits maturing within 180 days of the date of acquisition thereof issued by a bank or trust company that is not an Affiliate of the Company and that is organized under the laws of the United States of America or any state thereof, which bank or trust company has capital, surplus and undivided profits aggregating in excess of $500,000,000 and has outstanding debt which is rated "AA" (or similar equivalent rating) or higher by at least one nationally recognized statistical rating organization (as defined in Rule 436 under the Securities Act) or any money-market fund sponsored by a registered broker-dealer or mutual fund distributor; (iii) repurchase obligations with a term of not more than 30 days for underlying securities of the types described in clause (i) above entered into with a bank meeting the qualifications described in clause (ii) above; (iv) investments in commercial paper, maturing not more than 90 days after the date of acquisition, issued by a corporation (other than an Affiliate of the Company) organized and in existence under the laws of the United States of America with a rating of "P-1" or higher according to Moody's Investors Service, Inc. or "A-1" or higher according to Standard & Poor's Ratings Group; and (v) investments in securities with maturities of six months or less from the date of acquisition issued or fully guaranteed by any state, commonwealth or territory of the United States of America, or by any political subdivision or taxing authority thereof, and rated at least "A" by Standard & Poor's Ratings Group or Moody's Investors Service, Inc. "Unrestricted Subsidiary" means (i) any Subsidiary of the Company that at the time of determination shall be designated an Unrestricted Subsidiary by the Board of Directors in the manner provided below and (ii) any Subsidiary of an Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of the Company (including any newly acquired or newly formed Subsidiary) to be an Unrestricted Subsidiary unless (a) such Subsidiary or any of its Subsidiaries owns any Capital Stock or Indebtedness of, or holds any Lien on any property of, the Company or any other Subsidiary of the Company that is not a Subsidiary of the Subsidiary to be so designated or (b) any such Subsidiary has outstanding any Indebtedness other than Non-Recourse Debt; provided, however, that such designation would be a permitted Restricted Investment under the covenant described under " -- Certain Covenants -- Limitation on Restricted Payments". The Board of Directors may designate any Unrestricted Subsidiary to be a Restricted Subsidiary; provided, however, that immediately after giving effect to such designation (x) the Company could Incur $1.00 of additional Indebtedness under paragraph (a) of the covenant described under " -- Certain Covenants -- Limitation on Indebtedness" and (y) no Default or Event of Default shall have occurred and be continuing or would result therefrom. Any such designation by the Board of Directors shall be evidenced by the Company to the Trustee by promptly filing with the Trustee a copy of the board resolution giving effect to such designation and an Officers' Certificate certifying that such designation complied with the foregoing provisions. "U.S. Government Obligations" means direct obligations (or certificates representing an ownership interest in such obligations) of the United States of America (including any agency or instrumentality thereof) for the payment of which the full faith and credit of the United States of America is pledged and which are not callable at the issuer's option. "Voting Stock" of a Person means all classes of Capital Stock or other interests (including partnership interests) of such Person then outstanding and normally entitled (without regard to the occurrence of any contingency) to vote in the election of directors, managers or trustees thereof. 80 83 "Warehouse Facility" means any funding arrangement with a financial institution or other lender or purchaser exclusively to finance the purchase or origination of Receivables by the Company or a Restricted Subsidiary of the Company for the purpose of pooling such Receivables prior to securitization or sale in the ordinary course of business, including any Purchase Facilities. "Warehouse Indebtedness" means the consideration received by the Company or its Restricted Subsidiaries under a Warehouse Facility with respect to Receivables until such time such Receivables are (i) securitized, (ii) repurchased by the Company or its Restricted Subsidiaries or (iii) sold by the counterpart under the Warehouse Facility to a Person who is not an Affiliate of the Company. "Wholly Owned Restricted Subsidiary" means a Restricted Subsidiary all the Capital Stock of which (other than directors' qualifying shares and shares held by other Persons to the extent such shares are required by applicable law to be held by a Person other than the Company or a Restricted Subsidiary) is owned by the Company or one or more Wholly Owned Restricted Subsidiaries. "Wholly Owned Subsidiary" means a Subsidiary all the Capital Stock of which (other than directors' qualifying shares and shares held by other Persons to the extent such shares are required by applicable law to be held by a Person other than the Company or a Subsidiary) is owned by the Company or one or more Wholly Owned Subsidiaries. 81 84 UNDERWRITING Subject to the terms and conditions contained in an underwriting agreement with respect to the Offering among the Company and the underwriters named below (the "Underwriters"), for whom Friedman, Billings, Ramsey & Co., Inc. and Oppenheimer & Co., Inc. are acting as representatives (the "Representatives"), each of the Underwriters has severally agreed to purchase from the Company, and the Company has agreed to sell to the Underwriters, the respective aggregate principal amount of the Notes set forth opposite their names below.
AGGREGATE PRINCIPAL NAME AMOUNT OF NOTES -------------------------------------------------------------------- ------------------- Friedman, Billings, Ramsey & Co., Inc. ............................. $ Oppenheimer & Co., Inc. ............................................ --------- Total..................................................... $40,000,000 =========
The Underwriting Agreement provides that the obligations of the several Underwriters thereunder are subject to approval of certain legal matters by counsel and to various other conditions. The Underwriters are committed to purchase all of the Notes if any are purchased. The Underwriters propose to offer the Notes directly to the public at the initial public offering price set forth on the cover page of this Prospectus and to certain dealers at such price less a concession not in excess of % of the principal amount. The Underwriters may allow, and such dealers may reallow, a concession not in excess of % of the principal amount on sales to certain other dealers. The offering of the Notes is made for delivery when, as and if accepted by the Underwriters and is subject to prior sale and to withdrawal, cancellation or modification of the offer without notice. The Underwriters reserve the right to reject any offer for the purchase of the Notes. After the initial public offering of the Notes, the public offering price and other selling terms may be changed by the Underwriters. Prior to the Offering, there has been no public trading market for the Notes and there can be no assurance that any active trading market will develop for the Notes or, if developed, will be maintained. The Representatives have informed the Company that the Underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. The Company has agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the federal securities laws, or to contribute to payments that the Underwriters may be required to make in respect thereof. Oppenheimer & Co., Inc. has provided from time to time, and expects to provide in the future, investment banking and financial services to the Company and its affiliates, for which Oppenheimer & Co., Inc. has received and will receive customary fees and commissions. LEGAL MATTERS The legality of the Notes offered hereby will be passed upon for the Company by Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quentel, P.A., Miami, Florida. Gibson, Dunn & Crutcher LLP, New York, New York has acted as counsel for the Underwriters in connection with the Offering. 82 85 EXPERTS The financial statements included in this Prospectus have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report appearing herein and elsewhere in the registration statement, and are so included in reliance upon their authority as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission") a Registration Statement on Form S-1 (together with all amendments, exhibits and schedules thereto, the "Registration Statement") under the Securities Act, with respect to the Notes offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement. For further information with respect to the Company and the Notes offered hereby, reference is hereby made to such Registration Statement. Statements contained in this Prospectus as to the contents of any contract or other document are not necessarily complete and, in each instance, reference is made to the copy of such contract or document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. Copies of the Registration Statement, including all exhibits thereto, may be obtained from the Commission's principal office at 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of the fees prescribed by the Commission, or may be examined without charge at the offices of the Commission at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, as well as the Commission's regional offices at Seven World Trade Center, Suite 1300, New York, New York 10048, and Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. In addition, copies of the Registration Statement and related documents may be obtained from the Commission's web site at http://www.sec.gov. Upon completion of the Offering and the Common Stock Offering, the Company will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, and in accordance therewith will file annual and quarterly reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information may be inspected, and copies of such material may be obtained upon payment of prescribed fees, at the Commission's Public Reference Section at the addresses set forth above. The Company intends to furnish its stockholders with annual reports containing audited financial statements of the Company which have been certified by its independent public accountants. 83 86 MEGO MORTGAGE CORPORATION INDEX TO FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report.......................................................... F-2 Financial Statements: Balance Sheets -- August 31, 1994 and 1995 and May 31, 1996 (unaudited)............. F-3 Statements of Operations -- Years Ended August 31, 1994 and 1995 and Nine Months Ended May 31, 1995 and 1996 (unaudited).......................................... F-4 Statements of Cash Flows -- Years Ended August 31, 1994 and 1995 and Nine Months Ended May 31, 1995 and 1996 (unaudited).......................................... F-5 Statements of Stockholder's Equity -- Years Ended August 31, 1994 and 1995 and Nine Months Ended May 31, 1995 and 1996 (unaudited)................................... F-6 Notes to Financial Statements......................................................... F-7
F-1 87 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholder of Mego Mortgage Corporation Las Vegas, Nevada We have audited the accompanying balance sheets of Mego Mortgage Corporation (a wholly owned subsidiary of Mego Financial Corp.) (the "Company") as of August 31, 1994 and 1995, and the related statements of operations, stockholder's equity and of cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements referred to above present fairly, in all material respects, the financial position of the Company as of August 31, 1994 and 1995, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. As discussed in Note 13 to the financial statements, the accompanying 1994 financial statements have been restated. As discussed in Note 2 to the financial statements, the Company adopted Statement of Financial Accounting Standards No. 122, Accounting for Mortgage Servicing Rights. Las Vegas, Nevada February 29, 1996 (October , 1996 as to the last paragraph of Note 2) The accompanying financial statements retroactively reflect the effect of a sixteen-hundred-for-one stock split of the common stock which is to be effected before the effective date of this Registration Statement. The above opinion is in the form which will be signed by Deloitte & Touche LLP upon consummation of such stock split, which is described in Note 2 of Notes to Financial Statements, and assuming that, from February 29, 1996 to the date of such stock split, no other events shall have occurred that would affect the accompanying financial statements and notes thereto. DELOITTE & TOUCHE LLP Las Vegas, Nevada October 1, 1996 F-2 88 MEGO MORTGAGE CORPORATION BALANCE SHEETS (IN THOUSANDS OF DOLLARS)
AUGUST 31, -------------------------- MAY 31, 1994 1995 1996 -------------- ------- ----------- (AS RESTATED-- (UNAUDITED) NOTE 15) ASSETS Cash...................................................... $ 824 $ 752 $ 841 Cash deposits, restricted................................. -- 2,532 2,399 Loans held for sale, net.................................. 1,463 3,676 4,671 Mortgage related securities, at fair value................ -- -- 15,144 Excess servicing rights................................... 904 14,483 12,796 Mortgage servicing rights................................. -- 1,076 2,738 Other receivables......................................... 313 142 15 Due from affiliate........................................ 276 -- -- Property and equipment, at cost, net...................... 237 429 800 Organizational costs, net................................. 867 675 530 Other assets.............................................. 238 316 565 ------- ------- ------- TOTAL ASSETS.................................... $ 5,122 $24,081 $40,499 ======= ======= ======= LIABILITIES AND STOCKHOLDER'S EQUITY Liabilities: Notes and contracts payable............................. $ 637 $ 1,458 $ 8,872 Accounts payable and accrued liabilities................ 280 2,239 2,678 Allowance for losses on loans sold with recourse........ 66 886 838 State income taxes payable.............................. -- 264 687 Due to affiliated company............................... -- -- 50 Due to parent company................................... -- 8,453 11,963 ------- ------- ------- Total liabilities............................... 983 13,300 25,088 ------- ------- ------- Commitments (Note 12) Stockholder's equity (Note 2): Common Stock -- $.01 par value per share Authorized -- 50,000,000 shares Issued and outstanding -- 10,000,000 shares.......... 5,000 5,000 5,000 Additional paid in capital.............................. 650 3,650 3,650 Retained earnings (accumulated deficit)................. (1,511) 2,131 6,761 ------- ------- ------- Total stockholder's equity...................... 4,139 10,781 15,411 ------- ------- ------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY...... $ 5,122 $24,081 $40,499 ======= ======= =======
See notes to financial statements. F-3 89 MEGO MORTGAGE CORPORATION STATEMENTS OF OPERATIONS (IN THOUSANDS OF DOLLARS EXCEPT PER SHARE AMOUNTS)
FOR THE NINE FOR THE YEARS ENDED MONTHS ENDED AUGUST 31, MAY 31, -------------------------- ------------------------- 1994 1995 1995 1996 ----------- ---------- ---------- ---------- (AS (UNAUDITED) RESTATED -- NOTE 15) REVENUES Gain on sale of loans................. $ 579 $ 12,233 $ 6,098 $ 11,621 Net unrealized gain on mortgage related securities................. -- -- -- 2,182 Net loan servicing income............. -- 873 418 3,049 Interest income, net.................. 172 473 313 538 -------- ------- ------- ------- Total revenues................ 751 13,579 6,829 17,390 -------- ------- ------- ------- COSTS AND EXPENSES Provision for credit losses........... 96 864 558 815 Depreciation and amortization......... 136 403 260 641 Commissions and selling............... 13 552 339 1,560 Other interest........................ 22 187 58 120 General and administrative Payroll and benefits............... 975 3,611 2,442 3,550 Professional services.............. -- 409 244 716 Services by affiliate.............. 442 690 503 503 FHA insurance...................... 11 231 110 390 Other.............................. 567 713 461 1,632 -------- ------- ------- ------- Total costs and expenses...... 2,262 7,660 4,975 9,927 -------- ------- ------- ------- INCOME BEFORE INCOME TAXES.............. (1,511 ) 5,919 1,854 7,463 INCOME TAXES............................ -- 2,277 651 2,833 -------- ------- ------- ------- NET INCOME (LOSS)....................... $ (1,511 ) $ 3,642 $ 1,203 $ 4,630 ======== ======= ======= ======= NET INCOME (LOSS) PER SHARE (Note 2).... $ (0.15 ) $ 0.36 $ 0.12 $ 0.46 ======== ======= ======= ======= WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING (Note 2).................. 10,000,000 10,000,000 10,000,000 10,000,000 ======== ======= ======= =======
See notes to financial statements. F-4 90 MEGO MORTGAGE CORPORATION STATEMENTS OF CASH FLOW (IN THOUSANDS OF DOLLARS)
FOR THE NINE FOR THE YEARS ENDED MONTHS ENDED AUGUST 31, MAY 31, ------------------------ ------------------- 1994 1995 1995 1996 ------------- -------- -------- -------- (AS (UNAUDITED) RESTATED-- NOTE 15) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)..................................................... $(1,511) $ 3,642 $ 1,203 $ 4,630 ------- -------- -------- -------- Adjustments to reconcile net income (loss) to net cash used in operating activities: Gain on sale of loans............................................... (579) (12,233) (6,098) (11,621) Net unrealized gain on mortgage related securities.................. -- -- -- (2,182) Provision for credit losses......................................... 96 864 558 815 Income tax.......................................................... -- 2,277 651 2,833 Depreciation and amortization....................................... 136 403 260 641 Amortization of excess servicing rights............................. -- 519 241 1,730 Amortization of other assets........................................ 50 50 50 75 Increase in loans originated, net................................... (8,019) (87,556) (52,438) (89,391) Proceeds from sale of loans......................................... 6,555 85,297 47,448 88,073 Changes in operating assets and liabilities: Increase (decrease) in cash deposits, restricted.................. -- (2,532) (1,438) 133 Increase (decrease) in excess servicing rights.................... (355) (1,865) (986) (1,257) Increase in mortgage servicing rights............................. -- (1,176) (697) (2,022) (Increase) decrease in other assets............................... (549) 16 98 (343) Increase in accounts payable and accrued liabilities.............. 279 1,959 1,125 414 ------- -------- -------- -------- Total adjustments.............................................. (2,386) (13,977) (11,226) (12,642) ------- -------- -------- -------- Net cash used in operating activities.......................... (3,897) (10,335) (10,023) (8,012) ------- -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from borrowings on notes and contracts payable............... 6,275 77,178 47,860 92,202 Payments on notes and contracts payable............................... (5,638) (76,357) (43,705) (84,788) Increase in due (from) to affiliate................................... (505) 276 1,901 50 Increase in due to parent............................................. -- 6,440 1,200 1,125 Receipt of common stock subscription.................................. 4,500 -- 3,000 -- Increase in paid in capital........................................... -- 3,000 -- -- ------- -------- -------- -------- Net cash provided by financing activities...................... 4,632 10,537 10,256 8,589 ------- -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment.................................... (263) (274) (168) (488) ------- -------- -------- -------- Net cash used in investing activities.......................... (263) (274) (168) (488) ------- -------- -------- -------- NET INCREASE (DECREASE) IN CASH......................................... 472 (72) 65 89 CASH -- BEGINNING OF PERIOD............................................. 352 824 824 752 ------- -------- -------- -------- CASH -- END OF PERIOD................................................... $ 824 $ 752 $ 889 $ 841 ======= ======== ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for: Interest............................................................ $ 38 $ 618 $ 254 $ 560 ======= ======== ======== ======== Income taxes........................................................ $ -- $ 3 $ -- $ -- ======= ======== ======== ======== SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES: In connection with the organization of the Company, the Company's parent contributed $650,000 to the Company as additional paid-in capital by the issuance of 475,000 shares of its Common Stock to an unrelated entity for services rendered.............................. $ 650 $ -- $ -- $ -- ======= ======== ======== ======== In connection with the transfer of mortgage backed securities, the Company retained an interest only security and a residual interest security............................................................ $ -- $ -- $ -- $ 15,144 ======= ======== ======== ========
See notes to financial statements. F-5 91 MEGO MORTGAGE CORPORATION STATEMENTS OF STOCKHOLDER'S EQUITY FOR THE YEARS ENDED AUGUST 31, 1994 AND 1995 AND THE NINE MONTHS ENDED MAY 31, 1996 (UNAUDITED) (IN THOUSANDS OF DOLLARS)
RETAINED COMMON STOCK ADDITIONAL EARNINGS ------------------- PAID IN (ACCUMULATED) SHARES AMOUNT CAPITAL DEFICIT TOTAL ---------- ------ ---------- ------------- ------- (NOTE 2) BALANCE AT AUGUST 31, 1993................. 10,000,000 $5,000 $ -- $ -- $ 5,000 Additional paid in capital............... -- -- 650 -- 650 Net loss for the year ended August 31, 1994 (as restated -- Note 15)................. -- -- -- (1,511) (1,511) ----- ------ ------ ------- -------- BALANCE AT AUGUST 31, 1994 (AS RESTATED -- NOTE 15)................................. 10,000,000 5,000 650 (1,511) 4,139 Additional paid in capital............... -- -- 3,000 -- 3,000 Net income for the year ended August 31, 1995..................................... -- -- -- 3,642 3,642 ----- ------ ------ ------- -------- BALANCE AT AUGUST 31, 1995................. 10,000,000 5,000 3,650 2,131 10,781 Net income for the nine months ended May 31, 1996............................. -- -- -- 4,630 4,630 ----- ------ ------ ------- -------- BALANCE AT MAY 31, 1996 (UNAUDITED)........ 10,000,000 $5,000 $3,650 $ 6,761 $15,411 ===== ====== ====== ======= ========
See notes to financial statements. F-6 92 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS FOR THE YEARS ENDED AUGUST 31, 1994 AND 1995 AND THE NINE MONTHS ENDED MAY 31, 1995 (UNAUDITED) AND 1996 (UNAUDITED) 1. NATURE OF OPERATIONS Mego Mortgage Corporation (the "Company") was incorporated on June 12, 1992, in the State of Delaware. The authorized capital stock of the Company is 50,000,000 shares of Common Stock with a par value of $.01 per share. The Company issued a total of 10,000,000 shares of its capital stock to Mego Financial Corp. ("Mego Financial"), a New York corporation, for $5,000,000 and became a wholly-owned subsidiary of Mego Financial. The Company, through its loan correspondents and home improvement contractors, is primarily engaged in the business of originating, servicing, pooling and selling home improvement loans ("Loans"), which qualify under the provisions of Title I of the National Housing Act which is administered by the U.S. Department of Housing and Urban Development ("HUD"). Pursuant to that program 90% of the principal balances of the Loans are U.S. government insured ("Title I Loans"), with a cumulative maximum equal to 10% of all Title I Loans originated by the Company. In May 1996, the Company commenced the origination of conventional home improvement loans through its network of loan correspondents. Interim Unaudited Financial Information -- In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting only of various normal accruals) necessary to present fairly the Company's financial position, results of operations and cash flows. The financial position at May 31, 1996 is not necessarily indicative of the financial position to be expected at August 31, 1996 and results of operations for the nine months ended May 31, 1996 are not necessarily indicative of the results of operations to be expected for the year ending August 31, 1996. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash Deposits, Restricted -- Restricted cash represents cash on deposit which is restricted in accordance with the Loan sale agreement and untransmitted funds received from collection of Loans which have not as yet been disbursed to the purchasers of such Loans in accordance with the Loan sale agreement. Loans Held for Sale -- Loans held for sale are carried at the lower of cost or market value in the accompanying balance sheets, net of allowance for credit losses. Cost includes the cost of origination. Mortgage Related Securities -- The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115") on September 1, 1995. There was no cumulative effect as a result of adopting SFAS 115. In accordance with the provisions of SFAS No. 115, the Company classifies residual interests securities and interest only securities as trading securities which are recorded at fair value with any unrealized gains or losses recorded in the results of operations in the period of the change in fair value. Valuations at origination and at each reporting period are based on discounted cash flow analyses. The cash flows are estimated as the excess of the weighted average coupon on each pool of loans sold over the sum of the pass-through interest rate, a servicing fee, a trustee fee, an insurance fee and an estimate of annual future credit losses related to the loans securitized, over the life of the loans. These cash flows are projected over the life of the loans using prepayment, default, loss, and interest rate assumptions that market participants would use for similar financial instruments subject to prepayment, credit and interest rate risk and are discounted using an interest rate that a purchaser unrelated to the seller of such a financial instrument would demand. Revenue Recognition-Gain on Sales of Loans -- Gain on sale of loans includes the gain on sale of mortgage backed securities and the gain on sale of Loans. In accordance with EITF 88-11, the gain on sale of mortgage backed securities is determined by an allocation of the cost of the securities based on the relative fair value of the securities sold and the securities retained. The Company retains an interest only strip security and the residual interest security. The fair value of the interest only strip and residual interest security is the present value of the estimated cash flow to be received after considering the effects of estimated prepayments F-7 93 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) and credit losses. The interest only strip and residual interest security are included in Mortgage related securities in the balance sheet. The present value of expected net cash flows from the sale of loans are recorded at the time of sale as Excess servicing rights. Excess servicing rights are amortized as a charge to income, as payments are received on the retained interest differential over the estimated life of the underlying Loans. Excess servicing rights are carried at the lower of unamortized cost or estimated fair value. The expected cash flows used to determine the Excess servicing rights asset have been reduced for potential losses under recourse provisions of the sales agreements. The Allowance for losses on loans sold with recourse represents the Company's estimate of losses to be incurred in connection with the recourse provisions of the sales agreements and is shown separately as a liability on the Company's balance sheet. In discounting cash flows related to loan sales the Company defers servicing income at annual rates of 1.00% to 1.25% and discounts cash flows on its sales at the rate it believes a purchaser would require as a rate of return. The cash flows were discounted to present value using discount rates which averaged 12.0% for the years ended August 31, 1994 and 1995 and the nine months ended May 31, 1995 and 1996, respectively. The Company has developed its assumptions based on experience with its own portfolio, available market data and ongoing consultation with its investment bankers. In determining expected cash flows, management considers economic conditions at the date of sale. In subsequent periods, these estimates may be revised as necessary using the original discount rate, and any losses arising from prepayment and loss experience will be recognized as realized. Mortgage Servicing Rights -- At August 31, 1995, effective September 1, 1994, the Company adopted the provisions of SFAS No. 122 "Accounting for Mortgage Servicing Rights, an amendment of SFAS No. 65" which requires that a mortgage banking enterprise recognize as separate assets the rights to service mortgage loans for others however those servicing rights are acquired. The effect of adopting SFAS No. 122 on the Company's financial statements was to increase income before income taxes by $1,076,000 for the year ended August 31, 1995. The fair value of capitalized mortgage servicing rights was estimated by taking the present value of expected net cash flows from mortgage servicing using assumptions the Company believes market participants would use in their estimates of future servicing income and expense, including assumptions about prepayment, default and interest rates. Capitalized mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. The estimate of fair value was based on a one hundred basis points per annum servicing fee reduced by estimated costs of servicing using a discount rate of 12% for the nine months ended May 31, 1995, and a one hundred twenty-five basis points per annum servicing fee reduced by estimated costs of servicing using a discount rate of 12% for the nine months ended May 31, 1996. At August 31, 1995 and May 31, 1996, the capitalized servicing rights approximated fair value. The Company periodically reviews capitalized servicing fees receivable to evaluate for impairment. This review is performed on a disaggregated basis based on date of origination. Impairment is recognized in a valuation allowance for each pool in the period of impairment. The Company has developed its assumptions based on experience with its own portfolio, available market data and ongoing consultation with its investment bankers. Allowance for Credit Losses -- Provision for credit losses relating to unsold Loans is charged to income in amounts sufficient to maintain the allowance at a level considered adequate to provide for anticipated losses resulting from liquidation of outstanding Loans. The provision for credit losses is based upon periodic analysis of the portfolio, economic conditions and trends, historical credit loss experience, borrowers' ability to repay, collateral values and giving effect to estimated FHA Insurance recoveries on Title I Loans. Property and Equipment -- Property and equipment is stated at cost and is depreciated over its estimated life (5 years) using the straight-line method. Costs of maintenance and repairs that do not improve or extend the life of the respective assets are charged to expense. The cost and related accumulated depreciation of F-8 94 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) property sold or retired are removed from the accounts and any gains or losses realized are included in the determination of income. Organizational Costs -- Organizational costs associated with the commencement of originating, purchasing, selling and servicing of Title I Loans are being amortized over a five year period which commenced on March 1, 1994. Such amortization is included in Depreciation and amortization. Accumulated amortization was $96, $289 and $434 at August 31, 1994 and 1995 and May 31, 1996, respectively. Loan Origination Costs and Fees -- Loan origination costs and fees including non-refundable Loan origination fees and incremental direct costs associated with Loan originations are deferred and amortized over the lives of the Loans. Unamortized Loan origination costs and fees are recorded as expense or income upon sale of the related Loans. Allowance for Losses on Loans Sold with Recourse -- Recourse to the Company on sales of Loans is governed by the agreements between the purchasers and the Company. The allowance for losses on Loans sold with recourse represents the Company's best estimate of its probable future credit losses to be incurred over the life of the Loans, giving effect to estimated FHA Insurance recoveries on Title I Loans. Net Loan Servicing Income -- Fees for servicing Loans originated or acquired by the Company and sold with servicing rights retained are generally based on a stipulated percentage of the outstanding principal balance of such Loans and are recognized when earned. Interest received on Loans sold, less amounts paid to investors, is reported as Net loan servicing income. Capitalized excess servicing rights are amortized systematically to reduce Net loan servicing income to an amount representing normal servicing income and the present value discount. Late charges and other ancillary income are recognized when collected. Costs to service Loans are charged to income as incurred. Income Taxes -- For Federal income tax purposes the Company reports its income in a consolidated return filed by its parent, Mego Financial. As part of a tax sharing arrangement, the Company records a liability to Mego Financial for Federal income taxes calculated at the Federal statutory rate (currently 34%) applied to the Company's financial statement income before giving consideration to income tax expense. The Company also provides for state income taxes at the rate of 6% of Income before income taxes. Recently Issued Accounting Standards -- The Financial Accounting Standards Board (the "FASB") has issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"). SFAS 121 requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. SFAS 121 is effective for fiscal years beginning after December 15, 1995. The Company has not determined the effect upon adoption on results of operation or financial condition. The FASB issued Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), which establishes financial accounting and reporting standards for stock-based employee compensation plans and for transactions in which an entity issues its equity instruments to acquire goods or services from nonemployees. SFAS 123 is generally effective for fiscal years beginning after December 15, 1995. The Company intends to provide the pro forma and other additional disclosure about stock-based employee compensation plans in its 1997 financial statements as required by SFAS 123. The FASB has issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement provides new accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. This statement also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings and requires that liabilities and derivatives incurred or obtained by transferors as part of a transfer of financial assets be initially measured at fair value. It also requires that servicing assets be measured by F-9 95 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) allocating the carrying amount between the assets sold and retained interests based on their relative fair values at the date of transfer. Additionally, this statement requires that the servicing assets and liabilities be subsequently measured by (a) amortization in proportion to and over the period of estimated net servicing income and (b) assessment for asset impairment or increased obligation based on their fair values. The Company has not adopted the new standard for the current period, but must adopt the new requirements effective January 1, 1997. The Company has not determined the effect on results of operations or financial condition in the period of adoption. Use of Estimates -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Income (Loss) Per Share -- Shares used in computing income (loss) per share include the weighted average of common stock outstanding during the period adjusted for the proposed sixteen-hundred-for-one stock split. There are no common stock equivalents. Reclassification -- Certain prior years information has been reclassified to conform with current period presentation. Stock Split -- The accompanying financial statements retroactively reflect a proposed sixteen-hundred-for-one stock split, an increase in authorized shares of Common Stock to 50,000,000 and the establishment of a $.01 par value per share which are to be effective before the effective date of the Registration Statement covering shares issued in the Company's initial public offering of its Common Stock. 3. FAIR VALUES OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosure about Fair Value of Financial Instruments" ("SFAS 107"), requires disclosure of fair value information about financial instruments, whether or not recognized in the statement of financial condition. Fair values are based on estimates using present value or other valuation techniques in cases where quoted market prices are not available. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. F-10 96 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Estimated fair values, carrying values and various methods and assumptions used in valuing the Company's financial instruments at May 31, 1996 are set forth below (in thousands of dollars).
CARRYING ESTIMATED FAIR VALUE VALUE -------- -------------- Financial Assets: Cash(a).............................................................. $ 841 $ 841 Loans held for sale, net(b).......................................... 4,671 4,814 Mortgage related securities(c)....................................... 15,144 15,144 Excess servicing rights(c)........................................... 12,796 12,796 Mortgage servicing rights(c)......................................... 2,738 2,738 Financial Liabilities: Notes and contracts payable(d)....................................... 8,872 8,872
- ------------------------ (a) The carrying value of cash is considered to be a reasonable estimate of fair value. (b) Since it is the Company's business to sell loans it originates, the fair value was estimated by using current investor yields or outstanding commitments from investors after consideration of non-qualified loans and the collateral securing such loans. (c) The fair value was estimated by discounting future cash flows using rates available for instruments with similar terms and remaining maturities. (d) Notes payable generally are adjustable rate and indexed to the prime rate; therefore, carrying value is a reasonable estimate of fair value. Contracts payable represent capitalized equipment leases with implicit fixed interest rates ranging from 8.81% to 9.93%, which approximate fair value in the aggregate. The fair value estimates made at May 31, 1996 were based upon pertinent market data and relevant information on the financial instruments at that time. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire portion of the financial instrument. Because no market exists for a portion of the financial instruments, fair value estimates may be based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For instance, the Company has certain fee-generating business lines (e.g., its loan servicing operations) that were not considered in these estimates since these activities are not financial instruments. In addition, the tax implications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates. Off-Balance Sheet Activities -- The Company is exposed to on-balance sheet credit risk related to its loans held for sale and mortgage related securities. The Company is exposed to off-balance sheet credit risk related to loans which the Company has committed to originate. The Company is party to financial instruments with off-balance sheet credit risk in the normal course of business. These financial instruments include commitments to extend credit to borrowers and commitments to purchase loans from others. As of August 31, 1995 and May 31, 1996, the Company had outstanding commitments to extend credit or purchase loans in the amounts of $53,447,000 and $49,120,000, respectively. F-11 97 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 4. LOANS HELD FOR SALE, NET Loans held for sale, net (in thousands of dollars) consisted of the following at:
AUGUST 31, ----------------- MAY 31, 1994 1995 1996 ------ ------ ----------- (UNAUDITED) Loans held for sale................................... $1,493 $3,750 $ 4,766 Less: Allowance for credit losses..................... 30 74 95 ------ ------ ------ Net total................................... $1,463 $3,676 $ 4,671 ====== ====== ======
The serviced Loan portfolio which includes Loans sold to investors and Loans retained by the Company aggregate approximately $8,027,000, $92,286,000 and $171,048,000 at August 31, 1994 and 1995 and May 31, 1996, respectively. At August 31, 1994 and 1995 and May 31, 1996, the Company was contingently liable for losses, to the extent not covered by FHA insurance, with respect to Loans sold with recourse totaling $6,555,000, $88,565,000 and $83,801,000, respectively. During the years ended August 31, 1994 and 1995 and the nine months ended May 31, 1996, the Company originated 497, 5,818 and 5,900 Title I and conventional loans respectively, with Loan proceeds of $8,133,000, $87,751,000 and $89,391,000, respectively. Additionally, the Company was servicing 11,700 Loans with an unpaid principal balance of $171,048,000 at May 31, 1996. The Company provides an allowance for credit losses, in an amount which in the Company's judgment will be adequate to absorb losses after FHA insurance recoveries on the Loans, that may become uncollectible. The Company's judgment in determining the adequacy of this allowance is based on its continual review of its portfolio of Loans which utilizes historical experience and current economic factors. These reviews take into consideration changes in the nature and level of the portfolio, current and future economic conditions which may affect the obligor's ability to pay, collateral values and overall portfolio quality. Changes in the allowance for credit losses for Loans (in thousands of dollars) consisted of the following:
FOR THE YEARS ENDED AUGUST FOR THE NINE 31, MONTHS ENDED ------------- MAY 31, 1994 1995 1996 ---- ---- ------------ (UNAUDITED) Balance at beginning of year............................. $-- $ 96 $ 960 Provisions for credit losses on Company generated Loans.................................................. 68 864 815 Provision for credit losses on acquired Loans............ 28 -- -- Reductions due to reacquisition and securitization....... -- -- (842) --- ---- ----- Balance at end of year................................... $96 $960 $ 933 === ==== ===== Allowance for credit losses.............................. $30 $ 74 $ 95 Allowance for Loans sold with recourse................... 66 886 838 --- ---- ----- Total.......................................... $96 $960 $ 933 === ==== =====
F-12 98 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 5. MORTGAGE RELATED SECURITIES Mortgage related securities are classified as trading securities and are carried at estimated market value. Changes in the estimated market value are recorded in current operations. As of May 31, 1996 mortgage related securities (in thousands of dollars) consisted of the following: Interest only security..................................................... $ 2,992 Residual interest security................................................. 12,152 ------- Total............................................................ $15,144 =======
6. EXCESS SERVICING RIGHTS Activity in excess servicing rights (in thousands of dollars) consisted of the following:
FOR THE YEARS FOR THE NINE MONTHS ENDED AUGUST 31, ENDED MAY 31, ---------------- ------------------- 1994 1995 1995 1996 ---- ------- ------ -------- Beginning balance............................. $ -- $ 904 $ 904 $ 14,483 Plus additions................................ 904 14,098 7,084 15,675 Less amortization............................. -- (519) (241) (1,730) Less transfers to securities.................. -- -- -- (15,632) ---- ------- ------ -------- Ending balance...................... $904 $14,483 $7,747 $ 12,796 ==== ======= ====== ========
The Company sold $6,555,000, $85,182,000 and $88,073,000 of Title I Loans in the fiscal years ended August 31, 1994 and 1995 and the nine months ended May 31, 1996, respectively, at an average yield to the purchaser of 8.5%, 8.4% and 7.1%, respectively. During the nine months ended May 31, 1995 and 1996, the Company sold $55,889,000 and $88,073,000 of Title I Loans to financial institutions. From the proceeds $43,688,000 and $79,856,000, respectively, were used to pay debt. The Title I Loans bear interest rates averaging 14.5% and 14.3%, respectively, and were sold to yield returns averaging 8.6% and 7.1%, respectively, to the purchaser, with any excess interest received from the obligors being payable to the Company. During the years ended August 31, 1994 and 1995 and the nine months ended May 31, 1996, amortization of the Excess servicing rights was zero, $519,000 and $1,730,000, respectively, and reduces Net loan servicing income. Of the Title I Loans sold in the year ended August 31, 1995, $56,922,000 of such Loans were sold to a purchaser, in a series of sales commencing on April 21, 1995, under a continuing sales agreement which provides for the yield to the purchaser to be adjusted monthly to a rate equal to 200 basis points (2%) per annum over the one-month London Interbank Offered Rate ("LIBOR"). LIBOR was 5.875% per annum at August 31, 1995. Certain loans were reacquired and sold as part of a securitization in March 1996. The principal balance of Loans subject to the LIBOR adjustment was $28,823,000 at May 31, 1996. The effect of an increase or decrease in LIBOR of 100 basis points (1.0%) applied to those Loans would be a decrease or increase, respectively, to the Company's future pre-tax income of approximately $953,000. The Company's serviced portfolio is geographically diversified within the United States. The Company services mortgage loans in 45 states and the District of Columbia. At May 31, 1996, 38% of the dollar value of loans serviced had been originated in California and no other state accounted for more than 10% of the serviced portfolio. The risk inherent in such concentration is dependent upon regional and general economic stability which affects property values and the financial well-being of the borrowers. F-13 99 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 7. MORTGAGE SERVICING RIGHTS Activity in mortgage servicing rights (in thousands of dollars) consisted of the following:
FOR THE YEARS FOR THE NINE ENDED AUGUST MONTHS ENDED 31, MAY 31, --------------- --------------- 1994 1995 1995 1996 ---- ------ ---- ------ Beginning balance.................................. $ -- $ -- $ -- $1,076 Plus additions..................................... -- 1,176 697 2,023 Less amortization.................................. -- (100) (46) (361) ---- ------ ---- ------ Ending balance........................... $ -- $1,076 $651 $2,738 ==== ====== ==== ======
As indicated in Note 2, the Company adopted the provisions of SFAS No. 122 effective September 1, 1994. 8. PROPERTY AND EQUIPMENT Property and equipment (in thousands of dollars) consisted of the following at:
AUGUST 31, -------------- MAY 31, 1994 1995 1996 ---- ----- ------- Office equipment and furnishings......................... $180 $ 337 $ 617 Vehicles................................................. -- 34 34 EDP equipment............................................ 83 166 374 ---- ----- ------- 263 537 1,025 Less accumulated depreciation............................ (26) (108) (225 ) ---- ----- ------- Total property and equipment, net.............. $237 $ 429 $ 800 ==== ===== ========
9. OTHER ASSETS Other assets (in thousands of dollars) consisted of the following at:
AUGUST 31, ------------- MAY 31, 1994 1995 1996 ---- ---- ----------- (UNAUDITED) Deferred loan costs...................................... $ 50 $129 $ 104 Software costs, net of amortization (Note 13)............ 117 127 163 Other.................................................... 71 60 298 ---- ---- ---- Total.......................................... $238 $316 $ 565 ==== ==== ====
10. NOTES AND CONTRACTS PAYABLE Notes and contracts payable (in thousands of dollars) consisted of the following at:
AUGUST 31, ------------- MAY 31, 1994 1995 1996 ---- ------ ----------- (UNAUDITED) Note payable -- warehouse line of credit.................... $373 $1,039 $ 3,012 Note payable -- demand...................................... -- -- 5,000 Contracts payable........................................... 264 419 860 ---- ------ ------ Total............................................. $637 $1,458 $ 8,872 ==== ====== ======
F-14 100 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Notes payable at May 31, 1996 included $3,012,000 of borrowings outstanding under a Warehousing Credit and Security Agreement with a bank that provides available credit facilities up to $20,000,000. The outstanding borrowings bear interest at the bank's prevailing prime rate plus 1% (9.25% at May 31, 1996) and are collateralized by security interests in the Company's Loans held for sale. The revolving line of credit is due for renewal on August 9, 1997. Availability of borrowings under this credit facility is subject to certain conditions as specified in such agreement. Beginning as of August 11, 1995, the terms of this credit facility contain, among other provisions, financial covenants requiring the maintenance of a minimum tangible net worth of $7,500,000 (changed to $12,500,000 in August 1996), a minimum level of profitability of at last $500,000 per six month period and certain restrictions, including but not limited to, restrictions on additional indebtedness. This note is guaranteed by Mego Financial. In addition to the $20.0 million warehouse line of credit, at May 31, 1996, the Company had a $5.0 million demand note facility from the same lender expiring August 31, 1996, bearing interest at the bank's prime rate plus 2%, with respect to which $5.0 million was outstanding on that date. This facility was secured by a pledge of the Company's Excess servicing rights (together with the Mortgage related securities). As of June 28, 1996, this facility was replaced by a $10.0 million revolving credit loan from the same lender, with the same security. The new facility has an eighteen month revolving credit period followed by a thirty month payment period, and requires the Company to maintain a minimum tangible net worth of $12.5 million and a minimum level of profitability of at least $500,000 per rolling six month period. Borrowings under this facility cannot exceed the lesser of (a) 40% of the Company's Excess servicing rights and Mortgage related securities or (b) six times the aggregate of the Excess servicing rights and Mortgage related securities payments actually received by the Company over the most recent three month period. The agreement contains certain restrictions, including but not limited to, restrictions on additional indebtedness. Both lines of credit have been guaranteed by Mego Financial. At August 31, 1994 and 1995 and the nine months ended May 31, 1996, Contracts payable consisted of $264,000, $419,000 and $860,000, respectively, in obligations under lease purchase arrangements secured by Property and equipment, bearing an interest rate of prime plus 1%. The prime rate of interest was 8.25% at May 31, 1996. Scheduled maturities of the Company's debt, excluding lines of credit of $8,012,000 at May 31, 1996 are as follows (in thousands of dollars):
FOR THE YEARS ENDED AUGUST 31, ------------------------------------------------------- TOTAL 1996 1997 1998 1999 2000 THEREAFTER - ----- ---- ---- ---- ---- ---- ---------- $860 $46 $224 $246 $192 $145 $7 ==== === ==== ==== ==== ====
11. PAID IN CAPITAL During fiscal 1995, Mego Financial contributed $3,000,000 to the Company as Additional paid in capital. During fiscal 1994, Mego Financial contributed $650,000 to the Company as Additional paid in capital by the issuance of 475,000 shares of Common Stock of Mego Financial to an unrelated company for its services in obtaining the necessary HUD approval, state licensing and other matters in connection with the organization of the Company. 12. COMMITMENTS The Company leases its main office under the terms of a lease that expires March 31, 1999. During fiscal 1994, 1995 and the nine months ended May 31, 1996, the Company's rent expense related to this lease was $54,000, $154,000 and $123,000, respectively. Future minimum rental payments under the lease (in thousands of dollars) are set forth below. In April 1996, the Company executed a lease in another location on space for F-15 101 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) its main offices which it will occupy in September 1996. The 1996 lease commences September 1, 1996, expires August 31, 2002 and is guaranteed by Mego Financial. Future minimum rental payments under the lease (in thousands of dollars) are set forth below.
1995 1996 FOR THE YEARS ENDED AUGUST 31, LEASE LEASE ---------------------------------------------------------------------- ----- ------ 1996.................................................................. $ 42 $ -- 1997.................................................................. 169 774 1998.................................................................. 169 902 1999.................................................................. 84 921 2000.................................................................. -- 939 Thereafter............................................................ -- 1,935 ---- ------ Total....................................................... $ 464 $5,471 ==== ======
13. RELATED PARTY TRANSACTIONS During the years ended August 31, 1994 and 1995 and the nine months ended May 31, 1996, an affiliated company, Preferred Equities Corporation ("PEC"), provided certain services to the Company including loan servicing and collection of $13,000, $174,000 and $479,000, respectively. In addition, certain expenses including executive, accounting, legal, management information, advertising and promotional materials totalling $442,000, $690,000 and $503,000 are included in General and administrative expenses for the years ended August 31, 1994 and 1995 and the nine months ended May 31, 1996, respectively. Included in Interest expense for the year ended August 31, 1995 and the nine months ended May 31, 1996, is $85,000 and $23,000 related to advances from PEC. At August 31, 1995, PEC transferred the related receivable to Mego Financial. During the years ended August 31, 1994, 1995 and the nine months ended May 31, 1996, the Company paid PEC for developing certain computer programming (see Note 8), incurring costs of $130,000, $36,000 and $56,000, respectively. The Company is amortizing these costs over a five year period. During fiscal 1994 and 1995 and for the nine months ended May 31, 1996, amortization of $13,000, $26,000 and $20,000, respectively, was included in expense. At May 31, 1996 and at August 31, 1995, the Company had a non-interest bearing liability to Mego Financial of $11,963,000 and $8,453,000, respectively, for Federal income taxes and cash advances, which is due on demand and has not as yet been paid. At August 31, 1994, the Company had a receivable from PEC of $276,000 resulting from an adjustment in charges for services to the Company, which amount was subsequently paid during September 1994. It is the Company's belief that Mego Financial, its parent, will continue to provide the Company with sufficient financial support, as circumstances warrant, to enable the Company to meet its obligations as they become due. However, Mego Financial has no contractual obligation to provide such support other than its guaranty of the warehouse line of credit, revolving credit loan and operating lease described in Notes 10 and 12. F-16 102 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) 14. INCOME TAXES As described in Note 2, the Company records a liability to Mego Financial for Federal income taxes at the statutory rate (currently 34%) applied to Income before income taxes. State income taxes are computed at the appropriate state rate (6%) net of any available operating loss carryovers and are recorded as State income taxes payable. For the years ended August 31, 1994 and 1995, Income tax expense has been computed (in thousands of dollars) as follows:
FOR THE YEARS ENDED FOR THE NINE AUGUST 31, MONTHS ENDED ---------------- MAY 31, 1994 1995 1996 ------- ------ ------------ (UNAUDITED) Income (loss) before income taxes....................... $(1,511) $5,919 $7,463 ======= ====== ====== Federal income taxes at 34% of income................... $ -- $2,013 $2,385 State income taxes at 6% of income after application of prior year carryforward............................... -- 264 448 ------- ------ ------ Income tax expense...................................... $ -- $2,277 $2,833 ======= ====== ======
As part of a tax sharing arrangement, the Company records a liability to its parent, Mego Financial, for Federal income taxes calculated at the Federal statutory rate (currently 34%) applied to the Company's financial statement income before giving consideration to income tax expense. Income tax expense (benefit) is comprised of the following:
YEARS ENDED AUGUST 31, NINE MONTHS ------------------ ENDED MAY 1994 1995 31, 1996 ----- ------ ----------- Current........................................... $ -- $1,670 $ 1,340 Deferred.......................................... -- 607 1,493 ----- ------ ----------- Total................................... $ -- $2,277 $ 2,833 ===== ====== ============
F-17 103 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, (b) temporary differences between the timing of revenue recognition for book purposes and income tax purposes and (c) operating loss and tax credit carryforwards. The tax effects of significant items comprising the Company's net deferred tax liability as of August 31, 1994 and 1995, and May 31, 1996 (in thousands of dollars), are as follows:
AUGUST 31, ---------------- MAY 31, 1994 1995 1996 ----- ------ ------- Deferred tax liabilities: Difference between book and tax carrying value of assets........................................... $ -- $ 1 $ 117 Timing of revenue recognition...................... -- 541 1,283 Mortgage servicing rights.......................... -- 366 931 ----- ------ ------- -- 908 2,331 ----- ------ ------- Deferred tax assets: Operating loss carryforward........................ 514 -- -- Difference between book and tax carrying value of assets........................................... 5 -- -- Timing of revenue recognition...................... 22 301 285 ----- ------ ------- 541 301 285 ----- ------ ------- Valuation allowance..................................... 541 -- -- ----- ------ ------- Net deferred tax liability.................... $ -- $ 607 $2,046 ----- ------ -------
15. RESTATEMENT Subsequent to the issuance of its financial statements for the year ended August 31, 1994, the Company determined that certain adjustments were required to be made to the previously reported amounts as of and for the year ended August 31, 1994. As a result, the Company restated such previously reported amounts to reflect appropriate estimates and assumptions used to determine the discounted revenue related to the gain on Loans sold by the Company during fiscal 1994, to properly record deferred loan origination costs included in Loans held for sale, net and to write-off certain expenses previously included in Organizational costs. The restatement also included other miscellaneous adjustments. A summary of the effect of the restatement on the Balance Sheet at August 31, 1994 is as follows (in thousands of dollars):
AS PREVIOUSLY REPORTED AS RESTATED ------------- ----------- Loans held for sale, net...................................... $ 1,416 $ 1,463 Excess servicing rights....................................... 1,246 904 Due from affiliate............................................ 145 276 Organizational costs, net of amortization..................... 1,756 867 Other assets.................................................. 271 238 Accounts payable and accrued liabilities...................... 230 280 Allowance for losses on Loans sold with recourse.............. 59 66 Accumulated deficit........................................... (368) (1,511)
F-18 104 MEGO MORTGAGE CORPORATION NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) A summary of the effect of the restatement on the Statement of Operations for the year ended August 31, 1994 is as follows (in thousands of dollars):
AS PREVIOUSLY REPORTED AS RESTATED ------------- ----------- Gain on sale of Loans......................................... $ 1,206 $ 579 Interest income............................................... 298 279 Interest...................................................... 79 129 Provision for credit losses................................... 133 96 Depreciation and amortization................................. 189 136 Commissions and selling....................................... -- 13 General and administrative.................................... 1,471 1,995 Net loss...................................................... (368) (1,511)
F-19 105 ------------------------------------------------------ ------------------------------------------------------ NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND ANY INFORMATION OR REPRESENTATION NOT CONTAINED HEREIN MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES TO WHICH IT RELATES OR AN OFFER TO ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF. ------------------------------ TABLE OF CONTENTS ------------------------------
PAGE ---- Prospectus Summary......................... 3 Risk Factors............................... 9 Use of Proceeds............................ 20 Capitalization............................. 21 Selected Financial Data.................... 22 Management's Discussion and Analysis of Financial Condition and Results of Operations............................ 24 Business................................... 33 Management................................. 48 Principal Stockholders..................... 52 Certain Transactions....................... 53 Description of the Notes................... 55 Underwriting............................... 82 Legal Matters.............................. 82 Experts.................................... 83 Additional Information..................... 83 Index to Financial Statements.............. F-1
UNTIL , 1996, ALL DEALERS EFFECTING TRANSACTIONS IN THE NOTES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. ------------------------------------------------------ ------------------------------------------------------ ------------------------------------------------------ ------------------------------------------------------ $40,000,000 MEGO MORTGAGE CORPORATION % SENIOR SUBORDINATED NOTES DUE 2001 ------------------------------ PROSPECTUS ------------------------------ FRIEDMAN, BILLINGS, RAMSEY & CO., INC. OPPENHEIMER & CO., INC. , 1996 ------------------------------------------------------ ------------------------------------------------------ 106 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The Registrant estimates that expenses in connection with the offering described in this registration statement will be as follows: Securities and Exchange Commission registration fee....................... $ 12,122 NASD filing fee........................................................... 4,500 Printing expenses......................................................... * Accounting fees and expenses.............................................. * Legal fees and expenses................................................... * Fees and expenses (including legal fees) for qualifications under state securities laws......................................................... * Transfer agent's fees and expenses........................................ * Miscellaneous............................................................. * -------- Total........................................................... $ * ========
- --------------- * To be provided by amendment All amounts except the Securities and Exchange Commission registration fee and the NASD filing fee are estimated. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Section 145(a) of the Delaware General Corporation Law (the "GCL") provides that a Delaware corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that such person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation or enterprise, against expenses, judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding if he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no cause to believe his or her conduct was unlawful. Section 145(b) of the GCL provides that a Delaware corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that such person acted in any of the capacities set forth above, against expenses actually and reasonably incurred by such person in connection with the defense or settlement of such action or suit if he or she acted under similar standards, except that no indemnification may be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his or her duty to the corporation unless and only to the extent that the court in which such action or suit was brought shall determine that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to be indemnified for such expenses which the court shall deem proper. Section 145 of GCL further provides that to the extent a director or officer of a corporation has been successful in the defense of any action, suit or proceeding referred to in subsection (a) and (b) or in the defense of any claim, issue or matter therein, such officer or director shall be indemnified against expenses actually and reasonably incurred by him or her in connection therewith; that indemnification provided for by Section 145 shall not be deemed exclusive of any other rights to which the indemnified party may be entitled; and that the corporation may purchase and maintain insurance on behalf of a director or officer of the II-1 107 corporation against any liability asserted against such officer or director and incurred by him or her in any such capacity or arising out of his or her status as such, whether or not the corporation would have the power to indemnify him or her against such liabilities under Section 145. As permitted by Section 102(b)(7) of the GCL, the Company's Amended and Restated Certificate of Incorporation provides that a director shall not be liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director. However, such provision does not eliminate or limit the liability of a director for acts or omissions not in good faith or for breaching his or her duty of loyalty, engaging in intentional misconduct or knowingly violating a law, paying a dividend or approving a stock repurchase which was illegal, or obtaining an improper personal benefit. A provision of this type has no effect on the availability of equitable remedies, such as injunction or rescission, for breach of fiduciary duty. The Company's Bylaws require the Company to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Company) by reason of the fact that he is or was a director, officer, employee or agent of the Company, or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company, and with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, does not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal action or proceeding, that he had reasonable cause to believe that his conduct was unlawful. In addition, the Company's Bylaws require the Company to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Company to procure a judgment in its favor by reason of the fact that he is or was a director, officer, employee or agent of the Company, or is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company, except that no indemnification may be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable for negligence or misconduct in the performance of his duty to the Company unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. Any indemnification (unless ordered by a court) made by the Company may be only as authorized in the specific case upon a determination that indemnification of the director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct as set forth above. Such determination must be made (i) by the Board by a majority vote of a quorum consisting of directors who were not parties to such action, suit or proceeding, or (ii) if such a quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (iii) by the stockholders. To the extent that a director, officer, employee or agent of the Company has been successful on the merits or otherwise in defense of any covered action, suit or proceeding, or in defense of any covered claim, issue or matter therein, he will be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. Expenses incurred by an officer or director in defending a civil or criminal action, suit or proceeding may be paid by the Company in advance of the final disposition of such action, suit or proceeding as authorized by II-2 108 the Board in the specific case upon receipt of an undertaking by or on behalf of the director or officer to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the Company as authorized in the Amended and Restated Certificate of Incorporation. Such expenses incurred by other employees and agents may be so paid upon such terms and conditions, if any, as the Board deems appropriate. The Company presently maintains policies of directors' and officers' liability insurance in the amount of $30.0 million. Pursuant to the Underwriting Agreement to be filed as Exhibit 1.1 to this Registration Statement, the Underwriters have agreed to indemnify the directors, officers and controlling persons of the Registrant against certain civil liabilities that may be incurred in connection with the Offering, including certain liabilities under the Securities Act of 1933, as amended. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. No securities that were not registered under the 1933 Act have been issued or sold by the Registrant within the past three years. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits:
EXHIBIT NUMBER DESCRIPTION - -------- -------------------------------------------------------------------------------- 1.1* -- Underwriting Agreement. 3.1* -- Amended and Restated Certificate of Incorporation of the Registrant. 3.2* -- By-laws of the Registrant, as amended. 4.1* -- Form of Note. 4.2* -- Form of Indenture. 5.1* -- Opinion of Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quentel, P.A. 10.1* -- Stock Option Plan 10.2(1) -- Agreement for Line of Credit and Commercial Promissory Note between the Registrant and First National Bank of Boston, dated January 4, 1994. 10.3(1) -- Agreement between the Registrant and Hamilton Consulting, Inc., dated January 31, 1994. 10.4(1) -- Loan Purchase and Sale Agreement dated March 22, 1994, between the Registrant as Buyer, and Southwest Beneficial Finance, Inc. as Seller. 10.5(1) -- Master Loan Purchase and Servicing Agreement dated as of August 26, 1994, between the Registrant as Seller, and First National Bank of Boston, as Purchaser. 10.6(2) -- Master Loan Purchase and Servicing Agreement dated April 1, 1995, by and between Greenwich Capital Financial Products, Inc. and the Registrant. 10.7(2) -- Participation and Servicing Agreement dated May 25, 1995, by and between Atlantic Bank, N.A. and the Registrant. 10.8(2) -- Warehousing Credit and Security Agreement, dated as of August 11, 1995, between the Registrant and First National Bank of Boston. 10.9* -- Tax Sharing Agreement among the Registrant, Mego Financial Corp., Preferred Equities Corporation and the subsidiaries of Preferred Equities Corporation. 10.10* -- Servicing Agreement between the Registrant and Preferred Equities Corporation. 10.11(3) -- Servicing Agreement by and among Mego Mortgage FHA Title I Loan Trust 1996-1, First Trust of New York, National Association, as Trustee, Norwest Bank Minnesota, N.A., as Master Servicer and the Registrant, as Servicer dated as of March 21, 1996. 10.12(3) -- Loan Purchase Agreement between Financial Asset Securities Corp., as Purchaser, and the Registrant, as Seller, dated as of March 21, 1996. 10.13 -- Indemnification Agreement among MBIA Insurance Corporation, as Insurer, the Registrant, as Seller and Greenwich Capital Markets, Inc. as Underwriter, dated as of March 29, 1996.
II-3 109
EXHIBIT NUMBER DESCRIPTION - -------- -------------------------------------------------------------------------------- 10.14(3) -- Pooling and Servicing Agreement, dated as of March 21, 1996, among the Registrant, Financial Asset Securities Corp., as Depositor, First Trust of New York, National Association, as Trustee and Contract of Insurance Holder and Norwest Bank Minnesota, N.A., as Master Servicer. 10.15 -- Insurance Agreement among MBIA Insurance Corporation, as Insurer, Norwest Bank Minnesota, N.A., as Master Servicer, the Registrant, as Seller, Servicer and Claims Administrator, Financial Asset Securities Corp., as Depositor, Greenwich Capital Financial Products, Inc., and First Trust of New York, National Association, as Trustee and Contract of Insurance Holder, dated as of March 21, 1996. 10.16 -- Credit Agreement dated as of June 28, 1996 between the Registrant and First National Bank of Boston as Agent. 10.17(3) -- Loan Purchase Agreement dated as of August 1, 1996 between Financial Asset Securities Corp., as Purchaser, and the Registrant, as Seller. 10.18(3) -- Pooling and Servicing Agreement dated as of August 1, 1996 between Financial Asset Securities Corp., as Purchaser, and the Registrant, as Seller. 10.19 -- Amendment No. 1 to Warehousing Credit and Security Agreement dated as of August 9, 1996 between the Registrant and First National Bank of Boston. 10.20* -- Office Lease by and between MassMutual and the Registrant dated April 1996. 10.21 -- Amendment to Master Loan Purchase and Servicing Agreement between Greenwich Capital Financial Products, Inc. and the Registrant dated February 1, 1996. 10.22 -- Amendment No. 2 to Master Loan Purchase and Servicing Agreement between Greenwich Capital Financial Products, Inc. and the Registrant dated July 1, 1996. 10.23* -- Management Agreement between Mego Financial Corp. and the Registrant dated October 1996. 10.24 -- Employment Agreement between the Registrant and Jeffrey S. Moore dated January 1, 1994. 12.1(3) -- Computation of Ratio of Earnings to Fixed Charges. 21.1(3) -- Subsidiaries of the Registrant. 23.1* -- Consent of Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quentel, P.A. (to be included in its opinion to be filed as Exhibit 5.1*). 23.2 -- Consent of Deloitte & Touche LLP. 24.1 -- Reference is made to the Signatures section of this Registration Statement for the Power of Attorney contained therein. 25.1* -- Statement of Eligibility of Trustee. 27.1(3) -- Financial Data Schedule (for SEC use only)
- --------------- * To be filed by amendment (1) Filed as part of the Form 10-K for the fiscal year ended August 31, 1994 of Mego Financial Corp. and incorporated herein by reference. (2) Filed as part of the Form 10-K for the fiscal year ended August 31, 1995 of Mego Financial Corp. and incorporated herein by reference. (3) Filed as part of the Registration Statement on Form S-1 filed by the Company on September 20, 1996 (File No. 333-12443) and incorporated herein by reference. ITEM 17. UNDERTAKINGS. (a) The undersigned registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. (b) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, II-4 110 the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (c) The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 111 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Atlanta, State of Georgia, on October 3, 1996. MEGO MORTGAGE CORPORATION By: /s/ JEROME J. COHEN ------------------------------------ Jerome J. Cohen, Chairman of the Board and Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jerome J. Cohen and Don A. Mayerson and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution for him and in his name, place and stead, in any and all capacities to sign any and all amendments (including post-effective amendments) to this Registration Statement, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that each said attorneys-in-fact and agents or any of them or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the date indicated.
SIGNATURE TITLE DATE - --------------------------------------------- --------------------------- ------------------- /s/ JEROME J. COHEN Chairman of the Board and October 3, 1996 - --------------------------------------------- Chief Executive Officer Jerome J. Cohen /s/ JEFFREY S. MOORE President, Chief Operating October 3, 1996 - --------------------------------------------- Officer and Director Jeffrey S. Moore /s/ JAMES L. BELTER Executive Vice President October 3, 1996 - --------------------------------------------- and Chief Financial James L. Belter Officer /s/ ROBERT NEDERLANDER Director October 3, 1996 - --------------------------------------------- Robert Nederlander /s/ HERBERT B. HIRSCH Director October 3, 1996 - --------------------------------------------- Herbert B. Hirsch /s/ DON A. MAYERSON Director October 3, 1996 - --------------------------------------------- Don A. Mayerson
II-6 EX-10.13 2 INDEMNIFICATION AGREEMENT 1 EXHIBIT 10.13 EXECUTION COPY ================================================================================ MBIA INSURANCE CORPORATION, as Insurer MEGO MORTGAGE CORPORATION, as Seller and GREENWICH CAPITAL MARKETS, INC. as Underwriter INDEMNIFICATION AGREEMENT Mego Mortgage FHA Title I Loan Trust 1996-1 FHA Title I Loan Asset-Backed Certificates, Series 1996-1 Class A-1, Class A-2, Class A-3 and Class S Dated as of March 29, 1996 ================================================================================ 2 TABLE OF CONTENTS
Page ---- Section 1. Definitions...................................................................1 Section 2. Representations and Warranties of the Insurer.................................2 Section 3. Agreements, Representations and Warranties of the Underwriter.................3 Section 4. Agreements, Representations and Warranties of the Seller......................3 Section 5. Indemnification...............................................................5 Section 6. Insurer Undertaking...........................................................5 Section 7. Notice To Be Given Insurer....................................................5 Section 8. Notice To Be Given the Underwriter............................................6 Section 9. Notice To Be Given the Seller.................................................7 Section 10. Contribution..................................................................8 Section 11 Notices.......................................................................9 Section 12. Governing Law, Etc...........................................................10 Section 13. Insurance Agreement..........................................................10 Section 14. Limitations..................................................................10 Section 15. Counterparts.................................................................10 TESTIMONIUM....................................................................Signature Page SIGNATURES.....................................................................Signature Page
3 INDEMNIFICATION AGREEMENT This Agreement, dated as of March 29, 1996 (this "Agreement"), is by and among MBIA Insurance Corporation (the "Insurer"), as the Insurer under the Certificate Guaranty Insurance Policy (the "Policy") issued in connection with the Certificates described below, Mortgage Corporation (the "Seller") and Greenwich Capital Markets, Inc. (the "Underwriter"). Section 1. DEFINITIONS. As used in this Agreement, the following terms shall have the respective meanings stated herein, unless the context clearly requires otherwise, in both singular and plural form, as appropriate. Capitalized terms used in this Agreement but not otherwise defined herein will have the meanings ascribed to such terms in the Pooling and Servicing Agreement (as defined below). "Act" means the Securities Act of 1933, as amended, together with all related rules and regulations. "Certificates" means the Mego Mortgage FHA Title I Loan Trust 1996-1, FHA Title I Loan Asset-Backed Certificates, Series 1996-1 issued pursuant to the Pooling and Servicing Agreement. "Depositor" means Financial Asset Securities Corp. "Indemnified Party" means any party entitled to any indemnification pursuant to Section 5 below, as the context requires. "Indemnifying Party" means any party required to provide indemnification pursuant to Section 5 below, as the context requires. "Insurance Agreement" means the Insurance Agreement, dated as of March 21, 1996, by and among the Seller, as seller, claims administrator and servicer, the Depositor, First Trust of New York, National Association, as trustee, Norwest Bank Minnesota, N.A., as master servicer and the Insurer. "Insurer Party" means the Insurer and its respective parents, subsidiaries and affiliates and any shareholder, director, officer, employee, agent or any "controlling person" (as such term is used in the Act) of any of the foregoing. "Losses" means (i) any actual out-of-pocket loss paid by the party entitled to indemnification or contribution hereunder and (ii) any actual out-of-pocket costs and expenses paid by such party, including reasonable fees and expenses of its counsel, to the extent not paid, satisfied or reimbursed from funds provided by any other Person (provided that the foregoing shall not create or imply any obligation to pursue recourse against any such other Person). 4 "Person" means any individual, partnership, joint venture, corporation, trust fund or unincorporated organization or any government or agency or political subdivision thereof. "Pooling and Servicing Agreement" means the Pooling and Servicing Agreement dated as of March 21, 1996 among the Depositor, as depositor, the Seller, seller, claims administrator and servicer, and First Trust of New York, National Association, as trustee. "Prospectus Supplement" means the Prospectus Supplement with respect to the Class A Certificates dated March 28, 1996. "Seller Party" means the Seller, each of its parents, subsidiaries and affiliates and any shareholder, director, officer, employee, agent or any "controlling person" (as such term is used in the Act) of any of the foregoing. "State Securities Law" means any state, local or foreign statute, and any rule or regulation thereunder, regulating (i) transactions and dealings in securities, (ii) any Person or entity engaging in such transactions or advising with respect to securities or (iii) investment companies. "Underwriting Party" means the Underwriter, each of its parents, subsidiaries and affiliates and any shareholder, director, officer, employee, agent or any "controlling person" (as such term is defined in the Act) or any of the foregoing. Section 2. REPRESENTATIONS AND WARRANTIES OF THE INSURER. The Insurer represents and warrants to the Seller as follows: (a) Organization and Licensing. The Insurer is a duly incorporated and existing New York stock insurance company licensed to transact financial guaranty insurance business under the laws of the State of New York. (b) Corporate Power. The Insurer has the corporate power and authority to issue the Policy and execute and deliver this Agreement and the Insurance Agreement and to perform all of its obligations hereunder and thereunder. (c) Authorization; Approvals. The issuance of the Policy and the execution, delivery and performance of this Agrreement and the Insurance Agreement have been duly 2 5 authorized by all necessary corporate proceedings. No further approvals or filings of any kind, including, without limitation, any further approvals of or further filings with any governmental agency or other governmental authority, or any approval of the Insurer's board of directors or stockholders, are necessary for the Policy, this Agreement and the Insurance Agreement to constitute the legal, valid and binding obligations of the Insurer. (d) Enforceability. The Policy, when issued, and this Agreement and the Insurance Agreement will each constitute a legal, valid and binding obligation of the Insurer, enforceable against the Insurer in accordance with its terms, subject, as to the enforcement of remedies, to bankruptcy, insolvency, reorganization, rehabilitation, moratorium and other similar laws affecting the enforceability of creditors' rights generally and to general principles of equity and, in the case of this Agreement, subject to principles of public policy limiting the right to enforce the indemnification provisions contained herein insofar as such provisions relate to indemnification for liabilities arising under the securities laws. (e) Financial Information. The balance sheet of the Insurer as of December 31, 1994 and the related statements of income, stockholders' equity and cash flows for the fiscal year then ended, and the accompanying footnotes, together with an opinion thereon dated February 1, 1995 of Coopers & Lybrand, independent certified public accountants, a copy of which is attached as Annex I to the Prospectus Supplement (the "Insurer Audited Financial Statements"), fairly present in all material respects the financial condition of the Insurer as of such date and for the period covered by such statements in accordance with generally accepted accounting principles consistently applied. The balance sheet of the Insurer as of September 30, 1995 and the related statements of income, stockholders' equity and cash flows for the period then ended, a copy of which is attached as Annex I to the Prospectus Supplement (the "Insurer Unaudited Financial Statements" and, together with the Insurer Audited Financial Statements, the "Insurer Financial Statements") present fairly in all material respects the financial condition of the Insurer as of such date and for the period covered by such statements in accordance with generally accepted accounting principles applied in a manner consistent with the accounting principles used in preparing the Insurer Audited Financial Statements, and, since September 30, 1995 there has been no material change in such financial condition of the Insurer which would materially and adversely affect its ability to perform its obligations under the Policy. (f) Insurer Information. The information in the Prospectus Supplement as of the date hereof under the captions "THE CERTIFICATE GUARANTY INSURANCE POLICY" and "THE CERTIFICATE INSURER" (the "Insurer Information") is true and correct in all material respects. 3 6 (g) No Litigation. There are no actions, suits, proceedings or investigations pending or, to the best of the Insurer's knowledge, threatened against it at law or in equity or before or by any court, governmental agency, board or commission or any arbitrator which, if decided adversely, would materially and adversely affect its condition (financial or otherwise) or operations or which would materially and adversely affect its ability to perform its obligations under this Agreement, the Policy or the Insurance Agreement. (h) Exemption From Registration. The Policy is exempt from registration under the Act. Section 3. AGREEMENTS, REPRESENTATIONS AND WARRANTIES OF THE UNDERWRITER. The Underwriter represents and warrants to and agrees with the Seller and the Insurer that the information as of the date hereof under the caption "METHOD OF DISTRIBUTION" in the Prospectus Supplement and the third paragraph of page S-2 of the Prospectus Supplement (the "Underwriter Information") is true and correct in all material respects and does not contain any untrue statement of a material fact or omit to state therein a fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. Section 4. AGREEMENTS, REPRESENTATIONS AND WARRANTIES OF THE SELLER. The Seller represents and warrants to and agrees with the Insurer as follows: (a) Seller Information. The information in the "Prospectus Supplement (other than the Insurer Information, the Insurer Financial Statements and the Underwriter Information) (the "Seller Information") is true and correct in all material respects and does not contain any untrue statement of a material fact, or omit to state therein a fact necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. (b) Organization. The Seller is duly incorporated under the laws of the state of its incorporation. The Seller is in good standing in each jurisdiction in which the nature of its business, or the properties owned or leased by it, makes such qualification necessary. (c) Corporate Power. The Seller has the corporate power and authority to execute and deliver this Agreement, the Insurance Agreement and the Pooling and Servicing Agreement and to perform all of its obligations hereunder and thereunder. (d) Authorization; Approvals. The execution, delivery and performance of this Agreement, the Insurance Agreement and the Pooling and Servicing Agreement by the Seller have been duly authorized by all necessary corporate proceedings. No further 4 7 approvals or filings of any kind, including, without limitation, any further approvals of or further filing with any governmental agency or other governmental authority, or any approval of the Seller's board of directors or stockholders, are necessary for this Agreement, the Insurance Agreement and the Pooling and Servicing Agreement to constitute the legal, valid and binding obligations of the Seller. (e) Enforceability. This Agreement, the Insurance Agreement and the Pooling and Servicing Agreement will each constitute a legal, valid and binding obligation of the Seller, each enforceable in accordance with its terms, subject, as to the enforcement of remedies, to bankruptcy, insolvency, reorganization, moratorium and other similar laws affecting the enforceability of creditors' rights generally applicable in the event of the bankruptcy, insolvency or reorganization of the Seller and to general principles of equity and, in the case of this Agreement and the Insurance Agreement, subject to principles of public policy limiting the right to enforce the indemnification provisions contained herein insofar as such provisions relate to indemnification for liabilities arising under the securities laws. (f) No Litigation. There are no actions, suits, proceedings or investigations pending or, to the best of the Seller's knowledge, threatened against it at law or in equity or before any court, governmental agency, board or commission or any arbitrator which, if decided adversely, would materially and adversely affect its condition (financial or otherwise) or operations or which would materially and adversely affect its ability to perform its obligations under this Agreement, the Insurance Agreement or the Pooling and Servicing Agreement. (g) No Conflicts. To the extent material to the enforceability of the Insurance Agreement, this Agreement or the Pooling and Servicing Agreement, neither the execution by the Seller of the Insurance Agreement, this Agreement or the Pooling and Servicing Agreement, nor the performance by the Seller of its obligations thereunder, will conflict with any provisions of the certificate of incorporation or the bylaws of the Seller, nor result in a breach of, or constitute a default under, any material agreement or other instrument to which the Seller is a party or by which any of its property is bound, nor violate any judgment, order or decree applicable to the Seller of any governmental or regulatory body, administrative agency, court or arbitrator having jurisdiction over the Seller. Section 5. INDEMNIFICATION. (a) The Insurer hereby agrees, upon the terms and subject to the conditions of this Agreement, to indemnify, defend and hold harmless each Seller Party and each Underwriter Party against any and all Losses incurred by it with respect to the offer and sale of any of the Class A Certificates and resulting from the Insurer's breach of any of its representations and warranties set forth in Section 2 of this Agreement. (b) The Underwriter hereby agrees upon the terms and subject to the conditions of this Agreement, to indemnify, defend and hold harmless each Seller Party and each Insurer Party 5 8 against any and all Losses incurred by it with respect to the offer and sale of any Certificates and resulting from the Underwriter's breach of any of its representations and warranties set forth in Section 3 of this Agreement. (c) The Seller hereby agrees, upon the terms and subject to the conditions of this Agreement, to indemnify, defend and hold harmless each Insurer Party against any and all Losses incurred by it with respect to the offer and sale of any of the Certificates and resulting from the Seller's breach of any of its representations and warranties set forth in Section 4 of this Agreement. (d) Upon the incurrence of any Losses entitled to indemnification hereunder, the Indemnifying Party shall reimburse the Indemnified Party promptly upon establishment by the Indemnified Party to the Indemnifying Party of the Losses incurred. Section 6. INSURER UNDERTAKING. The Insurer hereby agrees that, in connection with the sale of any of the Certificates, the Insurer will furnish to either the Underwriter or the Seller, upon written request of such party and not at the expense of the Insurer, copies of the Insurer's most recent financial statements (annual or interim, as the case may be) prepared in accordance with generally accepted accounting principles (subject, as to interim statements, to normal year-end adjustments) within a reasonable time after they are available. Section 7. NOTICE TO BE GIVEN INSURER. Except as provided below in Section 10 with respect to contribution, the indemnification provided herein by the Insurer shall be the exclusive remedy of each Underwriter Party or Seller Party for the Losses resulting from the Insurer's breach of a representation, warranty or agreement hereunder; provided, however, that each Underwriter Party or Seller Party shall be entitled to pursue any other remedy at law or in equity for any such breach so long as the damages sought to be recovered shall not exceed the Losses incurred thereby resulting from such breach. In the event that any action or regulatory proceeding shall be commenced or claim asserted which may entitle any Underwriter Party or Seller Party to be indemnified under this Agreement, such party shall give the Insurer written or telegraphic notice of such action or claim reasonably promptly after receipt of written notice thereof. The Insurer shall be entitled to participate in the defense of any such action or claim in reasonable cooperation with, and with the reasonable cooperation of, each Underwriter Party or Seller Party. The Indemnified Party will have the right to employ its own counsel in any such action in addition to counsel for the Insurer, but the fees and expenses of such counsel will be at the expense of such Indemnified Party unless (1) the employment of counsel by the Indemnified Party at its expense has been authorized in writing by the Insurer, 6 9 (2) the Insurer has not in fact employed counsel to assume the defense of such action within a reasonable time after receiving notice of the commencement of the action or (3) the named parties to any such action include, on the one hand, the Insurer, and, on the other hand, the Indemnified Party, and such Indemnified Party shall have been advised by counsel that there may be one or more legal defenses available to it which are different from or additional to those available to the Insurer (in which case, if such Indemnified Party notifies the Insurer in writing that it elects to employ separate counsel at the expense of the Insurer, the Insurer shall not have the right to assume the defense of such action or proceeding on such Indemnified Party's behalf), in each of which cases the reasonable fees and expenses of counsel (including local counsel) will be at the expense of the Insurer, and all such fees and expenses will be reimbursed promptly as they are incurred but, in connection with any one action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, the Insurer shall not be liable for the fees and expenses of more than one counsel for all Seller Parties and more than one counsel for all Underwriter Parties. The Underwriter Parties or Seller Parties shall cooperate with the Insurer Parties in resolving any event which would give rise to an indemnity obligation pursuant to Section 5(a) hereof in the most efficient manner. No settlement of any such claim or action shall be entered into without the consent of each Seller Party or each Underwriter Party, who is subject to such claim or action, on the one hand, and each Insurer Party who is subject to such claim or action, on the other hand; provided, however, that the consent of such Seller Party or Underwriter Party, shall not be required if such settlement fully discharges, with prejudice against the plaintiff, the claim or action against such Seller Party or Underwriter Party. Any failure by a Seller Party or an Underwriter Party, to comply with the provisions of this Section shall relieve the Insurer of liability only if such failure is materially prejudicial to any legal pleadings, grounds, defenses or remedies in respect thereof or the Insurer's financial liability hereunder, and then only to the extent of such prejudice. Section 8. NOTICE TO BE GIVEN THE UNDERWRITER. Except as provided below in Section 10 with respect to contribution, the indemnification provided herein by the Underwriter shall be the exclusive remedy of any Insurer Party or Seller Party for the Losses resulting from the Underwriter's breach of a representation, warranty or agreement hereunder; provided, however, that each Insurer or Party Seller Party shall be entitled to pursue any other remedy at law or in equity for any such breach so long as the damages sought to be recovered shall not exceed the Losses incurred thereby resulting from such breach. In the event that any action or regulatory proceeding shall be commenced or claim asserted which may entitle any Insurer Party or Seller Party to be indemnified under this Agreement, such party shall give the Underwriter written or telegraphic notice of such action or claim reasonably promptly after receipt of written notice thereof. The UnderwriterUnderwriter shall be entitled to participate in the defense of any such action or claim in reasonable cooperation with, and with the reasonable cooperation of, each Insurer Party, each Seller Party or each DepositoSeller Party, as the case may be. The Indemnified Party will have the right to employ its own counsel in any such action in addition to counsel for the 7 10 Underwriter, but the fees and expenses of such counsel will be at the expense of such Indemnified Party unless (1) the employment of counsel by the Indemnified Party at its expense has been authorized in writing by the Underwriter, (2) the Underwriter has not in fact employed counsel to assume the defense of such action within a reasonable time after receiving notice of the commencement of the action or (3) the named parties to any such action include, on the one hand, the Underwriter, and, on the other hand, the Indemnified Party, and such Indemnified Party shall have been advised by counsel that there may be one or more legal defenses available to it which are different from or additional to those available to the Underwriter (in which case, if such Indemnified Party notifies the Underwriter in writing that it elects to employ separate counsel at the expense of the Underwriter, the Underwriter shall not have the right to assume the defense of such action or proceeding on such Indemnified Party's behalf), in each of which cases the reasonable fees and expenses of counsel (including local counsel) will be at the expense of the UnderwriterUnderwriter, and all such fees and expenses will be reimbursed promptly as they are incurred but, in connection with any one action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, the Underwriter shall not be liable for the fees and expenses of more than one counsel for all Insurer Parties or more than one counsel for all Seller Parties. The Insurer Parties and Seller Parties shall cooperate with the Underwriter Parties in resolving any event which would give rise to an indemnification obligation pursuant to Section 5(b) hereof in the most efficient manner. No settlement of any such claim or action shall be entered into without the consent of each Insurer Party or each Seller Party, as the case may be, who is subject to such claim or action, on the one hand, and each Underwriter Party who is subject to such claim or action, on the other hand; provided, however, that the consent of such Insurer Party or such Seller Party shall not be required if such settlement fully discharges, with prejudice against the plaintiff, the claim or action against such Insurer Party, or such Seller Party. Any failure by an Insurer Party or an Seller Party, as the case may be, to comply with the provisions of this Section shall relieve the Underwriter of liability only if such failure is materially prejudicial to any legal pleadings, grounds, defenses or remedies in respect thereof or the Underwriter's liability hereunder, and then only to the extent of such prejudice. Section 9. NOTICE TO BE GIVEN THE SELLER. Except as provided below in Section 10 with respect to contribution, the indemnification provided herein by the Seller shall be the exclusive remedy of each Insurer Party, or each Underwriter Party for the Losses resulting from the Seller's breach of a representation, warranty or agreement hereunder; provided, however, that the Insurer Party or the Underwriter Party, shall be entitled to pursue any other remedy at law or in equity for any such breach so long as the damages sought to be recovered shall not exceed the Losses incurred thereby resulting from such breach. In the event that any action or regulatory proceeding shall be commenced or claim asserted 8 11 which may entitle an Insurer Party or an Underwriter Party to be indemnified under this Agreement, such party shall give the Seller written or telegraphic notice of such action or claim reasonably promptly after receipt of written notice thereof. The Seller shall be entitled to participate in the defense of any such action or claim in reasonable cooperation with, and with the reasonable cooperation of, each Insurer Party or each Underwriter Party. The Indemnified Party will have the right to employ its own counsel in any such action in addition to counsel for the Seller, but the fees and expenses of such counsel will be at the expense of such Indemnified Party unless (1) the employment of counsel by the Indemnified Party at its expense has been authorized in writing by the Seller, (2) the Seller has not in fact employed counsel to assume the defense of such action within a reasonable time after receiving notice of the commencement of the action or (3) the named parties to any such action include, on the one hand, the Seller, and, on the other hand, the Indemnified Party, and such Indemnified Party shall have been advised by counsel that there may be one or more legal defenses available to it which are different from or additional to those available to the Seller (in which case, if such Indemnified Party notifies the Seller in writing that it elects to employ separate counsel at the expense of the Seller, the Seller shall not have the right to assume the defense of such action or proceeding on such Indemnified Party's behalf), in each of which cases the reasonable fees and expenses of counsel (including local counsel) will be at the expense of the Seller, and all such fees and expenses will be reimbursed promptly as they are incurred but, in connection with any one action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, the Seller shall not be liable for the fees and expenses of more than one counsel for all Insurer Parties and more than one counsel for all Underwriter Parties. The Insurer Parties and the Underwriter Parties shall cooperate with each Seller Party in resolving any event which would give rise to an indemnification obligation pursuant to Section 5(c) hereof in the most efficient manner. No settlement of any such claim or action shall be entered into without the consent of each Insurer Party, or Underwriter Party who is subject to such claim or action, on the one hand, and the Seller Party, on the other hand; provided, however, that the consent of such Insurer Party or Underwriter Party, shall not be required if such settlement fully discharges, with prejudice against the plaintiff, the claim or action against such Insurer Party or Underwriter Party. Any failure by an Insurer Party or Underwriter Party, as the case may be, to comply with the provisions of this Section shall relieve the Seller of liability only if such failure is materially prejudicial to any legal pleadings, grounds, defenses or remedies in respect thereof or the Seller's liability hereunder, and then only to the extent of such prejudice. 9 12 Section 10. CONTRIBUTION. (a) To provide for just and equitable contribution if the indemnification provided by the Insurer is determined to be unavailable for any Underwriter Party or Seller Party (other than by reason of failure to comply with Section 5 or 7 of this Agreement), the Insurer shall contribute to the compensation for Losses arising from any breach of a representation or warranty set forth in this Agreement on the basis of the relative fault of and relative benefit to all Underwriter Parties, all Seller Parties and all Insurer Parties, respectively. (b) To provide for just and equitable contribution if the indemnification provided by the Seller is determined to be unavailable for any Insurer Party (other than by reason of failure to comply with Section 5 or 9 of this Agreement), the Seller shall contribute to the compensation for Losses arising from any breach of a representation or warranty set forth in this Agreement on the basis of the relative fault of and relative benefit to all Underwriter Parties, Seller Parties and all Insurer Parties. (c) To provide for just and equitable contribution if the indemnification provided by the Underwriter is determined to be unavailable for any Insurer Party or Seller Party (other than by reason of failure to comply with Section 5 or 8 of this Agreement), the Underwriter shall contribute to the compensation for Losses arising from any breach of a representation or warranty set forth in this Agreement on the basis of the relative fault of and relative benefit to all Underwriter Parties, all Seller Parties and all Insurer Parties. (d) The relative fault of each Indemnifying Party, on the one hand, and of each Indemnified Party, on the other hand, shall be determined by reference to, among other things, whether the breach of, or alleged breach of, any of its representations and warranties set forth in Section 2, 3, or 4 of this Agreement relates to information supplied by, or action within the control of, the Indemnifying Party or the Indemnified Party and the Parties' relative intent, knowledge, access to information and opportunity to correct or prevent such breach. (e) Relative benefit with respect to the Seller, the Underwriter and the Insurer shall be deemed to be in the same proportions as (i) the net proceeds from the sale of the Loans as specified 10 13 in the Purchase Agreement received by the Seller bears to (ii) the total underwriting discounts and commissions received by the Underwriter in connection with the offering the Class A Certificates and (iii) the aggregate Premium (as defined in the Insurance Agreement) paid to the Insurer, as the case may be. (f) The parties hereto agree that the Insurer shall be solely responsible for the Insurer Information and for the Insurer Financial Statements, that the Underwriter shall be responsible for the Underwriter Information, Prospectus Supplement. (g) No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. (h) The indemnity and contribution agreements contained in this Agreement shall remain operative and in full force and effect, regardless of (i) any investigation made by or on behalf of any Underwriter Party, any Seller Party, or any Insurer Party, (ii) the issuance of any Certificates or the Policy or (iii) any termination of the Pooling and Servicing Agreement. (i) Upon the incurrence of any Losses entitled to contribution hereunder, the contributor shall reimburse the party entitled to contribution promptly upon establishment by the party entitled to contribution to the contributor of the Losses incurred. Section 11. NOTICES. All notices and other communications provided for under this Agreement shall be addressed to the address set forth below as to each party or at such other address as shall be designated by a party in a written notice to the other party. If to the Insurer: MBIA Insurance Corporation 113 King Street Armonk, NY 10504 Attention: General Counsel If to the Underwriter: Greenwich Capital Markets, Inc. 600 Steamboat Road Greenwich, CT 06830 Attention: Kari Skilbred 11 14 If to the Seller: Mego Mortgage Corporation 210 Interstate North Parkway Suite 250 Atlanta, GA 30339 Attention: Jeff Moore Section 12. GOVERNING LAW, ETC. This Agreement shall be deemed to be a contract under the laws of the State of New York and shall be governed by and construed in accordance with the laws of the State of New York without regard to its conflicts of laws provisions. This Agreement may not be assigned by any party without the express written consent of each other party. Amendments of this Agreement shall be in writing signed by each party. This Agreement shall not be effective until executed by each party hereto. Section 13. INSURANCE AGREEMENT. This Agreement in no way limits or otherwise affects the indemnification obligations of the Seller under the Insurance Agreement. Section 14. LIMITATIONS. Nothing in this Agreement shall be construed as a representation or undertaking by the Insurer concerning maintenance of the rating currently assigned to its claims-paying ability by Moody's Investors Service, Inc. ("Moody's") and/or Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc. ("S&P"), or any other rating agency (collectively, the "Rating Agencies"). Section 15. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall together constitute but one and the same instrument. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered by their respective officers thereunto duly authorized, all as of the date first above written. MBIA INSURANCE CORPORATION By /s/ ------------------------------------ Title --------------------------------- MEGO MORTGAGE CORPORATION By /s/ ------------------------------------ Title --------------------------------- GREENWICH CAPITAL MARKETS, INC. By /s/ ------------------------------------ Title --------------------------------- Mego 1996-1 Indemnification Agreement Signature Page EX-10.15 3 INSURANCE AGREEMENT 1 EXHIBIT 10.15 EXECUTION COPY ================================================================================ MBIA INSURANCE CORPORATION, as Insurer NORWEST BANK MINNESOTA, N.A., as Master Servicer MEGO MORTGAGE CORPORATION, as Seller, Servicer and Claims Administrator FINANCIAL ASSET SECURITIES CORP. as Depositor GREENWICH CAPITAL FINANCIAL PRODUCTS, INC., as GCFP and FIRST TRUST OF NEW YORK, NATIONAL ASSOCIATION, as Trustee and Contract of Insurance Holder INSURANCE AGREEMENT Mego Mortgage FHA Title I Loan Trust 1996-1 FHA Title I Loan Asset-Backed Certificates, Series 1996-1 Class A-1, Class A-2, Class A-3 and Class S Dated as of March 21, 1996 ================================================================================ 2 TABLE OF CONTENTS (This Table of Contents is for convenience of reference only and shall not be deemed to be a part of this Agreement. All capitalized terms used in this Agreement and not otherwise defined shall have the meanings set forth in Article I of this Agreement.)
Page ---- ARTICLE I DEFINITIONS ........................................................................................ 1 ARTICLE II REPRESENTATIONS, WARRANTIES AND COVENANTS Section 2.01. .......................................... Representations and Warranties of the Seller. 4 Section 2.02. ................................................... Affirmative Covenants of the Seller. 7 Section 2.03. ...................................................... Negative Covenants of the Seller. 13 Section 2.04. .................................................... Affirmative Covenants of Depositor. 13 Section 2.05. ........................................................ Negative Covenant of Depositor. 14 Section 2.06. Affirmative Covenants of the Claims Administrator and the Contract of Insurance Holder. 14 Section 2.07. ................................. Representations and Warranties of the Master Servicer. 16 Section 2.08. .......................................... Affirmative Covenants of the Master Servicer. 19 Section 2.09. ............................................ Negative Covenants of the Master Servicer . 25 Section 2.10. .................... Additional Covenants of Depositor, Seller and Claims Administrator. 26 ARTICLE III THE POLICY; REIMBURSEMENT Section 3.01. ................................................................ Issuance of the Policy. 26 Section 3.02. ........................................................... Payment of Fees and Premium. 29 Section 3.03. ....................................... Reimbursement and Additional Payment Obligation. 29 Section 3.04. .................................... Indemnification by Seller; Limitation of Liability. 31 Section 3.05. ........................... Indemnification by Master Servicer; Limitation of Liability. 32 SSction 3.06. ...................................... Indemnification by GCFP; Limitation of Liability. 34 Section 3.07. ..................................................................... Payment Procedure. 35
3
ARTICLE IV FURTHER AGREEMENTS Section 4.01. ....................................... Effective Date; Term of the Insurance Agreement. 36 Section 4.02. ......................................... Further Assurances and Corrective Instruments. 36 Section 4.03. .................................................................. Obligations Absolute. 36 Section 4.04. .......................................... Assignments; Reinsurance; Third-Party Rights. 38 Section 4.05. .............................................................. Liability of the Insurer. 38 Section 4.06. .......................................................................... Legal Action. 39 Section 4.07. .......... Trustee, Depositor, Seller and Master Servicer To Join in Enforcement Action. 39 ARTICLE V DEFAULTS; REMEDIES Section 5.01. ......................................................... .................... Defaults. 39 Section 5.02. ......................................................... Remedies; No Remedy Exclusive. 40 Section 5.03. ............................................................................... Waivers. 41 ARTICLE VI MISCELLANEOUS Section 6.01. ....................................................................... Amendments, Etc. 41 Section 6.02. ............................................................................... Notices. 41 Section 6.03. .......................................................................... Severability. 43 Section 6.04. ......................................................................... Governing Law. 43 Section 6.05. ............................................................... Consent to Jurisdiction. 43 Section 6.06. ................................................................ Consent of the Insurer. 44 Section 6.07. .......................................................................... Counterparts. 44 Section 6.08. .............................................................................. Headings. 44 Section 6.09. .................................................................. Trial by Jury Waived. 44 Section 6.10. ..................................................................... Limited Liability. 44 Section 6.11. ...................................................................... Entire Agreement. 44
TESTIMONIUM SIGNATURES ii 4 INSURANCE AGREEMENT INSURANCE AGREEMENT (this "Insurance Agreement"), dated as of March 21, 1996 by and among MEGO MORTGAGE CORPORATION, as seller, servicer and claims administrator (together with its permitted successors and assigns, the "Seller"), NORWEST BANK MINNESOTA, N.A., in its capacity as Master Servicer under the PSA described below (together with its permitted successors and assigns, the "Master Servicer"), FINANCIAL ASSET SECURITIES CORP., a Delaware corporation (the "Depositor"), GREENWICH CAPITAL FINANCIAL PRODUCTS, INC. ("GCFP"), MBIA INSURANCE CORPORATION (the "Insurer") and FIRST TRUST OF NEW YORK, NATIONAL ASSOCIATION, as Trustee and Contract of Insurance Holder (the "Trustee"). WHEREAS, the Pooling and Servicing Agreement dated as of March 21, 1996 relating to the Mego Mortgage FHA Title I Loan Trust 1996-1, FHA Title I Loan Asset-Backed Certificates, Series 1996-1, Class A-1, Class A-2, Class A-3 and Class S by and among the Seller, the Master Servicer, the Depositor and the Trustee (the "PSA") provides for, among other things, the issuance of mortgage asset backed certificates, representing fractional ownership interests in the trust estate established thereby and the Insurer has issued its certificate guaranty insurance policy (the "Policy") that guarantees certain payments due from the Trust (as defined herein) on the Mego Mortgage FHA Title I Loan Trust 1996-1, FHA Title I Loan Asset-Backed Certificates, Series 1996-1, Class A-1, Class A-2, Class A-3 and Class S (as defined in the PSA); and WHEREAS, the Insurer shall be paid an insurance premium pursuant to the PSA, and the details of such premium are set forth herein; and WHEREAS, the Seller, the Depositor and the Master Servicer have undertaken certain obligations in consideration for the Insurer's issuance of the Policy; NOW, THEREFORE, in consideration of the premises and the mutual agreements herein contained, the parties hereto agree as follows: 5 ARTICLE I DEFINITIONS The terms defined in this Article I shall have the meanings provided herein for all purposes of this Insurance Agreement, unless the context clearly requires otherwise, in both singular and plural form, as appropriate. Unless the context clearly requires otherwise, all capitalized terms used herein and not otherwise defined in this Article I shall have the meanings assigned to them in the PSA. All words used herein shall be construed to be of such gender or number as the circumstances require. This "Insurance Agreement" shall mean this Insurance Agreement as a whole and as the same may, from time to time hereafter, be amended, supplemented or modified. The words "herein," "hereby," "hereof," "hereto," "hereinabove" and "hereinbelow," and words of similar import, refer to this Insurance Agreement as a whole and not to any particular paragraph, clause or other subdivision hereof, unless otherwise specifically noted. "Base Prospectus" means the Prospectus dated March 20, 1996. "Code" means the Internal Revenue Code of 1986, including, unless the context otherwise requires, the rules and regulations thereunder, as amended from time to time. "Commission" means the Securities and Exchange Commission. "Commitment" means the letter of commitment from the Insurer to the Seller dated March 29, 1996. "Date of Issuance" means the date on which the Policy is issued as specified therein. "Default" means any event which results, or which with the giving of notice or the lapse of time or both would result, in an Event of Default. "Event of Default" means any event of default specified in Section 5.01 of this Insurance Agreement. "Financial Statements" means, with respect to the Seller, the balance sheets as of August 31, 1994 and August 31, 1995 and the statements of income, retained earnings and cash flows for the 12-month period then ended and the notes thereto and, with respect to the Master Servicer, the balance sheets as of December 31, 1994 and the statements of income, retained earnings and cash flows for the 12-month period then ended and the notes thereto. "Fiscal Agent" means the Fiscal Agent, if any, designated pursuant to the terms of the Policy. 2 6 "Indemnification Agreement" means the Indemnification Agreement dated as of March 29, 1996 among the Insurer, the Seller and the Underwriter. "Investment Company Act" means the Investment Company Act of 1940, including, unless the context otherwise requires, the rules and regulations thereunder, as amended. "Late Payment Rate" means, for any Distribution Date, the rate of interest as it is publicly announced by Citibank, N.A. at its principal office in New York, New York as its prime rate (any change in such prime rate of interest to be effective on the date such change is announced by Citibank, N.A.) plus 2%. The Late Payment Rate shall be computed on the basis of a year of 365 days calculating the actual number of days elapsed. In no event shall the Late Payment Rate exceed the maximum rate permissible under any applicable law limiting interest rates. "Loan Purchase Agreement" means the Loan Purchase Agreement dated as of March 21, 1996 between the Seller and the Depositor. "Material Adverse Change" means, in respect of any Person, a material adverse change in (i) the business, financial condition, results of operations or properties of such Person or (ii) the ability of such Person to perform its obligations under any of the Transaction Documents. "Moody's" means Moody's Investors Service, Inc., a Delaware corporation, and any successor thereto, and, if such corporation shall for any reason no longer perform the functions of a securities rating agency, "Moody's" shall be deemed to refer to any other nationally recognized rating agency designated by the Insurer. "Notice of Claim" means a Notice of Claim and Certificate in the form attached as Exhibit A to the Policy. "Offering Document" means the Prospectus Supplement dated March 28, 1996 of the Depositor in respect of the Class A Certificates and any amendment or supplement thereto, other than the Registration Statement, and any other offering document in respect of the Securities prepared by the Depositor, the Seller or the Master Servicer that makes reference to the Policy. "Owners" means registered holders of Securities. "Person" means an individual, joint stock company, trust, unincorporated association, joint venture, corporation, business or owner trust, partnership or other organization or entity (whether governmental or private). "Premium" means the premium payable in accordance with Section 3.02 of this Insurance Agreement. 3 7 "Premium Percentage" shall have the meaning ascribed to such term in Section 3.02 hereof. "Registration Statement" means Registration Statement number 33-99018 (including any documents incorporated by reference therein pursuant to the Securities Exchange Act during the period from March 20, 1996 through and including March 29, 1996 with respect to the Transaction, including the Base Prospectus but excluding the Prospectus Supplement. "Securities" means the Senior Certificates issued by the Trust pursuant to the PSA. "Securities Act" means the Securities Act of 1933, including, unless the context otherwise requires, the rules and regulations thereunder, as amended from time to time. "Securities Exchange Act" means the Securities Exchange Act of 1934, including, unless the context otherwise requires, the rules and regulations thereunder, as amended from time to time. "S&P" means Standard & Poor's Rating Services, and any successor thereto, and, if such corporation shall for any reason no longer perform the functions of a securities rating agency, "S&P" shall be deemed to refer to any other nationally recognized rating agency designated by the Insurer. "Term of the Insurance Agreement" shall be determined as provided in Section 4.01 of this Insurance Agreement. "Transaction" means the transactions contemplated by the Transaction Documents, including the transactions described in the Offering Document. "Transaction Documents" means this Insurance Agreement, the Indemnification Agreement, the Commitment, the PSA, the Servicing Agreement, the Underwriting Agreement, and the Loan Purchase Agreement. "Trust" means the trust created pursuant to the PSA. "Trustee" means First Trust of New York, National Association, a national banking association, as trustee under the PSA, and any successor to the Trustee under the PSA. "Trust Indenture Act" means the Trust Indenture Act of 1939, including, unless the context otherwise requires, the rules and regulations thereunder, as amended from time to time. "Underwriter " means Greenwich Capital Markets, Inc. "Underwriting Agreement" means the Underwriting Agreement between the Underwriter and the Depositor with respect to the offer and sale of the Class A Certificates, as the same may be 4 8 amended from time to time. ARTICLE II REPRESENTATIONS, WARRANTIES AND COVENANTS Section 2.01. REPRESENTATIONS AND WARRANTIES OF THE SELLER. The Seller represents, warrants and covenants as follows: (a) Due Organization and Qualification. The Seller is a corporation, duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation. The Seller is duly qualified to do business, is in good standing and has obtained all necessary licenses, permits, charters, registrations and approvals (together, "approvals") necessary for the conduct of its business as currently conducted and as described in the Offering Document and the performance of its obligations under the Transaction Documents, in each jurisdiction in which the failure to be so qualified or to obtain such approvals would render any Transaction Document unenforceable in any respect or would have a material adverse effect upon the Transaction. (b) Power and Authority. The Seller has all necessary corporate power and authority to conduct its business as currently conducted and, as described in the Offering Document, to execute, deliver and perform its obligations under the Transaction Documents to which it is a party and to consummate the Transaction. (c) Due Authorization. The execution, delivery and performance of the Transaction Documents to which the Seller is a party by the Seller have been duly authorized by all necessary corporate action and do not require any additional approvals or consents, or other action by or any notice to or filing with any Person, including, without limitation, any governmental entity (other than the Transfer of Note Report with the FHA) or the Seller's stockholders, which have not previously been obtained or given by the Seller. (d) Noncontravention. Neither the execution and delivery of the Transaction Documents, to which the Seller is a party, by the Seller, the consummation of the transactions contemplated thereby nor the satisfaction of the terms and conditions of the Transaction Documents: (i) conflicts with or results in any breach or violation of any provision of the certificate of incorporation or bylaws of the Seller or any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award currently in effect having applicability to the Seller or any of their material properties, including regulations issued by an administrative agency or other governmental authority 5 9 having supervisory powers over the Seller; (ii) constitutes a default by the Seller under or a breach of any provision of any material loan agreement, mortgage, indenture or other material agreement or instrument to which the Seller is a party or by which any of its properties, which are individually or in the aggregate material to the Seller, is or may be bound or affected; or (iii) results in or requires the creation of any lien upon or in respect of any assets of the Seller (other than as created by the Transaction Documents). (e) Legal Proceedings. There is no action, proceeding or investigation by or before any court, governmental or administrative agency or arbitrator against or affecting the Seller or any of its subsidiaries, or any properties or rights of the Seller or any of its subsidiaries, pending or, to the Seller's knowledge after reasonable inquiry, threatened, which, in any case, could reasonably be expected to result in a Material Adverse Change with respect to the Seller. (f) Valid and Binding Obligations. The Transaction Documents to which the Seller is a party, when executed and delivered by the Seller, will constitute the legal, valid and binding obligations of the Seller, enforceable in accordance with their respective terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting creditors' rights generally and general equitable principles and public policy considerations as to rights of indemnification for violations of federal securities laws. The Seller will not at any time in the future deny that the Transaction Documents to which it is a party constitute the legal, valid and binding obligations the Seller. (g) Financial Statements. The Financial Statements of the Seller, copies of which have been furnished to the Insurer in March, 1996, (i) are, as of the dates and for the periods referred to therein, complete and correct in all material respects, (ii) present fairly the financial condition and results of operations of the Seller as of the dates and for the periods indicated and (iii) have been prepared in accordance with generally accepted accounting principles consistently applied, except as noted therein (subject as to interim statements to normal year-end adjustments). Since the date of the most recent Financial Statements of the Seller, there has been no Material Adverse Change in respect of the Seller. Except as disclosed in the Financial Statements of the Seller, the Seller is not subject to any contingent liabilities or commitments that, individually or in the aggregate, have a material possibility of causing a Material Adverse Change in respect of the Seller. (h) Compliance With Law, Etc. No practice, procedure or policy employed, or 6 10 proposed to be employed, by the Seller in the conduct of its business violates any law, regulation, judgment, agreement, order or decree applicable to any of them that, if enforced, could reasonably be expected to result in a Material Adverse Change with respect to the Seller. (i) Taxes. The Seller and the Seller's parent company or companies have filed prior to the date hereof all federal and state tax returns that are required to be filed and paid all taxes, including any assessments received by them that are not being contested in good faith, to the extent that such taxes have become due, except for any failures to file or pay that, individually or in the aggregate, would not result in a Material Adverse Change with respect to the Seller. (j) Accuracy of Information. Neither the Transaction Documents, nor the Offering Document, nor other information relating to the Loans, the operations of the Seller (including servicing or origination of loans) or the financial condition of the Seller as set forth in the Financial Statements furnished to the Insurer in March, 1996 (collectively, the "Documents"), as amended, supplemented or superseded, furnished to the Insurer by the Seller contain any statement of a material fact by the Seller which was untrue or misleading in any material adverse respect when made. The Seller has no knowledge or circumstances that could reasonably be expected to cause a Material Adverse Change with respect to the Seller. Since the furnishing of the Documents, there has been no change nor any development or event involving a prospective change known to the Seller that would render any of the Documents untrue or misleading in a material respect. (k) [Reserved] (l) Transaction Documents. Each of the representations and warranties of the Seller contained in the Transaction Documents is true and correct in all material respects, and the Seller hereby makes each such representation and warranty to, and for the benefit of, the Insurer as if the same were set forth in full herein; provided that the remedy for any breach of this paragraph shall be limited to the remedies specified in the related Transaction Document. (m) Solvency. The Seller is solvent and will not be rendered insolvent by the Transaction and, after giving effect to the Transaction, the Seller will not be left with an unreasonably small amount of capital with which to engage in its business, nor does the Seller intend to incur, or believe that it has incurred, debts beyond its ability to pay as they mature. The Seller does not contemplate the commencement of insolvency, bankruptcy, liquidation or consolidation proceedings or the appointment of a receiver, liquidator, conservator, trustee or similar official in respect of the Seller or any of its assets. 7 11 (n) Principal Place of Business. The principal place of business of the Seller is located in Atlanta, Georgia. Section 2.02. AFFIRMATIVE COVENANTS OF THE SELLER. The Seller hereby agrees that during the Term of the Insurance Agreement, unless the Insurer shall otherwise expressly consent in writing: (a) Compliance With Agreements and Applicable Laws. The Seller shall not be in default under the Transaction Documents to which it is a party and shall comply with all material requirements of any law, rule or regulation applicable to it. The Seller shall not agree to any amendment to or modification of the terms of any Transaction Documents unless the Insurer shall have otherwise consented. (b) Corporate Existence. The Seller, and its successors and assigns, shall maintain its corporate existence and shall at all times continue to be duly organized under the laws of its jurisdiction of incorporation and duly qualified and duly authorized (as described in subsections 2.01(a), (b) and (c) hereof) and shall conduct its business in accordance with the terms of its certificate of incorporation and bylaws. (c) Financial Statements; Accountants' Reports; Other Information. The Seller shall keep or cause to be kept in reasonable detail books and records of account of its assets and business, including, but not limited to, books and records relating to the Transaction. The Seller shall furnish or cause to be furnished to the Insurer: (i) Annual Financial Statements. As soon as available, and in any event within 120 days after the close of each fiscal year of the Seller, the audited consolidated balance sheets of the Seller and its subsidiaries as of the end of such fiscal year and the related audited consolidated statements of income, changes in shareholders' equity and cash flows for such fiscal year, all in reasonable detail and stating in comparative form the respective figures for the corresponding date and period in the preceding fiscal year, prepared in accordance with generally accepted accounting principles, consistently applied, and accompanied by the audit opinion of the Seller's independent accountants (which shall be a nationally recognized independent public accounting firm) and by the certificate specified in Section 2.02(d) hereof. (ii) Quarterly Financial Statements. As soon as available, and in any event within 90 days after each of the first three fiscal quarters of each fiscal year of the Seller, the unaudited consolidated balance sheets of the Seller and its subsidiaries as of the end of such fiscal quarter and the related unaudited consolidated statements of income, changes in shareholders' equity and cash flows 8 12 such fiscal quarter, all in reasonable detail and stating in comparative form the respective figures for the corresponding date and period in the preceding fiscal year, prepared in accordance with generally accepted accounting principles, consistently applied, and accompanied by the certificate specified in Section 2.02(d) hereof. (iii) Initial and Continuing Reports. On or before the Closing Date, the Seller will provide the Insurer a copy of the magnetic tape to be delivered to the Trustee on the Closing Date setting forth as to each Loan, the information required under the definition of "Loan Schedule" at Section 1.01 of the PSA. (iv) Certain Information. Upon the reasonable request of the Insurer, the Seller shall promptly provide copies of any requested proxy statements, financial statements, reports and registration statements which the Seller files with, or delivers to, the Commission or any national securities exchange. (v) Other Information. Promptly upon receipt thereof, copies of all schedules, financial statements or other similar reports delivered to or by the Seller pursuant to the terms of the PSA and, promptly upon request, such other data as the Insurer may reasonably request. All financial statements specified in clauses (i) and (ii) above shall be furnished in consolidated form for the Seller and all its subsidiaries. The Insurer agrees that it and its agents, accountants and attorneys shall keep confidential all financial statements, reports and other information delivered by the Seller pursuant to this subsection 2.02(c) to the extent provided in subsection 2.02(e) hereof. (d) Compliance Certificate. The Seller shall deliver to the Insurer, concurrently with the delivery of the financial statements required pursuant to subsection 2.02(c)(i) and (ii) hereof, one or more certificates signed by an officer of the Seller authorized to execute such certificates on behalf of the Seller stating that: (i) a review of the Seller's performance under the Transaction Documents during such period has been made under such officer's supervision; (ii) to the best of such individual's knowledge following reasonable inquiry, no Default or Event of Default has occurred, or if a Default or Event of Default has occurred, specifying the nature thereof and, if the Seller has a right to cure pursuant to the Transaction Documents, stating in reasonable detail (including, if applicable, any supporting calculations) the steps, if any, being taken by the Seller to cure such Default or Event of Default or to otherwise comply with the terms of 9 13 the agreement to which such Default or Event of Default relates; (iii) the attached Financial Statements submitted in accordance with subsection 2.02(c)(i) or (ii), as the case may be, hereof are complete and correct in all material respects and present fairly the financial condition and results of operations of the Seller as of the dates and for the periods indicated, in accordance with generally accepted accounting principles consistently applied; and (iv) the Seller, so long as it is the servicer under the Servicing Agreement, has in full force and effect a blanket fidelity bond (or direct surety bond) and an errors and omissions insurance policy in accordance with the terms and requirements of Section 8.01 of the Servicing Agreement. (e) Access to Records; Discussions With Officers and Accountants. On an annual basis, or upon the occurrence of a Material Adverse Change, the Seller shall, upon the request of the Insurer, permit the Insurer or its authorized agents, at the expense of the Insurer, at reasonable times and upon reasonable notice: (i) to inspect the books and records of the Seller as they may relate to the Securities, the obligations of the Seller under the Transaction Documents, and the Transaction; (ii) to discuss the affairs, finances and accounts of the Seller with the chief operating officer and the chief financial officer of the Seller; and (iii) with the Seller's consent, which consent shall not be unreasonably withheld, to discuss the affairs, finances and accounts of the Seller with the Seller's independent accountants, provided that an officer of the Seller shall have the right to be present during such discussions. Such inspections and discussions shall be conducted during normal business hours and shall not unreasonably disrupt the business of the Seller. The books and records of the Seller will be maintained at the address of the Seller designated herein for receipt of notices, unless the Seller shall otherwise advise the parties hereto in writing. The Insurer agrees that it and its shareholders, employees, directors, agents, accountants and attorneys shall keep confidential any matter of which it becomes aware through such inspections or discussions (unless readily available from public sources), except as may be otherwise required by regulation, law or court order or by appropriate governmental authorities or as necessary to preserve its rights or security under or to enforce the Transaction Documents, provided that the foregoing shall not limit the right of 10 14 the Insurer to make such information available to its regulators, securities rating agencies, reinsurers, credit and liquidity providers, counsel and accountants. If the Insurer is required (by oral questions, interrogatories, requests for information or documents subpoena, civil investigative demand or similar process) to disclose any information of which it becomes aware through such inspections or discussions, the Insurer will promptly notify the Seller of such request(s) so that the Seller may seek an appropriate protective order and/or waive the Insurer's compliance with the provisions of this Insurance Agreement. If, in the absence of a protective order or the receipt of a waiver hereunder, the Insurer is, nonetheless, in the opinion of its counsel, compelled to disclose such information to any tribunal or else stand liable for contempt or suffer other censure or significant penalty, the Insurer may disclose such information to such tribunal that the Insurer is compelled to disclose, provided that a copy of all information disclosed is provided to the Seller promptly upon such disclosure. (f) Notice of Material Events. The Seller shall be obligated promptly to inform the Insurer in writing of the occurrence of any of the following to the extent any of the following relate to it: (i) the submission of any claim or the initiation or written threat of any legal process, litigation or administrative or judicial investigation, or rule making or disciplinary proceeding by or against the Seller that (A) could be required to be disclosed to the Commission or to the Seller's shareholders or (B) could result in a Material Adverse Change with respect to the Seller, or the promulgation of any proceeding or any proposed or final rule which would result in a Material Adverse Change with respect to the Seller; (ii) any change in the location of the Seller's principal offices or any change in the location of the Seller's books and records; (iii)the occurrence of any Default or Event of Default or of any Material Adverse Change; (iv) the commencement of any proceedings by or against the Seller under any applicable bankruptcy, reorganization, liquidation, rehabilitation, insolvency or other similar law now or hereafter in effect or of any proceeding in which a receiver, liquidator, conservator, trustee or similar official shall have been, or may be, appointed or requested for the Seller or any of its assets; or (v) the receipt of notice that (A) the Seller is being placed under regulatory supervision, (B) any license, permit, charter, registration or approval necessary for the conduct of the Seller's business is to be, or may be suspended or revoked, or (C) the Seller is to cease and desist any practice, procedure or policy 11 15 employed by the Seller in the conduct of its business, and such cessation may result in a Material Adverse Change with respect to the Seller. (g) Financing Statements and Further Assurances. The Seller will cause to be filed all necessary financing statements or other instruments, and any amendments or continuation statements relating thereto, necessary to be kept and filed in such manner and in such places as may be required by law to preserve and protect fully the interest of the Trustee in the Trust. The Seller shall, upon the request of the Insurer, from time to time, execute, acknowledge and deliver, or cause to be executed, acknowledged and delivered, with ten days of such request, such amendments hereto and such further instruments and take such further action as may be reasonably necessary to effectuate the intention, performance and provisions of the Transaction Documents. In addition, the Seller agrees to cooperate with S&P and Moody's in connection with any review of the Transaction that may be undertaken by S&P and Moody's after the date hereof. (h) Maintenance of Licenses. The Seller, or any successors thereof, shall maintain all required licenses, permits, charters and registrations which are material to the conduct of its business. (i) Disclosure Document. Each Offering Document prepared by or on behalf of the Seller and delivered with respect to the Securities shall clearly disclose that the Policy is not covered by the property/casualty insurance security fund specified in Article 76 of the New York Insurance Law. (j) Third-Party Beneficiary. The Seller consents to the Insurer as a third-party beneficiary in respect of the PSA and hereby incorporates and restates its representations, warranties and covenants as set forth therein for the benefit of the Insurer; provided, however, that, with respect to the representations of the Seller in Section 2.03 of the PSA relating to the Loans, the remedies for any breach of such representations shall be limited to the remedies specified in the PSA. (k) Servicing of Loans. The Seller will provide the Insurer with written notice of any change or amendment to any Transaction Document to which it is a party as currently in effect and agrees that it will not make any change or amendment to any Transaction Document without the prior written consent of the Insurer thereto. (l) Maintenance of Trust. On or before each March 21, beginning in 1997, so long as any of the Securities are outstanding, the Seller shall furnish, or cause to be furnished, to the Insurer and the Trustee an Officers' Certificate either stating that such action has been taken with respect to the recording, filing, rerecording and refiling of any financing statements and continuation statements as is necessary to maintain the interest of 12 16 the Trustee created by the PSA with respect to the Trust and reciting the details of such action or stating that no such action is necessary to maintain such interests. Such Officers' Certificate shall also describe the recording, filing, rerecording and refiling of any financing statements and continuation statements that will be required to maintain the interest of the Trustee in the Trust until the date such next Officers' Certificate is due. The Seller will use its best efforts to cause any necessary recordings or filings to be made with respect to the Trust. (m) Closing Documents. The Seller shall provide or cause to be provided to the Insurer an executed original copy of each document executed in connection with the Transaction within 30 days after the date of closing (except with respect to subsequent transfers of Loans). (n) Preference Payments. With respect to any Preference Amount (as defined in the Policy), the Seller, for so long as the Seller is the Servicer, shall provide to the Insurer upon the request of the Insurer: (i) a certified copy of the final nonappealable order of a court having competent jurisdiction ordering the recovery by a trustee in bankruptcy as voidable preference amounts included in previous distributions under Section 4.02 of the PSA to any Owner pursuant to the United States Bankruptcy Code; (ii) an opinion of counsel satisfactory to the Insurer, and upon which the Insurer shall be entitled to rely, stating that such order is final and is not subject to appeal; (iii) an assignment in such form as reasonably required by the Insurer, irrevocably assigning to the Insurer all rights and claims of the Seller, the Trustee and any Certificateholder relating to or arising under the Mortgage Loan against the debtor which made such preference payment or otherwise with respect to such preference amount; and (iv) appropriate instruments to effect (when executed by the affected party) the appointment of the Insurer as agent for the Trustee and any Certificateholders in any legal proceeding relating to such preference payment being in a form satisfactory to the Insurer. (o) Additional Reporting. The Seller shall prepare for the benefit of the Insurer and deliver to the Insurer the letters, certificates and reports specified in Sections 6.04 and 6.17 of the Servicing Agreement and Section 4.08 of the PSA. In addition, the Seller shall provide the Insurer with monthly reports for all transactions utilizing the Contract of 13 17 Insurance used in the Transaction. (p) Power of Attorney. The Seller represents and warrants that, to the best of the Seller's knowledge, the Power of Attorney of the Trustee dated March 29, 1996 (the "Power of Attorney") is sufficient to enable the Seller to perform its duties as Claims Administrator and hereby covenants to immediately notify the Trustee and the Insurer in writing if any person named in the Power of Attorney is no longer an officer of the Seller or is otherwise unable to act as attorney-in-fact under the Power of Attorney or if the Seller has knowledge that the Power of Attorney is no longer sufficient and the Seller hereby covenants to use its best efforts to obtain any powers of attorney or other documents necessary to perform its duties as Claims Administrator. Section 2.03. NEGATIVE COVENANTS OF THE SELLER. The Seller hereby agrees that during the Term of the Insurance Agreement, unless the Insurer shall otherwise expressly consent in writing: (a) Impairment of Rights. The Seller shall not take any action, or fail to take any action, if such action or failure to take action may result in a material adverse change as described in clause (ii) of the definition of Material Adverse Change with respect to the Seller, or may interfere with the enforcement of any rights of the Insurer under or with respect to the Transaction Documents. The Seller shall give the Insurer written notice of any such action or failure to act on the earlier of: (i) the date upon which any publicly available filing or release is made with respect to such action or failure to act or (ii) promptly prior to the date of consummation of such action or failure to act. The Seller shall furnish to the Insurer all information requested by it that is reasonably necessary to determine compliance with this paragraph. (b) Adverse Selection Procedure. The Seller will not use any adverse selection procedure in selecting Loans to be transferred to the Trustee from the outstanding Loans that qualify under the PSA for inclusion in the Trust. (c) Waiver, Amendments, Etc. Except in accordance with the Transaction Documents, the Seller shall not waive, modify or amend, or consent to any waiver, modification or amendment of, any of the terms, provisions or conditions of the Transaction Documents without the consent of the Insurer. (d) Mortgage Loan Agreements; Charge-off Policy. Except as otherwise permitted in the PSA, the Seller shall not alter or amend any Loan or their respective charge-off policies in a manner that materially adversely affects the Insurer unless the Insurer shall have previously given its consent, which consent shall not be unreasonably 14 18 withheld. Section 2.04. AFFIRMATIVE COVENANTS OF DEPOSITOR. The Depositor hereby agrees that during the Term of the Insurance Agreement, unless the Insurer shall otherwise expressly agree in writing: (a) Financing Statements and Further Assurances. The Depositor will cause to be filed all necessary financing statements or other instruments, and any amendments or continuation statements relating thereto, necessary to be kept and filed in such manner and in such places as may be required by law to preserve and protect fully the interest of the Trustee in the Trust. The Depositor shall, upon the request of the Insurer, from time to time, execute, acknowledge and deliver, or cause to be executed, acknowledged and delivered, with ten days of such request, such amendments hereto and such further instruments and take such further action as may be reasonably necessary to effectuate the intention, performance and provisions of the Transaction Documents. In addition, the Depositor agrees to cooperate with S&P and Moody's in connection with any review of the Transaction that may be undertaken by S&P and Moody's after the date hereof. (b) Disclosure Document. Each Offering Document delivered with respect to the Securities shall clearly disclose that the Policy is not covered by the property/casualty insurance security fund specified in Article 76 of the New York Insurance Law. Section 2.05. NEGATIVE COVENANT OF DEPOSITOR. The Depositor shall not amend its certificate of incorporation without the Insurer's prior written consent. Section 2.06. AFFIRMATIVE COVENANTS OF THE CLAIMS ADMINISTRATOR AND THE CONTRACT OF INSURANCE HOLDER. The Claims Administrator and the Trustee, as Contract of Insurance Holder, hereby covenant and agree that during the term of this Agreement: (a) Access to Records; Discussions With Officers and Accountants. The Claims Administrator and the Contract of Insurance Holder shall, upon the request of the Insurer, permit the Insurer, or its authorized agent, at the expense of the Insurer, at reasonable times and upon reasonable notice: (i) to inspect such books and records of the Claims Administrator and the Contract of Insurance Holder as may relate to the Certificates, the Loans, the obligations of the Claims Administrator and the Contract of Insurance Holder under the Transaction Documents, the business of the Claims Administrator and the Contract of Insurance Holder and the transactions consummated in connection herewith; 15 19 (ii) to discuss the affairs, finances and accounts of the Claims Administrator and the Contract of Insurance Holder as they relate to the Certificates with an appropriate officer of the Claims Administrator or the Contract of Insurance Holder, as applicable; and (iii) to discuss the affairs, finances and accounts of the Claims Administrator and the Contract of Insurance Holder as they relate to the Certificates with the independent public accountants of the Claims Administrator or the Contract of Insurance Holder, as applicable, provided that an appropriate officer of the Claims Administrator and the Contract of Insurance Holder, as applicable, shall have the right to be present during such discussions. Such inspections and discussions shall be conducted during normal business hours and shall not unreasonably disrupt the business of the Claims Administrator or the Contract of Insurance Holder. (b) Inform Insurer of Material Events. The Claims Administrator and the Contract of Insurance Holder shall promptly inform the Insurer and the Trustee in writing of the following: (i) any default or any fact or event which results, or which with notice or the passage of time, or both, would result in an event of default under any Transaction Document or would constitute a material breach of a representation, warranty or covenant by the Claims Administrator or the Contract of Insurance Holder under any Transaction Document; (ii) the submission of any claim or the initiation of any legal process, litigation or administrative or judicial investigation against the Claims Administrator, the Contract of Insurance Holder, the Seller or the Master Servicer, as the case may be, in any federal, state or local court or before any governmental body or agency, or before any arbitration board, or any such proceedings threatened by any governmental agency, which, if adversely determined, would have a material adverse effect upon the ability of the Claims Administrator, the Contract of Insurance Holder, the Seller or the Master Servicer, as the case may be, to perform its obligations under any Transaction Document; (iii) the submission of any claim or the initiation of any legal process, litigation or administrative or judicial investigation against the Claims Administrator, the Contract of Insurance Holder, the Seller or the Master Servicer, as the case may be, in any federal, state or local court or before any arbitration board, or any such proceeding threatened by any governmental agency, which, if 16 20 adversely determined, would have a material adverse effect on the Loans as a whole; and (iv) the commencement of any proceedings by or against the Claims Administrator, the Contract of Insurance Holder, the Seller or the Servicer, as the case may be, under any applicable bankruptcy, reorganization, liquidation, insolvency or other similar law now or hereafter in effect or of any proceeding in which a receiver, liquidator, trustee or other similar official shall have been, or may be, appointed or requested for the Claims Administrator, the Contract of Insurance Holder, the Seller or the Servicer. (c) Access to HUD Audit Letters. The Contract of Insurance Holder shall, upon the written request of the Insurer, furnish the Insurer copies of all HUD audit letters addressed to the Contract of Insurance Holder received within the last five years and received during the term of this Agreement and the Contract of Insurance Holder's responses to all such letters. (d) Power of Attorney. If the Contract of Insurance Holder receives notice from the Claims Administrator that any person named in the Power of Attorney is no longer an officer of the Claims Administrator or is otherwise unable to act as attorney-in-fact under the Power of Attorney, or if the Seller is no longer acting as Claims Administrator, the Contract of Insurance Holder shall immediately appoint an attorney-in-fact or attorneys-in-fact, as the case may be, nominated by the Claims Administrator, acceptable to the Insurer and qualified to perform as attorney-in-fact or attorneys-in-fact, as the case may be, under a power of attorney acceptable to the Insurer. Section 2.07. REPRESENTATIONS AND WARRANTIES OF THE MASTER SERVICER. The Master Servicer represents, warrants and covenants, as follows: (a) Due Organization and Qualification. The Master Servicer is a national banking association, duly organized, validly existing and in good standing under the laws of the United States of America. The Master Servicer is duly qualified to do business, is in good standing and has obtained all necessary licenses, permits, charters, registrations and approvals (together, "approvals") necessary for the conduct of its business as currently conducted and as described in the Offering Document and the performance of its obligations under the Transaction Documents, in each jurisdiction in which the failure to be so qualified or to obtain such approvals would render any Transaction Document unenforceable in any respect or would have a material adverse effect upon the Transaction. (b) Power and Authority. The Master Servicer has all necessary power and authority to conduct its business as currently conducted and, as described in the Offering 17 21 Document, to execute, deliver and perform its obligations under the Transaction Documents and to consummate the Transaction. (c) Due Authorization. The execution, delivery and performance of the Transaction Documents to which the Master Servicer is a party by the Master Servicer have been duly authorized by all necessary action and do not require any additional approvals or consents, or other action by or any notice to or filing with any Person, including, without limitation, any governmental entity or the Master Servicer's stockholders, which have not previously been obtained or given by the Master Servicer. (d) Noncontravention. Neither the execution and delivery of the Transaction Documents by the Master Servicer, the consummation of the transactions contemplated thereby nor the satisfaction of the terms and conditions of the Transaction Documents: (i) conflicts with or results in any breach or violation of any provision of the charter, certificate of incorporation or bylaws of the Master Servicer or any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award currently in effect having applicability to the Master Servicer or any of their material properties, including regulations issued by an administrative agency or other governmental authority having supervisory powers over the Master Servicer; (ii) constitutes a default by the Master Servicer under or a breach of any provision of any material loan agreement, mortgage, indenture or other material agreement or instrument to which the Master Servicer is a party or by which any of its properties, which are individually or in the aggregate material to the Master Servicer, is or may be bound or affected; or (iii) results in or requires the creation of any lien upon or in respect of any assets of the Master Servicer. (e) Legal Proceedings. There is no action, proceeding or investigation by or before any court, governmental or administrative agency or arbitrator against or materially affecting the Master Servicer, or any of its subsidiaries, or any properties or rights of the Master Servicer, or any of its subsidiaries, pending or, to the Master Servicer's knowledge after reasonable inquiry, threatened, which, in any case, could reasonably be expected to result in a Material Adverse Change with respect to the Master Servicer. (f) Valid and Binding Obligations. The Transaction Documents to which the Master Servicer is a party (other than the Securities), when executed and delivered by the Master Servicer, will constitute the legal, valid and binding obligations of the Master Servicer enforceable in accordance with their respective terms, except as such enforceability 18 22 may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting creditors' rights generally and general equitable principles and public policy considerations as to rights of indemnification for violations of federal securities laws. The Master Servicer will not at any time in the future deny that the Transaction Documents to which it is a party constitute the legal, valid and binding obligations of the Master Servicer. (g) Financial Statements. The Financial Statements of the Master Servicer, copies of which have been furnished to the Insurer, (i) are, as of the dates and for the periods referred to therein, complete and correct in all material respects, (ii) present fairly the financial condition and results of operations of the Master Servicer as of the dates and for the periods indicated and (iii) have been prepared in accordance with generally accepted accounting principles consistently applied, except as noted therein (subject as to interim statements to normal year-end adjustments). Since the date of the most recent Financial Statements of the Master Servicer, there has been no Material Adverse Change in respect of the Master Servicer. Except as disclosed in the Financial Statements of the Master Servicer, the Master Servicer is not subject to any contingent liabilities or commitments that, individually or in the aggregate, have a material possibility of causing a Material Adverse Change in respect of the Master Servicer. (h) Compliance With Law, Etc. No practice, procedure or policy employed, or proposed to be employed, by the Master Servicer in the conduct of its business violates any law, regulation, judgment, agreement, order or decree applicable to any of them that, if enforced, could reasonably be expected to result in a Material Adverse Change with respect to the Master Servicer. (i) Taxes. The Master Servicer and the Master Servicer's parent company or companies have filed prior to the date hereof all federal and state tax returns that are required to be filed and paid all taxes, including any assessments received by them that are not being contested in good faith, to the extent that such taxes have become due, except for any failures to file or pay that, individually or in the aggregate, would not result in a Material Adverse Change with respect to the Master Servicer. (j) Accuracy of Information. Neither the Transaction Documents nor other information relating to the Loans, the operations of the Master Servicer (including servicing or origination of loans) or the financial condition of the Master Servicer (collectively, the "Documents"), as amended, supplemented or superseded, furnished to the Insurer by the Master Servicer contain any statement of a material fact by the Master Servicer which was untrue or misleading in any material adverse respect when made. The Master Servicer has no knowledge or circumstances that could reasonably be expected to cause a Material Adverse Change with respect to the Master Servicer. Since the furnishing of the Documents, there has been no change nor any development or event involving a prospective 19 23 change known to the Master Servicer that would render any of the Documents untrue or misleading in a material respect. (k) Compliance With Securities Laws. The information in the Offering Document set forth under the heading "THE MASTER SERVICER" does not contain any untrue statement of a material fact and does not omit to state a material fact necessary to make the statements made therein, in light of the circumstances under which they were made, not misleading. (l) Transaction Documents. Each of the representations and warranties of the Master Servicer contained in the Transaction Documents is true and correct in all material respects, and the Master Servicer hereby makes each such representation and warranty to, and for the benefit of, the Insurer as if the same were set forth in full herein, provided that the remedy for any breach of this paragraph shall be limited to the remedies specified in the related Transaction Document. (m) Solvency. The Master Servicer is solvent and will not be rendered insolvent by the Transaction and, after giving effect to the Transaction, the Master Servicer will not be left with an unreasonably small amount of capital with which to engage in its business, nor does the Master Servicer intend to incur, or believe that it has incurred, debts beyond its ability to pay as they mature. The Master Servicer does not contemplate the commencement of insolvency, bankruptcy, liquidation or consolidation proceedings or the appointment of a receiver, liquidator, conservator, trustee or similar official in respect of the Master Servicer or any of its assets. (n) Principal Place of Business. The principal place of business for the master servicing activities of the Master Servicer is located in Columbia, Maryland. Section 2.08. AFFIRMATIVE COVENANTS OF THE MASTER SERVICER. The Master Servicer hereby agrees that during the Term of the Insurance Agreement, unless the Insurer shall otherwise expressly consent in writing: (a) Compliance With Agreements and Applicable Laws. The Master Servicer shall not be in default under the Transaction Documents and shall comply with all material requirements of any law, rule or regulation applicable to it. The Master Servicer shall not agree to any amendment to or modification of the terms of any Transaction Documents unless the Insurer shall have otherwise consented. (b) Corporate Existence. The Master Servicer, and its successors and assigns, shall maintain its existence and shall at all times continue to be duly organized under the laws of the United States of America or another jurisdiction of organization and duly 20 24 qualified and duly authorized (as described in subsections 2.07(a), (b) and (c) hereof) and shall conduct its business in accordance with the terms of its charter or certificate of incorporation and bylaws. (c) Financial Statements; Accountants' Reports; Other Information. The Master Servicer shall keep or cause to be kept in reasonable detail books and records of account of its assets and business, including, but not limited to, books and records relating to the Transaction. The Master Servicer shall furnish or cause to be furnished to the Insurer: (i) Annual Financial Statements. As soon as available, and in any event within 120 days after the close of each fiscal year of the Master Servicer, the audited consolidated balance sheets of the Master Servicer and its subsidiaries as of the end of such fiscal year and the related audited consolidated statements of income, changes in shareholders' equity and cash flows for such fiscal year, all in reasonable detail and stating in comparative form the respective figures for the corresponding date and period in the preceding fiscal year, prepared in accordance with generally accepted accounting principles, consistently applied, and accompanied by the audit opinion of the Master Servicer's independent accountants (which shall be a nationally recognized independent public accounting firm) and by the certificate specified in Section 2.08(d) hereof. (ii) Quarterly Financial Statements. As soon as available, and in any event within 90 days after each of the first three fiscal quarters of each fiscal year of the Master Servicer, the unaudited consolidated balance sheets of the Master Servicer and its subsidiaries as of the end of such fiscal quarter and the related unaudited consolidated statements of income, changes in shareholders' equity and cash flows for such fiscal quarter, all in reasonable detail and stating in comparative form the respective figures for the corresponding date and period in the preceding fiscal year, prepared in accordance with generally accepted accounting principles, consistently applied, and accompanied by the certificate specified in Section 2.08(d) hereof. (iii) Continuing Reports. Thereafter, the Master Servicer shall deliver to the Insurer not later than 12:00 noon, New York City time, on each Determination Date the Master Servicer Certificate required by Section 4.01(c) of the PSA. (iv) Certain Information. Upon the reasonable request of the Insurer, the Master Servicer shall promptly provide copies of any requested proxy statements, financial statements, reports and registration statements which the Master Servicer files with, or delivers to, the Commission or any national securities exchange. 21 25 (v) Other Information. Promptly upon receipt thereof, copies of all schedules, financial statements or other similar reports delivered to or by the Master Servicer pursuant to the terms of the PSA and, promptly upon request, such other data as the Insurer may reasonably request. All financial statements specified in clause (i) above shall be furnished in consolidated form for the Master Servicer and all its affiliates in the event the Master Servicer shall consolidate its financial statements with its affiliates. The Insurer agrees that it and its agents, accountants and attorneys shall keep confidential all financial statements, reports and other information delivered by the Master Servicer pursuant to this subsection 2.08(c) to the extent provided in subsection 2.09(e) hereof. (d) Compliance Certificate. The Master Servicer shall deliver to the Insurer, concurrently with the delivery of the financial statements required pursuant to subsection 2.08(c)(i) and (ii) hereof, one or more certificates signed by a Master Servicing Officer of the Master Servicer authorized to execute such certificates on behalf of the Master Servicer stating that: (i) a review of the Master Servicer performance under the Transaction Documents during such period has been made under such officer's supervision; (ii) to the best of such individual's knowledge following reasonable inquiry, no Default or Event of Default has occurred, or if a Default or Event of Default has occurred, specifying the nature thereof and, if the Master Servicer has a right to cure pursuant to Section 7.01 of the PSA, stating in reasonable detail (including, if applicable, any supporting calculations) the steps, if any, being taken by the Master Servicer to cure such Default or Event of Default or to otherwise comply with the terms of the agreement to which such Default or Event of Default relates; (iii) the attached Financial Statements submitted in accordance with subsection 2.09(c)(i) or (ii), as the case may be, hereof are complete and correct in all material respects and present fairly the financial condition and results of operations of the Master Servicer as of the dates and for the periods indicated, in accordance with generally accepted accounting principles consistently applied; and (iv) the Master Servicer has in full force and effect a blanket fidelity bond (or direct surety bond) and an errors and omissions insurance policy in accordance with the terms and requirements of Section 3.20 of the PSA. 22 26 (e) Access to Records; Discussions With Officers and Accountants. On an annual basis, or upon the occurrence of a Material Adverse Change, the Master Servicer shall, upon the request of the Insurer, permit the Insurer or its authorized agents, at the expense of the Insurer, at reasonable times and upon reasonable notice: (i) to inspect the books and records of the Master Servicer as they may relate to the Securities, the obligations of the Master Servicer under the Transaction Documents, and the Transaction; (ii) to discuss the affairs, finances and accounts of the Master Servicer with the chief operating officer and the chief financial officer of the Master Servicer, as the case may be; and (iii) with the Master Servicer's consent, which consent shall not be unreasonably withheld, to discuss the affairs, finances and accounts of the Master Servicer with the Master Servicer's independent accountants, provided that an officer of the Master Servicer shall have the right to be present during such discussions. Such inspections and discussions shall be conducted during normal business hours and shall not unreasonably disrupt the business of the Master Servicer. The books and records of the Master Servicer will be maintained at the address of the Master Servicer designated herein for receipt of notices, unless the Master Servicer shall otherwise advise the parties hereto in writing. The Insurer agrees that it and its shareholders, employees, directors, agents, accountants and attorneys shall keep confidential any matter of which it becomes aware through such inspections or discussions (unless readily available from public sources), except as may be otherwise required by regulation, law or court order or requested by appropriate governmental authorities or as necessary to preserve its rights or security under or to enforce the Transaction Documents, provided that the foregoing shall not limit the right of the Insurer to make such information available to its regulators, securities rating agencies, reinsurers, credit and liquidity providers, counsel and accountants. If the Insurer is requested or required (by oral questions, interrogatories, requests for information or documents subpoena, civil investigative demand or similar process) to disclose any information of which it becomes aware through such inspections or discussions, the Insurer will promptly notify the Master Servicer of such request(s) so that the Master Servicer may seek an appropriate protective order and/or waive the Insurer's compliance with the provisions of this Insurance Agreement. If, in the absence of a protective order or the receipt of a waiver hereunder, the Insurer is, nonetheless, in the opinion of its counsel, compelled to disclose such information to any tribunal or else stand liable for contempt or 23 27 suffer other censure or significant penalty, the Insurer may disclose such information to such tribunal that the Insurer is compelled to disclose, provided that a copy of all information disclosed is provided to the Master Servicer promptly upon such disclosure. (f) Notice of Material Events. The Master Servicer shall be obligated promptly to inform the Insurer in writing of the occurrence of any of the following to the extent any of the following relate to it: (i) the submission of any claim or the initiation or threat of any legal process, litigation or administrative or judicial investigation, or rule making or disciplinary proceeding by or against the Master Servicer that (A) could be required to be disclosed to the Commission or to the Master Servicer's shareholders or (B) could result in a Material Adverse Change with respect to the Master Servicer, or the promulgation of any proceeding or any proposed or final rule which would result in a Material Adverse Change with respect to the Master Servicer; (ii) any change in the location of the Master Servicer's principal offices or any change in the location of the Master Servicer's books and records; (iii) the occurrence of any Default or Event of Default or of any Material Adverse Change; (iv) the commencement of any proceedings by or against the Master Servicer under any applicable bankruptcy, reorganization, liquidation, rehabilitation, insolvency or other similar law now or hereafter in effect or of any proceeding in which a receiver, liquidator, conservator, trustee or similar official shall have been, or may be, appointed or requested for the Master Servicer or any of its or their assets; or (v) the receipt of notice that (A) the Master Servicer is being placed under regulatory supervision, (B) any license, permit, charter, registration or approval necessary for the conduct of the Master Servicer's business is to be, or may be suspended or revoked, or (C) the Master Servicer is to cease and desist any practice, procedure or policy employed by the Master Servicer in the conduct of its business, and such cessation may result in a Material Adverse Change with respect to the Master Servicer. (g) Financing Statements and Further Assurances. The Master Servicer will cause to be filed all necessary financing statements or other instruments, and any amendments or continuation statements relating thereto, necessary to be kept and filed in such manner and in such places as may be required by law to preserve and protect fully 24 28 the interest of the Trustee in the Trust. The Master Servicer shall, upon the request of the Insurer, from time to time, execute, acknowledge and deliver, or cause to be executed, acknowledged and delivered, with ten days of such request, such amendments hereto and such further instruments and take such further action as may be reasonably necessary to effectuate the intention, performance and provisions of the Transaction Documents. In addition, the Master Servicer agrees to cooperate with S&P and Moody's in connection with any review of the Transaction that may be undertaken by S&P and Moody's after the date hereof. (h) Maintenance of Licenses. The Master Servicer, or any successors thereof, shall maintain all licenses, permits, charters and registrations which are material to the conduct of its business. (i) Disclosure Document. Each Offering Document prepared by or on behalf of the Master Servicer and delivered with respect to the Securities shall clearly disclose that the Policy is not covered by the property/casualty insurance security fund specified in Article 76 of the New York Insurance Law. (j) Third-Party Beneficiary. The Master Servicer agrees that the Insurer shall have all rights of a third-party beneficiary in respect of the PSA and hereby incorporates and restates its representations, warranties and covenants as set forth therein for the benefit of the Insurer. (k) Servicing of Loans. The Master Servicer will provide the Insurer with written notice of any change or amendment to any Transaction Document as currently in effect and agrees that it will not make any change or amendment to any Transaction Document without the prior written consent of the Insurer thereto. (l) Maintenance of Trust. On or before each March 21, beginning in 1997, so long as any of the Securities are outstanding, the Master Servicer shall furnish, or cause to be furnished, to the Insurer and the Trustee an Officers' Certificate either stating that such action has been taken with respect to the recording, filing, rerecording and refiling of any financing statements and continuation statements as is necessary to maintain the interest of the Trustee created by the PSA with respect to the Trust and reciting the details of such action or stating that no such action is necessary to maintain such interests. Such Officers' Certificate shall also describe the recording, filing, rerecording and refiling of any financing statements and continuation statements that will be required to maintain the interest of the Trustee in the Trust until the date such next Officers' Certificate is due. The Master Servicer will use its best efforts to cause any necessary recordings or filings to be made with respect to the Trust. 25 29 (m) Closing Documents. The Master Servicer shall provide or cause to be provided to the Insurer an executed original copy of each document executed in connection with the Transaction within 30 days after the date of closing (except with respect to subsequent transfers of Loans). (n) Preference Payments. With respect to any Preference Amount (as defined in the Policy), the Master Servicer shall provide to the Insurer upon the request of the Insurer: (i) a certified copy of the final nonappealable order of a court having competent jurisdiction ordering the recovery by a trustee in bankruptcy as voidable preference amounts included in previous distributions under Section 4.02 of the PSA to any Owner pursuant to the United States Bankruptcy Code; (ii) an opinion of counsel satisfactory to the Insurer, and upon which the Insurer shall be entitled to rely, stating that such order is final and is not subject to appeal; (iii) an assignment in such form as reasonably required by the Insurer, irrevocably assigning to the Insurer all rights and claims of the Master Servicer, the Trustee and any Certificateholder relating to or arising under the Mortgage Loan against the debtor which made such preference payment or otherwise with respect to such preference amount; and (iv) appropriate instruments to effect (when executed by the affected party) the appointment of the Insurer as agent for the Trustee and any Certificateholders in any legal proceeding relating to such preference payment being in a form satisfactory to the Insurer. (o) Additional Reporting. The Master Servicer shall prepare the following for the benefit of the Insurer: (i) To the extent that the Master Servicer is directly servicing any of the Loans, an annual letter prepared by a firm of independent certified public accountants acceptable to the Insurer, whose acceptance may not be unreasonably withheld, stating that such firm has examined the Master Servicer's operations in accordance with the requirements of the Uniform Single Audit Program for Mortgage Bankers. (ii) An annual certificate stating that the Master Servicer is in compliance, in all material respects, with all of its obligations and responsibilities 26 30 outlined in the PSA. (iii) Monthly reports which include distributions made to the holders of the Certificates, delinquency and default information with respect to the mortgage pool, the status of all loans for which claims with the FHA have been made and the outstanding amount available under the Contract of Insurance. In addition, the Master Servicer shall provide the Insurer with monthly reports for all transactions utilizing the same Contract of Insurance as the one to which the loans underlying the Certificates are subject. Section 2.09. NEGATIVE COVENANTS OF THE MASTER SERVICER . The Master Servicer hereby agrees that during the Term of the Insurance Agreement, unless the Insurer shall otherwise expressly consent in writing: (a) Impairment of Rights. The Master Servicer shall not take any action, or fail to take any action, if such action or failure to take action may result in a material adverse change as described in clause (ii) of the definition of Material Adverse Change with respect to the Master Servicer, or may interfere with the enforcement of any rights of the Insurer under or with respect to the Transaction Documents. The Master Servicer shall give the Insurer written notice of any such action or failure to act on the earlier of: (i) the date upon which any publicly available filing or release is made with respect to such action or failure to act or (ii) promptly prior to the date of consummation of such action or failure to act. The Master Servicer shall furnish to the Insurer all information requested by it that is reasonably necessary to determine compliance with this paragraph. (b) Waiver, Amendments, Etc. Except in accordance with the Transaction Documents, the Master Servicer shall not waive, modify or amend, or consent to any waiver, modification or amendment of, any of the terms, provisions or conditions of the Transaction Documents without the consent of the Insurer. (c) Mortgage Loan Agreements; Charge-off Policy. Except as otherwise permitted in the PSA, the Master Servicer shall not alter or amend any Mortgage Loan or their respective charge-off policies in a manner that materially adversely affects the Insurer unless the Insurer shall have previously given its consent, which consent shall not be unreasonably withheld. Section 2.10. ADDITIONAL COVENANTS OF DEPOSITOR, SELLER AND CLAIMS ADMINISTRATOR. None of the Seller, the Depositor or the Claims Administrator shall submit, or cause to be submitted, a claim to the FHA in respect of the Loans if the amount of such claim would, when aggregated with all prior claims made to the FHA in respect of the Loans, exceed the Trust Designated Insurance Amount without the prior written consent of the Insurer. In the event that claims are made under 27 31 the Contract of Insurance in respect of the Loans in excess of the Trust Designated Insurance Amount, the Class R Certificateholders shall not receive distributions until such time as an amount equal to such excess claims (the "Excess Claim Amount") has been deposited into a reserve account acceptable to the Insurer. The Excess Claim Amount will be deposited at the direction of the Insurer in other MBIA-insured Mego Title I transactions or distributed to the Class R Certificateholders at the direction of the Insurer. The Excess Claim Amount shall be equal to 90% of the excess of (x) the claims made under the Contract of Insurance for the 1996-1 transaction over (y) the Trust Designated Insurance Amount. ARTICLE III THE POLICY; REIMBURSEMENT Section 3.01. ISSUANCE OF THE POLICY. The Insurer agrees to issue the Policy on the Closing Date subject to satisfaction of the conditions precedent set forth below: (a) Payment of Initial Premium and Expenses. The Insurer shall have been paid, by the Seller, that portion of a nonrefundable Premium payable on the Closing Date and the Seller shall agree to reimburse or pay directly other fees and expenses identified in Section 3.02 as payable, and the Insurer shall have received a fully executed copy of the Commitment. (b) Transaction Documents. The Insurer shall have received a copy of each of the Transaction Documents, in form and substance satisfactory to the Insurer, duly authorized, executed and delivered by each party thereto. (c) Certified Documents and Resolutions. The Insurer shall have received a copy of (i) the charter or certificate of incorporation and bylaws of the Master Servicer and the Seller, (ii) the resolutions of the Seller's Board of Directors authorizing the execution, delivery and performance by the Seller of the Transaction Documents and the transactions contemplated thereby, and (iii) the resolutions of the Depositor's Board of Directors authorizing the issuance of the Securities and the execution, delivery and performance by the Depositor of the Transactions Documents and the transactions contemplated thereby certified by the Secretary or an Assistant Secretary of the Master Servicer, the Seller and the Depositor, respectively (which certificate shall state that such charter or certificate of incorporation, bylaws and resolutions are in full force and effect without modification on the Date of Issuance). (d) Incumbency Certificate. The Insurer shall have received a certificate of the Secretary or an Assistant Secretary of the Master Servicer and the Seller certifying the names and signatures of the officers of the Master Servicer and the Seller authorized to 28 32 execute and deliver the Transaction Documents and that shareholder consent to the execution and delivery of such documents is not necessary. (e) Representations and Warranties; Certificate. The representations and warranties of the Master Servicer and the Seller set forth or incorporated by reference in this Insurance Agreement shall be true and correct as of the Date of Issuance as if made on the Date of Issuance and the Insurer shall have received a certificate of appropriate officers of the Master Servicer and the Seller to that effect. (f) Opinions of Counsel. (i) The law firm of Brown & Wood shall have issued its favorable opinion or opinions, in form and substance acceptable to the Insurer and its counsel, regarding the corporate existence and authority of the Seller and the Depositor and the validity and enforceability of the Transaction Documents against such parties. (ii) The law firm of Brown & Wood shall have furnished its opinions, in form and substance acceptable to the Insurer and its counsel, regarding the sale of the home improvement loans and the tax treatment of payments on the Certificates under federal and New York tax laws. (iii) Legal opinions shall be furnished by Swidler & Berlin in form and substance acceptable to the Insurer, regarding the ability to assign and transfer the rights to file and collect claims with FHA to a successor servicer or trustee. (iv) The Insured shall have been provided with opinions, in form and substance acceptable to the Insurer and its counsel, to the effect that: (A) the Trustee is an "investing lender" in good standing under 24 CFR Section 202.7 and authorized to purchase, hold and sell loans that have been originated and insured under 24 CFR Part 201 and there are no administrative actions pending or threatened which, if successful, could change such good standing; (B) the Seller is a "non-supervised lender" in good standing under 24 CFR Section 202.5 and authorized to originate, purchase, hold, service and sell loans insured under 24 CFR Part 201 and there are no administrative actions pending or threatened which, if successful, could change such good standing; and (C) all actions necessary under Title I to permit the Seller, as claims administrator, to act as the duly authorized agent and attorney-in-fact of the Trustee, as if a duly authorized officer of the Trustee itself were so acting, for purposes of handling all aspects of administering, processing and submitting FHA claims to HUD/FHA. (v) The Insurer shall have received such other opinions of counsel, in form and 29 33 substance acceptable to the Insurer and its counsel, addressing such other matters as the Insurer may reasonably request. (g) Approvals, Etc. The Insurer shall have received true and correct copies of all approvals, licenses and consents, if any, including, without limitation, any required approval of the shareholders of the Master Servicer and the Seller, required in connection with the Transaction. (h) No Litigation, Etc. No suit, action or other proceeding, investigation or injunction, or final judgment relating thereto, shall be pending or threatened before any court or governmental agency in which it is sought to restrain or prohibit or to obtain damages or other relief in connection with the Transaction Documents or the consummation of the Transaction. (i) Legality. No statute, rule, regulation or order shall have been enacted, entered or deemed applicable by any government or governmental or administrative agency or court that would make the transactions contemplated by any of the Transaction Documents illegal or otherwise prevent the consummation thereof. (j) Satisfaction of Conditions of the Underwriting Agreement. All conditions in the Underwriting Agreement relating to the investors' obligation to purchase the Securities shall have been satisfied. (k) Issuance of Ratings. The Insurer shall have received confirmation that the risk secured by the Policy constitutes a BBB risk by S&P and a Baa risk by Moody's and that the Certificates, when issued, will be rated "AAA" by S&P and "Aaa" by Moody's. (l) No Default. No Default or Event of Default shall have occurred. (m) Additional Items. The Insurer shall have received such other documents, instruments, approvals or opinions requested by the Insurer as may be reasonably necessary to effect the Transaction, including, but not limited to, evidence satisfactory to the Insurer that the conditions precedent, if any, in the Transaction Documents have been satisfied. (n) Underwriting Agreement. The Insurer shall have received copies of each of the documents, and specifically be entitled to rely on each of the documents, required to be delivered to the Underwriter pursuant to the Underwriting Agreement. (o) Conform to Documents. The Insurer and its counsel shall have determined that all documents, certificates and opinions to be delivered in connection with the Certificates conform to the terms of the PSA, the Commitment, the Offering Document and this Insurance Agreement. 30 34 (p) Compliance With Commitment. All other terms, conditions and requirements of the Commitment shall have been satisfied. (q) HUD Audit Letters. The Insurer shall have received copies of all HUD audit letters addressed to the Contract of Insurance Holder received within the last five years and the Contract of Insurance Holder's response to such letters. The issuance of the Policy will be conclusive evidence of satisfaction or waiver of any of the conditions set forth in this Section 3.01. Section 3.02. PAYMENT OF FEES AND PREMIUM. (a) Legal and Accounting Fees. The Seller shall pay or cause to be paid, on the Date of Issuance, legal fees and disbursements incurred by the Insurer in connection with the issuance of the Policy in accordance with the terms of the Commitment. Any fees of the Insurer's auditors payable in respect of any amendment or supplement to the Offering Document or any other Offering Document incurred after the Date of Issuance shall be paid by the Seller on demand. (b) Premium. In consideration of the issuance by the Insurer of the Policy, the Insurer shall be entitled to receive the Premium in an amount equal to the product of 0.0308% and the outstanding Certificate balance of the Class A Certificates on the Closing Date. On each Distribution Date following the Closing Date, beginning in April 1996 and monthly thereafter, the Seller shall pay, or cause to be paid, to the Insurer an amount (rounded to the nearest dollar) equal to 0.0308% or the outstanding principal balance of the Class A Certificates on the Business Day immediately preceding the Determination Date for which such payment is due; provided, however, no Premium shall be due to the Insurer so long as the Insurer shall have failed to make a payment required under the Policy in accordance with its terms. The Premium paid hereunder or under the PSA shall be nonrefundable without regard to whether the Insurer makes any payment under the Policy or any other circumstances relating to the Securities or provision being made for payment of the Certificates prior to maturity. The Seller shall make all payments of Premium to be made by them by wire transfer to an account designated from time to time by the Insurer by written notice to the Seller. Section 3.03. REIMBURSEMENT AND ADDITIONAL PAYMENT OBLIGATION. (a) In accordance with the priorities established in Section 4.05 of the PSA, the Insurer shall be entitled to reimbursement for any payment made by the Insurer under the Policy, which reimbursement shall be due and payable on the date that any amount is to be paid pursuant to a Notice (as defined in the Policy), in an amount equal to the amount to be so paid and all amounts previously paid that remain unreimbursed, together with interest on any and all amounts remaining unreimbursed (to the extent 31 35 permitted by law, if in respect of any unreimbursed amounts representing interest) from the date such amounts became due until paid full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate. (b) The Seller agrees to pay to the Insurer as follows: anything in subsection 3.03(a) to the contrary notwithstanding, the Insurer shall be entitled to reimbursement from the Seller (i) for payments made under the Policy arising as a result of the Seller's failure to repurchase any Mortgage Loan required to be repurchased by it pursuant to the PSA, together with interest on any and all amounts remaining unreimbursed (to the extent permitted by law, if in respect of any unreimbursed amounts representing interest) from the date such amounts became due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate, and (ii) for payments made under the Policy, arising as a result of the Seller's failure to deposit into the Collection Account any amount required to be so deposited by it pursuant to the PSA, together with interest on any and all amounts remaining unreimbursed (to the extent permitted by law, if in respect to any unreimbursed amounts representing interest) from the date such amounts became due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate. (c) The Seller agrees to pay to the Insurer as follows: any and all charges, fees, costs and expenses that the Insurer may reasonably pay or incur, including, but not limited to, attorneys' and accountants' fees and expenses, in connection with (i) any accounts established to facilitate payments under the Policy to the extent the Insurer has not been immediately reimbursed on the date that any amount is paid by the Insurer under the Policy, (ii) the enforcement, defense or preservation of any rights in respect of any of the Transaction Documents, including defending, monitoring or participating in any litigation or proceeding (including any insolvency or bankruptcy proceeding in respect of any Transaction participant or any affiliate thereof) relating to any of the Transaction Documents, any party to any of the Transaction Documents, in its capacity as such a party, or the Transaction, (iii) any amendment, waiver or other action with respect to, or related to, any Transaction Document, whether or not executed or completed, or (iv) preparation of bound volumes of the Transaction documents; costs and expenses shall include a reasonable allocation of compensation and overhead attributable to the time of employees of the Insurer spent in connection with the actions described in clause (ii) above, and the Insurer reserves the right to charge a reasonable fee as a condition to executing any waiver or consent proposed in respect of any of the Transaction Documents. (d) The Seller agrees to pay to the Insurer as follows: interest on any and all amounts described in subclauses (b), (c), (e) and (f) of this Section 3.03 from the date payable or paid by such party until payment thereof in full, and interest on any and all amounts described in Section 3.02 from the date due until payment thereof in full, in each case, payable to the Insurer at the Late Payment Rate per annum. 32 36 (e) Following termination of the PSA pursuant to Section 9.01 thereof, the Seller agrees to reimburse the Insurer for any Insured Payments required to be made pursuant to the Policy subsequent to the date of such termination. (f) The Master Servicer agrees to pay the Insurer as follows: the Insurer shall be entitled to reimbursement from the Master Servicer for payments made under the Policy arising as a result of (i) the Master Servicer's failure to deposit into the Collection Account any amount required to be so deposited by the Master Servicer pursuant to the PSA and (ii) the Master Servicer's failure to repurchase any Mortgage Loan required to be purchased by it under the PSA, together with interest on any and all amounts remaining unreimbursed (to the extent permitted by law, if in respect to any unreimbursed amounts relating to interest) from the date such amounts became due until paid in full (after as well as before judgment), at a rate of interest equal to the Late Payment Rate. All such amounts are to be immediately due and payable without demand. Section 3.04. INDEMNIFICATION BY SELLER; LIMITATION OF LIABILITY. (a) In addition to any and all rights of indemnification or any other rights of the Insurer pursuant hereto or under law or equity, the Seller and any successors thereto agree to pay, and to protect, indemnify and save harmless, the Insurer and its officers, directors, shareholders, employees, agents, and each person, if any, who controls the Insurer within the meaning of either Section 15 of the Securities Act of 1933, as amended, or Section 20 of the Securities and Exchange Act of 1934, as amended, from and against any and all claims, losses, liabilities (including penalties), actions, suits, judgments, demands, damages, costs or reasonable expenses (including, without limitation, reasonable fees and expenses of attorneys, consultants and auditors and reasonable costs of investigations) or obligations whatsoever paid by the Insurer (herein collectively referred to as "Liabilities") of any nature arising out of or relating to the transactions contemplated by the Transaction Documents by reason of: (i) any untrue statement or alleged untrue statement of a material fact contained in the Offering Document or in any amendment or supplement thereto or in any preliminary offering document other than the Base Prospectus or the Registration Statement, or arising out of or based upon any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as such Liabilities arise out of or are based upon any such untrue statement or omission or allegation thereof based upon the Insurer Information or the Underwriter Information (as such terms are defined in the Indemnification Agreement) or the Master Servicer Information (as defined in Section 3.05 hereof); 33 37 (ii) to the extent not covered by clause (i) above, any act or omission of the Seller in connection with the offering, issuance, sale or delivery of the Certificates other than by reason of false or misleading information provided by the Insurer, the Underwriter or the Master Servicer in writing for inclusion in the Offering Document as specified in clause (i) above or the allegation thereof; (iii) the misfeasance or malfeasance of, or negligence or theft committed by, any director, officer, employee or agent of the Seller; (iv) the violation by the Seller of any federal or state securities, banking or antitrust laws, rules or regulations in connection with the issuance, offer and sale of the Certificates or the transactions contemplated by the Transaction Documents; (v) the violation by the Seller of any federal or state laws, rules or regulations relating to the maximum amount of interest permitted to be received on account of any loan of money or with respect to the Loans; (vi) the breach by the Seller of any of its obligations under this Agreement or any of the Transaction Documents to which the Seller is a party; and (vii) the breach by the Seller of any representation or warranty on the part of the Seller contained in the Transaction Documents to which the Seller is a party or in any certificate or report furnished or delivered to the Insurer thereunder. This indemnity provision shall survive the termination of this Agreement and shall survive until the statute of limitations has run on any causes of action which arise from one of these reasons and until all suits filed as a result thereof have been finally concluded. (b) Any party which proposes to assert the right to be indemnified under this Section 3.04 will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim is to be made against the Seller under this Section 3.04, notify the Seller of the commencement of such action, suit or proceeding, enclosing a copy of all papers served. In case any action, suit or proceeding shall be brought against any indemnified party and it shall notify the Seller of the commencement thereof, the Seller shall be entitled to participate in, and, to the extent that it shall wish, to assume the defense thereof, with counsel satisfactory to such indemnified party, and after notice from the Seller to such indemnified party of its election so to assume the defense thereof, the Seller shall not be liable to such indemnified party for any legal or other expenses other than reasonable costs of investigation subsequently incurred by such indemnified party in connection with the defense thereof. The indemnified party shall have the right to employ its counsel in any such action the defense of which is assumed by the Seller in accordance with the terms of this subsection (b), but the fees and 34 38 expenses of such counsel shall be at the expense of such indemnified party unless the employment of counsel by such indemnified party has been authorized by the Seller. The Seller shall not be liable for any settlement of any action or claim effected without its consent. Section 3.05. INDEMNIFICATION BY MASTER SERVICER; LIMITATION OF LIABILITY. (a) In addition to any and all rights of indemnification or any other rights of the Insurer pursuant hereto or under law or equity, the Master Servicer and any successors thereto agree to pay, and to protect, indemnify and save harmless, the Insurer and its officers, directors, shareholders, employees, agents, and each person, if any, who controls the Insurer within the meaning of either Section 15 of the Securities Act of 1933, as amended, or Section 20 of the Securities and Exchange Act of 1934, as amended, from and against any and all claims, losses, liabilities (including penalties), actions, suits, judgments, demands, damages, costs or reasonable expenses (including, without limitation, reasonable fees and expenses of attorneys, consultants and auditors and reasonable costs of investigations) or obligations whatsoever paid by the Insurer (herein collectively referred to as "Liabilities") of any nature arising out of or relating to the transactions contemplated by the Transaction Documents by reason of: (i) any untrue statement or alleged untrue statement of a material fact contained in the Offering Document under the heading "THE MASTER SERVICER" (hereinafter, referred to as the "Master Servicer Information") or in any amendment or supplement thereto or in any preliminary offering document, or arising out of or based upon any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; (ii) to the extent not covered by clause (i) above, any act or omission of the Master Servicer in connection with the offering, issuance, sale or delivery of the Certificates other than by reason of false or misleading information provided by the Insurer in writing for inclusion in the Offering Document as specified in clause (i) above or the allegation thereof; (iii) the misfeasance or malfeasance of, or negligence or theft committed by, any director, officer, employee or agent of the Master Servicer; (iv) the violation by the Master Servicer of any federal or state securities, banking or antitrust laws, rules or regulations in connection with the issuance, offer and sale of the Certificates or the transactions contemplated by the Transaction Documents; (v) the violation by the Master Servicer of any federal or state laws, rules or regulations relating to the maximum amount of interest permitted to be received on account of any loan of money or with respect to the Loans; 35 39 (vi) the breach by the Master Servicer of any of its obligations under this Agreement or any of the Transaction Documents to which the Master Servicer is a party; and (vii) the breach by the Master Servicer of any representation or warranty on the part of the Master Servicer contained in the Transaction Documents to which the Master Servicer is a party or in any certificate or report furnished or delivered to the Insurer thereunder. This indemnity provision shall survive the termination of this Agreement and shall survive until the statute of limitations has run on any causes of action which arise from one of these reasons and until all suits filed as a result thereof have been finally concluded. (b) Any party which proposes to assert the right to be indemnified under this Section 3.05 will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim is to be made against the Master Servicer under this Section 3.05, notify the Master Servicer of the commencement of such action, suit or proceeding, enclosing a copy of all papers served. In case any action, suit or proceeding shall be brought against any indemnified party and it shall notify the Master Servicer of the commencement thereof, the Master Servicer shall be entitled to participate in, and, to the extent that it shall wish, to assume the defense thereof, with counsel satisfactory to such indemnified party, and after notice from the Master Servicer to such indemnified party of its election so to assume the defense thereof, the Master Servicer shall not be liable to such indemnified party for any legal or other expenses other than reasonable costs of investigation subsequently incurred by such indemnified party in connection with the defense thereof. The indemnified party shall have the right to employ its counsel in any such action the defense of which is assumed by the Master Servicer in accordance with the terms of this subsection (b), but the fees and expenses of such counsel shall be at the expense of such indemnified party unless the employment of counsel by such indemnified party has been authorized by the Master Servicer. The Master Servicer shall not be liable for any settlement of any action or claim effected without its consent. Section 3.06. INDEMNIFICATION BY GCFP; LIMITATION OF LIABILITY. (a) In addition to any and all rights of indemnification or any other rights of the Insurer pursuant hereto or under law or equity, GCFP and any successors thereto agree to pay, and to protect, indemnify and save harmless, the Insurer and its officers, directors, shareholders, employees, agents, and each person, if any, who controls the Insurer within the meaning of either Section 15 of the Securities Act of 1933, as amended, or Section 20 of the Securities and Exchange Act of 1934, as amended, from and against any and all claims, losses, liabilities (including penalties), actions, suits, judgments, demands, damages, costs or reasonable expenses (including, without limitation, reasonable fees and expenses of attorneys, consultants and auditors and reasonable costs of investigations) or obligations whatsoever paid by the Insurer (herein collectively referred to as "Liabilities") of any nature arising 36 40 out of or relating to the transactions contemplated by the Transaction Documents by reason of: (i) any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement, or arising out of or based upon any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, except insofar as such Liabilities arise out of or are based upon any such untrue statement or omission or allegation thereof based upon the Insurer Information or the Underwriter Information (as such terms are defined in the Indemnification Agreement) or the Master Servicer Information; (ii) to the extent not covered by clause (i) above, any act or omission of the Depositor in connection with the offering, issuance, sale or delivery of the Certificates other than by reason of false or misleading information provided by the Insurer, the Underwriter, the Seller or the Master Servicer in writing for inclusion in the Offering Document or as specified in clause (i) above or the allegation thereof; (iii) the misfeasance or malfeasance of, or negligence or theft committed by, any director, officer, employee or agent of the Depositor; (iv) the violation by the Depositor of any federal or state securities, banking or antitrust laws, rules or regulations in connection with the issuance, offer and sale of the Certificates or the transactions contemplated by the Transaction Documents; (v) the breach by the Depositor of any of its obligations under this Agreement or any of the Transaction Documents to which the Depositor is a party; and (vi) the breach by the Depositor of any representation or warranty on the part of the Depositor contained in the Transaction Documents to which the Depositor is a party or in any certificate or report furnished or delivered to the Insurer thereunder. This indemnity provision shall survive the termination of this Agreement and shall survive until the statute of limitations has run on any causes of action which arise from one of these reasons and until all suits filed as a result thereof have been finally concluded. (b) Any party which proposes to assert the right to be indemnified under this Section 3.06 will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim is to be made against GCFP under this Section 3.06, notify GCFP of the commencement of such action, suit or proceeding, enclosing a copy of all papers served. In case any action, suit or proceeding shall be brought against any indemnified party and it shall notify GCFP of the commencement thereof, GCFP shall be entitled to participate in, and, to the extent that it shall wish, to assume the defense thereof, with counsel 37 41 satisfactory to such indemnified party, and after notice from GCFP to such indemnified party of its election so to assume the defense thereof, GCFP shall not be liable to such indemnified party for any legal or other expenses other than reasonable costs of investigation subsequently incurred by such indemnified party in connection with the defense thereof. The indemnified party shall have the right to employ its counsel in any such action the defense of which is assumed by GCFP in accordance with the terms of this subsection (b), but the fees and expenses of such counsel shall be at the expense of such indemnified party unless the employment of counsel by such indemnified party has been authorized by GCFP. GCFP shall not be liable for any settlement of any action or claim effected without its consent. Section 3.07. PAYMENT PROCEDURE. In the event of any payment by the Insurer, the Trustee, the Master Servicer and the Seller agree to accept the voucher or other evidence of payment as prima facie evidence of the propriety thereof and the liability therefor to the Insurer except in the case of manifest error. All payments to be made to the Insurer under this Insurance Agreement shall be made to the Insurer in lawful currency of the United States of America in immediately available funds at the notice address for the Insurer as specified in the PSA on the date when due or as the Insurer shall otherwise direct by written notice to the other parties hereto. In the event that the date of any payment to the Insurer or the expiration of any time period hereunder occurs on a day which is not a Business Day, then such payment or expiration of time period shall be made or occur on the next succeeding Business Day with the same force and effect as if such payment was made or time period expired on the scheduled date of payment or expiration date. Payments to be made to the Insurer under this Insurance Agreement shall bear interest at the Late Payment Rate from the date when due to the date paid. ARTICLE IV FURTHER AGREEMENTS Section 4.01. EFFECTIVE DATE; TERM OF THE INSURANCE AGREEMENT. This Insurance Agreement shall take effect on the Date of Issuance and shall remain in effect until the later of (a) such time as the Insurer is no longer subject to a claim under the Policy and the Policy shall have been surrendered to the Insurer for cancellation and (b) all amounts payable to the Insurer by the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller or from any other source under the Transaction Documents and all amounts payable under the Securities have been paid in full; provided, however, that the provisions of Sections 3.02 and 3.03 hereof shall survive any termination of this Insurance Agreement. Section 4.02. FURTHER ASSURANCES AND CORRECTIVE INSTRUMENTS. (a) Excepting at such times as a default in payment under the Policy shall exist or shall have occurred, none of the Master Servicer, the Claims Administrator, the Contract of Insurance Holder, the Seller or the Trustee shall grant any waiver of rights under any of the Transaction Documents to which any of them is a party 38 42 without the prior written consent of the Insurer, and any such waiver without the written consent of the Insurer shall be null and void and of no force or effect. (b) To the extent permitted by law, the Master Servicer, the Claims Administrator, the Contract of Insurance Holder and the Seller agree that they will, from time to time, execute, acknowledge and deliver, or cause to be executed, acknowledged and delivered, such supplements hereto and such further instruments as the Insurer may request and as may be required in the Insurer's judgment to effectuate the intention of or facilitate the performance of this Insurance Agreement. Section 4.03. OBLIGATIONS ABSOLUTE. (a) The obligations of the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller hereunder shall be absolute and unconditional and shall be paid or performed strictly in accordance with this Insurance Agreement under all circumstances irrespective of: (i) any lack of validity or enforceability of, or any amendment or other modifications of, or waiver, with respect to any of the Transaction Documents, the Securities or the Policy; (ii) any exchange or release of any other obligations hereunder; (iii) the existence of any claim, setoff, defense, reduction, abatement or other right that the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller may have at any time against the Insurer or any other Person; (iv) any document presented in connection with the Policy proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (v) any payment by the Insurer under the Policy against presentation of a certificate or other document that does not strictly comply with terms of the Policy; (vi) any failure of the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller to receive the proceeds from the sale of the Securities; or (vii) any breach by the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller of any representation, or warranty or covenant contained in any of the Transaction Documents. (b) The Master Servicer, the Claims Administrator, the Contract of Insurance Holder, the Seller and any and all others who are now or may become liable for all or part of the obligations of the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller 39 43 under this Insurance Agreement agree to be bound by this Insurance Agreement and (i) to the extent permitted by law, waive and renounce any and all redemption and exemption rights and the benefit of all valuation and appraisement privileges against the indebtedness and obligations evidenced by any Transaction Document or by any extension or renewal thereof; (ii) waive presentment and demand for payment, notices of nonpayment and of dishonor, protest of dishonor and notice of protest; (iii) waive all notices in connection with the delivery and acceptance hereof and all other notices in connection with the performance, default or enforcement of any payment hereunder, except as required by the Transaction Documents; (iv) waive all rights of abatement, diminution, postponement or deduction, or any defense other than payment, or to any right of setoff or recoupment arising out of any breach under any of the Transaction Documents, by any party thereto or any beneficiary thereof, or out of any obligation at any time owing to the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller; (v) agree that its liabilities hereunder shall, except as otherwise expressly provided in this Section 4.03, be unconditional and without regard to any setoff, counterclaim or the liability of any other Person for the payment hereof; (vi) agree that any consent, waiver or forbearance hereunder with respect to an event shall operate only for such event and not for any subsequent event; (vii) consent to any and all extensions of time that may be granted by the Insurer with respect to any payment hereunder or other provisions hereof and to the release of any security at any time given for any payment hereunder, or any part thereof, with or without substitution, and to the release of any Person or entity liable for any such payment; and (viii) consent to the addition of any and all other makers, endorsers, guarantors and other obligors for any payment hereunder, and to the acceptance of any and all other security for any payment hereunder, and agree that the addition of any such obligors or security shall not affect the liability of the parties hereto for any payment hereunder. (c) Nothing herein shall be construed as prohibiting the Master Servicer or the Seller from pursuing any rights or remedies it may have against any other Person in a separate legal proceeding. Section 4.04. ASSIGNMENTS; REINSURANCE; THIRD-PARTY RIGHTS. (a) This Insurance Agreement shall be a continuing obligation of the parties hereto and shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. Neither the Master Servicer, the Claims Administrator, the Contract of Insurance Holder nor the Seller may assign its rights under this Insurance Agreement, or delegate any of its duties hereunder, without the prior written consent of the Insurer. (b) The Insurer shall have the right to give participations in its rights under this Insurance Agreement and to enter into contracts of reinsurance with respect to the Policy upon such terms and conditions as the Insurer may in its discretion determine, provided that no such grant of a participation or contract of reinsurance shall (i) be executed if such transaction would affect any then current rating on the Certificates, (ii) affect any obligation of the Insurer hereunder or under the Policy or (iii) require the Seller, the Depositor, the Master Servicer or the Trustee to correspond 40 44 with any party other than the Insurer. (c) In addition, the Insurer shall be entitled to assign or pledge to any bank or other lender providing liquidity or credit with respect to the Transaction or the obligations of the Insurer in connection therewith any rights of the Insurer under the Transaction Documents or with respect to any real or personal property or other interests pledged to the Insurer, or in which the Insurer has a security interest, in connection with the Transaction. (d) Except as provided herein with respect to participants and reinsurers, nothing in this Insurance Agreement shall confer any right, remedy or claim, express or implied, upon any Person, including, particularly, any Owner, other than the Insurer against the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller, and all the terms, covenants, conditions, promises and agreements contained herein shall be for the sole and exclusive benefit of the parties hereto and their successors and permitted assigns. Neither the Trustee nor any Owner shall have any right to payment from any Premiums paid or payable hereunder or under the PSA or from any other amounts paid by the Master Servicer or the Seller pursuant to Section 3.02 or 3.03 hereof. Section 4.05. LIABILITY OF THE INSURER. Neither the Insurer nor any of its officers, directors or employees shall be liable or responsible for: (a) the use that may be made of the Policy by the Trustee or for any acts or omissions of the Trustee in connection therewith; or (b) the validity, sufficiency, accuracy or genuineness of documents delivered to the Insurer (or its Fiscal Agent) in connection with any claim under the Policy, or of any signatures thereon, that are believed by the Insurer to be genuine and to have been signed or presented by the proper party or parties, even if such documents or signatures should in fact prove to be in any or all respects invalid, insufficient, fraudulent or forged (unless the Insurer shall have actual knowledge thereof). In furtherance and not in limitation of the foregoing, the Insurer (or its Fiscal Agent) may accept documents that appear on their face to be in order, without responsibility for further investigation. Section 4.06. LEGAL ACTION. The Insurer shall have the right to bring an action seeking injunctive relief to perform the terms of the related pooling and servicing agreement providing for the maintenance of the Contract of Insurance and the filing and paying of claims thereunder and to prevent the claims from filing claims in an aggregate amount which exceeds the amount of FHA Insurance allocated to any particular transaction pursuant to the terms of the related pooling and servicing agreement. Section 4.07. TRUSTEE, DEPOSITOR, SELLER AND MASTER SERVICER TO JOIN IN ENFORCEMENT ACTION. To the extent necessary to enforce any right of the Insurer in or remedy of the Insurer under any Mortgage Loan, the Trustee, the Depositor, the Claims Administrator, the Contract of Insurance Holder, the Seller and the Master Servicer agree to join in any action initiated by the Trust or the Insurer for the protection of such right or exercise of such remedy. 41 45 ARTICLE V DEFAULTS; REMEDIES Section 5.01. DEFAULTS. The occurrence of any of the following events shall constitute an Event of Default hereunder: (a) Any representation or warranty made by the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller hereunder or under the Transaction Documents, or in any certificate furnished hereunder or under the Transaction Documents, shall prove to be untrue or incomplete in any material respect; (b)(i) The Master Servicer or the Seller shall fail to pay when due any amount payable by the Master Servicer or the Seller hereunder or (ii) a legislative body has enacted any law that declares or a court of competent jurisdiction shall find or rule that this Insurance Agreement or the PSA is not valid and binding on the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller; (c) The occurrence and continuance of an "Event of Default" under the PSA (as defined therein); (d) Any failure on the part of the Master Servicer, the Claims Administrator , the Contract of Insurance Holder or the Seller duly to observe or perform in any material respect any other of the covenants or agreements on the part of the Master Servicer or the Seller contained in this Insurance Agreement or in any other Transaction Document which continues unremedied for a period of 30 days with respect to this Insurance Agreement, or, with respect to any other Transaction Document, beyond any cure period provided for therein, after the date on which written notice of such failure, requiring the same to be remedied, shall have been given to the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller, as applicable, by the Insurer (with a copy to the Trustee) or by the Trustee (with a copy to the Insurer); (e) A decree or order of a court or agency or supervisory authority having jurisdiction in the premises in an involuntary case under any present or future federal or state bankruptcy, insolvency or similar law or the appointment of a conservator or receiver or liquidator or other similar official in any insolvency, readjustment of debt, marshaling of assets and liabilities or similar proceedings, or for the winding-up or liquidation of its affairs, shall have been entered against the Master Servicer, the Claims Administrator , the Contract of Insurance Holder or the Seller and such decree or order shall have remained in force undischarged or unstayed for a period of 90 consecutive days; 42 46 (f) The Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller shall consent to the appointment of a conservator or receiver or liquidator or other similar official in any insolvency, readjustment of debt, marshaling of assets and liabilities or similar proceedings of or relating to the Master Servicer or the Seller or of or relating to all or substantially all of the property of either; or (g) The Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller shall admit in writing its inability to pay its debts generally as they become due, file a petition to take advantage of or otherwise voluntarily commence a case or proceeding under any applicable bankruptcy, insolvency, reorganization or other similar statute, make an assignment for the benefit of its creditors or voluntarily suspend payment of its obligations. Section 5.02. REMEDIES; NO REMEDY EXCLUSIVE. (a) Upon the occurrence of an Event of Default, the Insurer may exercise any one or more of the rights and remedies set forth below: (i) declare all indebtedness of every type or description then owed by the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller to the Insurer to be immediately due and payable, and the same shall thereupon be immediately due and payable; (ii) exercise any rights and remedies under the PSA in accordance with the terms of the PSA or direct the Trustee to exercise such remedies in accordance with the terms of the PSA; or (iii) take whatever action at law or in equity as may appear necessary or desirable in its judgment to collect the amounts then due under this Insurance Agreement or the PSA or to enforce performance and observance of any obligation, agreement or covenant of the Master Servicer, the Claims Administrator, the Contract of Insurance Holder or the Seller under this Insurance Agreement or the PSA. (b) Unless otherwise expressly provided, no remedy herein conferred upon or reserved is intended to be exclusive of any other available remedy, but each remedy shall be cumulative and shall be in addition to other remedies given under this Insurance Agreement, the PSA or existing at law or in equity. No delay or omission to exercise any right or power accruing under this Insurance Agreement or the PSA upon the happening of any event set forth in Section 5.01 hereof shall impair any such right or power or shall be construed to be a waiver thereof, but any such right and power may be exercised from time to time and as often as may be deemed expedient. In order to entitle the Insurer to exercise any remedy reserved to the Insurer in this Article, it shall not be necessary to give any notice, other than such notice as may be required in this Article. 43 47 Section 5.03. WAIVERS. (a) No failure by the Insurer to exercise, and no delay by the Insurer in exercising, any right hereunder shall operate as a waiver thereof. The exercise by the Insurer of any right hereunder shall not preclude the exercise of any other right, and the remedies provided herein to the Insurer are declared in every case to be cumulative and not exclusive of any remedies provided by law or equity. (b) The Insurer shall have the right, to be exercised in its complete discretion, to waive any Event of Default hereunder, by a writing setting forth the terms, conditions and extent of such waiver signed by the Insurer and delivered to the Master Servicer, the Claims Administrator , the Contract of Insurance Holder and the Seller. Unless such writing expressly provides to the contrary, any waiver so granted shall extend only to the specific event or occurrence which gave rise to the Event of Default so waived and not to any other similar event or occurrence which occurs subsequent to the date of such waiver. ARTICLE VI MISCELLANEOUS Section 6.01. AMENDMENTS, ETC. This Insurance Agreement may be amended, modified or terminated only by written instrument or written instruments signed by the parties hereto. The Master Servicer agrees to promptly provide a copy of any amendment to this Insurance Agreement to the Trustee and the rating agencies. No act or course of dealing shall be deemed to constitute an amendment, modification or termination hereof. Section 6.02. NOTICES. All demands, notices and other communications to be given hereunder shall be in writing (except as otherwise specifically provided herein) and shall be mailed by registered mail or personally delivered or telecopied to the recipient as follows: (a) To the Insurer: MBIA Insurance Corporation 113 King Street Armonk, NY 10504 Attention: Insured Portfolio Management-- Structured Finance (IPM-SF) Mego Mortgage FHA Title I Trust 1996-1 Telecopy No.: (914) 765-3164 Confirmation: (914) 273-4545 (in each case in which notice or other communication to the Insurer refers to an Event of Default, a claim on the Policy or with respect to which failure on the part of the 44 48 Insurer to respond shall be deemed to constitute consent or acceptance, then a copy of such notice or other communication should also be sent to the attention of each of the general counsel and the Insurer and shall be marked to indicate "URGENT MATERIAL ENCLOSED.") (b) To the Seller, Servicer and Claims Administrator: Mego Mortgage Corporation Suite 250 210 Interstate North Parkway Atlanta, GA 30339 Attention: Jeff Moore Telecopy No.: (800) 694-6346 Confirmation: (800) 550-6346 (c) To the Master Servicer: Norwest Bank Minnesota, N.A. 11000 Broken Land Parkway Columbia, MD 21044-3562 Attention: Master Servicing Department FHA Title I Loan Trust 1996-1 Telecopy No.: (410) 884-2363 Confirmation: (410) 884-2056 (d) To the Trustee and Contract of Insurance Holder: First Trust of New York, National Association c/o First Bank National Association 180 East Fifth Street St. Paul, MN 55101 Attention: Structured Finance Telecopy No.: (612) 244-0089 Confirmation: (612) 244-5021 (e) To the Depositor: Financial Asset Securities Corp. 600 Steamboat Road Greenwich, CT 06830 45 49 Attention: Charles A. Forbes Telecopy No.: Confirmation: (f) To GCFP: Greenwich Capital Financial Products, Inc. 600 Steamboat Road Greenwich, CT 06830 Attention: Telecopy No.: Confirmation: A party may specify an additional or different address or addresses by writing mailed or delivered to the other parties as aforesaid. All such notices and other communications shall be effective upon receipt. Section 6.03. SEVERABILITY. In the event that any provision of this Insurance Agreement shall be held invalid or unenforceable by any court of competent jurisdiction, the parties hereto agree that such holding shall not invalidate or render unenforceable any other provision hereof. The parties hereto further agree that the holding by any court of competent jurisdiction that any remedy pursued by any party hereto is unavailable or unenforceable shall not affect in any way the ability of such party to pursue any other remedy available to it. Section 6.04. GOVERNING LAW. This Insurance Agreement shall be governed by and construed in accordance with the laws of the State of New York. Section 6.05. CONSENT TO JURISDICTION. (a) The parties hereto hereby irrevocably submit to the jurisdiction of the United States District Court for the Southern District of New York and any court in the State of New York located in the City and County of New York, and any appellate court from any thereof, in any action, suit or proceeding brought against it and to or in connection with any of the Transaction Documents or the transactions contemplated thereunder or for recognition or enforcement of any judgment, and the parties hereto hereby irrevocably and unconditionally agree that all claims in respect of any such action or proceeding may be heard or determined in such New York state court or, to the extent permitted by law, in such federal court. The parties hereto agree that a final judgment in any such action, suit or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. (b) To the extent permitted by applicable law, the parties hereto shall not seek and hereby waive the right to any review of the judgment of any such court by any court of any other 46 50 nation or jurisdiction which may be called upon to grant an enforcement of such judgment. (c) Nothing contained in this Insurance Agreement shall limit or affect the Insurer's right to serve process in any other manner permitted by law or to start legal proceedings relating to any of the Transaction Documents against the Master Servicer or the Seller or its or their property in the courts of any jurisdiction. Section 6.06. CONSENT OF THE INSURER. In the event that the consent of the Insurer is required under any of the Transaction Documents, the determination whether to grant or withhold such consent shall be made by the Insurer in its sole discretion without any implied duty towards any other Person, except as otherwise expressly provided therein. Section 6.07. COUNTERPARTS. This Insurance Agreement may be executed in counterparts by the parties hereto, and all such counterparts shall constitute one and the same instrument. Section 6.08. HEADINGS. The headings of Articles and Sections and the Table of Contents contained in this Insurance Agreement are provided for convenience only. They form no part of this Insurance Agreement and shall not affect its construction or interpretation. Unless otherwise indicated, all references to Articles and Sections in this Insurance Agreement refer to the corresponding Articles and Sections of this Insurance Agreement. Section 6.09. TRIAL BY JURY WAIVED. Each party hereto hereby waives, to the fullest extent permitted by law, any right to a trial by jury in respect of any litigation arising directly or indirectly out of, under or in connection with any of the Transaction Documents or any of the transactions contemplated thereunder. Each party hereto (A) certifies that no representative, agent or attorney of any party hereto has represented, expressly or otherwise, that it would not, in the event of litigation, seek to enforce the foregoing waiver and (B) acknowledges that it has been induced to enter into the Transaction Documents to which it is a party by, among other things, this waiver. Section 6.10. LIMITED LIABILITY. No recourse under any Transaction Document shall be had against, and no personal liability shall attach to, any officer, employee, director, affiliate or shareholder of any party hereto, as such, by the enforcement of any assessment or by any legal or equitable proceeding, by virtue of any statute or otherwise in respect of any of the Transaction Documents, the Certificates or the Policy, it being expressly agreed and understood that each Transaction Document is solely a corporate obligation of each party hereto, and that any and all personal liability, either at common law or in equity, or by statute or constitution, of every such officer, employee, director, affiliate or shareholder for breaches by any party hereto of any obligations under any Transaction Document is hereby expressly waived as a condition of and in consideration for the execution and delivery of this Insurance Agreement. Section 6.11. ENTIRE AGREEMENT. This Insurance Agreement and the Policy set forth the 47 51 entire agreement between the parties with respect to the subject matter thereof, and this Insurance Agreement supersedes and replaces any agreement or understanding that may have existed between the parties prior to the date hereof in respect of such subject matter. 48 52 IN WITNESS WHEREOF, the parties hereto have executed this Insurance Agreement, all as of the day and year first above mentioned. MBIA INSURANCE CORPORATION By /s/ ----------------------------- Title -------------------------- NORWEST BANK MINNESOTA, N.A., as Master Servicer By /s/ ----------------------------- Title -------------------------- MEGO MORTGAGE CORPORATION, as Seller, Servicer and Claims Administrator By /s/ ----------------------------- Title -------------------------- FINANCIAL ASSET SECURITIES CORP., as Depositor By /s/ ----------------------------- Title -------------------------- FIRST TRUST OF NEW YORK, NATIONAL ASSOCIATION, as Trustee and Contract of Insurance Holder By /s/ ----------------------------- Title -------------------------- Mego 1996-1 Insurance Agreement Signature Page 53 GREENWICH CAPITAL FINANCIAL PRODUCTS, INC., as GCFP By /s/ ----------------------------- Title -------------------------- Mego 1996-1 Insurance Agreement Signature Page EX-10.16 4 CREDIT AGREEMENT 1 EXHIBIT 10.16 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- MEGO MORTGAGE CORPORATION CREDIT AGREEMENT Dated as of June 28, 1996 THE FIRST NATIONAL BANK OF BOSTON, Agent - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS Page 1. Definitions; Certain Rules of Construction................................. 1 1.1. "Affiliate"........................................................ 1 1.2. "Agent"............................................................ 1 1.3. "Agreement"........................................................ 1 1.4. "Applicable Rate".................................................. 1 1.5. "Assignee"......................................................... 2 1.6. "Assignment and Acceptance"........................................ 2 1.7. "Atlantic Agreement"............................................... 2 1.8. "Bank of Boston"................................................... 2 1.9. "Banking Day"...................................................... 2 1.10. "Bankruptcy Code".................................................. 2 1.11. "Bankruptcy Default"............................................... 2 1.12. "Base Rate"........................................................ 2 1.13. "Borrowing Base"................................................... 2 1.14. "Boston Agreement"................................................. 3 1.15. "Boston Office".................................................... 3 1.16. "By-laws".......................................................... 3 1.17. "Capitalized Lease"................................................ 3 1.18. "Capitalized Lease Obligations".................................... 3 1.19. "Cash Equivalents"................................................. 3 1.20. "Charter".......................................................... 4 1.21. "Class R Certificates"............................................. 4 1.22. "Class S Certificates"............................................. 4 1.23. "Closing Date"..................................................... 4 1.24. "Collection Accounts".............................................. 4 1.25. "Code"............................................................. 4 1.26. "Commitment"....................................................... 4 1.27. "Company".......................................................... 4 1.28. "Computation Covenants"............................................ 4 1.29. "Consolidated"..................................................... 4 1.30. "Consolidated Net Income".......................................... 5 1.31. "Consolidated Pro Forma Debt Service".............................. 5 1.32. "Consolidated Tangible Net Worth".................................. 6 1.34. "Conversion Date".................................................. 6 1.35. "Credit Documents"................................................. 6 1.36. "Credit Obligations"............................................... 7 1.37. "Credit Participant"............................................... 7 1.38. "Credit Security".................................................. 7
-i- 3 1.39. "Default".......................................................... 7 1.40. "Demand Loan"...................................................... 7 1.41. "Distribution"..................................................... 7 1.42. "Distributable Excess Spread"...................................... 8 1.43. "Distribution Date"................................................ 8 1.44. "ERISA"............................................................ 8 1.45. "ERISA Group Person"............................................... 8 1.46. "Eurodollars"...................................................... 9 1.47. "Eurodollar Basic Rate"............................................ 9 1.48. "Eurodollar Interest Period"....................................... 9 1.49. "Eurodollar Office"................................................ 9 1.50. "Eurodollar Pricing Options"....................................... 9 1.51. "Eurodollar Rate".................................................. 9 1.52. "Eurodollar Reserve Rate".......................................... 10 1.53. "Event of Default"................................................. 10 1.54. "Excess Servicing Rights".......................................... 10 1.55. "Exchange Act"..................................................... 10 1.56. "Federal Funds Rate"............................................... 10 1.57. "Fee Letter"....................................................... 10 1.58. "Final Maturity Date".............................................. 10 1.59. "Financial Officer"................................................ 10 1.60. "Financing Debt"................................................... 11 1.61. "Funding Liability"................................................ 11 1.62. "GAAP"............................................................. 11 1.63. "Guarantee"........................................................ 11 1.64. "Guarantor"........................................................ 12 1.65. "Greenwich Agreement".............................................. 12 1.66. "Indebtedness"..................................................... 12 1.67. "Indemnified Party"................................................ 13 1.68. "Initial Closing Date"............................................. 13 1.69. "Interest Rate Protection Agreement"............................... 13 1.70. "Investment"....................................................... 13 1.71. "Legal Requirement"................................................ 14 1.72. "Lender"........................................................... 14 1.73. "Lending Officer".................................................. 14 1.74. "Lien"............................................................. 14 1.75. "Loan"............................................................. 15 1.76. "Loan Sale Agreements"............................................. 15 1.77. "Margin Stock"..................................................... 15 1.78. "Material Adverse Change".......................................... 15 1.79. "Material Agreements".............................................. 15 1.80. "Maximum Amount of Revolving Credit"............................... 15 1.81. "Net Excess Spread"................................................ 15
-ii- 4 1.82. "Notes"............................................................ 16 1.83. "Obligor".......................................................... 16 1.84. "Overdue Reimbursement Rate"....................................... 16 1.85. "Payment Date"..................................................... 16 1.86. "Percentage Interest".............................................. 16 1.87. "Person"........................................................... 16 1.88. "Plan"............................................................. 17 1.89. "Private Loan Sale Agreements"..................................... 17 1.90. "Public Securitization Agreements"................................. 17 1.91. "Register"......................................................... 17 1.92. "Required Lenders"................................................. 17 1.93. "Revolving Loan"................................................... 17 1.94. "Revolving Notes".................................................. 17 1.95. "S&P".............................................................. 17 1.96. "Security Agreement"............................................... 17 1.97. "Stockholder Guarantee"............................................ 17 1.98. "Subsidiary"....................................................... 17 1.99. "Tax".............................................................. 17 1.100. "Term Loan"........................................................ 18 1.101. "Term Note"........................................................ 18 1.102. "United States Funds".............................................. 18 1.103. "Wholly Owned Subsidiary".......................................... 18 2. The Credits................................................................ 18 2.1. Revolving Credit................................................... 18 2.1.1. Revolving Loan............................................ 18 2.1.2. Maximum Amount of Revolving Credit........................ 18 2.1.3. Borrowing Requests........................................ 18 2.1.4. Revolving Notes........................................... 19 2.2. Term Credit........................................................ 19 2.2.1. Term Loan................................................. 19 2.2.2. Term Notes................................................ 19 2.3. Application of Proceeds............................................ 19 2.3.1. Revolving Loan............................................ 20 2.3.2. Term Loan................................................. 20 2.3.3. Specifically Prohibited Applications...................... 20 3. Interest; Eurodollar Pricing Options; Fees................................. 20 3.1. Interest........................................................... 20 3.2. Eurodollar Pricing Options......................................... 20 3.2.1. Election of Eurodollar Pricing Options.................... 20 3.2.2. Notice to Lenders and Company............................. 21 3.2.3. Selection of Eurodollar Interest Periods.................. 21
-iii- 5 3.2.4. Additional Interest....................................... 22 3.2.5. Violation of Legal Requirements........................... 22 3.2.6. Funding Procedure......................................... 23 3.3. Commitment Fees.................................................... 23 3.4. Prepayment Fee..................................................... 23 3.5. Changes in Circumstances; Yield Protection......................... 23 3.5.1. Reserve Requirements, etc................................. 23 3.5.2. Taxes..................................................... 24 3.5.3. Capital Adequacy.......................................... 24 3.5.4. Regulatory Changes........................................ 24 3.5.5. Compensation Claims....................................... 25 3.5.6. Mitigation................................................ 25 3.6. Computations of Interest and Fees.................................. 25 4. Payment.................................................................... 25 4.1. Payment at Maturity................................................ 26 4.2. Required Prepayments............................................... 26 4.2.1. Contingent Required Prepayments........................... 26 4.2.2. Scheduled Prepayments..................................... 26 4.3. Voluntary Prepayments.............................................. 26 4.4. Reborrowing; Application of Payments, etc.......................... 26 4.4.1. Reborrowing............................................... 26 4.4.2. Order of Application...................................... 26 4.4.3. Payment with Accrued Interest, etc........................ 27 4.4.5. Payments for Lenders...................................... 27 5. Conditions to Extending Credit............................................. 27 5.1. Conditions on Initial Closing Date................................. 27 5.1.1. Revolving Notes........................................... 27 5.1.2. Payment of Fees........................................... 27 5.1.3. Legal Opinions............................................ 27 5.1.4. Security Agreement........................................ 28 5.1.5. Perfection of Security.................................... 28 5.1.6. Stockholder Guarantee..................................... 28 5.1.7. Repayment of Demand Loan.................................. 28 5.1.8. Proper Proceedings........................................ 28 5.1.9. General................................................... 28 5.2. Conditions to Each Extension of Credit............................. 29 5.2.1. Officer's Certificate..................................... 29 5.2.2. Legality, etc............................................. 29 6. General Covenants.......................................................... 29 6.1. Taxes and Other Charges; Accounts Payable.......................... 29
-iv- 6 6.1.1. Taxes and Other Charges.......................................... 29 6.1.2. Accounts Payable................................................. 30 6.2. Conduct of Business, etc.................................................. 30 6.2.1. Types of Business................................................ 30 6.2.2. Statutory Compliance............................................. 30 6.2.3. Compliance with Material Agreements.............................. 30 6.3. Insurance................................................................. 30 6.3.1. Liability Insurance.............................................. 30 6.4. Financial Statements and Reports.......................................... 31 6.4.1. Annual Reports................................................... 31 6.4.2. Monthly Reports.................................................. 32 6.4.3. Monthly Borrowing Base........................................... 32 6.4.4. Other Reports.................................................... 32 6.4.5. Notice of Litigation, Defaults, etc.............................. 33 6.4.6. Other Information................................................ 33 6.5. Certain Financial Tests................................................... 33 6.5.1. Consolidated Tangible Net Worth.................................. 33 6.5.2. Consolidated Net Income.......................................... 34 6.5.3. Net Excess Spread to Consolidated Pro Forma Debt Service......... 34 6.6. Indebtedness.............................................................. 34 6.7. Guarantees; Letters of Credit............................................. 35 6.8. Liens..................................................................... 36 6.9. Investments and Acquisitions.............................................. 37 6.10. Distributions............................................................. 38 6.11. Asset Dispositions and Mergers............................................ 38 6.12. Derivative Contracts...................................................... 38 6.13. Negative Pledge Clauses................................................... 39 6.14. Transactions with Affiliates.............................................. 39 6.15. Accounts to be Maintained with Bank of Boston............................. 39 6.16. Transfer of Funds from Collection Accounts................................ 39 7. Representations and Warranties.................................................... 39 7.1. Organization and Business................................................. 39 7.1.1. The Company...................................................... 39 7.1.2. Subsidiaries..................................................... 40 7.1.3. The Guarantor.................................................... 40 7.1.4. Qualification.................................................... 40 7.2. Financial Statements and Other Information; Material Agreements........... 41 7.2.1. Financial Statements and Other Information....................... 41 7.2.2. Material Agreements.............................................. 42 7.3. Agreements Relating to Financing Debt, Investments, etc................... 42 7.4. Changes in Condition...................................................... 42 7.5. Title to Assets........................................................... 42
-v- 7 7.6. Operations in Conformity With Law, etc.................................... 42 7.7. Litigation................................................................ 42 7.8. Authorization and Enforceability.......................................... 43 7.9. No Legal Obstacle to Agreements........................................... 43 7.10. Defaults.................................................................. 44 7.11. Tax Returns............................................................... 44 7.12. Certain Business Representations.......................................... 44 7.12.1. Antitrust........................................................ 44 7.12.2. Consumer Protection.............................................. 44 7.13. Pension Plans............................................................. 45 7.14. Government Regulation; Margin Stock....................................... 45 7.14.1. Government Regulation............................................ 45 7.14.2. Margin Stock..................................................... 45 7.15. Disclosure................................................................ 45 8. Defaults.......................................................................... 45 8.1. Events of Default......................................................... 45 8.1.1. Payment.......................................................... 45 8.1.2. Specified Covenants.............................................. 45 8.1.3. Other Covenants.................................................. 45 8.1.4. Representations and Warranties................................... 46 8.1.5. Cross Default, etc............................................... 46 8.1.6. Ownership; Liquidation; etc...................................... 46 8.1.7. Enforceability, etc.............................................. 47 8.1.8. Judgments........................................................ 47 8.1.9. FHA Insurance.................................................... 47 8.1.10. Bankruptcy, etc................................................. 47 8.1.11. Change in Management............................................. 48 8.2. Certain Actions Following an Event of Default............................. 48 8.2.1. Terminate Obligation to Extend Credit............................ 48 8.2.2. Specific Performance; Exercise of Rights......................... 48 8.2.3. Acceleration..................................................... 48 8.2.4. Enforcement of Payment; Credit Security; Setoff.................. 49 8.2.5. Cumulative Remedies.............................................. 49 8.3. Annulment of Defaults..................................................... 49 8.4. Waivers................................................................... 49 9. Expenses; Indemnity............................................................... 50 9.1. Expenses.................................................................. 50 9.2. General Indemnity......................................................... 50 10. Operations; Agent................................................................. 51
-vi- 8 11. Successors and Assigns; Lender Assignments and Participations..................... 51 11.1. Assignments by Lenders.................................................... 51 11.1.1. Assignees and Assignment Procedures............................. 51 11.1.2. Terms of Assignment and Acceptance.............................. 52 11.1.3. Register........................................................ 53 11.1.4. Acceptance of Assignment and Assumption......................... 53 11.1.5. Federal Reserve Bank............................................ 54 11.1.6. Further Assurances.............................................. 54 11.2. Credit Participants....................................................... 54 12. Confidentiality .................................................................. 55 13. Notices........................................................................... 55 14. Course of Dealing; Amendments and Waivers......................................... 56 15. No Strict Construction............................................................ 56 16. Defeasance........................................................................ 56 17. Venue; Service of Process......................................................... 56 18. WAIVER OF JURY TRIAL.............................................................. 57 19. General........................................................................... 57
-vii- 9 EXHIBITS 2.1.4 - Revolving Note 2.2.2 - Term Note 5.1.4 - Security Agreement 5.1.6 - Stockholder Guarantee 5.2.1 - Officer's Certificate 7.1 - Company and its Subsidiaries 7.2.2 - Material Agreements 7.3 - Financing Debt, Certain Investments, etc. 7.7 - Litigation 7.9 - Legal Obstacles 11.1.1 - Form of Assignment and Acceptance -viii- 10 MEGO MORTGAGE CORPORATION CREDIT AGREEMENT This Agreement, dated as of June 28, 1996, is among Mego Mortgage Corporation, a Delaware corporation (the "Company"), the Lenders from time to time party hereto and The First National Bank of Boston, both in its capacity as a Lender and in its capacity as Agent for itself and the other Lenders. The parties agree as follows: 1. Definitions; Certain Rules of Construction. Certain capitalized terms are used in this Agreement and in the other Credit Documents with the specific meanings defined below in this Section 1. Except as otherwise explicitly specified to the contrary or unless the context clearly requires otherwise, (a) the capitalized term "Section" refers to sections of this Agreement, (b) the capitalized term "Exhibit" refers to exhibits to this Agreement, (c) references to a particular Section include all subsections thereof, (d) the word "including" shall be construed as "including without limitation", (e) accounting terms not otherwise defined herein have the meaning provided under GAAP, (f) references to a particular statute or regulation include all rules and regulations thereunder and any successor statute, regulation or rules, in each case as from time to time in effect and (g) references to a particular Person include such Person's successors and assigns to the extent not prohibited by this Agreement and the other Credit Documents. References to "the date hereof" mean the date first set forth above. 1.1. "Affiliate" means, with respect to the Company (or any other specified Person), any other Person directly or indirectly controlling, controlled by or under direct or indirect common control with the Company (or such specified Person), and shall include (a) any officer or director or general partner of the Company (or such specified Person) and (b) any Person of which the Company (or such specified Person) or any Affiliate (as defined in clause (a) above) of the Company (or such specified Person) shall, directly or indirectly, beneficially own either (i) at least 10% of the outstanding equity securities having the general power to vote or (ii) at least 10% of all equity interests. 1.2. "Agent" means Bank of Boston in its capacity as agent for the Lenders hereunder, as well as its successors and assigns in such capacity. 1.3. "Agreement" means this Credit Agreement as from time to time amended, modified and in effect. 1.4. "Applicable Rate" means, at any date, the sum of: (a) (i) with respect to each portion of the Loan subject to a Eurodollar Pricing Option, the sum of 5% plus the Eurodollar Rate with respect to such Eurodollar Pricing Option; 11 (ii) with respect to each other portion of the Loan, the sum of 2% plus the Base Rate; plus (b) an additional 2% effective on the day the Agent notifies the Company that the interest rates hereunder are increasing as a result of the occurrence and continuance of an Event of Default until the earlier of such time as (i) such Event of Default is no longer continuing or (ii) such Event of Default is deemed no longer to exist, in each case pursuant to Section 8.3. 1.5. "Assignee" is defined in Section 11.1.1. 1.6. "Assignment and Acceptance" is defined in Section 11.1.1. 1.7. "Atlantic Agreement" means, collectively, the Master Loan Participation and Servicing Agreements dated as of May 25, 1995 and June 28, 1995, as amended from time to time, between Atlantic Bank N.A. and the Company with respect to FHA Insured Title I Home Improvement Loans Series 1995-1A and - -1B. 1.8. "Bank of Boston" means The First National Bank of Boston. 1.9. "Banking Day" means any day other than Saturday, Sunday or a day on which banks in Boston, Massachusetts or Atlanta, Georgia are authorized or required by law or other governmental action to close and, if such term is used with reference to a Eurodollar Pricing Option, any day on which dealings are effected in the Eurodollars in question by first-class banks in the inter-bank Eurodollar markets in New York, New York. 1.10. "Bankruptcy Code" means Title 11 of the United States Code. 1.11. "Bankruptcy Default" means an Event of Default referred to in Section 8.1.10. 1.12. "Base Rate" means, on any date, the greater of (a) the rate of interest announced by Bank of Boston at the Boston Office as its Base Rate or (b) the sum of 1/2% plus the Federal Funds Rate. 1.13. "Borrowing Base" means, on any date the lesser of: (a) 40% of Excess Servicing Rights as of the most recently completed month for which financial statements have been (or are required to have been) furnished to the Lenders in accordance with Section 6.4.2 and (b) 600% of the aggregate Net Excess Spread for the period of three consecutive months ending with the month described in clause (a) above; -2- 12 provided, however, that the Borrowing Base shall be reduced to $1.00 at any time when the Company has failed to furnish the computation of the Borrowing Base required by Section 6.4.3 within five days after such computation was originally due. 1.14. "Boston Agreement" means the Master Loan Purchase and Servicing Agreement dated as of August 26, 1994, as amended from time to time, between The First National Bank of Boston and the Company with respect to Fixed Rate FHA Insured Title I Home Improvement Loans. 1.15. "Boston Office" means the principal banking office of Bank of Boston in Boston, Massachusetts. 1.16. "By-laws" means all written by-laws, rules, regulations and all other documents relating to the management, governance or internal regulation of any Person other than an individual, or interpretive of the Charter of such Person, all as from time to time in effect. 1.17. "Capitalized Lease" means any lease which is required to be capitalized on the balance sheet of the lessee in accordance with GAAP, including Statement Nos. 13 and 98 of the Financial Accounting Standards Board. 1.18. "Capitalized Lease Obligations" means the amount of the liability reflecting the aggregate discounted amount of future payments under all Capitalized Leases calculated in accordance with GAAP, including Statement Nos. 13 and 98 of the Financial Accounting Standards Board. 1.19. "Cash Equivalents" means: (a) negotiable certificates of deposit, time deposits (including sweep accounts), demand deposits and bankers' acceptances having a maturity of nine months or less and issued by any United States financial institution having capital and surplus and undivided profits aggregating at least $100,000,000 and rated at least Prime-1 by Moody's or A-1 by S&P or issued by any Lender; (b) corporate obligations having a maturity of nine months or less and rated at least Prime-1 by Moody's or A-1 by S&P or issued by any Lender; (c) any direct obligation of the United States of America or any agency or instrumentality thereof, or of any state or municipality thereof, (i) which has a remaining maturity at the time of purchase of not more than one year or which is subject to a repurchase agreement with any Lender (or any other financial institution referred to in clause (a) above) exercisable within one year from the time of purchase and (ii) which, in the case of obligations of any state or municipality, is rated at least -3- 13 Aa by Moody's or AA by S&P; and (d) any mutual fund or other pooled investment vehicle rated at least Aa by Moody's or AA by S&P which invests principally in obligations described above. 1.20. "Charter" means the articles of organization, certificate of incorporation, statute, constitution, joint venture agreement, partnership agreement, trust indenture, limited liability company agreement or other charter document of any Person other than an individual, each as from time to time in effect. 1.21. "Class R Certificates" means the Class R certificates issued to the Company by Mego Mortgage FHA Title I Loan trust 1996-1 and any similar certificates issued to the Company in future public securitization offerings. 1.22. "Class S Certificates" means the Class S certificates issued to the Company by Mego Mortgage FHA Title I Loan trust 1996-1 and any similar certificates issued to the Company in future public securitization offerings. 1.23. "Closing Date" means the Initial Closing Date, the Conversion Date and each other date on which any extension of credit is made pursuant to Sections 2.1, 2.2 or 2.3. 1.24. "Collection Accounts" means accounts into which the Company is required to deposit cash payments that it receives with respect to loans that it has sold and with respect to which it acts as a servicing agent, which payments are held for the benefit of the purchasers of such loans. 1.25. "Code" means the federal Internal Revenue Code of 1986. 1.26. "Commitment" means, with respect to any Lender, such Lender's obligations to extend the credits contemplated by Section 2. The original Commitments are set forth in Exhibit 10 and the current Commitments are recorded from time to time in the Register. 1.27. "Company" means Mego Mortgage Corporation, a Delaware corporation. 1.28. "Computation Covenants" means Sections 6.5, 6.6.7, 6.6.11, 6.6.12, and 6.10.2. 1.29. "Consolidated" and "Consolidating", when used with reference to any term, mean that term as applied to the accounts of the Company (or other specified Person) and all of its Subsidiaries (or other specified group of Persons), if any, or such of its Subsidiaries as may be specified, consolidated (or combined) or consolidating (or combining), as the case may be, in accordance with GAAP and with appropriate deductions for minority interests in Subsidiaries. -4- 14 1.30. "Consolidated Net Income" means, for any period, the net income (or loss) of the Company and its Subsidiaries, determined in accordance with GAAP on a Consolidated basis; provided, however, that Consolidated Net Income shall not include: (a) the income (or loss) of any Person accrued prior to the date such Person becomes a Subsidiary or is merged into or consolidated with the Company or any of its Subsidiaries; (b) the income (or loss) of any Person (other than a Subsidiary) in which the Company or any of its Subsidiaries has an ownership interest; provided, however, that (i) Consolidated Net Income shall include amounts in respect of the income of such Person when actually received in cash by the Company or such Subsidiary in the form of dividends or similar Distributions and (ii) Consolidated Net Income shall be reduced by the aggregate amount of all Investments, regardless of the form thereof, made by the Company or any of its Subsidiaries in such Person for the purpose of funding any deficit or loss of such Person; (c) all amounts included in computing such net income (or loss) in respect of (i) the write-up of any asset on or after August 31, 1995, or (ii) the retirement of any Indebtedness or equity at less than face value after August 31, 1995; (d) extraordinary and nonrecurring gains; and (e) the income of any Subsidiary to the extent the payment of such income in the form of a Distribution or repayment of Indebtedness to the Company or a Wholly Owned Subsidiary is not permitted, whether on account of any Charter or By-law restriction, any agreement, instrument, deed or lease or any law, statute, judgment, decree or governmental order, rule or regulation applicable to such Subsidiary. 1.31. "Consolidated Pro Forma Debt Service" means, for any period, the sum of the following items, projected to be accrued by the Company and its Subsidiaries: (a) interest expense (including commitments fees) payable in connection with Loans under this Credit Agreement, plus (b) the aggregate amount of all mandatory scheduled payments, mandatory scheduled prepayments, and mandatory reductions in revolving loans as a result of reductions in revolving credit availability, to the extent required under this Agreement. For purposes of computing Consolidated Pro Forma Debt Service: (i) the amount of the Loan outstanding on the first day of such period shall be assumed to remain outstanding during the entire period, except to the -5- 15 extent required to be reduced by mandatory scheduled payments, reductions in revolving credit availability and other items described in paragraph (b) above; and (ii) where interest varies with a floating rate, the rate in effect for the entire period will be assumed to be the sum of 2% plus the Base Rate in effect on the first day of the period. 1.32. "Consolidated Tangible Net Worth" means, at any date, the total of: (a) stockholders' equity of the Company and its Subsidiaries determined in accordance with GAAP on a Consolidated basis; minus (b) the amount by which such stockholders' equity has been increased after August 31, 1995 by the items described in clauses (a) through (e) of the definition of Consolidated Net Income or by goodwill; minus (c) the amount of intangible assets carried on the balance sheet of the Company and its Subsidiaries determined in accordance with GAAP on a Consolidated basis, including goodwill, patents, patent applications, copyrights, trademarks, tradenames, research and development expense, organizational expense, unamortized debt discount, deferred financing charges and debt acquisition costs, but excluding Excess Servicing Rights and Mortgage Servicing Rights. 1.33. "Constant Prepayment Rate" means, for any period, the rate at which the home improvement loans underlying Net Excess Spread during such period are either (a) prepaid prior to stated maturity, or (b) 150 days past due on payments of principal or interest, as indicated in the Constant Prepayment Rate Summary for that period. 1.34. "Conversion Date" means the earliest of (a) December 31, 1997 or (b) such other Banking Day designated by the Agent upon at least three Banking Days prior written notice in the event that the Constant Prepayment Rate exceeds 25% for the most recent period of three consecutive months for which reports have been (or are required to have been) furnished to the Lenders in accordance with Section 6.4.3 or (c) the date Indebtedness is first incurred under Section 6.6.11. 1.35. "Credit Documents" means: (a) this Agreement, the Notes, the Security Agreement, the Stockholder Guarantee, the Fee Letter described in Section 5.1.2 and each Interest Rate Protection Agreement provided by a Lender (or an Affiliate of a Lender) to the Company or any of its Subsidiaries, each as from time to time in effect; -6- 16 (b) all financial statements, reports, notices, mortgages, assignments, UCC financing statements or certificates delivered to the Agent or any of the Lenders by the Company, any of its Subsidiaries or any other Obligor in connection herewith; and (c) any other present or future agreement or instrument from time to time entered into among the Company, any of its Subsidiaries or any other Obligor, on one hand, and the Agent or all the Lenders, on the other hand, relating to, amending or modifying this Agreement or any other Credit Document referred to above or which is stated to be a Credit Document, each as from time to time in effect. 1.36. "Credit Obligations" means all present and future liabilities, obligations and Indebtedness of the Company, any of its Subsidiaries or any other Obligor owing to the Agent or any Lender (or any Affiliate of a Lender) under or in connection with this Agreement or any other Credit Document, including obligations in respect of principal, interest, prepayment fees, commitment fees, amounts provided for in Sections 3.2.4, 3.5 and 9 and other fees, charges, indemnities and expenses from time to time owing hereunder or under any other Credit Document (whether accruing before or after a Bankruptcy Default). 1.37. "Credit Participant" is defined in Section 11.2. 1.38. "Credit Security" means all assets now or from time to time hereafter subjected to a security interest, mortgage or charge (or intended or required so to be subjected pursuant to the Security Agreement or any other Credit Document) to secure the payment or performance of any of the Credit Obligations, including the assets described in section 2.1 of the Security Agreement. 1.39. "Default" means any Event of Default and any event or condition which with the passage of time or giving of notice, or both, would become an Event of Default and the filing against the Company, any of its Subsidiaries or any other Obligor of a petition commencing an involuntary case under the Bankruptcy Code. 1.40. "Demand Loan" means the $5,000,000 loan made by Bank of Boston to the Company on May 31, 1996. 1.41. "Distribution" means, with respect to the Company (or other specified Person): (a) the declaration or payment of any dividend or distribution, including dividends payable in shares of capital stock of or other equity interests in the Company (or such specified Person), on or in respect of any shares of any class of capital stock of or other equity interests in the Company (or such specified Person); (b) the purchase, redemption or other retirement of any shares of any class -7- 17 of capital stock of or other equity interest in the Company (or such specified Person) or of options, warrants or other rights for the purchase of such shares, directly, indirectly through a Subsidiary or otherwise; (c) any other distribution on or in respect of any shares of any class of capital stock of or equity or other beneficial interest in the Company (or such specified Person); (d) any payment of principal or interest with respect to, or any purchase, redemption or defeasance of, Financing Debt of the Company (or such specified Person) which by its terms or the terms of any agreement is subordinated to the payment of the Credit Obligations; and (e) any payment, loan or advance by the Company (or such specified Person) to, or any other Investment by the Company (or such specified Person) in, the holder of any shares of any class of capital stock of or equity interest in the Company (or such specified Person), or any Affiliate of such holder (including the payment of management and transaction fees and expenses); provided, however, that the term "Distribution" shall not include (i) dividends payable in perpetual common stock of or other similar equity interests in the Company (or such specified Person) or (ii) payments in the ordinary course of business in respect of (A) reasonable compensation paid to employees, officers and directors, (B) advances and reimbursements to employees for travel expenses, drawing accounts and similar expenditures, or (C) rent paid to, or accounts payable for services rendered or goods sold by, non-Affiliates that own capital stock of or other equity interests in the Company (or such specified Person). 1.42. "Distributable Excess Spread" has the same meaning as in the Public Securitization Documents. 1.43. "Distribution Date" has the same meaning as in the Public Securitization Documents. 1.44. "ERISA" means the federal Employee Retirement Income Security Act of 1974. 1.45. "ERISA Group Person" means the Company, any Subsidiary of the Company and any Person which is a member of the controlled group or under common control with the Company or any Subsidiary within the meaning of section 414 of the Code or section 4001(a)(14) of ERISA. 1.46. "Eurodollars" means, with respect to any Lender, deposits of United States Funds in a non-United States office or an international banking facility of such Lender. -8- 18 1.47. "Eurodollar Basic Rate" means, for any Eurodollar Interest Period, the rate of interest at which Eurodollar deposits in an amount comparable to the Percentage Interest of Bank of Boston in the portion of the Loan as to which a Eurodollar Pricing Option has been elected and which have a term corresponding to such Eurodollar Interest Period are offered to the Agent by first class banks in the inter-bank Eurodollar market for delivery in immediately available funds at a Eurodollar Office on the first day of such Eurodollar Interest Period as determined by such Reference Lender at approximately 10:00 a.m. (Boston time) two Banking Days prior to the date upon which such Eurodollar Interest Period is to commence (which determination by the Agent shall, in the absence of manifest error, be conclusive). 1.48. "Eurodollar Interest Period" means any period, selected as provided in Section 3.2.1, of one, two, three or six months, commencing on any Banking Day and ending on the corresponding date in the subsequent calendar month so indicated (or, if such subsequent calendar month has no corresponding date, on the last day of such subsequent calendar month); provided, however, that subject to Section 3.2.3, if any Eurodollar Interest Period so selected would otherwise begin or end on a date which is not a Banking Day, such Eurodollar Interest Period shall instead begin or end, as the case may be, on the immediately preceding or succeeding Banking Day as determined by the Agent in accordance with the then current banking practice in the inter-bank Eurodollar market with respect to Eurodollar deposits at the applicable Eurodollar Office, which determination by the Agent shall, in the absence of manifest error, be conclusive. 1.49. "Eurodollar Office" means such non-United States office or international banking facility of any Lender as the Lender may from time to time select. 1.50. "Eurodollar Pricing Options" means the options granted pursuant to Section 3.2.1 to have the interest on any portion of the Loan computed on the basis of a Eurodollar Rate. 1.51. "Eurodollar Rate" for any Eurodollar Interest Period means the rate, rounded upward to the nearest 1/100%, obtained by dividing (a) the Eurodollar Basic Rate for such Eurodollar Interest Period by (b) an amount equal to 1 minus the Eurodollar Reserve Rate; provided, however, that if at any time during such Eurodollar Interest Period the Eurodollar Reserve Rate applicable to any outstanding Eurodollar Pricing Option changes, the Eurodollar Rate for such Eurodollar Interest Period shall automatically be adjusted to reflect such change, effective as of the date of such change to the extent required by the legal requirement implementing such change. 1.52. "Eurodollar Reserve Rate" means the stated maximum rate (expressed as a decimal) of all reserves (including any basic, supplemental, marginal or emergency reserve or any reserve asset), if any, as from time to time in effect, required by any Legal Requirement to be maintained by any Lender against (a) "Eurocurrency liabilities" as specified in Regulation D -9- 19 of the Board of Governors of the Federal Reserve System applicable to Eurodollar Pricing Options, (b) any other category of liabilities that includes Eurodollar deposits by reference to which the interest rate on portions of the Loan subject to Eurodollar Pricing Options is determined, (c) the principal amount of or interest on any portion of the Loan subject to a Eurodollar Pricing Option or (d) any other category of extensions of credit, or other assets, that includes loans subject to a Eurodollar Pricing Option by a non-United States office of any of the Lenders to United States residents, in each case without the benefits of credits for prorations, exceptions or offsets that may be available to a Lender. 1.53. "Event of Default" is defined in Section 8.1. 1.54. "Excess Servicing Rights" means, at any date, excess servicing rights of the Company and its Subsidiaries determined in accordance with GAAP on a Consolidated basis, that (a) arise from home improvement loans sold by the Company and (b) are not subject to any Liens other than Liens securing the Credit Obligations and Liens created under the agreements pursuant to which such Loans were sold. 1.55. "Exchange Act" means the federal Securities Exchange Act of 1934. 1.56. "Federal Funds Rate" means, for any day, the rate equal to the weighted average (rounded upward to the nearest 1/8%) of the rates on overnight federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers, (a) as such weighted average is published for such day (or, if such day is not a Banking Day, for the immediately preceding Banking Day) by the Federal Reserve Bank of New York or (b) if such rate is not so published for such Banking Day, as determined by the Agent using any reasonable means of determination. Each determination by the Agent of the Federal Funds Rate shall, in the absence of manifest error, be conclusive. 1.57. "Fee Letter" is defined in Section 5.1.2. 1.58. "Final Maturity Date" means the earlier of (a) June 30, 2000 or (b) the date 30 months after the Conversion Date. 1.59. "Financial Officer" of the Company (or other specified Person) means its chief executive officer, chief financial officer, chief operating officer, chairman, president, treasurer or any of its vice presidents whose primary responsibility is for its financial affairs, all of whose incumbency and signatures have been certified to the Agent by the secretary, assistant secretary or other appropriate attesting officer of the Company (or such specified Person). 1.60. "Financing Debt" means each of the items described in clauses (a) through (f) of the definition of the term "Indebtedness" and, without duplication, any Guarantees of such items. -10- 20 1.61. "Funding Liability" means (a) any Eurodollar deposit which was used (or deemed by Section 3.2.6 to have been used) to fund any portion of the Loan subject to a Eurodollar Pricing Option, and (b) any portion of the Loan subject to a Eurodollar Pricing Option funded (or deemed by Section 3.2.6 to have been funded) with the proceeds of any such Eurodollar deposit. 1.62. "GAAP" means generally accepted accounting principles as from time to time in effect, including the statements and interpretations of the United States Financial Accounting Standards Board; provided, however, that for purposes of compliance with Section 6 (other than Section 6.4) and the related definitions, "GAAP" means such principles as in effect on August 31, 1995 as applied by the Company and its Subsidiaries in the preparation of the most recent annual financial statements referred to in Section 7.2.1(a), and consistently followed, without giving effect to any subsequent changes thereto. 1.63. "Guarantee" means, with respect to the Company (or other specified Person): (a) any guarantee by the Company (or such specified Person) of the payment or performance of, or any contingent obligation by the Company (or such specified Person) in respect of, any Indebtedness or other obligation of any primary obligor; (b) any other arrangement whereby credit is extended to a primary obligor on the basis of any promise or undertaking of the Company (or such specified Person), including any binding "comfort letter" or "keep well agreement" written by the Company (or such specified Person), to a creditor or prospective creditor of such primary obligor, to (i) pay the Indebtedness of such primary obligor, (ii) purchase an obligation owed by such primary obligor, (iii) pay for the purchase or lease of assets or services regardless of the actual delivery thereof or (iv) maintain the capital, working capital, solvency or general financial condition of such primary obligor; (c) any liability of the Company (or such specified Person), as a general partner of a partnership in respect of Indebtedness or other obligations of such partnership; (d) any liability of the Company (or such specified Person) as a joint venturer of a joint venture in respect of Indebtedness or other obligations of such joint venture; (e) any liability of the Company (or such specified Person) with respect to the tax liability of others as a member of a group (other than a group consisting solely of the Company and its Subsidiaries) that is consolidated for tax purposes; and (f) reimbursement obligations, whether contingent or matured, of the Company (or such specified Person) with respect to letters of credit, bankers acceptances, surety bonds, other financial guarantees and Interest Rate Protection -11- 21 Agreements, whether or not any of the foregoing are reflected on the balance sheet of the Company (or such specified Person) or in a footnote thereto; provided, however, that the term "Guarantee" shall not include endorsements for collection or deposit in the ordinary course of business. 1.64. "Guarantor" means Mego Financial Corp., a New York corporation. 1.65. "Greenwich Agreement" means the Master Loan Purchase and Servicing Agreement dated as of April 1, 1995, as amended from time to time, between Greenwich Capital Financial Products, Inc. and the Company with respect to Fixed Rate FHA Insured Title I Home Improvement Loans. 1.66. "Indebtedness" means all obligations, contingent or otherwise, which in accordance with GAAP are required to be classified upon the balance sheet of the Company (or other specified Person) as liabilities, but in any event including (without duplication): (a) borrowed money; (b) indebtedness evidenced by notes, debentures or similar instruments; (c) Capitalized Lease Obligations; (d) the deferred purchase price of assets or securities, including related noncompetition, consulting and stock repurchase obligations (other than ordinary trade accounts payable within six months after the incurrence thereof in the ordinary course of business); (e) mandatory redemption or dividend rights on capital stock (or other equity); (f) reimbursement obligations, whether contingent or matured, with respect to letters of credit, bankers acceptances, surety bonds, other financial guarantees and Interest Rate Protection Agreements (without duplication of other Indebtedness supported or guaranteed thereby); (g) unfunded pension liabilities; and (h) all Guarantees in respect of Indebtedness of others. 1.67. "Indemnified Party" is defined in Section 9.2. 1.68. "Initial Closing Date" means June 30, 1996 or such other date prior to -12- 22 September 1, 1996 agreed to by the Company and the Agent as the first Closing Date hereunder. 1.69. "Interest Rate Protection Agreement" means any interest rate swap, interest rate cap, interest rate hedge or other contractual arrangement that converts variable interest rates into fixed interest rates, fixed interest rates into variable interest rates or other similar arrangements. 1.70. "Investment" means, with respect to the Company (or other specified Person): (a) any share of capital stock, partnership or other equity interest, evidence of Indebtedness or other security issued by any other Person; (b) any loan, advance or extension of credit to, or contribution to the capital of, any other Person; (c) any Guarantee of the Indebtedness of any other Person; (d) any acquisition of all, or any division or similar operating unit of, the business of any other Person or the assets comprising such business, division or unit; and (e) any other investment similar to the above. The investments described in the foregoing clauses (a) through (e) shall be included in the term "Investment" whether they are made or acquired by purchase, exchange, issuance of stock or other securities, merger, reorganization or any other method; provided, however, that the term "Investment" shall not include (i) current trade and customer accounts receivable for property leased, goods furnished or services rendered in the ordinary course of business and payable in accordance with customary trade terms, (ii) deposits, advances or prepayments to suppliers for property leased or licensed, goods furnished and services rendered in the ordinary course of business, (iii) advances to employees for relocation and travel expenses, drawing accounts and similar expenditures, (iv) stock or other securities acquired in connection with the satisfaction or enforcement of Indebtedness or claims due to the Company (or such specified Person) or as security for any such Indebtedness or claim or (v) demand deposits in banks or similar financial institutions. 1.71. "Legal Requirement" means any present or future requirement imposed upon any of the Lenders or the Company and its Subsidiaries by any law, statute, rule, regulation, directive, order, decree, guideline (or any interpretation thereof by courts or of administrative bodies) of the United States of America, or any jurisdiction in which any Eurodollar Office is located or any state or political subdivision of any of the foregoing, or by any board, governmental or administrative agency, central bank or monetary authority of the United States. -13- 23 of America, any jurisdiction in which any Eurodollar Office is located, or any political subdivision of any of the foregoing. Any such requirement imposed on any of the Lenders not having the force of law shall be deemed to be a Legal Requirement for purposes of Section 3 if such Lender reasonably believes that compliance therewith is in the best interest of such Lender. 1.72. "Lender" means each of the Persons listed as lenders on the signature page hereto, including Bank of Boston in its capacity as a Lender and such other Persons who may from time to time own a Percentage Interest in the Credit Obligations, but the term "Lender" shall not include any Credit Participant. 1.73. "Lending Officer" means such individuals whom the Agent may designate by notice to the Company from time to time as an officer who may receive telephone requests for borrowings under Section 2.1.3. 1.74. "Lien" means, with respect to the Company (or any other specified Person): (a) any lien, encumbrance, mortgage, pledge, charge or security interest of any kind upon any property or assets of the Company (or such specified Person), whether now owned or hereafter acquired, or upon the income or profits therefrom; (b) the acquisition of, or the agreement to acquire, any property or asset upon conditional sale or subject to any other title retention agreement, device or arrangement (including a Capitalized Lease); (c) the sale, assignment, pledge or transfer for security of any accounts, general intangibles or chattel paper of the Company (or such specified Person), with or without recourse; (d) the transfer of any tangible property or assets for the purpose of subjecting such items to the payment of previously outstanding Indebtedness in priority to payment of the general creditors of the Company (or such specified Person); and (e) the existence for a period of more than 120 consecutive days of any Indebtedness against the Company (or such specified Person) which if unpaid would by law or upon a Bankruptcy Default be given any priority over general creditors. 1.75. "Loan" means, collectively, the Revolving Loan and the Term Loan. 1.76. "Loan Sale Agreements" means, collectively, the Private Loan Sale Agreements and the Public Securitization Agreements. 1.77. "Margin Stock" means "margin stock" within the meaning of Regulations G, -14- 24 T, U or X of the Board of Governors of the Federal Reserve System. 1.78. "Material Adverse Change" means, since any specified date or from the circumstances existing immediately prior to the happening of any specified event, a material adverse change in (a) the business, assets, financial condition, income or prospects of the Company (on an individual basis) or the Guarantor and its Subsidiaries (on a Consolidated basis), whether as a result of (i) general economic conditions affecting the home improvement loan origination industry, (ii) fire, flood or other natural calamities, (iii) regulatory changes, judicial decisions, war or other governmental action or (iv) any other event or development, whether or not related to those enumerated above or (b) the ability of the Obligors to perform their obligations under the Credit Documents or (c) the rights and remedies of the Agent and the Lenders under the Credit Documents. 1.79. "Material Agreements" is defined in Section 7.2.2. 1.80. "Maximum Amount of Revolving Credit" is defined in Section 2.1.2. 1.81. "Net Excess Spread" means, for any period, the sum of: (a) the sum of (a) the total cash received by the Company and its Subsidiaries with respect to the Private Loan Sale Agreements during such period, minus (b) cash payments required to be made during such period to purchasers from such receipts pursuant to the Private Loan Sale Agreements, minus (c) loan servicing fees and reimbursable expenses payable during such period, minus (d) cash advances during such period to investors with respect to loans sold to the extent reimbursable from cash receipts described in paragraph (a)(1), and (b) the sum of (1) 100% of the cash actually received by the Company during such period with respect to Class S Certificates, plus (2) 100% of the cash actually received by the Company during -15- 25 such period with respect to Class R Certificates, plus (3) for periods ending before the Conversion Date, the sum of: (i) with respect to Class R Certificates that have been outstanding for less than 12 months as of the end of such period, 75% of the Distributable Excess Spread, if any, for Distribution Dates within such period, plus (ii) with respect to Class R Certificates that have been outstanding for at least 12 months but less than 15 months as of the end of such period, 50% of the Distributable Excess Spread, if any, for Distribution Dates within such period. 1.82. "Notes" means, collectively, the Revolving Notes and the Term Notes. 1.83. "Obligor" means the Company, the Guarantor and each other Person guaranteeing or providing collateral for the Credit Obligations. 1.84. "Overdue Reimbursement Rate" means, at any date, the highest Applicable Rate then in effect. 1.85. "Payment Date" means the last Banking Day of each March, June, September and December occurring after the Initial Closing Date. 1.86. "Percentage Interest" means (a) at all times when no Event of Default under Section 8.1.1 and no Bankruptcy Default exists, the ratio that the respective Commitments of the Lenders bear to the total Commitments of all Lenders as from time to time in effect and reflected in the Register, and (b) at all other times, the ratio that the respective amounts of the outstanding Credit Obligations (including Letter of Credit Exposure) owing to the Lenders in respect of extensions of credit under Section 2 bear to the total outstanding Credit Obligations owing to all Lenders. 1.87. "Person" means any present or future natural person or any corporation, association, partnership, joint venture, limited liability, joint stock or other company, business trust, trust, organization, business or government or any governmental agency or political subdivision thereof. 1.88. "Plan" means, at any date, any pension benefit plan subject to Title IV of ERISA maintained, or to which contributions have been made or are required to be made, by any ERISA Group Person within six years prior to such date. -16- 26 1.89. "Private Loan Sale Agreements" means, collectively, the Atlantic Agreement, the Boston Agreement and the Greenwich Agreement. 1.90. "Public Securitization Agreements" means the Pooling and Servicing Agreement (FHA Title I Home Improvement Loans) dated as of March 21, 1996, as amended from time to time, among the Company, Financial Asset Securities Corp., Norwest Bank Minnesota, N.A. and First Trust of New York, National Association, together with the related Servicing Agreement for Mego Mortgage FHA Title I Loan Trust 1996-1 and similar agreements that may be entered into by the Company before the Conversion Date. 1.91. "Register" is defined in Section 11.1.3. 1.92. "Required Lenders" means, with respect to any approval, consent, modification, waiver or other action to be taken by the Agent or the Lenders under the Credit Documents which require action by the Required Lenders, such Lenders as own at least a majority of the Percentage Interests. 1.93. "Revolving Loan" is defined in Section 2.1.4. 1.94. "Revolving Notes" is defined in Section 2.1.4. 1.95. "S&P" means Standard & Poor's Ratings Group, a division of McGraw Hill Corporation. 1.96. "Security Agreement" is defined in Section 5.1.4. 1.97. "Stockholder Guarantee" is defined in Section 5.1.6. 1.98. "Subsidiary" means any Person of which the Company (or other specified Person) shall at the time, directly or indirectly through one or more of its Subsidiaries, (a) own at least 50% of the outstanding capital stock (or other shares of beneficial interest) entitled to vote generally, (b) hold at least 50% of the partnership, joint venture or similar interests or (c) be a general partner or joint venturer. 1.99. "Tax" means any present or future tax, levy, duty, impost, deduction, withholding or other charges of whatever nature at any time required by any Legal Requirement (a) to be paid by any Lender or (b) to be withheld or deducted from any payment otherwise required hereby to be made to any Lender, in each case on or with respect to its obligations hereunder, the Loan, any payment in respect of the Credit Obligations or any Funding Liability not included in the foregoing; provided, however, that the term "Tax" shall not include taxes imposed upon or measured by the net income of such Lender or franchise -17- 27 taxes. 1.100. "Term Loan" is defined in Section 2.2.1. 1.101. "Term Note" is defined in Section 2.2.2. 1.102. "United States Funds" means such coin or currency of the United States of America as at the time shall be legal tender therein for the payment of public and private debts. 1.103. "Wholly Owned Subsidiary" means any Subsidiary of which all of the outstanding capital stock (or other shares of beneficial interest) entitled to vote generally (other than directors' qualifying shares and, in the case of Foreign Subsidiaries, shares required by Legal Requirements to be held by foreign nationals) is owned by the Company (or other specified Person) directly, or indirectly through one or more Wholly Owned Subsidiaries. 2. The Credits. 2.1. Revolving Credit. 2.1.1. Revolving Loan. Subject to all the terms and conditions of this Agreement and so long as no Default exists, from time to time on and after the Initial Closing Date and prior to the Conversion Date, the Lenders will, severally in accordance with their respective Commitments in the Revolving Loan, make loans to the Company in such amounts as may be requested by the Company in accordance with Section 2.1.3. The aggregate principal amount of loans made under this Section 2.1.1 at any one time outstanding shall in no event exceed the lesser of (a) the Maximum Amount of Revolving Credit and (b) the Borrowing Base. In no event will the principal amount of loans at any one time outstanding made by any Lender pursuant to this Section 2.1 exceed such Lender's Commitment with respect to the Revolving Loan. 2.1.2. Maximum Amount of Revolving Credit. The term "Maximum Amount of Revolving Credit" means the lesser of (a) $10,000,000 and (b) the amount (in an integral multiple of $100,000) from time to time irrevocably designated by the Company to the Agent. 2.1.3. Borrowing Requests. The Company may from time to time request a loan under Section 2.1.1 by providing to the Agent a notice (which may be given by a telephone call received by a Lending Officer if promptly confirmed in writing). Such notice must be not later than noon (Boston time) on the first Banking Day (third Banking Day if any portion of such loan will be subject to a Eurodollar Pricing Option on the requested Closing Date) prior to the requested Closing Date for such loan. The notice must specify (a) the amount of the requested loan (which shall be not less than $250,000) and (b) the requested Closing Date therefor (which shall be a Banking Day). -18- 28 Upon receipt of such notice, the Agent will promptly inform each other Lender (by telephone or otherwise). Each such loan will be made at the Boston Office by depositing the amount thereof to the general account of the Company with the Agent. In connection with each such loan, the Company shall furnish to the Agent a certificate in substantially the form of Exhibit 5.2.1. 2.1.4. Revolving Notes. The aggregate principal amount of the loans outstanding from time to time under this Section 2.1 is referred to as the "Revolving Loan". The Agent shall keep a record of the Revolving Loan. The Revolving Loan shall be deemed owed to each Lender having a Commitment therein severally in accordance with such Lender's Percentage Interest therein, and all payments thereon shall be for the account of each Lender in accordance with its Percentage Interest therein. The Company's obligations to pay each Lender's Percentage Interest in the Revolving Loan shall be evidenced by a separate note of the Company in substantially the form of Exhibit 2.1.4 (the "Revolving Notes"), payable to each Lender in accordance with such Lender's Percentage Interest in the Revolving Loan. 2.2. Term Credit. 2.2.1. Term Loan. Subject to all the terms and conditions of this Agreement and so long as no Default exists, on the Conversion Date the Lenders will, in accordance with their respective Percentage Interests therein, severally lend to the Company as a term loan, an aggregate amount equal to the Revolving Loan outstanding on such date. The aggregate principal amount of the loans made pursuant to this Section 2.2.1 at any one time outstanding is referred to as the "Term Loan". In connection with the Term Loan, the Company shall furnish to the Agent a certificate in substantially the form of Exhibit 5.2.1. 2.2.2. Term Notes. The Term Loan shall be made at the Boston Office by crediting the amount of such loan to the Revolving Loan against delivery to the Agent of the separate term notes of the Company (the "Term Notes") payable to the respective Lenders. The Term Note issued to each Lender shall be in a principal amount equal to such Lender's Percentage Interest in the Term Loan, and shall be in substantially the form of Exhibit 2.2.2. 2.3. Application of Proceeds. 2.3.1. Revolving Loan. Subject to Section 2.3.3, the Company will apply the proceeds of the Revolving Loan for working capital, to repay loans made to it by the Guarantor or its Affiliates, and for other lawful corporate purposes of the Company and its Subsidiaries. -19- 29 2.3.2. Term Loan. The Company will apply the proceeds of the Term Loan solely to repay the Revolving Loan. 2.3.3. Specifically Prohibited Applications. The Company will not, directly or indirectly, apply any part of the proceeds of any extension of credit made pursuant to the Credit Documents to purchase or to carry Margin Stock or to any transaction prohibited by Legal Requirements applicable to the Lenders or by the Credit Documents. 3. Interest; Eurodollar Pricing Options; Fees. 3.1. Interest. The Loan shall accrue and bear interest at a rate per annum which shall at all times equal the Applicable Rate. Prior to any stated or accelerated maturity of the Loan, the Company will, on each Payment Date, pay the accrued and unpaid interest on the portion of the Loan which was not subject to a Eurodollar Pricing Option. On the last day of each Eurodollar Interest Period or on any earlier termination of any Eurodollar Pricing Option, the Company will pay the accrued and unpaid interest on the portion of the Loan which was subject to the Eurodollar Pricing Option which expired or terminated on such date. In the case of any Eurodollar Interest Period longer than three months, the Company will also pay the accrued and unpaid interest on the portion of the Loan subject to the Eurodollar Pricing Option having such Eurodollar Interest Period at three-month intervals, the first such payment to be made on the last Banking Day of the three-month period which begins on the first day of such Eurodollar Interest Period. On the stated or any accelerated maturity of the Loan, the Company will pay all accrued and unpaid interest on the Loan, including any accrued and unpaid interest on any portion of the Loan which is subject to a Eurodollar Pricing Option. Upon the occurrence and during the continuance of an Event of Default, the Lenders may require accrued interest to be payable on demand or at regular intervals more frequent than each Payment Date. All payments of interest hereunder shall be made to the Agent for the account of each Lender in accordance with such Lender's Percentage Interest. 3.2. Eurodollar Pricing Options. 3.2.1. Election of Eurodollar Pricing Options. Subject to all of the terms and conditions hereof and so long as no Default exists, the Company may from time to time, by irrevocable notice to the Agent actually received not less than three Banking Days prior to the commencement of the Eurodollar Interest Period selected in such notice, elect to have such portion of the Loan as the Company may specify in such notice accrue and bear interest during the Eurodollar Interest Period so selected at the Applicable Rate computed on the basis of the Eurodollar Rate. In the event the Company at any time fails to elect a Eurodollar Pricing Option under this Section 3.2.1 for any portion of the Loan, then such portion of the Loan will accrue and bear interest at the Applicable Rate based on the Base Rate. No election of a Eurodollar Pricing -20- 30 Option shall become effective: (a) if, prior to the commencement of any such Eurodollar Interest Period, the Agent determines that (i) the electing or granting of the Eurodollar Pricing Option in question would violate a Legal Requirement, (ii) Eurodollar deposits in an amount comparable to the principal amount of the Loan as to which such Eurodollar Pricing Option has been elected and which have a term corresponding to the proposed Eurodollar Interest Period are not readily available in the inter-bank Eurodollar market, or (iii) by reason of circumstances affecting the inter-bank Eurodollar market, adequate and reasonable methods do not exist for ascertaining the interest rate applicable to such deposits for the proposed Eurodollar Interest Period; or (b) if any Lender shall have advised the Agent by telephone or otherwise at or prior to noon (Boston time) on the second Banking Day prior to the commencement of such proposed Eurodollar Interest Period (and shall have subsequently confirmed in writing) that, after reasonable efforts to determine the availability of such Eurodollar deposits, such Lender reasonably anticipates that Eurodollar deposits in an amount equal to the Percentage Interest of such Lender in the portion of the Loan as to which such Eurodollar Pricing Option has been elected and which have a term corresponding to the Eurodollar Interest Period in question will not be offered in the Eurodollar market to such Lender at a rate of interest that does not exceed the anticipated Eurodollar Basic Rate (unless the foregoing results from a deterioration subsequent to the date hereof in the creditworthiness of such Lender or a change in the availability of Eurodollar markets to such Lender pursuant to legal or regulatory restrictions). 3.2.2. Notice to Lenders and Company. The Agent will promptly inform each Lender (by telephone or otherwise) of each notice received by it from the Company pursuant to Section 3.2.1 and of the Eurodollar Interest Period specified in such notice. Upon determination by the Agent of the Eurodollar Rate for such Eurodollar Interest Period or in the event such election shall not become effective, the Agent will promptly notify the Company and each Lender (by telephone or otherwise) of the Eurodollar Rate so determined or why such election did not become effective, as the case may be. 3.2.3. Selection of Eurodollar Interest Periods. Eurodollar Interest Periods shall be selected so that: (a) the minimum portion of the Loan subject to any Eurodollar Pricing Option shall be $500,000; (b) no more than three Eurodollar Pricing Options shall be outstanding at any one time; and -21- 31 (c) no Eurodollar Interest Period with respect to any part of the Loan subject to a Eurodollar Pricing Option shall expire later than the Final Maturity Date. If on the Conversion Date all or any portion of the Revolving Loan is subject to one or more effective Eurodollar Pricing Options, then each such Eurodollar Pricing Option shall apply to an equal amount of the Term Loan until the expiration of the Eurodollar Interest Period for such Eurodollar Pricing Option. 3.2.4. Additional Interest. If any portion of the Loan subject to a Eurodollar Pricing Option is repaid, or any Eurodollar Pricing Option is terminated for any reason (including acceleration of maturity), on a date which is prior to the last Banking Day of the Eurodollar Interest Period applicable to such Eurodollar Pricing Option, the Company will pay to the Agent for the account of each Lender in accordance with such Lender's Percentage Interest, in addition to any amounts of interest otherwise payable hereunder, an amount equal to the present value (calculated in accordance with this Section 3.2.4) of interest for the unexpired portion of such Eurodollar Interest Period on the portion of the Loan so repaid, or as to which a Eurodollar Pricing Option was so terminated, at a per annum rate equal to the excess, if any, of (a) the rate applicable to such Eurodollar Pricing Option minus (b) the rate of interest obtainable by the Agent upon the purchase of debt securities customarily issued by the Treasury of the United States of America which have a maturity date approximating the last Banking Day of such Eurodollar Interest Period. The present value of such additional interest shall be calculated by discounting the amount of such interest for each day in the unexpired portion of such Eurodollar Interest Period from such day to the date of such repayment or termination at a per annum interest rate equal to the interest rate determined pursuant to clause (b) of the preceding sentence, and by adding all such amounts for all such days during such period. The determination by the Agent of such amount of interest shall, in the absence of manifest error, be conclusive. For purposes of this Section 3.2.4, if any portion of the Loan which was to have been subject to a Eurodollar Pricing Option is not outstanding on the first day of the Eurodollar Interest Period applicable to such Eurodollar Pricing Option other than for reasons described in Section 3.2.1, the Company shall be deemed to have terminated such Eurodollar Pricing Option. 3.2.5. Violation of Legal Requirements. If any Legal Requirement shall prevent any Lender from funding or maintaining through the purchase of deposits in the interbank Eurodollar market any portion of the Loan subject to a Eurodollar Pricing Option or otherwise from giving effect to such Lender's obligations as contemplated by Section 3.2, (a) the Agent may by notice to the Company terminate all of the affected Eurodollar Pricing Options, (b) the portion of the Loan subject to such terminated Eurodollar Pricing Options shall immediately bear interest thereafter at the Applicable Rate computed on the basis of the Base Rate and (c) the Company shall make any payment required by Section 3.2.4. -22- 32 3.2.6. Funding Procedure. The Lenders may fund any portion of the Loan subject to a Eurodollar Pricing Option out of any funds available to the Lenders. Regardless of the source of the funds actually used by any of the Lenders to fund any portion of the Loan subject to a Eurodollar Pricing Option, however, all amounts payable hereunder, including the interest rate applicable to any such portion of the Loan and the amounts payable under Sections 3.2.4 and 3.5, shall be computed as if each Lender had actually funded such Lender's Percentage Interest in such portion of the Loan through the purchase of deposits in such amount of the type by which the Eurodollar Basic Rate was determined with a maturity the same as the applicable Eurodollar Interest Period relating thereto and through the transfer of such deposits from an office of the Lender having the same location as the applicable Eurodollar Office to one of such Lender's offices in the United States of America. 3.3. Commitment Fees. In consideration of the Lenders' commitments to make the extensions of credit provided for in Section 2.1, the Company will pay to the Agent for the account of the Lenders in accordance with the Lenders' respective Commitments in the Revolving Loan, on each Payment Date and on the Conversion Date, an amount equal to interest computed at the rate of 0.5% per annum on the amount by which (a) the average daily Maximum Amount of Revolving Credit during the three-month period or portion thereof ending on such Payment Date exceeded (b) the average daily Revolving Loan during such period or portion thereof; provided, however, that the first such payment shall be for the period beginning on the Initial Closing Date and ending on the first Payment Date. 3.4. Prepayment Fee. In the event the Company reduces the Maximum Amount of Revolving Credit (or prepays the Term Loan) within one year after the Initial Closing Date, the Company shall within one Banking Day pay to the Agent for the account of the Lenders a prepayment fee equal to 1% of the amount of such reduction (or the amount of the Term Loan so prepaid). 3.5. Changes in Circumstances; Yield Protection. 3.5.1. Reserve Requirements, etc. If any Legal Requirement shall (a) impose, modify, increase or deem applicable any insurance assessment, reserve, special deposit or similar requirement against any Funding Liability, (b) impose, modify, increase or deem applicable any other requirement or condition with respect to any Funding Liability, or (c) change the basis of taxation of Funding Liabilities (other than changes in the rate of taxes measured by the overall net income of such Lender) and the effect of any of the foregoing shall be to increase the cost to any Lender of issuing, making, funding or maintaining its respective Percentage Interest in any portion of the Loan subject to a Eurodollar Pricing Option, to reduce the amounts received or receivable by such Lender under this Agreement or to require such Lender to make any payment or forego any amounts otherwise payable to such Lender under this Agreement -23- 33 (other than any Tax or any reserves that are included in computing the Eurodollar Reserve Rate), then such Lender may claim compensation from the Company under Section 3.5.5. 3.5.2. Taxes. All payments of the Credit Obligations shall be made without set-off or counterclaim and free and clear of any deductions, including deductions for Taxes, unless the Company is required by law to make such deductions. If (a) any Lender shall be subject to any Tax with respect to any payment of the Credit Obligations or its obligations hereunder or (b) the Company shall be required to withhold or deduct any Tax on any payment on the Credit Obligations, then such Lender may claim compensation from the Company under Section 3.5.5. Whenever Taxes must be withheld by the Company with respect to any payments of the Credit Obligations, the Company shall promptly furnish to the Agent for the account of the applicable Lender official receipts (to the extent that the relevant governmental authority delivers such receipts) evidencing payment of any such Taxes so withheld. If the Company fails to pay any such Taxes when due or fails to remit to the Agent for the account of the applicable Lender the required receipts evidencing payment of any such Taxes so withheld or deducted, the Company shall indemnify the affected Lender for any incremental Taxes and interest or penalties that may become payable by such Lender as a result of any such failure. In the event any Lender receives a refund of any Taxes for which it has received payment from the Company under this Section 3.5.2, such Lender shall promptly pay the amount of such refund to the Company, together with any interest thereon actually earned by such Lender. 3.5.3. Capital Adequacy. If any Lender shall determine that compliance by such Lender with any Legal Requirement regarding capital adequacy of banks or bank holding companies has or would have the effect of reducing the rate of return on the capital of such Lender and its Affiliates as a consequence of such Lender's commitment to make the extensions of credit contemplated hereby, or such Lender's maintenance of the extensions of credit contemplated hereby, to a level below that which such Lender could have achieved but for such compliance (taking into consideration the policies of such Lender and its Affiliates with respect to capital adequacy immediately before such compliance and assuming that the capital of such Lender and its Affiliates was fully utilized prior to such compliance) by an amount deemed by such Lender to be material, then such Lender may claim compensation from the Company under Section 3.5.5. 3.5.4. Regulatory Changes. If any Lender shall determine that (a) any change in any Legal Requirement (including any new Legal Requirement) after the date hereof shall directly or indirectly (i) reduce the amount of any sum received or receivable by such Lender with respect to the Loan or the return to be earned by such Lender on the Loan, (ii) impose a cost on such Lender or any Affiliate of such Lender that is attributable to the making or maintaining of, or such Lender's commitment to make, its portion of the Loan, or (iii) require such Lender or any Affiliate of such -24- 34 Lender to make any payment on, or calculated by reference to, the gross amount of any amount received by such Lender under any Credit Document (other than Taxes or income or franchise taxes), and (b) such reduction, increased cost or payment shall not be fully compensated for by an adjustment in the Applicable Rate, then such Lender may claim compensation from the Company under Section 3.5.5. 3.5.5. Compensation Claims. Within 15 days after the receipt by the Company of a certificate from any Lender setting forth why it is claiming compensation under this Section 3.5 and computations (in reasonable detail) of the amount thereof, the Company shall pay to such Lender such additional amounts as such Lender sets forth in such certificate as sufficient fully to compensate it on account of the foregoing provisions of this Section 3.5, together with interest on such amount from the 15th day after receipt of such certificate until payment in full thereof at the Overdue Reimbursement Rate. The determination by such Lender of the amount to be paid to it and the basis for computation thereof hereunder shall, in the absence of manifest error, be conclusive. In determining such amount, such Lender may use any reasonable averaging and attribution methods. 3.5.6. Mitigation. Each Lender shall take such commercially reasonable steps as it may determine are not disadvantageous to it, including changing lending offices to the extent feasible, in order to reduce amounts otherwise payable by the Company to such Lender pursuant to Sections 3.2.4 and 3.5 or to make Eurodollar Pricing Options available under Sections 3.2.1 and 3.2.5. In addition, the Company shall not be responsible for costs (a) under Section 3.5 arising more than 90 days prior to receipt by the Company of the certificate from the affected Lender pursuant to such Section 3.5 or (b) under Section 3.2.4 arising from the termination of Eurodollar Pricing Options more than 90 days prior to the demand by the Agent for payment under Section 3.2.4. 3.6. Computations of Interest and Fees. For purposes of this Agreement, interest (and any other amount expressed as interest) shall be computed on the basis of a 360-day year for actual days elapsed. If any payment required by this Agreement becomes due on any day that is not a Banking Day, such payment shall, except as otherwise provided in the Eurodollar Interest Period, be made on the next succeeding Banking Day. If the due date for any payment of principal is extended as a result of the immediately preceding sentence, interest shall be payable for the time during which payment is extended at the Applicable Rate. 4. Payment. 4.1. Payment at Maturity. On the Final Maturity Date or any accelerated maturity of the Loan, the Company will pay to the Agent for the account of the Lenders an amount equal to the Loan then due, together with all accrued and unpaid interest and fees with respect thereto and all other Credit Obligations then outstanding. -25- 35 4.2. Required Prepayments. 4.2.1. Contingent Required Prepayments. If the Revolving Loan at any time exceeds the Maximum Amount of Revolving Credit, the Company shall within one Banking Day repay the amount of such excess to the Agent for the account of the Lenders. If the Revolving Loan at any time exceeds the Borrowing Base, the Company shall within 15 days either (a) repay the amount of such excess to the Agent for the account of the Lenders or (b) increase the Borrowing Base to eliminate such excess. 4.2.2. Scheduled Prepayments. On the last Banking Day of each of the third, sixth, ninth, twelfth, fifteenth, eighteenth, twenty-first, twenty-fourth, and twenty-seventh months ending after the Conversion Date, the Company shall pay to the Agent for the account of the Lenders the lesser of (a) 10% of the Term Loan on the Conversion Date, or (b) the amount of the Term Loan then outstanding. 4.3. Voluntary Prepayments. In addition to the prepayments required by Section 4.2, the Company may from time to time prepay all or any portion of the Loan (in a minimum amount of $500,000 and an integral multiple of $100,000, or such lesser amount as is then outstanding), without premium or penalty of any type except as provided in Section 3.2.4 with respect to the early termination of Eurodollar Pricing Options and Section 3.4 with respect to the prepayment fee. The Company shall give the Agent at least one Banking Day prior notice of its intention to prepay, specifying the date of payment, the total amount of the Loan to be paid on such date and the amount of interest to be paid with such prepayment. 4.4. Reborrowing; Application of Payments, etc. 4.4.1. Reborrowing. The amounts of the Revolving Loan prepaid pursuant to Section 4.3 may be reborrowed from time to time prior to the Conversion Date in accordance with Section 2.1, subject to the limits set forth therein. No portion of the Term Loan prepaid hereunder may be reborrowed. 4.4.2. Order of Application. Prepayments of the Term Loan made pursuant to Section 4.3 shall be applied first to the principal amount of the Term Note which is due on the Final Maturity Date and then to the installments required to be made on the Term Loan pursuant to Section 4.2.2 in the inverse order of the maturity thereof so that no partial prepayment of the Term Loan shall affect the obligation of the Company to make the prepayments required by Section 4.2.2. Any prepayment of the Loan shall be applied first to the portion of the Loan not then subject to Eurodollar Pricing Options, then the balance of any such prepayment shall be applied to the portion of the Loan then subject to Eurodollar Pricing Options, in the chronological order of the respective maturities thereof (or as the Company may otherwise specify in writing), together with -26- 36 any payments required by Section 3.2.4. 4.4.3. Payment with Accrued Interest, etc. Upon all prepayments of the Term Loan, the Company shall pay to the Agent the principal amount to be prepaid, together with unpaid interest in respect thereof accrued to the date of prepayment. Notice of prepayment having been given in accordance with Section 4.3, and whether or not notice is given of prepayments pursuant to Section 4.2, the amount specified to be prepaid shall become due and payable on the date specified for prepayment. 4.4.4. Charging Accounts. The Agent may charge the accounts of the Company (other than Collection Accounts), on the dates when the amounts thereof become due and payable, with the amounts of principal of and interest on the Loan, commitment fees, prepayment fees and all other fees and amounts owing under any Credit Document. 4.4.5. Payments for Lenders. All payments of principal hereunder shall be made to the Agent for the account of the Lenders in accordance with the Lenders' respective Percentage Interests. 5. Conditions to Extending Credit. 5.1. Conditions on Initial Closing Date. The obligations of the Lenders to make any extension of credit pursuant to Section 2 shall be subject to the satisfaction, on or before the Initial Closing Date, of the conditions set forth in this Section 5.1 as well as the further conditions in Section 5.2. If the conditions set forth in this Section 5.1 are not met on or prior to the Initial Closing Date, the Lenders shall have no obligation to make any extensions of credit hereunder. 5.1.1. Revolving Notes. The Company shall have duly executed and delivered to the Agent a Revolving Note for each Lender. 5.1.2. Payment of Fees. The Company shall have paid to the Agent the fees required by the separate fee letter dated on or prior to the Initial Closing Date between the Company and the Agent (the "Fee Letter"). 5.1.3. Legal Opinions. On the Initial Closing Date, the Lenders shall have received from the following counsel their respective opinions with respect to the transactions contemplated by the Credit Documents, which opinions shall be in form and substance satisfactory to the Required Lenders: (a) Greenberg Traurig Hoffman Lipoff Rosen & Quentel, P.A., special counsel for the Company. -27- 37 (b) Ropes & Gray, special counsel for the Agent. The Company authorizes and directs its counsel to furnish the foregoing opinions. 5.1.4. Security Agreement. The Company shall have duly authorized, executed and delivered to the Agent a Security Agreement in substantially the form of Exhibit 5.1.4 (the "Security Agreement"). 5.1.5. Perfection of Security. The Company shall have duly authorized, executed, acknowledged, delivered, filed, registered and recorded such security agreements, notices, financing statements and other instruments as the Agent may have requested in order to perfect the Liens purported or required pursuant to the Credit Documents to be created in the Credit Security and shall have paid all filing or recording fees or taxes required to be paid in connection therewith, including any recording, mortgage, documentary, transfer or intangible taxes. 5.1.6. Stockholder Guarantee. The Guarantor shall have duly authorized, executed and delivered to the Agent a Guarantee in substantially the form of Exhibit 5.1.6 (the "Stockholder Guarantee"). 5.1.7. Repayment of Demand Loan. Contemporaneously with the initial advance hereunder, the Company shall have paid in full all principal, interest and other accrued and outstanding amounts under the Demand Loan. All Liens securing amounts owing under the Demand Loan shall have been released or assigned to the Agent, and the Demand Loan shall have become terminated and of no further force or effect. 5.1.8. Proper Proceedings. This Agreement, each other Credit Document and the transactions contemplated hereby and thereby shall have been authorized by all necessary corporate or other proceedings. All necessary consents, approvals and authorizations of any governmental or administrative agency or any other Person of any of the transactions contemplated hereby or by any other Credit Document shall have been obtained and shall be in full force and effect. 5.1.9. General. All legal and corporate proceedings in connection with the transactions contemplated by this Agreement shall be satisfactory in form and substance to the Agent and the Agent shall have received copies of all documents, including certified copies of the Charter and By-Laws of the Company and the other Obligors, records of corporate proceedings, certificates as to signatures and incumbency of officers and opinions of counsel, which the Agent may have reasonably requested in connection therewith, such documents where appropriate to be certified by proper corporate or governmental authorities. -28- 38 5.2. Conditions to Each Extension of Credit. The obligations of the Lenders to make any extension of credit pursuant to Section 2 shall be subject to the satisfaction, on or before the Closing Date for such extension of credit, of the following conditions: 5.2.1. Officer's Certificate. The representations and warranties contained in Section 7 shall be true and correct on and as of such Closing Date with the same force and effect as though made on and as of such date (except as to any representation or warranty which refers to a specific earlier date); no Default shall exist on such Closing Date prior to or immediately after giving effect to the requested extension of credit; no Material Adverse Change shall have occurred since August 31, 1995; and the Company shall have furnished to the Agent in connection with the requested extension of credit a certificate to these effects, in substantially the form of Exhibit 5.2.1, signed by a Financial Officer. 5.2.2. Legality, etc. The making of the requested extension of credit shall not (a) subject any Lender to any penalty or special tax (other than a Tax for which the Company is required to reimburse the Lenders under Section 3.5), (b) be prohibited by any Legal Requirement or (c) violate any credit restraint program of the executive branch of the government of the United States of America, the Board of Governors of the Federal Reserve System or any other governmental or administrative agency so long as any Lender reasonably believes that compliance therewith is in the best interests of such Lender. 6. General Covenants. The Company covenants that, until all of the Credit Obligations shall have been paid in full and until the Lenders' commitments to extend credit under this Agreement and any other Credit Document shall have been irrevocably terminated, the Company and its Subsidiaries will comply with the following provisions: 6.1. Taxes and Other Charges; Accounts Payable. 6.1.1. Taxes and Other Charges. Each of the Company and its Subsidiaries shall duly pay and discharge, or cause to be paid and discharged, before the same becomes in arrears, all taxes, assessments and other governmental charges imposed upon such Person and its properties, sales or activities, or upon the income or profits therefrom, as well as all claims for labor, materials or supplies which if unpaid might by law become a Lien upon any of its property; provided, however, that any such tax, assessment, charge or claim need not be paid if the validity or amount thereof shall at the time be contested in good faith by appropriate proceedings and if such Person shall, in accordance with GAAP, have set aside on its books adequate reserves with respect thereto; and provided, further, that each of the Company and its Subsidiaries shall pay or bond, or cause to be paid or bonded, all such taxes, assessments, charges or other governmental claims immediately upon the commencement of proceedings to foreclose any Lien which may have attached as security therefor (except to the extent such -29- 39 proceedings have been dismissed or stayed). 6.1.2. Accounts Payable. Each of the Company and its Subsidiaries shall promptly pay when due, or in conformity with customary trade terms, all accounts payable incident to the operations of such Person not referred to in Section 6.1.1; provided, however, that any such Indebtedness need not be paid if the validity or amount thereof shall at the time be contested in good faith and if such Person shall, in accordance with GAAP, have set aside on its books adequate reserves with respect thereto. 6.2. Conduct of Business, etc. 6.2.1. Types of Business. The Company and its Subsidiaries shall engage only in the business of (a) originating, servicing, pooling and selling home improvement and home equity loans and (b) other activities related thereto. 6.2.2. Statutory Compliance. Each of the Company and its Subsidiaries shall comply in all material respects with all valid and applicable statutes, laws, ordinances, zoning and building codes and other rules and regulations of the United States of America, of the states and territories thereof and their counties, municipalities and other subdivisions and of any foreign country or other jurisdictions applicable to such Person, except where (a) compliance therewith shall at the time be contested in good faith by appropriate proceedings or (b) failure so to comply with the provisions being contested has not resulted, or does not create a material risk of resulting, in the aggregate in any Material Adverse Change. 6.2.3. Compliance with Material Agreements. Each of the Company and its Subsidiaries shall comply in all material respects with the Material Agreements (to the extent not in violation of the other provisions of this Agreement or any other Credit Document). Without the prior written consent of the Required Lenders, no Material Agreement shall be amended, modified, waived or terminated in any manner that would have in any material respect an adverse effect on the interests of the Lenders. 6.3. Insurance. 6.3.1. Liability Insurance. Each of the Company and its Subsidiaries shall maintain with financially sound and reputable insurers insurance against liability for hazards, risks and liability to persons and property, to the extent, in amounts and with deductibles at least as favorable as those generally maintained by businesses of similar size engaged in similar activities; provided, however, that it may effect workers' compensation insurance or similar coverage with respect to operations in any particular state or other jurisdiction through an insurance fund operated by such state or jurisdiction or by meeting the self-insurance requirements of such state or jurisdiction. -30- 40 6.4. Financial Statements and Reports. Each of the Company and its Subsidiaries shall maintain a system of accounting in which correct entries shall be made of all transactions in relation to their business and affairs in accordance with generally accepted accounting practice. The fiscal year of the Company and its Subsidiaries shall end on August 31 in each year and the fiscal quarters of the Company and its Subsidiaries shall end on February 28 (or 29), May 31, August 31 and November 30 in each year. 6.4.1. Annual Reports. The Company shall furnish to the Lenders as soon as available, and in any event within 120 days after the end of each fiscal year, the Consolidated balance sheet of the Company and its Subsidiaries as at the end of such fiscal year, the Consolidated statements of income, of changes in shareholders' equity and of cash flows of the Company and its Subsidiaries for such fiscal year (all in reasonable detail) together with comparative figures for the immediately preceding fiscal year, all accompanied by: (a) Reports of Deloitte & Touche LLP (or, if they cease to be auditors of the Company and its Subsidiaries, other independent certified public accountants of recognized national standing reasonably satisfactory to the Required Lenders), containing no material qualification, to the effect that they have audited the foregoing financial statements in accordance with generally accepted auditing standards and that such financial statements present fairly, in all material respects, the financial position of the Company and its Subsidiaries covered thereby at the dates thereof and the results of their operations for the periods covered thereby in conformity with GAAP. (b) The statement of such accountants that they have caused this Agreement to be reviewed and that in the course of their audit of the Company and its Subsidiaries no facts have come to their attention that cause them to believe that any Default exists and in particular that they have no knowledge of any Default under Sections 6.5 through 6.14 or, if such is not the case, specifying such Default and the nature thereof. This statement is furnished by such accountants with the understanding that the examination of such accountants cannot be relied upon to give such accountants knowledge of any such Default except as it relates to accounting or auditing matters within the scope of their audit. (c) A certificate of the Company signed by a Financial Officer to the effect that such officer has caused this Agreement to be reviewed and has no knowledge of any Default, or if such officer has such knowledge, specifying such Default and the nature thereof, and what action the Company has taken, is taking or proposes to take with respect thereto. (d) Computations by the Company demonstrating, as of the end of such fiscal year, compliance with the Computation Covenants, certified by a Financial Officer. -31- 41 (e) Supplements to Exhibits 7.1 and 7.3 and Exhibit 2.3 to the Security Agreement showing any changes in the information set forth in such exhibits not previously furnished to the Lenders in writing, as well as any changes in the Charter, Bylaws or incumbency of officers of the Obligors from those previously certified to the Agent. (f) In the event of a change in GAAP after August 31, 1995, computations by the Company, certified by a Financial Officer, reconciling the financial statements referred to above with financial statements prepared in accordance with GAAP as applied to the other covenants in Section 6 and related definitions. 6.4.2. Monthly Reports. The Company shall furnish to the Lenders as soon as available and, in any event, within 60 days after the end of each February, May, August, and November, and within 45 days after the end of each other month, the internally prepared Consolidated balance sheet of the Company and its Subsidiaries as at the end of such month and the Consolidated statement of income of the Company and its Subsidiaries for such month (all in reasonable detail), all accompanied by a certificate of the Company signed by a Financial Officer to the effect that such financial statements were prepared in accordance with GAAP and present fairly, in all material respects, the financial position of the Persons covered thereby at the dates thereof and the results of their operations for the periods covered thereby, subject only to normal year-end audit adjustments and the addition of footnotes. 6.4.3. Monthly Borrowing Base. The Company shall furnish to the Lenders as soon as available and, in any event, within 25 days after the end of each month, (a) a certificate of a Financial Officer supplying computations of the Borrowing Base at the beginning of such month and certifying that such computations were based on the monthly reports prepared in accordance with GAAP, (b) a Constant Prepayment Rate Report, and (c) a Three-month Excess Spread Summary. 6.4.4. Other Reports. The Company shall promptly furnish to the Lenders: (a) Any management letters furnished to the Guarantor or any of its Subsidiaries by the Guarantor's auditors. (b) All budgets, projections, statements of operations and other reports furnished generally to the shareholders of the Company or the Guarantor. (c) Such registration statements, proxy statements and reports, including Forms S-1, S-2, S-3, S-4, 10-K, 10-Q and 8-K, as may be filed by the Company or any of its Subsidiaries or by the Guarantor with the Securities and Exchange Commission. -32- 42 (d) Any 90-day letter or 30-day letter from the federal Internal Revenue Service (or the equivalent notice received from state or other taxing authorities) asserting tax deficiencies against the Guarantor or any of its Subsidiaries. 6.4.5. Notice of Litigation, Defaults, etc. The Company shall promptly furnish to the Lenders notice of any litigation or any administrative or arbitration proceeding (a) which creates a material risk of resulting, after giving effect to any applicable insurance, in the payment by the Guarantor or the Company and its Subsidiaries of more than $500,000 or (b) which results, or creates a material risk of resulting, in a Material Adverse Change. Promptly upon acquiring knowledge thereof, the Company shall notify the Lenders of the existence of any Default or Material Adverse Change, specifying the nature thereof and what action the Company or any Subsidiary has taken, is taking or proposes to take with respect thereto. 6.4.6. Other Information. From time to time at reasonable intervals upon request of any authorized officer of any Lender, each of the Company and its Subsidiaries shall furnish to the Lenders such other information regarding the business, assets, financial condition, income or prospects of the Company and its Subsidiaries as such officer may reasonably request, including copies of all tax returns, licenses, agreements, leases and instruments to which any of the Company or its Subsidiaries is party. The Lenders' authorized officers and representatives shall have the right during normal business hours upon reasonable notice and at reasonable intervals to examine the books and records of the Company and its Subsidiaries, to make copies and notes therefrom for the purpose of ascertaining compliance with or obtaining enforcement of this Agreement or any other Credit Document. 6.5. Certain Financial Tests. 6.5.1. Consolidated Tangible Net Worth. Consolidated Tangible Net Worth shall at all times equal the sum of (a) $12,500,000 plus (b) the amount by which Consolidated Net Worth has been increased after August 31, 1995 as a result of capital contributions, the issuance of capital stock or partnership interests of the Company or any of its Subsidiaries, the issuance of warrants, options or other rights to acquire such capital stock or partnership interests plus (c) 50% of Consolidated Net Income (if positive) for the period beginning on May 1, 1996 and ending with the most recently completed month. 6.5.2. Consolidated Net Income. On the last day of each month, Consolidated Net Income for the period of six consecutive months then ending shall exceed $500,000. 6.5.3. Net Excess Spread to Consolidated Pro Forma Debt Service. On the last day of each month on or after the Conversion Date, the quotient of dividing (a) -33- 43 400% of the aggregate Net Excess Spread (disregarding for this calculation clause (b)(3) of the definition of that term) for the period of three consecutive months then ending, by (b) Consolidated Pro Forma Debt Service for the 12-month period beginning immediately after such date, shall exceed 1.25. 6.6. Indebtedness. Neither the Company nor any of its Subsidiaries shall create, incur, assume or otherwise become or remain liable with respect to any Indebtedness (or become contractually committed do so), except the following: 6.6.1. Indebtedness in respect of the Credit Obligations. 6.6.2. Guarantees permitted by Section 6.7. 6.6.3. Current liabilities, other than Financing Debt, incurred in the ordinary course of business. 6.6.4. To the extent that payment thereof shall not at the time be required by Section 6.1, Indebtedness in respect of taxes, assessments, governmental charges and claims for labor, materials and supplies. 6.6.5. Indebtedness secured by Liens of carriers, warehouses, mechanics and landlords permitted by Sections 6.8.5 and 6.8.6. 6.6.6. Indebtedness in respect of judgments or awards (a) which have been in force for less than the applicable appeal period or (b) in respect of which the Company or any Subsidiary shall at the time in good faith be prosecuting an appeal or proceedings for review and, in the case of each of clauses (a) and (b), the Company or such Subsidiary shall have taken appropriate reserves therefor in accordance with GAAP and execution of such judgment or award shall not be levied. 6.6.7. To the extent permitted by Section 6.8.9, Indebtedness in respect of Capitalized Lease Obligations or secured by purchase money security interests; provided, however, that the aggregate principal amount of all Indebtedness permitted by this Section 6.6.7 at any one time outstanding shall not exceed $2,000,000. 6.6.8. Indebtedness in respect of deferred taxes arising in the ordinary course of business. 6.6.9. Indebtedness in respect of inter-company loans and advances among (a) the Company and its Subsidiaries which are not prohibited by Section 6.9 and (b) the Company and the Guarantor or Preferred Equities Corporation. 6.6.10. Indebtedness outstanding on the date hereof or Indebtedness created -34- 44 by drawing down commitments to provide credit existing on the date hereof, as described in Exhibit 7.3 and (except with respect to the Demand Note, which shall be terminated on the Initial Closing Date) all renewals and extensions thereof not in excess of the amount thereof outstanding (or, in the case of commitments, committed) immediately prior to such renewal or extension. 6.6.11. In the event that (a) at any time after August 31, 1996 the Company requests in good faith in writing an increase in the Maximum Amount of Revolving Credit and the Lenders decline to grant such request, and (b) the Loan is less than 30% of Excess Servicing Rights for the most recent month for which financial statements have been (or are required to have been) furnished to the Lenders in accordance with Section 6.4.2 and (c) the Loan is less than 450% of Net Excess Spread for the most recent period of three consecutive months for which financial statements have been (or are required to have been) furnished to the Lenders in accordance with Section 6.4.2, and (d) the test stated in Section 6.5.3 is satisfied on the last day of the month immediately preceding the month in which the Company proposes to incur additional indebtedness, the Company may incur Indebtedness in an amount not exceeding a customary borrowing base composed of Excess Servicing Rights that are not pledged as part of the Credit Security, in which event the Revolving Loan shall convert to the Term Loan. 6.6.12. Indebtedness (other than Financing Debt) in addition to the foregoing; provided, however, that the aggregate amount of all such Indebtedness at any one time outstanding shall not exceed $500,000. 6.7. Guarantees; Letters of Credit. Neither the Company nor any of its Subsidiaries shall become or remain liable with respect to any Guarantee, including reimbursement obligations, whether contingent or matured, under letters of credit or other financial guarantees by third parties (or become contractually committed do to so), except the following: 6.7.1. Guarantees of the Credit Obligations. 6.7.2. Guarantees by the Company of Indebtedness and other obligations incurred by its Subsidiaries and permitted by Section 6.6. 6.8. Liens. Neither the Company nor any of its Subsidiaries shall create, incur or enter into, or suffer to be created or incurred or to exist, any Lien (or become contractually committed to do so), except the following: 6.8.1. Liens on the Credit Security that secure the Credit Obligations or that were created under the agreements governing the sale of the loans underlying the Credit Security. -35- 45 6.8.2. Liens to secure taxes, assessments and other governmental charges, to the extent that payment thereof shall not at the time be required by Section 6.1. 6.8.3. Deposits or pledges made (a) in connection with, or to secure payment of, workers' compensation, unemployment insurance, old age pensions or other social security, (b) in connection with casualty insurance maintained in accordance with Section 6.3, (c) to secure the performance of bids, tenders, contracts (other than contracts relating to Financing Debt) or leases, (d) to secure statutory obligations or surety or appeal bonds, (e) to secure indemnity, performance or other similar bonds in the ordinary course of business or (f) in connection with contested amounts to the extent that payment thereof shall not at that time be required by Section 6.1. 6.8.4. Liens in respect of judgments or awards, to the extent that such judgments or awards are permitted by Section 6.6.6 but only to the extent that such Liens are junior to the Liens on the Credit Security granted to secure the Credit Obligations. 6.8.5. Liens of carriers, warehouses, mechanics and similar Liens, in each case (a) in existence less than 90 days from the date of creation thereof or (b) being contested in good faith by the Company or any Subsidiary in appropriate proceedings (so long as the Company or such Subsidiary shall, in accordance with GAAP, have set aside on its books adequate reserves with respect thereto). 6.8.6. Encumbrances in the nature of (a) zoning restrictions, (b) easements, (c) restrictions of record on the use of real property, (d) landlords' and lessors' Liens on rented premises and (e) restrictions on transfers or assignment of leases, which in each case do not materially detract from the value of the encumbered property or impair the use thereof in the business of the Company or any Subsidiary. 6.8.7. Restrictions under federal and state securities laws on the transfer of securities. 6.8.8. Liens on Excess Servicing Rights that are not pledged as part of the Credit Security to secure Indebtedness permitted by Section 6.6.11. 6.8.9. Liens constituting (a) purchase money security interests (including mortgages, conditional sales, Capitalized Leases and any other title retention or deferred purchase devices) in real property, interests in leases or tangible personal property (other than inventory) existing or created on the date on which such property is acquired, and (b) the renewal, extension or refunding of any security interest referred to in the foregoing clause (a) in an amount not to exceed the amount thereof remaining unpaid immediately prior to such renewal, extension or refunding; provided, however, -36- 46 that (i) each such security interest shall attach solely to the particular item of property so acquired, and the principal amount of Indebtedness (including Indebtedness in respect of Capitalized Lease Obligations) secured thereby shall not exceed the cost (including all such Indebtedness secured thereby, whether or not assumed) of such item of property; and (ii) the aggregate principal amount of all Indebtedness secured by Liens permitted by this Section 6.8.9 shall not exceed the amount permitted by Section 6.6.7. 6.8.10. Liens as in effect on the date hereof described in Exhibit 7.3 and securing Indebtedness permitted by Section 6.6.10. 6.8.11. Liens existing on property acquired through foreclosure by the Company. 6.9. Investments and Acquisitions. Neither the Company nor any of its Subsidiaries shall have outstanding, acquire or hold any Investment (including any Investment consisting of the acquisition of any business) (or become contractually committed to do so), except the following: 6.9.1. Cash Investments of the Company and its Subsidiaries in Persons that have become Wholly Owned Subsidiaries and guarantors of the Credit Obligations after the date hereof; provided, however, that no such Investment shall involve the transfer by the Company of any material assets other than cash. 6.9.2. Intercompany loans and advances from any Wholly Owned Subsidiary to the Company but in each case only to the extent reasonably necessary for Consolidated tax planning and working capital management; 6.9.3. Investments in Cash Equivalents. 6.9.4. Guarantees permitted by Section 6.7. 6.9.5. Investments in the ordinary course of business in home improvement and home equity loans. 6.10. Distributions. Neither the Company nor any of its Subsidiaries shall make any Distribution (or become contractually committed to do so), except the following: 6.10.1. Subsidiaries of the Company may make Distributions to the Company or any Wholly Owned Subsidiary of the Company and the Company and the Company may make Investments permitted by Sections 6.9.1 and 6.9.2. -37- 47 6.10.2. So long as immediately before and after giving effect thereto no Default exists, the Company may make Distributions to the Guarantor after the Initial Closing Date in a cumulative amount which shall not exceed 50% of Consolidated Net Income (if positive) for the period beginning on May 1, 1996 and ending with the last full month before the date a determination is being made under this Section 6.10.2. 6.10.3. The Company and its Subsidiaries may enter into transactions with Affiliates permitted by Section 6.14. 6.10.4. So long as immediately before and after giving effect thereto no Default exists, the Company may make payments to the Guarantor pursuant to intercompany loans and tax sharing agreements. 6.11. Asset Dispositions and Mergers. Neither the Company nor any of its Subsidiaries shall merge or enter into a consolidation or sell, lease, sell and lease back, sublease or otherwise dispose of any of its assets (or become contractually committed to do so), except the following: 6.11.1. The Company and any of its Subsidiaries may sell or otherwise dispose of (a) home improvement loans, loan servicing rights and Cash Equivalents in the ordinary course of business, (b) tangible assets to be replaced in the ordinary course of business within 12 months by other tangible assets of equal or greater value and (c) tangible assets that are no longer used or useful in the business of the Company or such Subsidiary in the ordinary course of business. 6.11.2. Any Wholly Owned Subsidiary of the Company may merge or be liquidated into the Company or any other Wholly Owned Subsidiary of the Company so long as after giving effect to any such merger to which the Company is a party the Company shall be the surviving or resulting Person. 6.12. Derivative Contracts. Neither the Company nor any of its Subsidiaries shall enter into any Interest Rate Protection Agreement, foreign currency exchange contract or other financial or commodity derivative contracts except to provide hedge protection for an underlying economic transaction in the ordinary course of business. 6.13. Negative Pledge Clauses. Neither the Company nor any of its Subsidiaries shall enter into any agreement, instrument, deed or lease which prohibits or limits the ability of the Company or any of its Subsidiaries to create, incur, assume or suffer to exist any Lien upon any of their respective properties, assets or revenues, whether now owned or hereafter acquired, or which requires the grant of any collateral for such obligation if collateral is granted for another obligation, except the following: 6.13.1. This Agreement and the other Credit Documents. -38- 48 6.13.2. Covenants in documents creating Liens permitted by Section 6.8 prohibiting further Liens on the assets encumbered thereby. 6.14. Transactions with Affiliates. Neither the Company nor any of its Affiliates (except for the Company and its Subsidiaries) on a basis less favorable to the Company and its Subsidiaries than would be the case if such transaction had been effected with a non-Affiliate. 6.15. Accounts to be Maintained with Bank of Boston. The Company shall maintain its core bank account and, to the extent it has authority to do so, Collection Accounts, with Bank of Boston. 6.16. Transfer of Funds from Collection Accounts. The Company shall transfer funds to which it is entitled (including, without limitation, funds representing mortgage servicing fees owed to the Company, that are in Collection Accounts from such Collection Accounts to its core bank account as promptly as possible, and in any event at least once each month. 7. Representations and Warranties. In order to induce the Lenders to extend credit to the Company hereunder, each of the Company and such of its Subsidiaries as are party hereto from time to time jointly and severally represents and warrants as follows: 7.1. Organization and Business. 7.1.1. The Company. The Company is a duly organized and validly existing corporation, in good standing under the laws of Delaware, with all power and authority, corporate or otherwise, necessary to (a) enter into and perform this Agreement and each other Credit Document to which it is party, (b) grant the Agent for the benefit of the Lenders the security interests in the Credit Security owned by it to secure the Credit Obligations and (c) own its properties and carry on the business now conducted or proposed to be conducted by it. Certified copies of the Charter and By-laws of the Company have been previously delivered to the Agent and are correct and complete. Exhibit 7.1, as from time to time hereafter supplemented in accordance with Section 6.4.1(e), sets forth, as of the later of the date hereof or the end of the most recent fiscal quarter for which financial statements are required to be furnished in accordance with such Sections, (i) the jurisdiction of incorporation of the Company, (ii) the address of the Company's principal executive office and chief place of business, (iii) each name, including any trade name, under which the Company conducts its business and (iv) the jurisdictions in which the Company keeps tangible personal property. 7.1.2. Subsidiaries. Each Subsidiary of the Company is duly organized, validly existing and in good standing under the laws of the jurisdiction in which it is -39- 49 organized, with all power and authority, corporate or otherwise, necessary to (a) enter into and perform this Agreement and each other Credit Document to which it is party, (b) guarantee the Credit Obligations, (c) grant the Agent for the benefit of the Lenders the security interest in the Credit Security owned by such Subsidiary to secure the Credit Obligations and (d) own its properties and carry on the business now conducted or proposed to be conducted by it. Certified copies of the Charter and By-laws of each Subsidiary of the Company have been previously delivered to the Agent and are correct and complete. Exhibit 7.1, as from time to time hereafter supplemented in accordance with Section 6.4.1(e), sets forth, as of the later of the date hereof or the end of the most recent fiscal quarter for which financial statements are required to be furnished in accordance with such Sections, (i) the name and jurisdiction of organization of each Subsidiary of the Company, (ii) the address of the chief executive office and principal place of business of each such Subsidiary, (iii) each name under which each such Subsidiary conducts its business, (iv) each jurisdiction in which each such Subsidiary keeps tangible personal property, and (v) the number of authorized and issued shares and ownership of each such Subsidiary. 7.1.3. The Guarantor. The Guarantor is a duly organized and validly existing corporation, in good standing under the laws of New York, with all power and authority, corporate or otherwise, necessary to (a) enter into and perform each Credit Document to which it is party, and (b) own its properties and carry on the business now conducted or proposed to be conducted by it. Certified copies of the Charter and By-laws of the Guarantor have been previously delivered to the Agent and are correct and complete. Exhibit 7.1 sets forth (i) the jurisdiction of incorporation of the Guarantor, (ii) the address of the Guarantor's principal executive office and chief place of business, (iii) each name, including any trade name, under which the Guarantor conducts its business and (iv) the jurisdictions in which the Guarantor keeps tangible personal property. 7.1.4. Qualification. Each of the Guarantor and its Subsidiaries is duly and legally qualified to do business as a foreign corporation or other entity and is in good standing in each state or jurisdiction in which such qualification is required and is duly authorized, qualified and licensed under all laws, regulations, ordinances or orders of public authorities, or otherwise, to carry on its business in the places and in the manner in which it is conducted, except for failures to be so qualified, authorized or licensed which would not in the aggregate result, or create a material risk of resulting, in any Material Adverse Change. 7.2. Financial Statements and Other Information; Material Agreements. 7.2.1. Financial Statements and Other Information. The Company has previously furnished to the Lenders copies of the following: -40- 50 (a) The audited balance sheets of the Company as at August 31 in each of 1995, 1994 (as restated) and 1993 and the audited statements of income and the audited Consolidated statements of changes in shareholders' equity and of cash flows of the Company for the fiscal years of the Company then ended. (b) The unaudited balance sheet of the Company as at April 30, 1996 and the unaudited statements of income, of changes in shareholders' equity and of cash flows of the Company for the portion of the fiscal year then ended. (c) The Guarantor's report on 10-K for its fiscal year ended August 31, 1995, as filed with the Securities and Exchange Commission. (d) Calculations demonstrating pro forma compliance with the Computation Covenants as of the end of the most recent quarter preceding the date hereof. The audited financial statements (including the notes thereto) referred to in clause (a) above were prepared in accordance with GAAP and fairly present in all material respects the financial position of the Company at the respective dates thereof and the results of its operations for the periods covered thereby. The unaudited financial statements referred to in clause (b) above were prepared in accordance with GAAP and fairly present in all material respects the financial position of the Company at the date thereof and the results of its operations for the periods covered thereby, subject to normal year-end audit adjustment and the addition of footnotes in the case of interim financial statements. The Company does not have any known contingent liability material to the Company which is not reflected in the balance sheets referred to in clauses (a) or (b) above (or delivered pursuant to Sections 6.4.1 or 6.4.2) or in the notes thereto. The Form 10-K referred to in clause (c) above contained all information required to be contained therein and otherwise complied in all material respects with the Exchange Act and the rules and regulations thereunder. Such Form 10-K did not contain any untrue statement of material fact or omit to state a material fact necessary in order to make the statements contained therein not misleading in the light of the circumstances under which they were made. 7.2.2. Material Agreements. The Company has previously furnished to the Lenders correct and complete copies, including all exhibits, schedules and amendments thereto, of the agreements, each as in effect on the date hereof, listed in Exhibit 7.2.2 (the "Material Agreements"). 7.3. Agreements Relating to Financing Debt, Investments, etc. Exhibit 7.3, as from time to time hereafter supplemented in accordance with Section 6.4.1, sets forth (a) the amounts (as of the dates indicated in Exhibit 7.3, as so supplemented) of all Financing Debt of -41- 51 the Company and its Subsidiaries and all agreements which relate to such Financing Debt, (b) all Liens and Guarantees with respect to such Financing Debt, (c) all agreements which directly or indirectly require the Company or any Subsidiary to sell any loans or loan servicing rights and (d) all agreements which require the Company or any of its Subsidiaries to provide loan servicing. The Company has furnished the Lenders with correct and complete copies of any agreements described in clauses (a) through (d) above requested by the Required Lenders. 7.4. Changes in Condition. Since August 31, 1995 no Material Adverse Change has occurred. 7.5. Title to Assets. The Company and its Subsidiaries have good and marketable title to all assets necessary for or used in the operations of their business as now conducted by them and reflected in the most recent balance sheet referred to in Section 7.2.1 (or the balance sheet most recently furnished to the Lenders pursuant to Sections 6.4.1 or 6.4.2), and to all assets acquired subsequent to the date of such balance sheet, subject to no Liens except for Liens permitted by Section 6.8 and except for assets disposed of as permitted by Section 6.11. The Guarantor has good and marketable title to all assets necessary for or used in the operations of its business as now conducted by it. 7.6. Operations in Conformity With Law, etc. The operations of the Guarantor and its Subsidiaries as now conducted or proposed to be conducted are not in violation of, nor is the Guarantor or its Subsidiaries in default under, any Legal Requirement presently in effect, except for such violations and defaults as do not and will not, in the aggregate, result, or create a material risk of resulting, in any Material Adverse Change. The Guarantor has received no notice of any such violation or default and has no knowledge of any basis on which the operations of the Guarantor or its Subsidiaries, as now conducted and as currently proposed to be conducted after the date hereof, would be held so as to violate or to give rise to any such violation or default. 7.7. Litigation. Except as disclosed in the Guarantor's most recent Form 10-K or set forth in Exhibit 7.7, no litigation, at law or in equity, or any formal proceeding before any court, board or other governmental or administrative agency or any arbitrator is pending or, to the knowledge of the Company, threatened which involves any material risk of any final judgment, order or liability which, after giving effect to any applicable insurance, has resulted, or creates a material risk of resulting, in any Material Adverse Change or which seeks to enjoin the consummation, or which questions the validity, of any of the transactions contemplated by this Agreement or any other Credit Document. No judgment, decree or order of any court, board or other governmental or administrative agency or any arbitrator has been issued against or binds the Guarantor or any of its Subsidiaries or any other Obligor which has resulted, or creates a material risk of resulting, in any Material Adverse Change. 7.8. Authorization and Enforceability. Each of the Company and each other Obligor has taken all corporate action required to execute, deliver and perform this Agreement -42- 52 and each other Credit Document to which it is party. No consent of stockholders of the Company or the Guarantor is necessary in order to authorize the execution, delivery or performance of any Credit Document to which the Company or the Guarantor is party. Each of this Agreement and each other Credit Document constitutes the legal, valid and binding obligation of each Obligor party thereto and is enforceable against such Obligor in accordance with its terms. 7.9. No Legal Obstacle to Agreements. Neither the execution and delivery of this Agreement or any other Credit Document, nor the making of any borrowings hereunder, nor the guaranteeing of the Credit Obligations, nor the securing of the Credit Obligations with the Credit Security, nor the consummation of any transaction referred to in or contemplated by this Agreement or any other Credit Document, nor the fulfillment of the terms hereof or thereof or of any other agreement, instrument, deed or lease contemplated by this Agreement or any other Credit Document, has constituted or resulted in or will constitute or result in: (a) any breach or termination of the provisions of any agreement, instrument, deed or lease to which the Company, any of its Subsidiaries or any other Obligor is a party or by which it is bound, or of the Charter or By-laws of the Company, any of its Subsidiaries or any other Obligor; (b) the violation of any law, statute, judgment, decree or governmental order, rule or regulation applicable to the Company, any of its Subsidiaries or any other Obligor; (c) the creation under any agreement, instrument, deed or lease of any Lien (other than Liens on the Credit Security which secure the Credit Obligations) upon any of the assets of the Company, any of its Subsidiaries or any other Obligor; or (d) any redemption, retirement or other repurchase obligation of the Company, any of its Subsidiaries or any other Obligor under any Charter, By-law, agreement, instrument, deed or lease. Except as provided in Exhibit 7.9, no approval, authorization or other action by, or declaration to or filing with, any governmental or administrative authority or any other Person is required to be obtained or made by the Company, any of its Subsidiaries or any other Obligor in connection with the execution, delivery and performance of this Agreement, the Notes or any other Credit Document, the transactions contemplated hereby or thereby, the making of any borrowing hereunder, the guaranteeing of the Credit Obligations or the securing of the Credit Obligations with the Credit Security (other than filings necessary to perfect the Agent's security interest in the Credit Security). 7.10. Defaults. Neither the Guarantor nor any of its Subsidiaries is in default under any provision of its Charter or By-laws or of this Agreement or any other Credit Document. -43- 53 Neither the Guarantor nor any of its Subsidiaries is in default under any provision of any agreement, instrument, deed or lease to which it is party or by which it or its property is bound in each case so as to result, or create a material risk of resulting, in any Material Adverse Change. Neither the Guarantor nor any of its Subsidiaries has violated any law, judgment, decree or governmental order, rule or regulation, in each case so as to result, or create a material risk of resulting, in any Material Adverse Change. 7.11. Tax Returns. Each of the Guarantor and its Subsidiaries has filed all material tax and information returns which are required to be filed by it and has paid, or made adequate provision for the payment of, all taxes which have or may become due pursuant to such returns or to any assessment received by it, other than taxes and assessments being contested by the Guarantor and its Subsidiaries in good faith by appropriate proceedings and for which adequate reserves have been taken in accordance with GAAP. Neither the Guarantor nor any of its Subsidiaries knows of any material additional assessments or any basis therefor. The Guarantor reasonably believes that the charges, accruals and reserves on the books of the Guarantor and its Subsidiaries in respect of taxes or other governmental charges are adequate. 7.12. Certain Business Representations. 7.12.1. Antitrust. Each of the Company and its Subsidiaries is in compliance in all material respects with all federal and state antitrust laws relating to its business and the geographic concentration of its business. 7.12.2. Consumer Protection. Neither the Company nor any of its Subsidiaries is in violation of any rule, regulation, order, or interpretation of any rule, regulation or order of the Federal Trade Commission (including truth-in-lending), with which the failure to comply, in the aggregate, has resulted, or creates a material risk of resulting, in a Material Adverse Change. 7.13. Pension Plans. Each Plan is in material compliance with the applicable provisions of ERISA and the Code. No Plan constitutes a "defined benefit plan" (as defined in ERISA). 7.14. Government Regulation; Margin Stock. 7.14.1. Government Regulation. Neither the Company nor any of its Subsidiaries, nor any Person controlling the Company or any of its Subsidiaries or under common control with the Company or any of its Subsidiaries, is subject to regulation under the Public Utility Holding Company Act of 1935, the Federal Power Act, the Investment Company Act, the Interstate Commerce Act or any statute or regulation which regulates the incurring by the Company or any of its Subsidiaries of Financing Debt as contemplated by this Agreement and the other Credit Documents. -44- 54 7.14.2. Margin Stock. Neither the Company nor any of its Subsidiaries owns any Margin Stock. 7.15. Disclosure. Neither this Agreement nor any other Credit Document to be furnished to the Lenders by or on behalf of the Guarantor or any of its Subsidiaries in connection with the transactions contemplated hereby or by such Credit Document contains any untrue statement of material fact or omits to state a material fact necessary in order to make the statements contained herein or therein not misleading in light of the circumstances under which they were made. 8. Defaults. 8.1. Events of Default. The following events are referred to as "Events of Default": 8.1.1. Payment. The Company shall fail to make any payment in respect of: (a) interest or any fee on or in respect of any of the Credit Obligations owed by it as the same shall become due and payable, and such failure shall continue for a period of three Banking Days, or (b) principal of any of the Credit Obligations owed by it as the same shall become due, whether at maturity or by acceleration or otherwise. 8.1.2. Specified Covenants. The Company or any of its Subsidiaries shall fail to perform or observe any of the provisions of Section 6.4.5 or Sections 6.5 through 6.14. 8.1.3. Other Covenants. The Company, any of its Subsidiaries or any other Obligor shall fail to perform or observe any other covenant, agreement or provision to be performed or observed by it under this Agreement or any other Credit Document, and such failure shall not be rectified or cured to the written satisfaction of the Required Lenders within 30 days after the earlier of (a) notice thereof by the Agent to the Company or (b) a Financial Officer shall have actual knowledge thereof. 8.1.4. Representations and Warranties. Any representation or warranty of or with respect to the Company, any of its Subsidiaries or any other Obligor made to the Lenders or the Agent in, pursuant to or in connection with this Agreement or any other Credit Document shall be materially false on the date as of which it was made. 8.1.5. Cross Default, etc. (a) The Company or any of its Subsidiaries shall fail to make any payment when due (after giving effect to any applicable grace periods) in respect of any Financing Debt (other than the Credit Obligations) outstanding in an aggregate amount of principal (whether or not due) and accrued interest exceeding $500,000; -45- 55 (b) the Company or any of its Subsidiaries shall fail to perform or observe the terms of any agreement or instrument relating to such Financing Debt, and such failure shall continue, without having been duly cured, waived or consented to, beyond the period of grace, if any, specified in such agreement or instrument, and such failure shall permit the acceleration of such Financing Debt; (c) all or any part of such Financing Debt of the Company or any of its Subsidiaries shall be accelerated or shall become due or payable prior to its stated maturity (except with respect to voluntary prepayments thereof) for any reason whatsoever; (d) any Lien on any property of the Company or any of its Subsidiaries securing any such Financing Debt shall be enforced by the obligee under such Financing Debt by foreclosure or similar action; or (e) any holder of any such Financing Debt shall exercise any right of rescission with respect to the issuance thereof or put or repurchase rights against any Obligor with respect to such Financing Debt (other than any such rights that may be satisfied with "payment in kind" notes or other similar securities). 8.1.6. Ownership; Liquidation; etc. Except as permitted by Section 6.11: (a) The Guarantor shall cease to own, beneficially and of record, at least two thirds of the voting stock and total equity capital of the Company or Preferred Equities Corporation; or (b) any Person, together with "affiliates" and "associates" of such Person within the meaning of Rule 12b-2 of the Exchange Act, or any "group" including such Person under sections 13(d) and 14(d) of the Exchange Act, shall acquire after the date hereof beneficial ownership within the meaning of Rule 13d-3 of the Exchange Act of 50% or more of either the voting stock or total equity capital of the Guarantor; or (c) the Company or the Guarantor shall initiate any action to dissolve, liquidate or otherwise terminate its existence. 8.1.7. Enforceability, etc. Any Credit Document shall cease for any reason (other than the scheduled termination thereof in accordance with its terms) to be enforceable in accordance with its terms or in full force and effect; or any party to any Credit Document shall so assert in a judicial or similar proceeding; or the security interests created by this Agreement or any other Credit Documents shall cease to be enforceable and of the same effect and priority purported to be created hereby. -46- 56 8.1.8. Judgments. A final judgment (a) which, with other outstanding final judgments against the Company and its Subsidiaries, exceeds an aggregate of $500,000 in excess of applicable insurance coverage shall be rendered against the Company or any of its Subsidiaries, or (b) which grants injunctive relief that results, or creates a material risk of resulting, in a Material Adverse Change and in either case if, (i) within 30 days after entry thereof, such judgment shall not have been discharged or execution thereof stayed pending appeal or (ii) within 30 days after the expiration of any such stay, such judgment shall not have been discharged. 8.1.9. FHA Insurance. The Company shall cease to have a contract of insurance issued by the Federal Housing Administration under the National Housing Act of 1934 with respect to loans eligible to be insured under Title I of such Act. 8.1.10. Bankruptcy, etc. The Company, any of its Subsidiaries or any other Obligor shall: (a) commence a voluntary case under the Bankruptcy Code or authorize, by appropriate proceedings of its board of directors or other governing body, the commencement of such a voluntary case; (b) (i) have filed against it a petition commencing an involuntary case under the Bankruptcy Code that shall not have been dismissed within 60 days after the date on which such petition is filed, or (ii) file an answer or other pleading within such 60-day period admitting or failing to deny the material allegations of such a petition or seeking, consenting to or acquiescing in the relief therein provided, or (iii) have entered against it an order for relief in any involuntary case commenced under the Bankruptcy Code; (c) seek relief as a debtor under any applicable law, other than the Bankruptcy Code, of any jurisdiction relating to the liquidation or reorganization of debtors or to the modification or alteration of the rights of creditors, or consent to or acquiesce in such relief; (d) have entered against it an order by a court of competent jurisdiction (i) finding it to be bankrupt or insolvent, (ii) ordering or approving its liquidation or reorganization as a debtor or any modification or alteration of the rights of its creditors or (iii) assuming custody of, or appointing a receiver or other custodian for, all or a substantial portion of its property; or (e) make an assignment for the benefit of, or enter into a composition with, its creditors, or appoint, or consent to the appointment of, or suffer to exist a receiver or other custodian for, all or a substantial portion of its property. 8.1.11. Change in Management. Any three of Jerome Cohen, Herbert -47- 57 Hirsch, Robert Nederlander and Don Mayerson shall fail to possess the power to direct or cause the direction of the management and policies of the Company, through stock ownership or otherwise. 8.2. Certain Actions Following an Event of Default. If any one or more Events of Default shall occur, then in each and every such case: 8.2.1. Terminate Obligation to Extend Credit. The Agent on behalf of the Lenders may (and upon written request of the Required Lenders the Agent shall) terminate the obligations of the Lenders to make any further extensions of credit under the Credit Documents by furnishing notice of such termination to the Company. 8.2.2. Specific Performance; Exercise of Rights. The Agent on behalf of the Lenders may (and upon written request of the Required Lenders the Agent shall) proceed to protect and enforce the Lenders' rights by suit in equity, action at law and/or other appropriate proceeding, either for specific performance of any covenant or condition contained in this Agreement or any other Credit Document or in any instrument or assignment delivered to the Lenders pursuant to this Agreement or any other Credit Document, or in aid of the exercise of any power granted in this Agreement or any other Credit Document or any such instrument or assignment. 8.2.3. Acceleration. The Agent on behalf of the Lenders may (and upon written request of the Required Lenders the Agent shall) by notice in writing to the Company declare all or any part of the unpaid balance of the Credit Obligations then outstanding to be immediately due and payable; provided, however, that if a Bankruptcy Default shall have occurred, the unpaid balance of the Credit Obligations shall automatically become immediately due and payable. 8.2.4. Enforcement of Payment; Credit Security; Setoff. The Agent on behalf of the Lenders may (and upon written request of the Required Lenders the Agent shall) proceed to enforce payment of the Credit Obligations in such manner as it may elect, and to realize upon any and all rights in the Credit Security. The Lenders may offset and apply toward the payment of the Credit Obligations (and/or toward the curing of any Event of Default) any Indebtedness from the Lenders to the respective Obligors, including any Indebtedness represented by deposits in any account maintained with the Lenders, regardless of the adequacy of any security for the Credit Obligations. The Lenders shall have no duty to determine the adequacy of any such security in connection with any such offset. 8.2.5. Cumulative Remedies. To the extent not prohibited by applicable law which cannot be waived, all of the Lenders' rights hereunder and under each other Credit Document shall be cumulative. -48- 58 8.3. Annulment of Defaults. Once an Event of Default has occurred, such Event of Default shall be deemed to exist and be continuing for all purposes of the Credit Documents until the Required Lenders or the Agent (with the consent of the Required Lenders) shall have waived such Event of Default in writing, stated in writing that the same has been cured to such Lenders' reasonable satisfaction or entered into an amendment to this Agreement which by its express terms cures such Event of Default, at which time such Event of Default shall no longer be deemed to exist or to have continued. No such action by the Lenders or the Agent shall extend to or affect any subsequent Event of Default or impair any rights of the Lenders upon the occurrence thereof. The making of any extension of credit during the existence of any Default or Event of Default shall not constitute a waiver thereof. 8.4. Waivers. To the extent that such waiver is not prohibited by the provisions of applicable law that cannot be waived, each of the Company and the other Obligors waives: (a) all presentments, demands for performance, notices of nonperformance (except to the extent required by this Agreement or any other Credit Document), protests, notices of protest and notices of dishonor; (b) any requirement of diligence or promptness on the part of any Lender in the enforcement of its rights under this Agreement, the Notes or any other Credit Document; (c) any and all notices of every kind and description which may be required to be given by any statute or rule of law; and (d) any defense (other than indefeasible payment in full) which it may now or hereafter have with respect to its liability under this Agreement, the Notes or any other Credit Document or with respect to the Credit Obligations. 9. Expenses; Indemnity. 9.1. Expenses. Whether or not the transactions contemplated hereby shall be consummated, the Company will pay: (a) all reasonable expenses of the Agent (including the out-of-pocket expenses related to forming the group of Lenders and reasonable fees and disbursements of the counsel to the Agent) in connection with the preparation and duplication of this Agreement and each other Credit Document, the transactions contemplated hereby and thereby and amendments, waivers, consents and other operations hereunder and thereunder; (b) all recording and filing fees and transfer and documentary stamp and similar taxes at any time payable in respect of this Agreement, any other Credit -49- 59 Document, any Credit Security or the incurrence of the Credit Obligations; and (c) all other reasonable expenses incurred by the Lenders or the holder of any Credit Obligation in connection with the enforcement of any rights hereunder or under any other Credit Document, including costs of collection and reasonable attorneys' fees (including a reasonable allowance for the hourly cost of attorneys employed by the Lenders on a salaried basis) and expenses. 9.2. General Indemnity. The Company shall indemnify the Lenders and the Agent and hold them harmless from any liability, loss or damage resulting from the violation by the Company of Section 2.3. In addition, the Company shall indemnify each Lender, the Agent, each of the Lenders' or the Agent's directors, officers and employees, and each Person, if any, who controls any Lender or the Agent (each Lender, the Agent and each of such directors, officers, employees and control Persons is referred to as an "Indemnified Party") and hold each of them harmless from and against any and all claims, damages, liabilities and reasonable expenses (including reasonable fees and disbursements of counsel with whom any Indemnified Party may consult in connection therewith and all reasonable expenses of litigation or preparation therefor) which any Indemnified Party may incur or which may be asserted against any Indemnified Party in connection with (a) the Indemnified Party's compliance with or contest of any subpoena or other process issued against it in any proceeding involving the Company or any of its Subsidiaries or their Affiliates, (b) any litigation or investigation involving the Company, any of its Subsidiaries or their Affiliates, or any officer, director or employee thereof, (c) the existence or exercise of any security rights with respect to the Credit Security in accordance with the Credit Documents, or (d) this Agreement, any other Credit Document or any transaction contemplated hereby or thereby; provided, however, that the foregoing indemnity shall not apply to litigation commenced by the Company against the Lenders or the Agent which seeks enforcement of any of the rights of the Company hereunder or under any other Credit Document and is determined adversely to the Lenders or the Agent in a final nonappealable judgment or to the extent such claims, damages, liabilities and expenses result from a Lender's or the Agent's gross negligence or willful misconduct. 10. Operations; Agent. In the event that Bank of Boston is no longer the sole Lender, the Company and Bank of Boston shall amend this Agreement to add Bank of Boston's standard and customary operations, agency and other multi-lender provisions. 11. Successors and Assigns; Lender Assignments and Participations. Any reference in this Agreement or any other Credit Document to any of the parties hereto shall be deemed to include the successors and assigns of such party, and all covenants and agreements by or on behalf of the Company, the other Obligors, the Agent or the Lenders that are contained in this Agreement or any other Credit Document shall bind and inure to the benefit of their respective successors and assigns; provided, however, that (a) the Company and its Subsidiaries may not assign their rights or obligations under this Agreement or any other Credit Document except for mergers or liquidations permitted by Section 6.11, and (b) the Lenders shall be not entitled -50- 60 to assign their respective Percentage Interests in the credits extended hereunder or their Commitments except in accordance with Section 11.1. 11.1. Assignments by Lenders. 11.1.1. Assignees and Assignment Procedures. Each Lender may (a) without the consent of the Agent or the Company if the proposed assignee is already a Lender hereunder or a Wholly Owned Subsidiary of the same corporate parent of which the assigning Lender is a Subsidiary, or (b) otherwise with the consents of the Agent and (so long as no Event of Default exists) the Company (which consents will not be unreasonably withheld), in compliance with applicable laws in connection with such assignment, assign to one or more commercial banks or other financial institutions (each, an "Assignee") all or a portion of its interests, rights and obligations under this Agreement and the other Credit Documents, including all or a portion of its Commitment, the portion of the Loan at the time owing to it and the Notes held by it; provided, however, that: (i) the aggregate amount of the Commitment of the assigning Lender subject to each such assignment to any Assignee other than another Lender (determined as of the date the Assignment and Acceptance with respect to such assignment is delivered to the Agent) shall be not less than $3,000,000 and in increments of $1,000,000; and (ii) the parties to each such assignment shall execute and deliver to the Agent an Assignment and Acceptance (the "Assignment and Acceptance") substantially in the form of Exhibit 11.1.1, together with the Note subject to such assignment and a processing and recordation fee of $3,000 payable to the Agent by the assigning Lender or the Assignee. Upon acceptance and recording pursuant to Section 11.1.4, from and after the effective date specified in each Assignment and Acceptance (which effective date shall be at least five Banking Days after the execution thereof unless waived by the Agent): (A) the Assignee shall be a party hereto and, to the extent provided in such Assignment and Acceptance, have the rights and obligations of a Lender under this Agreement and (B) the assigning Lender shall, to the extent provided in such assignment, be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Lender's rights and obligations under this Agreement, such Lender shall cease to be a party hereto but shall continue to be entitled to the benefits of Sections 3.2.4, 3.5 and 9, as -51- 61 well as to any fees accrued for its account hereunder and not yet paid). 11.1.2. Terms of Assignment and Acceptance. By executing and delivering an Assignment and Acceptance, the assigning Lender and Assignee shall be deemed to confirm to and agree with each other and the other parties hereto as follows: (a) other than the representation and warranty that it is the legal and beneficial owner of the interest being assigned thereby free and clear of any adverse claim, such assigning Lender makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with this Agreement or the execution, legality, validity, enforceability, genuineness, sufficiency or value of this Agreement, any other Credit Document or any other instrument or document furnished pursuant hereto; (b) such assigning Lender makes no representation or warranty and assumes no responsibility with respect to the financial condition of the Company and its Subsidiaries or the performance or observance by the Company or any of its Subsidiaries of any of its obligations under this Agreement, any other Credit Document or any other instrument or document furnished pursuant hereto; (c) such Assignee confirms that it has received a copy of this Agreement, together with copies of the most recent financial statements delivered pursuant to Section 7.2 or Section 6.4 and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Assignment and Acceptance; (d) such Assignee will independently and without reliance upon the Agent, such assigning Lender or any other Lender, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement; (e) such Assignee appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under this Agreement as are delegated to the Agent by the terms hereof, together with such powers as are reasonably incidental thereto; and (f) such Assignee agrees that it will perform in accordance with the terms of this Agreement all the obligations which are required to be performed by it as a Lender. 11.1.3. Register. The Agent shall maintain at the Boston Office a register (the "Register") for the recordation of (a) the names and addresses of the Lenders and the Assignees which assume rights and obligations pursuant to an assignment under -52- 62 Section 11.1.1, (b) the Percentage Interest of each such Lender as set forth in Exhibit 10.1 and (c) the amount of the Loan owing to each Lender from time to time. The entries in the Register shall be conclusive, in the absence of manifest error, and the Company, the Agent and the Lenders may treat each Person whose name is registered therein for all purposes as a party to this Agreement. The Register shall be available for inspection by the Company or any Lender at any reasonable time and from time to time upon reasonable prior notice. 11.1.4. Acceptance of Assignment and Assumption. Upon its receipt of a completed Assignment and Acceptance executed by an assigning Lender and an Assignee together with the Note subject to such assignment, and the processing and recordation fee referred to in Section 11.1.1, the Agent shall (a) accept such Assignment and Acceptance, (b) record the information contained therein in the Register and (c) give prompt notice thereof to the Company. Within five Banking Days after receipt of notice, the Company, at its own expense, shall execute and deliver to the Agent, in exchange for the surrendered Note, a new Note to the order of such Assignee in a principal amount equal to the applicable Commitment and Loan assumed by it pursuant to such Assignment and Acceptance and, if the assigning Lender has retained a Commitment and Loan, a new Note to the order of such assigning Lender in a principal amount equal to the applicable Commitment and Loan retained by it. Such new Note shall be in an aggregate principal amount equal to the aggregate principal amount of such surrendered Note, and shall be dated the date of the surrendered Note which it replaces. 11.1.5. Federal Reserve Bank. Notwithstanding the foregoing provisions of this Section 11, any Lender may at any time pledge or assign all or any portion of such Lender's rights under this Agreement and the other Credit Documents to a Federal Reserve Bank; provided, however, that no such pledge or assignment shall release such Lender from such Lender's obligations hereunder or under any other Credit Document. 11.1.6. Further Assurances. The Company and its Subsidiaries shall sign such documents and take such other actions from time to time reasonably requested by an Assignee to enable it to share in the benefits of the rights created by the Credit Documents. 11.2. Credit Participants. Each Lender may, without the consent of the Company or the Agent, in compliance with applicable laws in connection with such participation, sell to one or more commercial banks or other financial institutions (each a "Credit Participant") participations in all or a portion of its interests, rights and obligations under this Agreement and the other Credit Documents (including all or a portion of its Commitment, the Loan owing to it and the Note held by it); provided, however, that: (a) such Lender's obligations under this Agreement shall remain unchanged; -53- 63 (b) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations; (c) the Credit Participant shall be entitled to the benefit of the cost protection provisions contained in Sections 3.2.4, 3.5 and 9, but shall not be entitled to receive any greater payment thereunder than the selling Lender would have been entitled to receive with respect to the interest so sold if such interest had not been sold; and (d) the Company, the Agent and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under this Agreement, and such Lender shall retain the sole right as one of the Lenders to vote with respect to the enforcement of the obligations of the Company relating to the Loan and Letter of Credit Exposure and the approval of any amendment, modification or waiver of any provision of this Agreement (other than amendments, modifications, consents or waivers that reduce the amount of the Loan or the rate of interest thereon, extend the stated time of payment of the Loan, increase the Commitments or release a substantial portion of the Credit Security). Each Obligor agrees, to the fullest extent permitted by applicable law, that any Credit Participant and any Lender purchasing a participation from another Lender may exercise all rights of payment (including the right of set-off), with respect to its participation as fully as if such Credit Participant or such Lender were the direct creditor of the Obligors and a Lender hereunder in the amount of such participation. 12. Confidentiality. Each Lender will make no disclosure of confidential information furnished to it by the Company or any of its Subsidiaries unless such information shall have become public, except: (a) in connection with operations under or the enforcement of this Agreement or any other Credit Document to Persons who have a reasonable need to be furnished such confidential information and who agree to comply with the restrictions contained in this Section 12 with respect to such information; (b) pursuant to any statutory or regulatory requirement or any mandatory court order, subpoena or other legal process; (c) to any parent or corporate Affiliate of such Lender or to any Credit Participant, proposed Credit Participant or proposed Assignee; provided, however, that any such Person shall agree to comply with the restrictions set forth in this Section 12 with respect to such information; (d) to its independent counsel, auditors and other professional advisors with -54- 64 an instruction to such Person to keep such information confidential; and (e) with the prior written consent of the Company, to any other Person. 13. Notices. Except as otherwise specified in this Agreement or any other Credit Document, any notice required to be given pursuant to this Agreement or any other Credit Document shall be given in writing. Any notice, consent, approval, demand or other communication in connection with this Agreement or any other Credit Document shall be deemed to be given if given in writing (including telex, telecopy or similar teletransmission) addressed as provided below (or to the addressee at such other address as the addressee shall have specified by notice actually received by the addressor), and if either (a) actually delivered in fully legible form to such address (evidenced in the case of a telex by receipt of the correct answerback) or (b) in the case of a letter, unless actual receipt of the notice is required by any Credit Document, five days shall have elapsed after the same shall have been deposited in the United States mails, with first-class postage prepaid and registered or certified. If to the Company or any of its Subsidiaries, to it at its address set forth in Exhibit 7.1 (as supplemented pursuant to Section 6.4.1), to the attention of the President, with a copy to the Guarantor, to it at 1125 Northeast 125th Street, North Miami, Florida 33161, to the attention of Jerome J. Cohen. If to any Lender or the Agent, to it at its address set forth on the signature pages of this Agreement, with a copy to the Agent. 14. Course of Dealing; Amendments and Waivers. No course of dealing between any Lender or the Agent, on one hand, and the Company or any other Obligor, on the other hand, shall operate as a waiver of any of the Lenders' or the Agent's rights under this Agreement or any other Credit Document or with respect to the Credit Obligations. Each of the Company and the Guarantors acknowledges that if the Lenders or the Agent, without being required to do so by this Agreement or any other Credit Document, give any notice or information to, or obtain any consent from, the Company or any other Obligor, the Lenders and the Agent shall not by implication have amended, waived or modified any provision of this Agreement or any other Credit Document, or created any duty to give any such notice or information or to obtain any such consent on any future occasion. No delay or omission on the part of any Lender or the Agent in exercising any right under this Agreement or any other Credit Document or with respect to the Credit Obligations shall operate as a waiver of such right or any other right hereunder or thereunder. A waiver on any one occasion shall not be construed as a bar to or waiver of any right or remedy on any future occasion. No waiver, consent or amendment with respect to this Agreement or any other Credit Document shall be binding unless it is in writing and signed by the Agent or the Required Lenders. 15. No Strict Construction. The parties have participated jointly in the negotiation and drafting of this Agreement and the other Credit Documents with counsel sophisticated in -55- 65 financing transactions. In the event an ambiguity or question of intent or interpretation arises, this Agreement and the other Credit Documents shall be construed as if drafted jointly by the parties and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any provisions of this Agreement and the other Credit Documents. 16. Defeasance. When all Credit Obligations have been paid, performed and reasonably determined by the Lenders to have been indefeasibly discharged in full, and if at the time no Lender continues to be committed to extend any credit to the Company hereunder or under any other Credit Document, this Agreement and the other Credit Documents shall terminate and, at the Company's written request, accompanied by such certificates and other items as the Agent shall reasonably deem necessary, the Credit Security shall revert to the Obligors and the right, title and interest of the Lenders therein shall terminate. Thereupon, on the Obligor's demand and at their cost and expense, the Agent shall execute proper instruments, acknowledging satisfaction of and discharging this Agreement and the other Credit Documents, and shall redeliver to the Obligors any Credit Security then in its possession; provided, however, that Sections 3.2.4, 3.5, 9, 12, 17 and 18 shall survive the termination of this Agreement. 17. Venue; Service of Process. Each of the Company and the other Obligors: (a) Irrevocably submits to the nonexclusive jurisdiction of the state courts of The Commonwealth of Massachusetts and to the nonexclusive jurisdiction of the United States District Court for the District of Massachusetts for the purpose of any suit, action or other proceeding arising out of or based upon this Agreement or any other Credit Document or the subject matter hereof or thereof. (b) Waives to the extent not prohibited by applicable law that cannot be waived, and agrees not to assert, by way of motion, as a defense or otherwise, in any such proceeding brought in any of the above-named courts, any claim that it is not subject personally to the jurisdiction of such court, that its property is exempt or immune from attachment or execution, that such proceeding is brought in an inconvenient forum, that the venue of such proceeding is improper, or that this Agreement or any other Credit Document, or the subject matter hereof or thereof, may not be enforced in or by such court. Each of the Company and the other Obligors consents to service of process in any such proceeding in any manner at the time permitted by Chapter 223A of the General Laws of The Commonwealth of Massachusetts and agrees that service of process by registered or certified mail, return receipt requested, at its address specified in or pursuant to Section 14 is reasonably calculated to give actual notice. 18. WAIVER OF JURY TRIAL. TO THE EXTENT NOT PROHIBITED BY APPLICABLE LAW THAT CANNOT BE WAIVED, EACH OF THE COMPANY, THE OTHER OBLIGORS, THE AGENT AND THE LENDERS WAIVES, AND COVENANTS -56- 66 THAT IT WILL NOT ASSERT (WHETHER AS PLAINTIFF, DEFENDANT OR OTHERWISE), ANY RIGHT TO TRIAL BY JURY IN ANY FORUM IN RESPECT OF ANY ISSUE, CLAIM OR PROCEEDING ARISING OUT OF THIS AGREEMENT OR ANY OTHER CREDIT DOCUMENT OR THE SUBJECT MATTER HEREOF OR THEREOF OR ANY CREDIT OBLIGATION OR IN ANY WAY CONNECTED WITH THE DEALINGS OF THE LENDERS, THE AGENT, THE COMPANY OR ANY OTHER OBLIGOR IN CONNECTION WITH ANY OF THE ABOVE, IN EACH CASE WHETHER NOW EXISTING OR HEREAFTER ARISING AND WHETHER IN CONTRACT, TORT OR OTHERWISE. Each of the Company and the other Obligors acknowledges that it has been informed by the Agent that the provisions of this Section 18 constitute a material inducement upon which each of the Lenders has relied and will rely in entering into this Agreement and any other Credit Document, and that it has reviewed the provisions of this Section 18 with its counsel. Any Lender, the Agent, the Company or any other Obligor may file an original counterpart or a copy of this Section 18 with any court as written evidence of the consent of the Company, the other Obligors, the Agent and the Lenders to the waiver of their rights to trial by jury. 19. General. All covenants, agreements, representations and warranties made in this Agreement or any other Credit Document or in certificates delivered pursuant hereto or thereto shall be deemed to have been relied on by each Lender, notwithstanding any investigation made by any Lender on its behalf, and shall survive the execution and delivery to the Lenders hereof and thereof. The invalidity or unenforceability of any provision hereof shall not affect the validity or enforceability of any other provision hereof. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. This Agreement and the other Credit Documents (including any related fee agreements with the Agent or the Lenders) constitute the entire understanding of the parties with respect to the subject matter hereof and thereof and supersede all prior and contemporaneous understandings and agreements, whether written or oral. This Agreement may be executed in any number of counterparts which together shall constitute one instrument. This Agreement shall be governed by and construed in accordance with the laws (other than the conflict of laws rules) of The Commonwealth of Massachusetts. -57- 67 Each of the undersigned has caused this Agreement to be executed and delivered by its duly authorized officer as an agreement under seal as of the date first above written. MEGO MORTGAGE CORPORATION By /s/ ------------------------------------- Title: THE FIRST NATIONAL BANK OF BOSTON By /s/ ------------------------------------- Title: The First National Bank of Boston Diversified Finance Division 100 Federal Street Boston, Massachusetts 02110 Telecopy: (617) 434-4929 Telex: 940581 -58- EX-10.19 5 AMEND #1 TO WAREHOUSING CREDIT AGREEMENT 1 EXHIBIT 10.19 MEGO MORTGAGE CORPORATION WAREHOUSING CREDIT AND SECURITY AGREEMENT AMENDMENT NO. 1 This Agreement, dated as of August 9, 1996 (this "Agreement"), is between Mego Mortgage Corporation, a Delaware corporation, and The First National Bank of Boston. The parties agree as follows: 1. Credit Agreement; Definitions. This Agreement amends the Warehousing Credit and Security Agreement dated as of August 11, 1995 among the parties hereto (as in effect prior to giving effect to this Agreement, the "Credit Agreement"). Terms defined in the Credit Agreement as amended hereby (the "Amended Credit Agreement") and not otherwise defined herein are used with the meaning so defined. 2. Amendment of Credit Agreement. Effective upon the date all the conditions set forth in Section 4 hereof are satisfied (the "Amendment Date"), which conditions must be satisfied no later than August 13, 1996, the Credit Agreement is amended as follows: 2.1. Amendment of Section 1.1. The definitions of "Balance Sheet Date," "Termination Date," "Title I Loan" and "Title I Note" in Section 1.1 of the Credit Agreement are amended to read in their entirety as follows: Balance Sheet Date means August 31, 1995. Termination Date means the date which is the earliest to occur of (i) August 8, 1997, or (ii) the date on which the Bank accelerates the Obligations as the result of the occurrence of an Event of Default. Title I Loan means (i) an individual home improvement loan insured by the FHA pursuant to Title I, Section 2 of the National Housing Act, as amended and in effect from time to time, and (ii) an individual home improvement loan that is not insured by the FHA; provided, however, that the aggregate principal amount of all such uninsured individual home improvement loans that 2 constitute "Title I Loans" for purposes of the Loan Documents shall not exceed $5,555,555 at any one time outstanding. Title I Note means a note, bond or other evidence of indebtedness (which may be secured by a Mortgage) which constitutes a Title I Loan and which is in compliance with all Title I Regulations if it is (or is to be) insured by the FHA. Paragraphs (i)(d), (vi) and (xi) of the definition of Acceptable Loans Receivable are amended to read in its entirety as follows: (i)(d) If required by the Title I Regulations, a transfer of Note Report, completed in full except for the box requiring the FHA case number. * * * (vi) Such Title I Loan and Title I Collateral is in all respects as required by and in accordance with all applicable laws and regulations governing the same, including, without limitation, the Title I Regulations (if applicable) and the federal Consumer Credit Protection Act and the regulations promulgated thereunder and all applicable usury laws and restrictions. * * * (xi) The property covered by a Mortgage, if any, for such Title I Loan is free and clear of all liens except in favor of the Company (which has assigned any and all such liens to the Bank for the benefit of the Banks) and except as permitted by the Title I Regulations or, in the case of Title I Loans not subject to the Title I Regulations, liens that would be permitted by the Title I Regulations if such loans were in fact subject to the Title I Regulations. Paragraphs (b)(i) and (ii) of the definition of Availability are amended to read in their entirety as follows: (b) (i) the sum of (A) 95% of the then outstanding principal balance of each Acceptable Loan Receivable with respect to an FHA-insured Title I 3 Loan other than Undocumented Title I Collateral, and (B) 90% of the then outstanding principal balance of each Acceptable Loan Receivable with respect to Title I Loans that are not FHA-insured other than Undocumented Title I Collateral; plus (ii) the lesser of (A) the sum of (1) 95% of the then outstanding principal balance of each Acceptable Loan Receivable with respect to an FHA-insured Title I Loan plus (2) 90% of the then outstanding principal balance of each Acceptable Loan Receivable with respect to Title I Loans that are not FHA-insured and, in the case of Title I Loans described in the foregoing clauses (1) and (2), constituting Undocumented Title I Collateral as to which an Agreement to Pledge has been delivered to the Bank and which has not been included in the calculation of Availability for more than the Undocumented Period; or (B) $4,000,000.00; The definition of Tangible Net Worth is amended by adding at the end thereof the following provision: ", but not deducting excess servicing rights and mortgage servicing rights pursuant to clauses (a) and (b) above." The definition of Transfer of Note Report is amended to read in its entirety as follows: Transfer of Note Report means, with respect to each Title I Note subject to Title I Regulations, the Title I Transfer of Note Report as contained in the United States Department of Housing and Urban Development form number HUD-27030 (8-86) or any update or modification thereof. To the extent permissible under applicable H.U.D. rules and regulations, one Transfer of Note Report may be utilized for multiple Title I Notes. The following definition is added to Section 1.1: 1996 Credit Agreement means the Credit Agreement dated June 28, 1996, as from time to time in effect, between Mego -3- 4 Mortgage Corporation and The First National Bank of Boston, as Agent for itself and certain other lenders. 2.2. Amendment of Section 4.2. Section 4.2(a)(i) of the Credit Agreement is amended to read in its entirety as follows: (i) the sum of (A) ninety-five percent (95%) of the proceeds of any sale of Title I Collateral representing insured Title I Loans made pursuant to Section 4.1 above, plus (B) ninety percent (90%) of the proceeds of any sale of Title I Collateral representing uninsured Title I Loans made pursuant to Section 4.1 above, or 2.3. Amendment of Section 6.5. Section 6.5 of the Credit Agreement is amended by replacing the date "August 31, 1994" with the date "August 31, 1995." 2.4. Amendment of Section 6.16. Section 6.16 of the Credit Agreement is amended to read in its entirety as follows: 6.16. Representations Under Master Purchase Agreement. The Company remakes and reaffirms all of its representations set forth in the Master Purchase Agreement as if set forth at length herein, other than representations that (a) the Title I Loans are not subject to liens since the Company has granted liens to the Bank, (b) the Title I Loans are all subject to the Title I Regulations since Greenwich Capital has accepted non-FHA insured home improvement loans under the Master Purchase Agreement and (c) are not applicable to loans that are not subject to the Title I Regulations. 2.5. Amendment of Section 8.1. Section 8.1(a) of the Credit Agreement is amended to read in its entirety as follows: (a) Indebtedness to the Bank arising under any of the Loan Documents or Indebtedness arising under the 1996 Credit Agreement; 2.6. Amendment of Section 8.2. Clause (ii) of Section 8.2 of the Credit Agreement is amended to read in its entirety as follows: (ii) the encumbrances granted to the Bank hereunder and the encumbrances granted under the 1996 Credit Agreement; -4- 5 Clause (iv) of Section 8.2 of the Credit Agreement is amended by replacing the figure "$1,000,000.00" with "$2,000,000.00". 2.7. Amendment of Section 9. Section 9(a) of the Credit Agreement is amended to read in its entirety as follows: (a) The Company will not at any time permit its Tangible Net Worth to be less than the sum of (a) $12,500,000 plus (b) the amount by which Tangible Net Worth has been increased after August 31, 1995 as a result of capital contributions, the issuance of capital stock or partnership interests of the Company or any of its Subsidiaries, the issuance of warrants, options or other rights to acquire such capital stock or partnership interest plus (c) 50% of net income (determined in accordance with GAAP) (if positive) for the period beginning on May 1, 1996 and ending with the most recently completed month. 2.8. Amendment of Section 12.1. Section 12.1 of the Credit Agreement is amended so that: (a) the figure "$1,000,000.00" in paragraph (f) is replaced with "$500,000", (b) the figure "$250,000.00" in paragraph (h) is replaced with "$500,000"; (c) paragraph (j) reads in its entirety as follows: (j) Mego Financial Corp. shall cease to own legal and beneficial title to at least two-thirds of the outstanding capital stock of the Company; (d) paragraph (m) reads in its entirety as follows: (m) Mego Financial Corp. shall cease to own legal and beneficial title to at least two-thirds of the outstanding capital stock of Preferred Equities Corporation; 2.9. Amendment of Exhibit D. Exhibit D to the Credit Agreement is amended to read as set forth in Exhibit D hereto. -5- 6 3. Representations and Warranties. The Company represents and warrants as follows: 3.1. Legal Existence, Organization. The Company is duly organized and validly existing and in good standing under the laws of the jurisdiction of its organization, with all power and authority, corporate, partnership or otherwise, necessary (a) to enter into and perform this Agreement, the Amended Credit Agreement and the other Loan Documents to which it is party and (b) to own its properties and carry on the business now conducted or proposed to be conducted by it. The Company has taken all corporate or other action required to make the provisions of this Agreement and the Amended Credit Agreement the valid and enforceable obligations they purport to be. 3.2. Enforceability. The Company has duly authorized, executed and delivered this Agreement. Each of this Agreement and the Amended Credit Agreement is the legal, valid and binding obligation of the Company and is enforceable against it in accordance with its terms. 3.3. No Legal Obstacle to Agreements. Neither the execution, delivery or performance of this Agreement, nor the performance of the Amended Credit Agreement, nor the consummation of any other transaction referred to nor contemplated by this Agreement, nor the fulfillment of the terms hereof or thereof, has constituted or resulted in or will constitute or result in: (1) any breach or termination of the provisions of any agreement, instrument, deed or lease to which the Company is a party or by which it is bound, or of the charter documents or by-laws of the Company; (2) the violation of any law, judgment, decree or governmental order, rule or regulation applicable to the Company; (3) the creation under any agreement, instrument, deed or lease of any encumbrance (other than encumbrances on the Collateral which secure the Obligations) upon any of the assets of the Company; or (4) any redemption, retirement or other repurchase obligation of the Company under any charter document, by-law, agreement, instrument, deed or lease. No approval, authorization or other action by, or declaration to or filing -6- 7 with, any governmental or administrative authority or any other Person is required to be obtained or made by the Company in connection with the execution, delivery and performance of this Agreement or the performance of the Amended Credit Agreement, or the consummation of the transactions contemplated hereby or thereby. 3.4. Defaults. Immediately before and after giving effect to the amendments set forth in Section 2, no Default will exist. 3.5. Incorporation of Representations and Warranties. The representations and warranties set forth in Section 6 of the Amended Credit Agreement are true and correct on the date hereof as if originally made on and as of the date hereof. 4. Conditions. The effectiveness of this Agreement shall be subject to the satisfaction of the following conditions, which conditions must be satisfied prior to August 14, 1996 or this Agreement shall terminate: 4.1. Legal Opinion. On the Amendment Date, the Bank shall have received from Greenberg Traurig Hoffman Lipoff Rosen & Quentel, P.A., special counsel for the Company, their opinion with respect to the transactions contemplated by this Agreement, which opinion shall be in form and substance satisfactory to the Bank. The Company authorizes and directs its counsel to furnish the foregoing opinion. 4.2. Perfection of Security. The Company shall have duly authorized, executed, acknowledged, delivered, filed, registered and recorded such UCC financing statements, security agreements, notices, transfer powers and other instruments as the Bank may have requested in order to perfect the security interests and encumbrances purported or required pursuant to the Loan Documents to be created in the Collateral. 4.3. Officer's Certificate. The representations and warranties of the Company set forth or incorporated by reference herein shall be true and correct as of the Amendment Date as if originally made on and as of the Amendment Date; no Default shall have occurred on or prior to the Amendment Date or hereby; and the Bank shall have received a certificate to these effects signed by an officer of the Company in the event the Amendment Date occurs after the date hereof. 4.4. Proper Proceedings. This Agreement, each other Loan Document and the transactions contemplated hereby and thereby shall -7- 8 have been authorized by all necessary proceedings of the Company and any of its Affiliates party thereto. All necessary consents, approvals and authorizations of any governmental or administrative agency or any other Person with respect to any of the transactions contemplated hereby or by any other Loan Document shall have been obtained and shall be in full force and effect. The Bank shall have received copies of all documents, including certificates, records of corporate and partnership proceedings and opinions of counsel, which the Bank may have reasonably requested in connection therewith, such documents where appropriate to be certified by proper corporate, partnership or governmental authorities. 5. Further Assurances. The Company will, promptly upon the request of the Bank and from time to time, execute, acknowledge, deliver, file and record all such instruments and notices, and take all such other action, as the Bank deems necessary or advisable to carry out the intent and purposes of this Agreement. 6. General. The Amended Credit Agreement and all of the Loan Documents are each confirmed as being in full force and effect. This Agreement, the Amended Credit Agreement and the other Loan Documents referred to herein or therein constitute the entire understanding of the parties with respect to the subject matter hereof and thereof and supersede all prior and current understandings and agreements, whether written or oral. Each of this Agreement and the Amended Credit Agreement is a Loan Document and may be executed in any number of counterparts, which together shall constitute one instrument, and shall bind and inure to the benefit of the parties and their respective successors and assigns, including as such successors and assigns all holders of any Note. This Agreement shall be governed by and construed in accordance with the laws (other than the conflict of law rules) of The Commonwealth of Massachusetts. -8- 9 Each of the undersigned has caused this Agreement to be executed and delivered by its duly authorized officer as an agreement under seal as of the date first above written. MEGO MORTGAGE CORPORATION By /s/ ------------------------------------- Title: THE FIRST NATIONAL BANK OF BOSTON By /s/ ------------------------------------- Title: Each of the undersigned consents to the foregoing amendment and confirms that the Loan Documents to which it is party remain in full force and effect: MEGO FINANCIAL CORP. By /s/ ---------------------------------- Title: PREFERRED EQUITIES CORPORATION By /s/ ---------------------------------- Title: -9- 10 The undersigned consents to the foregoing amendment and confirms that (a) the Loan Documents to which it is party, including the Master Purchase Agreement and the related Collateral Assignment and Pricing Letters remain in full force and effect and (b) non-FHA insured home improvement loans pledged under the Credit Agreement are included in the Master Purchase Agreement and the related Collateral Assignment and Pricing Letters: GREENWICH CAPITAL FINANCIAL PRODUCTS, INC. By /s/ ------------------------------- Title: -10- EX-10.21 6 AMEND TO MASTER LOAN PURCHASE AGREEMENT 1 EXHIBIT 10.21 AMENDMENT AMENDMENT (this "Amendment") dated February 1, 1996 to Master Loan Purchase and Servicing Agreement between Greenwich Capital Financial Products, Inc. (the "Purchaser") and Mego Mortgage Corp. (the "Seller") dated as of April 1, 1995 (the "Master Agreement"). Unless the context otherwise clearly requires, capitalized terms used herein and not otherwise defined herein shall have the respective meanings assigned such terms in the Master Agreement. WHEREAS, the Purchaser has purchased Loans from the Seller under the Master Agreement and has executed a Pricing Letter (the "Pricing Letter") dated January 25, 1996 to purchase additional Loans; WHEREAS, the Seller is obligated to provide certain financial statements to the Purchaser pursuant to Section 18 of the Master Agreement; WHEREAS, the Seller expects to be able to provide such financial statements by February 29, 1996; and WHEREAS, to induce the Purchaser to purchase additional Loans under the Pricing Letter without such financial statements, the Seller has agreed to enter into this Amendment; NOW THEREFORE, the Purchaser and Seller hereby agree to amend the Master Agreement as herein provided. 1. The following clause is hereby added to Section 14.01 of the Master Agreement: "(ix) the Seller shall fail to deliver to the Purchaser by February 29, 1996 consolidated audited financial statements of Mego Financial Corp. for fiscal year 1995." 2. The following shall be added at the end of the penultimate paragraph of Section 14.01 of the Master Agreement: (Notwithstanding the foregoing, the Purchaser may in its discretion, in lieu of terminating the Seller's servicing rights hereunder as a result of an Event of Default described in Section 14.01 (ix), effect a Whole Loan Transfer or a Pass-Through Transfer (exclusive of the Seller's Excess Yield) of any or all of the Loans then held by the Purchaser pursuant to this Agreement on a servicing released basis 2 (the "Released Loans'7). Upon such disposition, the Seller shall have no servicing rights with respect to the Released Loans but shall continue to be obligated hereunder to service all other Loans other than the Released Loans The Seller shall cooperate and assist in the transfer of servicing of Released Loans to the same extent provided herein for the termination of all the Seller's servicing rights hereunder. No compensation shall be due the Seller in respect of any such transfer of the servicing fights of Released Loans." 3. In all other respects the Master Agreement and the Pricing Letter shall remain in 'till force and effect 4. The Seller hereby represents to the Purchaser as of the date hereof that: (a) The Seller believes in good faith that audited financial statements of Mego Financial Corp. will be released to the public by February 29, 1996; (b) Following the Purchaser's purchase of the additional Loans pursuant to the Pricing Letter, the Warehousing Credit and Security Agreement (the "Warehouse Agreement") between the Seller and The First National Bank of Boston will be in full force and effect and the warehouse line available to the Seller under the warehouse Agreement will be increased by 90% of the principal amount of Loans purchased by the Purchaser pursuant to the Pricing Letter which immediately prior to such purchase were pledged under the Warehouse Agreement; (c) The Seller has no present intention to file a petition in bankruptcy with respect to the Seller and no such action is presently contemplated. To the best of the Seller's knowledge, Mego Financial Corp. has no such intention with respect to itself or the Seller and no such action is presently contemplated by Mego Financial Corp.; and (d) The Seller has no reason to believe that a material adverse change will occur in the condition (financial or otherwise) of the Seller or Mego Financial Corp. between the date hereof and February 29, 1996. 3 IN WITNESS WHEREOF, the Purchaser and the Seller have caused this Amendment to be executed by their duly authorized representatives: GREENWICH CAPITAL FINANCIAL PRODUCTS, INC. By: Name: Jay N. Levine Title: Senior Vice President MEGO MORTGAGE CORPORATION By: Name: James L. Belter Title: Executive Vice President EX-10.22 7 AMEND #2 TO MASTER LOAN PURCHASE AGREEMENT 1 EXHIBIT 10.22 AMENDMENT NO.2 AMENDMENT No.2 (this "Amendment") dated as of JULY 1, 1996 to Master Loan Purchase and Servicing Agreement between Greenwich Capital Financial Products, Inc. (the "Purchaser") and Mego Mortgage Corporation (the "Seller") dated as of April 1, 1995 as amended by Amendment dated February 1, 1996 (the "Master Agreement"). Unless the context otherwise clearly requires, capitalized terms used herein and not otherwise defined herein shall have the respective meanings assigned such terms in the Master Agreement. WHEREAS, the Master Agreement provides for the purchase and sale of FHA insured Title I home improvement loans ("FHA Title I Loans"); and WHEREAS, the Initial Purchaser has purchased non-FHA insured home improvement loans ("Conventional Home Improvement Loans") from Seller pursuant to Pricing Letters executed pursuant to the Master Agreement; and WHEREAS, the Initial Purchaser and the Seller wish to formalize their agreement with respect to purchases of Conventional Home Improvement Loans under The Master Agreement; NOW THEREFORE, the Initial Purchaser and Seller hereby agree to amend the Master Agreement as herein provided. 1. The first recital is hereby deleted in its entirety and the following language is substituted: "WHEREAS, the Seller desires to sell, from time to time, to the Initial Purchaser, and the Initial Purchaser desires to purchase Loans, from time to time, from the Seller, exclusive of the Excess Yield, as described herein on a servicing-retained basis, and which shall be delivered in groups of whole loans on various dates as provided herein (each a "Closing Date");" 2. The following shall be substituted in lieu of the word "loan" in the first line of the definition of "Loan" in Section 1: "FHA Loan and each Conventional Loan" 3. The following definitions are hereby added to Section 1: "Conventional Loan: A home improvement loan which is not subject to an FHA Insurance Contract." "FHA Loan: A home improvement loan which is subject to an FHA Insurance Contract." 2 4. Section 1 is hereby amended by inserting the word "FHA" (a) before the word "Loans" in the definition of "FHA Insurance Contract", (b) before the word "Loan" in the definition of "FHA Insurance Proceeds" in and (c) before the word "Loans" in the definition of "FHA Insurance Reserves". 5. The following subsections of Section 7.02 are hereby amended and restated in their entirety as follows: (ii) With respect to each FHA Loan, The amount and The original term to maturity of the Loan comply with the FHA Regulations at the time of origination unless the requirements with respect to such FHA Loan are specifically waived by HUD with respect to such FHA Loan. (iii) Each Loan was originated and underwritten by the Seller in accordance with the underwriting criteria established by The Seller and, with respect to FHA Loans, the FHA and HUD; (iv) Each Loan (a)(i) is an FHA Title I property improvement loan (as defined in 24 CFR Section 201.2(aa)) underwritten by The Seller or an entity which at the time of origination, was a lender approved by the NM for participation in the programs under Tide I of the National Housing Act, in accordance with the 'MA requirements for the Tide I loan program as set forth in 24 CFR Parts 201 and 202, and is the subject of FHA Insurance, (ii) was originated and underwritten in accordance with applicable FHA requirements, and (iii) was made to provide financing for eligible home improvements for a Residential Dwelling or (b)(i) is a conventional home improvement loan underwritten by the Seller or an entity acceptable to the Initial Purchaser and (ii) was made to provide financing for home improvements for a Residential Dwelling. (xx) The origination, collection and servicing practices used by the Seller with respect to each Note and Mortgage have been in a respects legal, proper, prudent and customary in the mortgage origination and servicing industry and, with respect to each FHA Loan, have satisfied all FHA requirements. The Loan has been serviced by the Seller and any predecessor servicer in accordance with the terms of the Note; (xxx) Each FHA Loan was originated and has been serviced in a manner such that the FHA Loan will be eligible for the maximum amount of insurance made available by the FHA pursuant to Title I of The National Housing Act (subject to the aggregate limitation of the amount of FHA insurance available for The Seller), without any right of offset, counterclaim or any other defense by the FHA. The Seller has reported the origination of the FHA Loan to the FHA and has obtained or shall obtain a case number for the FHA Loan from the FHA; (xxxvi) With respect to each Loan originated by a dealer or contractor, the Seller is in possession of the completion certificate for the related improvement; (xxxvii) Seller has or will cause an amount of FHA Insurance Reserves with respect to FHA Loans equal to 10% of the outstanding principal balance of the FHA Loans as of the related Cut-off Date to be transferred or approved for transfer on or prior to the related Closing Date to the Purchaser's account maintained by the FHA; and (xxxviii) No FHA insurance premiums with respect to an FHA Loan are due and unpaid, and all such premiums for subsequent periods shall be timely paid. 3 6. In all other respects the Master Agreement shall remain in full force and effect, IN WITNESS WHEREOF, the Purchaser and the Seller have caused this Amendment to be executed by their duly authorized representatives as of the date first above written. GREENWICH CAPITAL FINANCIAL PRODUCTS, INC. By: Name: Jay N. Levine Title: Senior Vice President MEGO MORTGAGE CORPORATION By: Name: Robert V. Bellacosa Title: Vice President EX-10.24 8 EMPLOYMENT AGREEMENT-JEFFREY S. MOORE 1 EXHIBIT 10.24 EMPLOYMENT AND NON-COMPETITION AGREEMENT THIS AGREEMENT (the "Agreement") by and between MEGO MORTGAGE CORPORATION, a Delaware corporation (the "Company"), with its principal office located at 210 Interstate North Parkway, Suite 250, Atlanta, Ga 30339 and JEFFREY S. MOORE (the "Employee") shall become effective on the Effective Date, as hereinafter defined. BACKGROUND OF THE AGREEMENT A. The Company is about to commence the business of originating, purchasing and selling home improvement loans ("FHA Title I Loans") which are to be insured under the United States Department of Housing and Urban Development provisions of Title I, Section 2 of the National Housing Act, as amended. B. The Employee has previously been acting as an officer of the Company to assist it in its planning phase and to obtain the necessary approvals and licenses to commence operations; C. The Company desires to employ the Employee as its chief operating officer under terms that are mutually acceptable to the parties hereto; D. The Employee desires to be employed by the Company under the terms of this Agreement. AGREEMENT The Company and the Employee (individually, a "Party", and collectively, the "Parties"), in consideration of the promises and the mutual covenants herein set forth, agree as follows: 1. Employment. The Company hereby employs the Employee, and the Employee hereby accepts such employment, to serve as the chief operating officer of the Company on the terms and conditions provided in this Agreement. 2. Duties and Performance. The Employee shall serve as the chief operating officer of the Company, and shall perform such executive and administrative services as are generally expected of a chief operating officer, or as may be reasonably assigned to him from time to time by the board of directors of the Company (the "Board"). The Employee agrees to devote his full time, attention, energy and skill to the Company's 2 business and good will. 3. Term. This Agreement shall commence on the 1st day of January, 1994 (the "Effective Date"), and terminate on December, 1998, unless sooner terminated as provided in this Agreement. 4. Compensation. (a) The Company shall pay to the Employee, as compensation for his services, a salary of $200,000 for each year of this Agreement (the "Base Compensation"). The Base Compensation shall be payable in equal installments, the frequency of which shall be determined by the Company, but in no event less frequently than monthly. The Company shall withhold and pay over to the appropriate governmental agency all payroll taxes (including income, social security and unemployment compensation taxes) required by the federal, state and local governments with jurisdiction over the Company. (b) In addition to the Base Compensation, and subject to the limitation contained in Paragraph 4 (d) below, on the first business day of each March commencing with March, 1995, the Company shall pay to the Employee an amount (the "Incentive Bonus") equal to one and one-half percent (1.50%) of the Company's after tax income for the prior calendar year computed and based on the financial statements of the Company for such calendar year prepared in accordance with generally accepted accounting principles consistently applied; provided that this Agreement was in force for the entire prior calendar year and the Employee had performed the services to the Company required by this Agreement during the entire prior calendar year; and further provided that the Employee shall not be entitled to receive any Incentive Bonus for any calendar year in which the Company did not attain pre-tax earnings, as determined by the financial statements of the Company for such year prepared as set forth above, of at least the amount set forth for such year in Schedule "A" attached hereto and made a part hereof. It is understood and agreed that generally accepted accounting principles for the Company's financial statements require, in calculating net after tax income, a tax provision based on the statutory Federal tax rate for corporations as well as provision for all applicable state income taxes. If this Agreement had been terminated during the prior calendar year other than for "cause", as hereinafter defined, or if the Employee failed for 3 any reason to perform the services required hereunder for a portion of such calendar year, then such amount of Incentive Bonus calculated and due under this paragraph shall be prorated and paid only for that fraction of the calendar year during which this Agreement was in force or during which the Employee performed the services required by this Agreement. If this Agreement had been terminated for "cause" during the prior calendar year, no Incentive Bonus for that year shall be paid to the Employee, as more particularly set forth in Paragraph 5 (b) of this Agreement. (c) In addition to the Base Compensation and the Incentive Bonus, and subject to the limitation contained in Paragraph 4 (d) below, the Employee shall receive for each calendar year during the term of this Agreement, an amount ("the Deferred Compensation") equal to one percent (1.00%) of the amount of "Gain on Sale", for sales of Title I Loans and other receivables, as shown on the Company's financial statements prepared as set forth above in this Section 4, provided that this Agreement was in force for the entire prior calendar year and the Employee had performed the services to the Company required by this Agreement during the entire prior calendar year; and further provided that the Employee shall not be entitled to receive any Deferred Compensation for any calendar year that the Company has not attained pre-tax earnings of at least the amount set forth for such year in Schedule "A" attached hereto and made a part hereof. If this Agreement had been terminated during the prior calendar year other than for "cause", as hereinafter defined, or if the Employee failed for any reason to perform the services required hereunder for a portion of such calendar year, then such amount of Deferred Compensation calculated and due under this paragraph shall be prorated and paid only for that fraction of the calendar year during which this Agreement was in force or during which the Employee performed the services required by this Agreement. If this Agreement had been terminated for "cause" during the prior calendar year, no Deferred Compensation for that year shall be paid to the Employee as more particularly set forth in Paragraph 5 (b) of this Agreement. The Deferred Compensation due for any calendar year shall be payable in 48 equal install ment payments commencing on March 1 of the following year. Installment payments of Deferred Compensation due hereunder shall continue after the termination of this 4 Agreement unless such termination shall be for "cause" as defined in this agreement (d) Notwithstanding anything herein to the contrary, in the event the aggregate amount of Incentive Bonus and Deferred Compensation to be paid to Employee in any calendar year exceeds the sum of $500,000, any excess over $500,000 shall be payable to Employee only if approved by the Board of Directors of the Company, whose decision to pay such amount or not shall be in the Board's sole judgment and discretion. (e) In addition to the compensation described in Paragraphs 4 (a), (b) and (c) above, the Company has caused the Company's parent, Mego Financial Corp. ("Mego") to grant to the Employee an option under Mego's Key Employee Stock Option Plan (the "Plan") for the purchase of 25,000 shares of Mego's Common Stock at an option price of $2.50 per share. The Employee acknowledges that he has been provided with and is familiar with the Plan. (f) So long as Employee is performing his duties hereunder, Employee shall receive a monthly automobile allowance at least equivalent to similar allowances to senior executives of other Mego subsidiaries, but in no event less than $500 per month. (g) The Company will reimburse the Employee for moving expenses reasonably incurred by Employee in moving Employee and his family from Oklahoma City, Oklahoma to Atlanta Georgia, including real estate broker commissions in connection with the sale of Employee's Oklahoma City residence, the closing costs incurred in the sale of Employee's Oklahoma City residence and the closing costs and mortgage closing costs and points incurred in the purchase of his Atlanta residence, and an amount adequate to compensate Employee for the income tax liability, if any, attributable to the receipt of the moving expenses and other items set forth in this sub-paragraph for which Employee was or will be unable to obtain an income tax deduction or receive a tax benefit; PROVIDED HOWEVER that in no event shall the aggregate amount payable under this subparagraph for moving expenses and other items, including but not limited to the compensation for income taxes, exceed the sum of $28,000. (h) To assist Employee in the purchase of a home in Atlanta, and provided such monies are utilized to purchase 5 and/or furnish such residence, at the request of Employee, the Company will lend Employee an amount not to exceed the lesser of $32,000 or 10% of the purchase price of the residence, for a period not to exceed five years, which amount shall bear interest at the rate of 8% per annum. Such loan shall be secured by a second mortgage lien on Employee's Atlanta residence, and at the Company's option by a lien on and offset against any monies due from Company to Employee other than his Base Compensation, except that upon termination of this agreement any balance due on such loan can be offset against Base Compensation, as well as any Incentive Bonus, Deferred Compensation or other monies due to Employee. The loan shall be repaid in equal monthly installments based on a 15 year amortization with a balloon payment due at the end of five years, upon sale of the Employee's residence or upon termination of this agreement, whichever occurs first. (i) The Employee shall be entitled to three weeks of vacation time each year. (j) The Employee shall be entitled to such health, dental, medical, disability, life and other insurance as is provided to other executives the Company. (k) In addition to the foregoing, the Employee will be entitled to incur reasonable expenses for promoting the business of the Company. The Company shall reimburse the Employee for all such reasonable business expenses, including cost of travel, meals and lodging while traveling and entertainment. In addition, if the Company has not made Employee a participant in a corporate country club membership, the Company will reimburse Employee for the cost of a membership in a suitable country club, approved by the Company, with an initiation fee not to exceed $10,000 and dues not to exceed $10,000 per year, to be utilized for the obtaining of business and entertaining business connections. 5. Termination of Employment. 6 (a) The Company may immediately terminate the Em ployee's employment for "cause" upon giving written notice of such involuntary termination to the Employee. "Cause" shall mean any one of the following acts of, or omissions by, or actions of others relating to, the Employee, or the occurrence of the event described in subparagraph (vii) below: (i) Conviction of a felony, whether or not such conviction is appealed. (ii) Deliberate and premeditated acts against the best interests of the Company; (iii) Material breach of the terms of this Agreement; (iv) The Employee is found guilty of or is en joined from violation of any state or federal securities laws, state or federal laws governing the business of the Company, or rules and regulations of any state or federal agency regulating any of the business of the Company; (v) Misappropriation of the Company's funds or property; (vi) Habitual use of alcohol or drugs to a degree that such use substantially interferes with Employee's performance of his duties. (vii) The Company has failed to attain at least the amount of pre-tax earnings set forth in Exhibit "A" for the second, third and fourth calendar years following the Effective Date. (b) In the event the Employee's employment shall be terminated for "cause" prior to the expiration of the term of this agreement, the Employee shall be entitled only to his Base Compensation prorated to the effective date of such termination, less any unrepaid amounts borrowed from the Company, and shall not be entitled to any accrued but unpaid Incentive Bonus, Deferred Compensation or vacation time, except that Employee shall be entitled to receive accrued but unpaid Deferred Compensation for years prior to the year of termination if Employee is terminated for the "cause" set forth in Paragraph 5 (a) (vii) above. (c) This Agreement shall terminate immediately upon the Employee's death or total and permanent disability. For the purposes of this Agreement, total and permanent disability shall mean the Employee's inability to adequately perform his duties on behalf of the Company, as reasonably determined by the Board, for a period of ninety (90) consecutive days due to an illness or injury. In the event of such termination, the Employee shall be entitled to his Base Compensation prorated 7 to the end of the month of his death or the date of the determination of Employee's total and permanent disability by the Board, and any Incentive Bonus, Deferred Compensation and vacation time for the then current year shall be prorated to the date of such termination, and paid at such times as are otherwise provided herein. 6. Covenant Not to Compete. The following provisions shall hereinafter be referred to as the "Covenant Not to Compete"): (a) The Employee agrees that during the term of this Agreement and any renewal thereof, and for a period of six months after the expiration or termination of this Agreement with or without cause, the Employee will not (except as an employee of, and on behalf of, the Company), in any capacity, directly or indirectly: (i) engage in a business involving activities similar to that of the Company with respect to the purchase, origination or sale of FHA Title I Loans within the continental United States. (ii) take any action, directly or indirectly to invest in (other than a non-controlling ownership of securities issued by publicly held corporations), own, manage, operate, control, participate in, be employed or engaged by or be connected in any manner with any partnership, corporation or other business or entity engaging in a business involving activities similar to that of the Company with respect to the purchase, origination or sale of FHA Title I Loans within the continental United States. (iii) solicit or encourage other employees or officers of the Company to terminate their employment by the Company for any purpose whatsoever. (b) The Employee acknowledges and agrees that: (i) the foregoing restrictions as to time and area are reasonable for the protection of the goodwill and business of the Company against irreparable injury. 8 (ii) the foregoing restrictions do not place an undue hardship on the Employee. (c) The Employee agrees that the Company will be irreparably damaged by a breach of this Covenant Not to Compete and that damages at law will be an insufficient remedy for the Company. The Employee also agrees that the Company shall be entitled, upon application to a court of competent jurisdiction, to obtain injunctive relief to enforce the provisions of this Covenant Not to Compete, which injunctive relief shall be in addition to any other rights or remedies available to the Company. 7. Confidentiality. The Employee recognizes and acknowledges that the services which he will perform for the Company and the knowledge which he will obtain of the Company's proprietary information such as trade secrets, processes, business practices, strategic plans and financial data through his close relationship with the Company, are confidential, proprietary and valuable in nature. The Employee therefore agrees that, other than in the regular and proper course of the business of the Company, he will not divulge to others or use for his own benefit, or the benefit of any person, firm, corporation or other entity, other than the Company, at any time during or subsequent to this employment, any information obtained in the course of his employment, concerning such proprietary information without first obtaining the Company's written permission, unless such information has become public knowledge by a means other than a breach of the provisions of this Agreement. 8. Modification. No change or modification of this Agreement shall be valid unless made in writing and signed by both of the parties hereto. 9. Applicable Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware. 10. Assignment Prohibited. This Agreement is personal to the parties hereto and neither party may assign or transfer any rights or obligations under this Agreement without the written consent of the other party. 9 11. Entire Agreement. This Agreement incorporates the entire agreement between the parties and supersedes all other prior or contemporaneous agreements, negotiations or discussions between the Employee and the Company. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the 1st day of January, 1994. CORPORATION: MEGO MORTGAGE CORPORATION BY: ----------------------------- Title: EMPLOYEE: ----------------------------- Jeffrey S. Moore 10 EXHIBIT "A" YEAR 1: $1,200,000 YEAR 2: $4,225,000 YEAR 3: $6,150,000 YEAR 4: $9,000,000 YEAR 5: $12,000,000 EX-23.2 9 CONSENT OF DELOITTE & TOUCHE LLP 1 EXHIBIT 23.2 INDEPENDENT AUDITORS' CONSENT We consent to the use in this Registration Statement of Mego Mortgage Corporation on Form S-1 of our report dated February 29, 1996 (October , 1996 as to the last paragraph of Note 2), appearing in the Prospectus, which is part of this Registration Statement, and to the references to us under the headings "Selected Financial Data" and "Experts" in such Prospectus. Las Vegas, Nevada October , 1996 The financial statements of Mego Mortgage Corporation referred to in this consent retroactively reflect the effect of a sixteen-hundred-for-one stock split of common stock which is to be effected before the effective date of this Registration Statement. The above consent is in the form which will be signed by Deloitte & Touche LLP upon consummation of such stock split, which is described in Note 2 of Notes to Financial Statements, and assuming that, from February 29, 1996 to the date of such stock split, no other events shall have occurred that would affect the financial statements and notes thereto. DELOITTE & TOUCHE LLP Las Vegas, Nevada October 1, 1996 -----END PRIVACY-ENHANCED MESSAGE-----